IN remarks given at a conference in Islamabad, Sartaj Aziz is reported to have said that loans being taken under CPEC projects will be repaid at two per cent interest spread over 20 to 25 years. He is about one-quarter right.
What Aziz is not telling us, unless his comments were not reported in full, is that more than two-thirds of the money committed for the ‘early harvest’ projects is actually on commercial terms. Of the total $28 billion that come under the ‘early harvest’ projects, a full $19bn are in the form of foreign direct investment on commercial terms and even the agreement signed in November 2013 between the governments of China and Pakistan that created this raft of investments mentions that these will follow “market principles”.
In those project documents that are publicly available, the debt service terms are 7pc to 8pc with many of them pegged to six-month Libor and include Sinosure, which is the fee for reinsurance of all loans that Chinese banks require all foreign borrowers to have.
Then there is the equity portion. Most of the projects coming in as direct investment have a debt-to-equity ratio of around 80:20, or in some cases 75:25. And in most cases, return on equity (ROE) is guaranteed at either 17pc or 20pc.
So let’s do a little math here. If $19bn are coming in as investment on commercial terms, and 80pc of that is debt with the remaining as equity, what is the size of the outflow as debt service and return on equity that we can discern?
My math tells me that the debt service outflows will be about $1bn and the return on equity will be $646 million if it is kept at 17pc. Add to that $1.9bn as repayment of principal. That means an annual net outflow of $3.546bn per year once commercial operations begin.
To properly afford the CPEC projects, the country will need to lift its exports, boost its productivity, and give a large spur to private enterprise.
Somebody please tell me what I’m doing wrong here. You can tweak the numbers a bit, say debt service will be 6pc and not 7pc as I’ve assumed. ROEs are unlikely to be lower than 17pc. In one case at least, that of Karot Hydropower, Nepra had granted 17pc ROE to the sponsors but they have submitted a review petition asking for this to be raised to 20pc “so as to encourage the investor to invest in the hydropower sector”.
So how much is $3.546bn? Compare it with last fiscal year’s figures, when interest payments on external debt were $2.1bn, and income (for foreigners) from investments in Pakistan was $3.2bn. Pakistan’s total interest outflows (on government borrowing alone) were $1.1bn in fiscal year 2016.
In the case of CPEC investments, it is difficult to see how these will be booked, since technically they will not be on government account: each project will earn its own money and service its own obligations, whether to its creditors or its sponsors, from its own cash flow. Therefore these outflows (and I’ve only calculated the interest on them, the repayment of principal is on top) will not be booked as external debt service obligations of the state since they are not public debt (even though they are publicly guaranteed), and only the repatriated profits will be booked as income from investments.
It is difficult to compare government debt figures with CPEC-related investment though, because they are both booked differently since the former is a direct loan whereas the latter is an investment against a loan. But they both place a burden on foreign exchange reserves, which will need to increase correspondingly if we are to extract the proper benefit from CPEC projects and not be left with a herd of white elephants whose costs weigh the macro economy down more than their output lifts it up.
How many of us are reassured that the government has done its homework properly to ensure that this does not happen? The more I hear government leaders telling the people that these are all concessional loans that carry an interest charge of 2pc payable in 25 years, the less reassured I feel because they are telling us less than a quarter of the full story and stopping there, to leave us with the impression that there are no further costs beyond this.
In reality, to properly afford the CPEC projects that are being undertaken, the country will need to lift its exports, boost its productivity, and give a large spur to private enterprise to get the wheels of domestic investment moving again. To some extent, this is happening. Cement, for instance, is doing quite well. Cement, incidentally, is probably the only product the Chinese projects are sourcing locally, with everything else imported from Chinese firms, with loans taken from Chinese banks.
On the surface, these figures are not alarming. Pakistan’s economy can indeed absorb them, and still profitably benefit. But so far, the IMF and the State Bank are both warning that for the country to carry its external debt burden, exports need to increase rapidly. The State Bank has also been warning about the increasingly short-term nature of external debt, pointing that “domestic commercial banks have also been taking short-term loans from foreign banks to bridge the payment gaps”.
I’m no expert in this field. But just looking at what is happening on the external front of our economy makes me a little nervous and I need some reassurance. We’ve heard about “record-high reserves” before too, only to find ourselves knocking on the IMF’s door within a year.
And I’m even less reassured when I read what the government told the IMF in the last review when the Fund raised the issue of a growing Chinese debt burden being taken on. They were told that “additional Chinese investment over the longer term, building on CPEC as a platform, could also help cover the projected CPEC-related outflows”.
The writer is a member of staff.
Published in Dawn December 15th, 2016