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Asian Tribune is published by World Institute For Asian Studies|Powered by WIAS Vol. 12 No. 2675

IMF warns Pakistan on CPEC

By Malladi Rama Rao

Pakistan’s economy still faces “significant challenges”, and the country must undertake “key structural reforms” to foster higher and more inclusive growth, the International Monetary Fund (IMF) said in end September after a review of Pakistan’s financial health under its Fund’s extended facility, which is a euphemism for the IMF bailout.

The report also noted that investments by China under the China Pakistan Economic Corridor (CPEC) project have the potential to lift the Pak economy’s potential output, but warned that “repayment obligations that come with the investment will be serious”. Critics of Sharif government have picked up the IMF assessment to argue that Pakistan could end up as a Chinese colony with the Bamboo capitalist donning the mantle of the British East India Company.

What did the IMF actually say? It painted some positives from CPEC. If implemented as envisaged, the 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.

The IMF expects a surge in FDI into Pakistan during the investment phase of CPEC, which is also known as the “early harvest” phase. Not only Chinese Yuans, other external funding also will flow in. But increase in imports of machinery, industrial raw materials, and services will likely offset a significant share of these inflows. The current account deficit may widen as a result.

As of now, many foreign investors leaving the country are leaving Pakistan because of the energy crisis and bad governance. FDI divestments have already taken place in cement, metal and pharmaceutical sectors, according to the latest annual report of the State Bank of Pakistan (SBP), the apex bank of the country. For instance, Tuwairqi Steel has shut down its production unit because of a dispute with the government over the pricing of gas. “Some of these divestments highlight policy-related constraints in the manufacturing sector,” says the SBP report. It however expects implementation of infrastructure development and energy projects under the CPEC will improve investment environment.

CPEC is a $46 bn venture. While precise quantification of the impact of Chinese investments is difficult it is expected to reach about 2.2 percent of GDP, and CPEC-related imports to about 11 percent of the total projected imports in 2019-20

In the energy sector, Chinese firms are coming in with commercial loans borrowed from Chinese banks. They will operate as Independent Power Producers (IPPs); the power tariff and power sale are guaranteed through pre-negotiated power purchase agreements. Profits will be repatriated to China naturally. In the transport sector, Chinese government and banks will mostly provide concessional loans. Small infrastructure projects are expected to be financed through a mix of concessional loans and grants.

The IMF predicts that repayment obligations to CPEC-related government borrowing, including amortization and interest payments, will rise after FY 2020-21 due to the concessional terms of most of these loans. The outflows could reach about 0.4 percent of GDP per year over the long run. CPEC related growth could cover these payments but that this is not guaranteed, according to IMF projections.

While precise quantification of the impact of Chinese investments in Pakistan is difficult it is expected to reach about 2.2 percent of GDP in 2019-20, and CPEC-related imports to about 11 percent of the total projected imports in the same year.

In the energy sector, power plants will be set 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. Tariff is guaranteed under these deals. Profits will be repatriated to China naturally. In the transport sector, Chinese government and banks will mostly provide concessional loans. Other, smaller infrastructure projects are expected to be financed through a mix of concessional loans and grants.

The IMF predicts that repayment obligations to CPEC-related government borrowing, including amortization and interest payments, will rise after FY 2020/21 due to the concessional terms of most of these loans. These outflows could reach about 0.4 percent of GDP per year over the long run. CPEC related growth could cover these payments but that this is not guaranteed, according to IMF projections.

Well, there is an accepted view that the China propelled energy corridor, CPEC, could be a 'game-changer' for Pakistan over 10-15 years. This is because Pakistan’s FDI absorption capacity is no more than $5 billion a year at present. Writing in Business Recorder, M. Ziauddin claims that the annual outflow of foreign currency in the shape of profit repatriation will make the net inflow to no more than a maximum of $3 billion annually. He points out that Pakistan has a very liberal policy on repatriation for foreign direct investors. He takes note of the following aspects of Pakistan’s FDI policy as being relevant to the current situation:-

* Remittance of royalty, technology and franchise fee is allowed to projects in social, service, infrastructure, agriculture and international chains food franchise.

* Minimum share of the local (Pakistani) partner in a joint venture will be 60:40 for the service sector. However, 100% foreign equity can be owned for first 5 years.

* The Federal Board of Revenue will not question as to the source of investment; however, the FBR will only want to know whether the investor has paid requisite Income Tax on that specific investment. The FBR will not inquire into the source of the funds.

* Foreign investors are allowed to invest in industrial project on a 100% equity basis without any permission from the government.

* There is no requirement for a No Objection Certificate from the provincial government.

* In addition to manufacturing sector foreign investment on a repatriate-able basis is allowed in services, infrastructure and social sectors.

* Full repatriation of capital gains, dividends and profits.

* The facility for contracting foreign private loans is available to all those foreign investors who make investment in the approved sectors.

* Foreign controlled manufacturing concerns are allowed to borrow on the domestic market according to their requirements.

* Foreign controlled semi-manufacturing and non-manufacturing concerns can access loans equal to @ 75% & 50%, respectively, of their paid up capital including reserves.

* BoI's (Board of Investment) approval is not required for foreign companies to open a bank account.

* SBP regulates remittances in and out of Pakistan under legislature. There is no restriction on inward remittances by SBP but any outward remittances whether be royalty, technical fee and dividend have to have a prior approval from SBP, which the authorising bank/agent would do on the company's behalf.

* Similarly any contract for any such remittance needs prior approval of SBP.

In recent times, the real challenge for Pakistan has not been attracting FDI, but preventing outflows. For instance, the US investors, who are traditionally a big source of FDI, have pulled out $65.5 million in 2015-16, although net inflows from the world's largest economy amounted to US$208.9 million in the preceding fiscal year. Other major outflows are to Saudi Arabian investors ($102.2 million), Egypt investors ($45.6 million) and Germany ($33 million), SBP data shows.\

Petro chemicals sector recorded the largest net outflow of $136.1 million in 2015-16. It was followed by metal products ($59.1 million). Repatriation of profits and dividends nearly trebled to $145.8 million in July this fiscal from $52.5m in the same month last year. During the preceding fiscal year, the amount of profits repatriated by foreign companies operating in Pakistan stood at $2 billion, which was the second biggest payment after debt servicing for the country.

FDI inflows shrank to $64 million in July compared to $75 million a year ago. Pakistan hardly received $1.2 billion FDI in the previous fiscal year. Since exports are declining and remittances are falling, a rise in repatriation of profits and dividends will put the economy under more stress.

Pakistan’s trade deficit was close to US$21 billion in 2015-16. The $20 billion remittances helped to meet the trade gap and reduce the current account deficit, while it succeeded also to keep the foreign exchange reserves at $23 billion. Debt servicing amounted to $5.3 billion in the preceding fiscal year. So, all told the collective payments of debt servicing and profits were above US$7 billion.

The increases in this regard show that Pakistan will be under pressure to arrange more than $ 7 billion in the current fiscal year which would mean it would be almost impossible to keep its foreign exchange reserves at the current level. Falling remittances could add to the worries for a government struggling to increase exports, which have been declining for the last two years. July remittances fell 20 percent mainly because thousands of Pakistanis working in the Middle East, particularly in Saudi Arabia, have lost jobs and their payments were held by their employers.

In this sense, the latest IMF warning to Pakistan should be heeded and attention paid to the detail in the CPEC funding. Lest we forget, CPEC funding by China is really a land grab mechanism for the ‘Middle Kingdom’. At the end of the day, PM Sharif may well find that in 2018, Xi Jinping only matters for Pakistan!

- Asian Tribune -

IMF warns Pakistan on CPEC
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