Complexity of #CPEC Cost-Benefit Analysis

Provincial Share (approx.) Under Signed Agreements:-
Punjab ($12.45bn), Sindh ($9.25bn),
KPK ($2.72bn), and Balochistan ($1.21bn)
source: tribune.com.pk

An honest assessment of CPEC must, therefore, carefully evaluate its impact on real economic activity

The transformation which the China-Pakistan Economic Corridor (CPEC) will bring forth may be exaggerated but it surely has expanded the national discourse by introducing elements of economic development to it. Before I proceed, two general points must be made. First, hypothetically speaking, even if CPEC is only a passageway for the Chinese goods, there are significant positive externalities – developmental and geopolitical – associated with trade routes. Second, such projects have long lasting distributional consequences which could be easily managed at the conception stage.

Here I will focus on the effects of the CPEC on the Balance of Payments (BoP) of Pakistan. To fully appreciate the impact which CPEC may have on the BoP, a simple explanation and a brief history is necessary. BoP includes the Current Account (CA). Pakistan’s CA is largely driven by movements in the trade balance and remittances. Any deficit in the CA is mostly financed by foreign investment, State Bank of Pakistan (SBP) reserves and/or loans from the international market – mainly IMF.

Recall that following an increase in commodity prices in the world market, Pakistan’s trade balance worsened from -$13.8bn in fiscal year (FY) 2007 to -$21.4bn in FY2008, according to the SBP data. With no significant change in remittances, CA deficit increased from $6.8bn in FY2007 to $13.8bn in FY2008. Over the same time, foreign investments decreased from $10bn to $8.1bn. With CA deficit higher than total foreign investment, remaining deficit had to be financed from SBP reserves. Consequently, SBP gross reserves decreased from $15bn in FY2007 to $9.5bn in FY2008. Dwindling reserves lead to currency speculation thus forcing the then incoming government to negotiate a $7.6bn bailout package with the IMF in 2008. A similar episode was repeated between FY2011 and FY2013 but also coupled with the repayments of IMF loan. SBP gross reserves fell from the peak of $16.6bn in FY2011 to only $7.2bn in FY2013. Another bailout agreement of $6.6bn was signed with the IMF by the current government in 2013.

Against this backdrop, $46bn of Chinese investment expected over a decade or more under CPEC appears refreshing. It must, however, be noted that $35-37bn of this investment is in the energy sector having a significant import component in the form of power plants and project consultancy. Therefore, the dollar inflow will be significantly less than the size of the total portfolio. Another aspect of the energy projects is also the consequent repatriation of profits. Crude estimates from my discussions with the Planning Commission (PC) sources suggest profit repatriation of $10bn annually once all the energy projects are complete. A cursory analysis of the CPEC, therefore, suggests dollar inflows during the medium term followed by dollar outflows over the longer horizon.

Large dollar inflows during the implementation of the CPEC can also have significant consequences for the CA. It will appreciate the Rupee thus making our exports less competitive in the international market. An honest assessment of CPEC must, therefore, carefully evaluate its impact on real economic activity rather than focusing on its magnitude alone. Given the sheer size of the energy sector in total investment, one would have expected part of the investment to also focus on improving the efficiency of the electricity transmission network. With current line losses – a major cause of the circular debt – at close to 20%, it is intuitive to note that pouring more water in a bucket with a hole is surely not an optimal investment strategy.

It must also be considered how investing billions of dollars in an already established eastern trade route may further contribute towards growth? What are the opportunity costs? Could there have been alternate projects which would improve our trade linkages and open new markets for our exporters? We know that the development of the highway network in Balochistan aimed at linking Gwadar with the Central Asian markets via Quetta as well as with the national trade route via Ratedero faces financial starvation. As per PC documents, at the rate of FY2015 PSDP allocation, N-85 widening & improvement project will take another 4-5 years to complete. Also there is no indication of any work on the 549km Hoshab-Khuzdar section of the M-8. Since PC is expected to meet Pakistan’s part of the financing of CPEC projects, the completion of the above projects may be further delayed especially when tax targets for FY2016 are revised downwards.

Overall, the direct effect of CPEC on the BoP maybe short lived but potential indirect benefits through an improvement in the real economic activity could be substantial. However, much depends on the architecture of CPEC. Is it designed as a set of scattered projects largely intended to achieve immediate political objectives with economic returns as a by-product? Or is each project seen as a part of whole aimed at transforming Pakistan into a regional trade hub? I want to be optimistic.