Evaluating CPEC

Updated May 01, 2015


The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.
The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

THE formal launch of the China-Pakistan Economic Corridor (CPEC) during the recent visit of President Xi Jinping has understandably generated a lot of euphoria in Pakistan. With a planned portfolio of projects totalling around $45 billion, the size of the ‘investment’ in the CPEC over the next 15 years, if materialised, will equal the cumulative gross foreign direct investment inflows into Pakistan since 1970.

Viewing CPEC solely from the prism of the quantum of envisaged investment it will bring, as the government is doing, is wrong and misleading, however. There are a number of facets of this mega-project that merit a closer examination to be able to determine if it will ultimately generate economic benefits for Pakistan, as opposed to perceived strategic pay-offs for the two allies. In fact, a proper economic evaluation will need to arrive at the following conclusion: do the benefits outweigh the costs?

To arrive at an answer, the most fundamental aspect that needs to be studied is whether the proposed China-Pakistan Economic Corridor will truly be an ‘economic’ corridor, or will it be a string of strategically important roads and a bunch of power projects. An economic corridor [sic] “connects hubs or nodes of economic activity along a defined geography” (Asian Development Bank).

Hence, an empty road through a barren landscape connecting strategically important point A with strategically important point B 3,000 kilometres away does not fit the description. To be truly an economic corridor, the envisaged roads will need to connect demand (markets) with supply (production centres and clusters). The markets as well as production centres can be pre-existing ones, or new ones that will spring up as the ‘network effects’ of the economic corridor take root. An example of the latter could be new Special Economic Zones (SEZs) set up in different parts of the country to catalyse economic activity and exports.

An important consideration in planning the economic corridor should be the effect on Pakistan’s exports.

The new markets and production clusters may fall within the domestic geography, as in opening up previously economically unconnected regions of Pakistan; or these may be external, as in providing Pakistani businesses access to Chinese markets, and vice versa. Another beneficial aspect that could develop over a period of time is for a regional value chain to develop between China and Pakistan, whereby different components and parts of a product are manufactured in each country before being given final shape and exported to regional markets via the closest shipping point — Gwadar in this case.

Needless to say, if the CPEC can eventually be a major backbone or ‘highway’ for wider regional connectivity between South, West and Central Asia, its potential economic benefits will be that much larger.

An important consideration in planning and executing the CPEC should be the effect on Pakistan’s exports. If the CPEC fails to give a quantum boost to the country’s exports, it will have failed to achieve a major aim. While externalities will come into play as the dynamic unleashed by a properly developed and functioning economic corridor takes hold, engendering new businesses and economic activities of which many will be in the export sector, the CPEC will generate two-way trade. Hence, Pakistan’s imports will rise as well. While some part of the increase in imports will be trade diversion, in effect a shifting of imports from one source country to another with a neutral effect on the balance of payments, a net rise in the import bill should be expected as land connectivity with China improves (especially under the operation of a Free Trade Agreement).

A net increase in the import bill will only be a small part of the problem. Most of the envisioned projects will incur liabilities in foreign exchange (for capital and fuel imports, debt servicing, profit repatriation and wages), while their earnings will be in rupees; the currency mismatch, unless offset by a strong jump in exports, could prove to be a large drag on the country’s balance of payments position.

The potential pressure on the external account can be mitigated, however, through some smart negotiations. Contracts signed with Chinese companies under the CPEC should emphasise the maximum possible use of local labour and maximum possible local procurement. This will generate larger employment opportunities for locals and greater economic activity for domestic businesses. Another stratagem could be the negotiation of a follow-on, and larger, currency swap arrangement whereby Pakistan gets to pay in rupees rather than in US dollars or renminbi.

Unfortunately, ‘smart negotiations’ do not appear to be a forte of the government — nor a primary interest. As demonstrated by the LNG import project, other considerations combined with a lack of basic capacity hobble the ability of the government to get the best deal for the country. The government’s capacity to plan, coordinate and execute projects is at a seriously low ebb, and the lack of institutional reform is showing up in our inability to implement initiatives.

With new SEZs a central part of the economic corridor, it is useful to consider how many Pakistan has been able to set up since 2007 — virtually none under a proper SEZ framework. (Several years after its launch, the so-called ‘Garment City’, the Punjab government’s flagship industrial project, is nowhere on the ground.)

Beyond governmental capacity, another daunting challenge projects under the CPEC will face is availability of local financing. Even if external financing is fully arranged, the CPEC portfolio will have a substantial local financing component. With the government unable to credibly broaden the tax base, its ability to provide funds for development spending is seriously constrained. In addition, the failure to reform public finances also means that the government borrows most of the available credit from the banking system — leaving little or no room for financing of private infrastructure projects.

If, despite the odds, the CPEC can be structured and operationalised as a truly networked economic corridor, its benefits for Pakistan will no doubt be enormous. If, however, it ends up primarily as a bilateral strategic project, the economic costs could be substantial.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, May 1st, 2015

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