The IMF’s mixed CPEC ranking

By: Khaleeq Kiani

Amidst the domestic debate of a political nature over the route and benefits of the China-Pakistan Economic Corridor, the International Monetary Fund has come up with its analysis of the pros and cons of the landmark initiative, with a word of caution.

This is perhaps the first independent scrutiny by a multilateral agency of the $51.5bn project launched by President Xi Jinping and Prime Minister Nawaz Sharif two years ago.

In a special chapter on the macro-economic impact of the CPEC, in its departing note to Pakistan on the conclusion of the $6.15bn three year programme, the IMF said the CPEC would boost investment and growth in the short run and entail risks of repayment obligations and profit repatriation in the medium to long term period.

This is perhaps the CPEC’s first independent scrutiny by a multilateral agency

Therefore, it advised Pakistan to manage the initiative carefully and negotiate power sector agreements transparently, to keep their outcomes favourable to the distribution system and affordable to consumers, because of their impact over a period of three decades.

Mainly supported by the investment upturn related to CPEC, the IMF projected Pakistan’s growth rate going moderately up to 5pc during current fiscal year. “Medium-to long-term risks could arise from CPEC-related repayment obligations and profit repatriation”, it noted.

The Fund further stated that it was an opportunity for Pakistan to boost investment and growth as it was a large package of investment projects in energy and transport infrastructure, financed by China. The IMF estimated the total size of the CPEC at around $44.5bn (about 16pc of GDP in 2015-16), of which more than half ($28bn) is allocated to ‘early harvest’ projects over the next few years, with the remainder of the investments expected to materialise up to 2030 and beyond.

Of the early harvest projects, about $10bn is allocated to road, rail, and port infrastructure, which the government plans to execute within its regular development spending envelope. The remaining $18bn (6pc of GDP) will largely cover energy projects provided through foreign direct investment (FDI).

Some CPEC priority projects are already under way, which contributed to a pickup in FDI, imports of machinery and industrial materials, and the government’s external financing in the fiscal year 2015-16.

Financing modalities vary across sectors and projects. In the energy sector, power plant projects will be funded through FDI by Chinese firms, with commercial loans borrowed from Chinese banks. These firms will operate as Independent Power Producers (IPPs) and have their electricity sales guaranteed through pre-negotiated power purchase agreements, including guaranteed tariffs.

In the transport sector, financing will be provided by the Chinese government and state banks mostly as concessional loans. Other, smaller CPEC infrastructure projects are expected to be financed through a mix of concessional loans and grants.

The IMF expected the direct impact on the external balance to be substantial. During the investment phase, as the ‘early harvest’ projects proceed, Pakistan will experience a surge in FDI and other external funding inflows. A concomitant increase in import of machinery, industrial raw material, and services will likely offset a significant share of these inflows, such that the current account deficit will widen, with manageable net inflows into the balance of payments.

While precise quantification of these impacts was difficult for the IMF due to uncertainty and lack of available information, it noted that CPEC-related capital inflows (FDI and external borrowing) to reach about 2.2pc of the projected GDP in fiscal year 2019-20, and CPEC-related imports to about 11pc of the total projected imports in the same year.

“The broader positive impact on the economy would be considerable”, the IMF said. If implemented as envisaged, CPEC could go a long way towards alleviating Pakistan’s long-standing supply-side bottlenecks and lifting its long-term potential output.

Priority energy sector projects are expected to add significant power-generation capacity within the next few years, and subsequent energy projects could further expand the capacity over the long term. This would help mitigate Pakistan’s chronic electricity load-shedding problem and provide a reliable support for domestic economic activities and exports.

CPEC transport infrastructure projects (e.g. roads, railways, port facility upgrade) would allow easier and lower-cost access to domestic and overseas markets, promoting inter-regional and international merchandise trade. Service exports would also benefit from the increased trade traffic from China. Furthermore, these CPEC projects could catalyse private business investment and boost productivity.

Over the longer term, Pakistan will need to manage increasing CPEC-related outflows. As Chinese IPPs start their operations, profit repatriation by these companies would begin to rise in the subsequent years. While the path and the size of the repatriation would depend on project completion timing and the terms of the power agreements, it could add up to a significant level, given the magnitude of the FDI.

Repayment obligations to CPEC-related government borrowing, including amortisation and interest payments, are expected to rise after fiscal year 2020-21 due to the concessional terms of most of these loans. Combined, these CPEC-related outflows could reach about 0.4pc of GDP per year over the longer run.

Pro-growth reforms and prudent macro-economic policies will be essential in unlocking CPEC’s full potential. Supported by increased energy supply and transportation capacity, CPEC has the potential to catalyse higher private investment and exports, which would help cover CPEC-related outflows that are expected over the longer term.

Reaping the full potential benefits of CPEC will require forceful pro-growth and export-supporting reforms. These include improvements in the business climate, and strengthening governance and security. Real effective exchange rate appreciation should be contained by allowing greater downward exchange rate flexibility and keeping inflation well anchored.

Finally, fiscal policy should remain prudent and debt management strengthened to keep the long-term public debt path sustainable. Additional Chinese investment over the long term, building on CPEC as a platform, could also help cover the projected CPEC-related outflows.

Based on this, the IMF advised that sound project management and monitoring systems should be in place to ensure timely implementation and mitigate risks.

“There is a need to ensure sound project evaluation and prioritisation mechanisms based on effective cost-benefit analysis and realistic forecasts of macro-economic and financing conditions”. The procurement process should be transparent and competitive and it’s monitoring accountable.

Power purchase agreements with Chinese IPPs should be negotiated with terms that would adequately incentivise investment while ensuring that the cost of generated power remains favourable for the distribution system and consumers. Moreover, capacity improvements in the power transmission network will be needed to keep up with the increasing supply.

It is hoped that the authorities will pay heed to this advice.

Published in Dawn, Business & Finance weekly, October 17th, 2016

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