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The cost of CPEC

Updated March 12, 2017
On November 13, 2016, Prime Minister Nawaz Sharif, then Army Chief Raheel Sharif and Chinese Ambassador to Pakistan Sun Weidong inaugurate trade activities in Gwadar — White Star file photo
On November 13, 2016, Prime Minister Nawaz Sharif, then Army Chief Raheel Sharif and Chinese Ambassador to Pakistan Sun Weidong inaugurate trade activities in Gwadar — White Star file photo

It is hard to miss them: an excavator digging the road near Thokar Niaz Beg where another new concrete pillar will soon be raised. This structure is being constructed to support the almost 27-kilometres-long elevated track for the country’s first rapid transit train project, the Lahore Orange Line Metro Train. A front-loader waits nearby to be called to scoop up the rubble and load it on to the dumper to make room for the workers to fix a steel mould in the ditch for the concrete pillar.

Pushed by Chinese investment, there is indeed great economic activity in Pakistan around projects connected with the China-Pakistan Economic Corridor (CPEC). But, as the old adage goes, ‘there ain’t no such thing as a free lunch.’

The Lahore Metro Train is one of the several energy and transport infrastructure projects being built with Chinese money under the CPEC initiative, the new 3,200km long trade route that would connect Kashgar in China’s landlocked northwestern Xinjiang region with the Middle East, Europe and Africa via Pakistan’s deep sea port in its southernmost city of Gwadar through a network of highways, railways and pipelines. The Pakistan Muslim League-Nawaz (PML-N) government is fast-tracking several of these projects before its five-year term expires in May 2018.

Civil works on the 1.65-billion-dollar Metro Train project in Lahore, for example, are moving full steam ahead and the Shahbaz Sharif government hopes to finish the job long before the elections next year. This is despite a legal challenge from civil society activists, who obtained a court order in August last year that halted construction of the track in front of the city’s 11 heritage sites, including the historic Shalamar Gardens. Yet the administration doesn’t seem too worried about it.


Although money is being pumped in by China on the CPEC project, much of the opportunity is being exploited by Chinese companies rather than Pakistani ones. And the financial burdens are still obscured.


The value of the power and infrastructure deals concluded around the trade corridor has increased from the original 46 billion dollars to an estimated 57 billion dollars. Costs have swelled with the inclusion of Chinese financing for Pakistan Railways and transport projects in the provincial capitals of Sindh, Khyber-Pakhtunkhwa and Balochistan. While Beijing will pay for the larger part of the CPEC bill through commercial loans, soft loans, grants and private equity investment, Islamabad is also required to chip in funds for transport projects.

Almost 28 billion dollars of the proposed investment has been allocated for ‘early harvest’ projects — 18 billion dollars for power projects and 10 billion dollars for rail, road and port infrastructure — and the rest of the investment is expected to materialise by 2030 and beyond. Power plants are being funded through foreign direct investment by Chinese firms and commercial loans at the rate of six to seven percent from Chinese banks. The financing for the transport sector is provided by the Chinese government and the respective state-owned Chinese banks mostly as concessional loans have been taken at two to 2.4 percent mark-up.

Ever since President Xi Jinping showed up in Islamabad in April 2015 to sign the investment deals around the trade route, the corridor project has created huge expectations about future growth among the common people, businesspersons and the government. Even multilateral lenders such as the International Monetary Fund (IMF) in September last year described the CPEC initiative as an “opportunity for Pakistan to boost investment and growth.”

According to the IMF: “The CPEC could go a long way towards alleviating Pakistan’s long-standing supply-side bottlenecks and lifting its long-term potential output… power supply will improve for exports. Transport infrastructure (roads, rail and port) will allow easier and low-cost access to domestic and overseas markets, promoting inter-regional and international merchandise trade. Services trade will also benefit from the increased trade traffic from China ... (and the initiative) would catalyse private business investment and boost productivity.”

No wonder then that the Nawaz Sharif government is increasingly betting on Beijing’s commitment to pour money into energy and transport projects in Pakistan. The great hope is that it will reinvigorate Pakistan’s flagging economy, boost manufacturing, and create jobs for the millions of young people entering the job market every year as foreign private and official capital inflows from the West dry up and exports fall.

But the question is: has Pakistan safeguarded its interests when inking these deals? Or have we surrendered our autonomy in desperation for funds?

THE COST OF CHINESE INVESTMENT

Illustration by Essa Malik
Illustration by Essa Malik

Little less than two years after the two all-weather friends signed the investment deals, Chinese officials claim their government and companies have already spent about $14bn on various power and transport infrastructure projects in Pakistan. As work on CPEC-related projects makes ‘rapid’ progress, the focus of public debates is gradually shifting from ‘Will CPEC projects ever materialise?’ to ‘What is the price tag that will come attached to the Chinese investments for the ordinary Pakistani consumers?’

The government’s policy of keeping a tight leash on information relating to the financing of CPEC projects and the manner of their execution isn’t helping mitigate public concerns about the direct, indirect and hidden costs of the deals. Many fear that the deals made with China are going to impose enormous costs on the budget and consequently on the people.


In the case of power projects, the government has gone many steps further to appease Chinese investors. In some instances, it has forced Nepra to bump up tariff that the regulator had originally determined for the projects sponsored by the Chinese firms and investors. Take the case of the 660KV Matiari-Lahore DC (direct current) transmission line — Nepra was forced to raise the original tariff of 71 paisas per unit that it had determined to 74 paisas after the contractor refused to undertake the project at that price.


“We must pay a very, very heavy price before the Chinese money can help us,” asserts Ijaz A. Mumtaz, former president of the Lahore Chamber of Commerce and Industry (LCCI). “Given the poor state of our economy that stopped producing jobs many years ago, the CPEC initiative was unavoidable [for boosting growth]. So are its costs for the [national] budget and the ordinary citizen.”

These costs are piling up in different ways: expensive credit, hefty tax incentives for Chinese contractors and investors, higher power tariff and capital expenditure allowed for the CPEC power projects, preference given to Chinese enterprises in the award of the contracts, and so on and so forth.

Pakistan Business Council (PBC) chief executive officer Ehsan Malik points out that the industry and the people are still in the dark regarding the terms of the deal signed almost two years back. “We are being told by the government that the CPEC is a ‘gift horse’ from China. But who knows? It could turn out to be a Trojan horse for us. Unless the government ensures transparency in the deals it has made with the Chinese, the concerns will continue to rise.”

Mumtaz echoes this viewpoint. He argues that the exact price tag attached with CPEC deals cannot be calculated unless “we know how much of the promised Chinese money is coming as commercial debt, investors’ equity and soft loans. The government must ensure transparency about details of deals signed with China to put public worries to rest.”

While the exact price tag attached with the Chinese investments will become known over time as the work on the projects progresses, the costs they are going to impose on the budget have already started to unfold. On January 6, for example, the Economic Coordination Council of the Cabinet approved tax exemptions and reductions estimated at 20 billion rupees on imported machinery and equipment for the Lahore Metro Train project.

The Council made the decision on the demand of the Shahbaz Sharif government, which feared the mass transit project’s final cost would escalate to 1.845 billion dollars without the requested tax benefits. The provincial government had rested its case on the argument that similar preferential treatment had been extended to several power, transport and infrastructure projects underway across the country as part of the Corridor project.

Indeed, the Metro Train isn’t the first CPEC-related project to get tax benefits. Nor will it be the last one to secure tax discounts. “The ‘hidden’ costs of the power and transport infrastructure being developed under the CPEC initiative are building up,” contends Maqsood Ahmed Butt, a Lahore-based businessman “These are costs that no one had told us about. Nor had we anticipated them. And as the euphoria over the multi-billion-dollar power and transport infrastructure development deals melts down, even the supporters of the ruling party will start feeling the pinch.”

TAX HOLIDAY OR HEIST?

The first Chinese trade convoy also arrived the same day — White Star file photo
The first Chinese trade convoy also arrived the same day — White Star file photo

Apart from the Lahore metro train project, the government has already allowed similar, heftier tax concessions to the Chinese firm managing and developing the deep sea port and a special economic zone in Gwadar for a period of 40 years and 23 years, respectively. Tax incentives for Chinese contractors involved in the construction of the Sukkur-Multan section of the Karachi-Peshawar Motorway and the Thakot-Havelian section of the Karakoram Highway have also been notified by the Federal Board of Revenue.

In the energy sector, as media reports suggest, the Thar-based power projects were the first to secure tax benefits. Now the Chinese companies developing hydropower projects — Karot, Suki Kinari and Kohala hydropower projects — are also expecting tax waivers. Actually, in the case of power projects, the government has gone many steps further to appease Chinese investors.

In some instances, it has forced the National Electric Power Regulatory Authority (Nepra) to bump up the tariff that the regulator had originally determined for the projects sponsored by the Chinese firms and investors. Take the case of the 660KV Matiari-Lahore DC (direct current) transmission line, essential for evacuation of 4,000 megawatt electricity from the new, under-construction coal-fired plants at Port Qasim to energy load centres in Punjab. Nepra was forced to raise the original tariff of 71 paisas per unit that it had determined to 74 paisas after the contractor refused to undertake the project at that price.

In certain cases, Nepra has been approached by the government to accommodate the contractors’ request for upward revision of the projects’ capital expenditure determined earlier because costs escalated due to ‘unseen’ factors. In other cases such as solar power projects, the power sector regulator was manipulated into announcing a higher up-front tariff for Chinese firms before it was significantly reduced for other investors.

The government has also agreed to set up a revolving fund equal to 22 percent of estimated monthly invoicing, backed by sovereign guarantee, to ensure uninterrupted payment to the Chinese sponsors of the CPEC-related power projects. It means that if the power purchaser defaults on payments, the government will pick up the liability and pay 22 percent of the bills of Chinese power producers up-front. No such concessions and incentives are made available to the local investors, the industry sources complain.

“We may have surplus electricity once the new power projects being developed under the Corridor project come online. But we will not be able to afford it because the government has offered very high tariffs to the Chinese firms [based on the high CAPEX costs of the projects],” argues Shahid Sattar, a consultant who was member of the expert panel that drafted Pakistan’s first private power policy in the 1990s. “In Bangladesh, the Chinese firms investing in coal power have been offered as low a tariff as $0.062 per unit compared with $0.092 per unit in Pakistan. Moreover, Chinese investors are bringing the latest, environment-friendly technology to Bangladesh while we have allowed them to [relocate] their old plants in Pakistan,” alleges Sattar.

No official estimate of the cost of the tax benefits already granted to the contractors and sponsors of the CPEC-related project, or under consideration of the government for the upcoming undertakings, are available. “In principle, we should be able to answer your question, but we actually haven’t calculated the exact numbers,” an FBR official told Dawn Eos. A report carried by Dawn towards the end of January had nonetheless estimated the total cost of these benefits for the budget and consumers to be somewhere between 180 billion rupees and 200 billion rupees.

Much of the new cost build-up in the form of tax incentives is a one-time occurrence rather than recurring, though. However, the burden of the tax waivers and reductions on the budget, and consequently on the people, is feared to increase going forward with an increase in the volume of Chinese investments in the CPEC-related deals, whose size has already spiked to 57 billion dollars owing to the inclusion of several new projects, and the tax benefits being considered for the 29 planned special industrial zones along the trade route.

These costs are also exclusive of the price that the people will be required to pay and the budget will have to pick up in the shape of minimum guaranteed return on equity (RoE) of 17 percent and higher tariffs to the sponsors of the power projects through their life cycle. Nor do these include the cost of raising and maintaining the special security force for protecting the route, as well as Chinese investments and workers. Initially, the government tried in September last year to recover the security cost from consumers through their monthly power bills during the entire project life of 25-30 years by allowing one percent increase in the capital cost of all the upcoming power projects. It was rejected by the Nepra, though.

The proposal, according to a federal government official, still remains on the table. But for now, the federal government is focused on recovering security costs from the provinces through deduction of three percent from their share in the divisible pool under the next National Finance Commission (nfc) award. (Islamabad is seeking total seven percent deduction from the divisible pool before its vertical division between the federation and the province.) The proposal, if agreed and implemented, will certainly hurt the provinces’ expenditure on their social sectors going forward at the cost of service delivery to their citizens.

Last but not the least, since all CPEC-related power projects — whether thermal or hydel — are being set up in the private sector, mostly with Chinese money as independent power producers (IPPs), they also enjoy a life-time waiver on corporate tax payments, similar to the ones established in the 1990s and the 2000s, in spite of guaranteed profits.

“The exemption allowed to IPPs [has been in place] ever since Pakistan formulated its first private power policy in the early 1990s to attract investment in power generation. This means that the power company’s profits will not be taxed,” contends a senior executive of one of the projects underway on condition of anonymity.

Tax incentives being offered to Chinese contractors are also against the advice of the State Bank of Pakistan (SBP). In its annual report on the state of the economy during 2015/2016, the SBP had noted: “… since tax incentives impose significant costs on budgets (and are hard to withdraw), focus should be on regulatory and administrative incentives.”

In addition to various fiscal incentives given to Chinese investors, the investment deals signed with China allegedly bind Islamabad to award contracts for all CPEC projects to Chinese contractors, who may or may not partner with local firms and may or may not procure material from local manufacturers. The alleged agreement means that Pakistani companies would not be in a position to compete with the Chinese contractors for any project or will depend on their sweet will to sell their products for the projects being implemented here.

OPPORTUNITY COSTS

In December 2015, according to a newspaper report, the government cleared three infrastructure projects under the CPEC — the 392km Multan-Sukkur section of the Lahore-Karachi Motorway, the 120km Havelian-Thakot road project and construction of allied infrastructure in the Mullah Band area of Gwadar — at a price of 4.4 billion dollars, or one billion dollars more than the original estimate. The upward revision in the cost of these projects was the “limitations imposed under the framework agreement signed with China.” The story quotes an unnamed official of the planning ministry as saying that agreements inked bind the government to award all CPEC-related projects to Chinese contractors at whatever price they quote in their bids.

Little wonder then that many businessmen view CPEC investments as a bigger business opportunity for China than for Pakistan. “With the contracts for the Corridor projects being awarded to Chinese contractors and with the chunk of CPEC investments flowing back to China for equipment, machinery, materials and even manpower, the multi-billion-dollar initiative appears to be a bigger business opportunity for China rather than Pakistan,” says PBC’S Malik.

Businesspeople such as Mohammad Ali Tabba, chief executive officer of one of the country’s largest business conglomerates Younus Group, consider CPEC a major opportunity for Pakistan. “There is little doubt that Pakistan direly needed massive investment in energy and transport infrastructure projects to cut blackouts, boost growth and create jobs. China has come to our rescue when everyone else is shying from coming to Pakistan,” he asserts. But, he adds, the government should offer the same incentives and support to the local investors and firms it is giving to the Chinese companies (to provide them are even playing field to allow them to compete for the CPEC contracts).

Although the IMF viewed the CPEC project as an opportunity for Pakistan, it also warned about its immediate and long-term impact on the economy, especially the country’s fragile balance of payments position. “During the investment phase, Pakistan will see a surge in FDI and other external inflows. A concomitant increase in import of machinery, industrial raw materials and services will likely offset a significant share of these inflows, such that the current account deficit would widen, with manageable net inflows into the balance of payments,” IMF says in its final staff review of its 7.6 billion dollar loan in September 2016.

At the same time, the multilateral lender points out, these impacts were difficult to quantify due to uncertainty and lack of available information. “...IMF staff projects CPEC-related capital inflows (FDI and borrowing) to reach about 2.2 percent of the projected GDP and CPEC imports to about 11 percent of the total projected imports in 2019/2020.

“...As IPPs start operations, profit repatriation by these companies would begin to rise in the subsequent years… Repayment obligations to CPEC-related government borrowings, including amortisation and interest payments, are expected to rise after 2020/2021 due to concessional terms of these loans. Combined, these CPEC-related outflows could reach about 0.4pc of GDP per year over the longer term.”

The Fund was of the view that CPEC had the potential to catalyse higher private investment and exports, which would help cover the CPEC-related outflows that are expected over the long term. But it cautioned that “reaping the full potential benefits of CPEC will require forceful pro-growth and export-supporting reforms. These include improvements in business climate and strengthening security and governance.”

Comparing CPEC with the other two major trade corridors – Panama and Suez Canals — a Punjab University economics professor says on condition of anonymity: “While the Panama Canal earned 2.5-3 billion dollars a year and Suez five billion dollars through toll collection, Pakistan should not expect more than 3 billion dollars once the corridor becomes fully operational. This amount will be nothing compared with what we will be required to pay back to China for its ‘gift’.”

“If we really want to take advantage of the CPEC project, we must review the deals with Chinese investors and contractors, withdraw special incentives given to them in our desperation to attract investment, support our local businesses and provide a level playing field to our investors to boost growth and exports in the long-term,” says the professor from Punjab University. “Otherwise, the CPEC will prove to be yet another East India Company as pointed out by a MQM senator many months back. Do we want that?”

The writer is a member of staff

Published in Dawn, EOS, March 12th, 2017