Courting China with care

Published April 23, 2015
The writer is a member of staff.
The writer is a member of staff.

Let's clear up some misconceptions that have been doing the rounds since President Xi Jinping visited Islamabad and dangled a $46 billion carrot before us.

The money being offered is project financing, not aid and not concessionary loans. To get a good idea of what that means, take a look at one project that was approved and documents for which were signed during this visit: the Karot hydropower project.

Read: Economic corridor in focus as Pakistan, China sign 51 MoUs

Karot is a run-of-the-river hydropower project with a total generation capacity of 720MW. It is located on the river Jhelum, just south of Rawalpindi. The project was initiated in 2006, when a consortium of Associated Technologies (Pvt) Ltd and China Three Gorges International Corporation, which was the main sponsor of the project, applied for a Letter of Interest (LoI) from the Private Power Infrastructure Board (PPIB).

China has developed the template for fusing assistance and investment together into a single offering.

The LoI was granted in early 2007, and by 2009 a technical and financial feasibility study of the project had been completed by the project sponsors and approved by PPIB. Two years later, in 2011, the consortium applied for a generation tariff from Nepra, in which they detailed all the project’s technical and financial parameters.

The project was supposed to be financed according to a deb-to-equity ratio of 80:20. Equity was going to amount to $284.87 million and the debt component of the project was $1139.5m at the time.

All debt financed by Chinese banks is subject to Sinosure fee, which is China’s official export credit insurance agency, and all projects executed using Chinese funds require that they be insured using this agency. Its charges in this project were 1.2pc per annum for both debt and equity investments throughout the project life. Additionally, interest during construction was calculated at six-month Libor plus 4.75pc.

The project sponsors asked for an internal rate of return of 20pc, which at the time was higher than what was being given to thermal power plants. The equity had a gestation period of four years, and an investment horizon of 50 years.

As an aside, it should be mentioned that Return on Equity for another coal-based power plant coming up in Sahiwal that has just had its upfront tariff for two 660MW plants approved on March 31, 2015, is 27.2pc, and interest during construction is on the same terms as the Karot project: Libor plus 4.5pc.

Compare that to the country’s largest commercial bank, which had one of its most profitable years in 2014, and announced a return on equity of 20pc.

The levelized tariff the sponsors of Karot were seeking in 2011 was 7.5 cents per kilowatt hour for the project life of 50 years. There is no information on what levelized tariff the project has been finalised on today.

“The Pakistan government promised a sound return after recovering construction and operation costs,” says a statement by the Silk Road Fund, which is injecting the capital into a subsidiary of China Three Gorges Corp. There is no indication on what the return is.

My point in raking up this information is not to suggest that the terms being offered are exorbitant. In fact, they sound somewhat reasonable considering what IPPs currently in the system get, and the kinds of return on equity the sponsors were asking for then and now are high by global standards, but not unusual in Pakistan.

My point is simply to underline that these are not aid, nor concessionary funding lines. They are commercial ventures, project financing, on commercial terms.

The concessionary nature of the proposed investments comes in when you consider the fact that hardly anybody else is willing to invest in Pakistan. The World Bank has tired of funding large infrastructure projects, and most bilateral assistance from donor countries now prefers to go into small programmes with high visibility. Foreign direct investment into large infrastructure projects in Pakistan is not feasible since no private investor is ready to acquire large stakes in this country, given its realities.

So we have a bilateral commitment from China instead, which is part governmental in that the Silk Road Fund and the China Three Gorges South Asia Investment, a subsidiary of the China Three Gorges Corporation, is being directed by the government to make the investment. The fund and the company in question will comply with the directive of their government. But they will also seek a return on their investment in line with commercial considerations. If they cannot get that return, the project will not materialise.

This is an interesting model to fuse assistance and investment together into a single offering. The Chinese have developed the template through which to do this, and are applying it around the world.

A lesson from our experiences with the IPPs is worth bearing in mind as we move forward with this investment plan.

When the private power policy was announced, and all the investment in private power generation poured forth under it, the government of the time presented the whole enterprise as a big victory. Hubco was hailed as the “deal of the year” by Euromoney magazine, and the government bragged that Pakistan had a surplus in generation capacity.

That was true at the time, but then the reality hit home when the bills from these IPPs came in, and the new government of Nawaz Sharif discovered that the tariff’s had capacity charges, meaning you had to pay them even if you did not want to buy any of the power they were producing. And most of us remember how that worked out, how the private power policy went from being the panacea to all our problems, to being public enemy number one within a matter of weeks.

Let’s not be foolish about it this time. Let’s understand that we are being offered a historic opportunity, but let’s also tally up the costs and benefits clearly upfront, and keep our commitment to procedures and transparency as we move forward to take advantage of this opportunity.

The writer is a member of staff.

Twitter: @khurramhusain

Published in Dawn, April 23rd, 2015

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