Pakistan's CPEC delusion - first published 2016

This article was first published in the Indian Military review in 2017. I believe I was the first analyst to question the benefits of the CPEC. I think it was prescient, given Pakistan's economic collapse in 2023 and a good start to my blog.

Understanding the CPEC

The China Pakistan Economic corridor (CPEC) involves an investment of US$ 46 billion (now US$ 51.5 billion), by China, in Pakistan. It’s been touted as the game changer that can transform Pakistan’s economy and its strategic utility. The Pakistani and Chinese establishment have been understandably very optimistic about the gains from CPEC. The Indian media’s reaction is one of concern at the China-Pakistan partnership (and its negative implications for India’s defence), with suggestions that India join the CPEC.  There is an inadequate economic analysis of the CPEC. This is resulted in criticism of the project, focusing on, in my view, secondary issues – such as the use of territory in POK, prospects of terrorism, or the limited gains that may accrue to Baluchistan.
An analysis of the CPEC using data in the public domain and Pakistani sources, indicate that the project is deeply flawed. The project has been promoted by Chinese exigencies that neither Pakistan nor India fully understand.  Far from Pakistan gaining, the CPEC could result in serious damage to Pakistan’s economy and represents a significant risk to China.  

China’s goals: The CPEC is one of the several overseas investment initiatives China has announced or undertaken around the world. Under Xi Jinping, the scope and pace of these projects has greatly increased, exemplified by the One Belt One Road (OBOR initiative). It represents an audacious and risky gamble by Xi, to arrest falling growth and serious imbalances in the Chinese economy for the following reasons:

China has huge overcapacity and production of commodities like steel and coal – if production was to reflect demand, China’s GDP would fall further from the 6.5% currently projected ( a figure that is expected to fall steadily and which seems inflated when correlated with other indices ).  There is also disguised unemployment, in the form of workers in State owned enterprises producing things no one wants – including entire ‘ghost cities’. Overseas investments seek to utilize these materials and workforce abroad.

Chinese `aid’ is in the form of loans from Chinese banks . China built up unprecedented levels of debt from 2008 to 2015 and their banks now have few profitable ways to disburse this money.
They are in fact forced to lend to near bankrupt Chinese state owned enterprises. The CPEC enables them to lend to these enterprises for ventures with guaranteed returns, where the collateral for these loans are either the raw materials of the host country, or economic concessions – which would either secure China’s raw material sourcing, or help its exports.

The Impact so far:  Chinese investments are made in countries where there is either no credible democracy (e.g. Venezuela or African dictatorships) or where the Govt is too weak to withstand Chinese pressure and lacks a system of checks and balances (e.g. Sri Lanka, or Pakistan). In all cases, International agencies have found the projects financed by the Chinese, too risky.

Whatever evidence we have of Chinese overseas investments indicates that none have worked. A recent example is Chinese investments in Venezuela - US$ 57 Billion - in a country much smaller than Pakistan in which China has no military or strategic relationship, which have failed, due to the crash in oil prices and mismanagement by the Venezuelan govt. Thus while its citizens literally starve, the country’s future oil earnings have been pledged to China for loan repayment. This is similar to several Chinese investments in Africa, where a fall in commodity prices, will force the recipient country to renege on payments, particularly if there is a change in Govt. In Sri Lanka, every project financed by the Chinese has turned out to be a white elephant – the consequences of which Sri Lanka will have to face for decades. Thus a combination of unviable projects, a fall in commodity prices and inflated project costs threatens to cause failures across multiple countries. This is coupled with China’s own increasing economic problems (including high debt and huge NPAs of its banking sector) which have caused an increasing reluctance to lend to near bankrupt firms, for unviable projects.   

Characteristics of the CPEC: What the CPEC actually involves, seems rather different from what the media typically projects.
Almost all the money pledged by China comprises loans from Chinese banks to Chinese state owned enterprises. These are shown as loans in Pakistan Govt accounting.  Less than US$ 1 billion of 46, is either interest free loans, or aid. In the decade before CPEC too, barely US$ 200 million of aid was given by China. 

Virtually all the capital equipment, for which loans are provided, comes from China with single bidders (including coal plants scrapped in China due to excess pollution and inadequate demand). Most of the labor will also be Chinese. Thus Pakistan neither develops a manufacturing base, nor gets technology, or generates local employment.

While funding details are very opaque, Pakistan is expected to provide approx. $ 13 billion to the
project. Of this, it has so far allocated under US$ 3 billion. China has expressed frustration at the slow pace of disbursement of even the allocated amount.
China has announced loans of approx. US$ 26 billion for the CPEC, with upto US$ 7 billion of equity.
This coupled with Pakistan’s expected investment, broadly accounts for the US$ 46 billion.
So far, just $ 2.2 billion of Chinese money has actually been disbursed as loans and $750 million as equity.  

Chinese equity for power projects is guaranteed a 27% return on investment (compared to 15.5% in India). The investment itself is `gold plated’. Dividends to China are tax free. While the loan component has an interest rate of between 1.5 & 6% p.a this is Dollar denominated. Loan repayments, coupled with increased imports from China, under CPEC, will worsen Pakistan’s balance of payments. This will exacerbate currency depreciation and would result in a real interest rate of over 10%. This is for a highly inflated project cost – something inevitable in a single bidder situation, where the Pak army and politicians have to be paid off.  Capital costs are therefore significantly higher than equivalent projects in India. So far, $ 6 billion of CPEC funds have been disbursed (half by Pakistan) to start $16 billion worth of projects.

Impact of CPEC investments:  $ 33.7 billion of CPEC investments are in the energy sector. While that is expected to ease Pakistan’s energy crisis, the reality is quite different. Pakistan’s existing installed power capacity is 24000 MW. Peak demand is 19000MW and actual generation around 13000MW. The shortfall is due to shortages of low cost coal, or Indus water, high tariffs and poor management.
There are another 13000 MW of projects under construction, excluding CPEC projects.
 
CPEC plants add 13880 MW of additional capacity, which Pakistan will not need for several years. However, since the operators of the CPEC plants have to be paid, it will result in existing plants supplying relatively low cost power, to shut, in favor of the higher cost power supplied by CPEC plants. China gains by supplying mothballed coal based plants to Pakistan (which they are required to close to reduce pollution and because there is no demand for that power in China), at prices higher than new thermal plants in India. Thus the lowest cost plant under CPEC will cost approx.
$ 1.47 million/ MW compared to  under $ 1 million/MW for new plants in India. Pakistan imports both coal and gas at higher prices than India. CPEC is therefore a means for China to dump both surplus coal, coal plants and labor on Pakistan. Tariffs under CPEC start at Pak Rs 8.5/ unit (which will keep increasing) whereas Indian plants can run profitably at tariffs of IRs 3.05 unit (or Pak Rs 5/ unit).  Under CPEC, Operators have a sovereign guarantee on their returns.

The example of the only project completed so far – a solar plant, is illustrative. The agreed initial tariff for the Chinese operator  was Pak Rs. 14 / unit. Thereafter solar power tariff’s crashed and competitors in Pakistan offered to supply power at lower prices. However Chinese pressure ensured that the current tariff is PRs 17 /unit (more than double of India)      

Gwadar & Road projects:  The idea that China will use Gwadar port and the highway to Kashgar, to provide an alternate route for Middle east oil to Western China, is a myth. The reality is that the cost to supply oil by road from Gwadar will be upto $ 12/ barrel compared to $ 2.22/ barrel by Tanker to Shanghai and then inland to Central China. A Pipeline may be marginally cheaper than road, but the capital costs are too high for that. If an alternative to sea transport is required it would be cheaper to supply this from Kazakhstan (and less risky). In any case, China’s largest oilfield – The Tarim basin, is in the Xinjiang province, where the CPEC road project terminates.

The Gwadar port, which Pakistan suggests will handle 400MT of cargo under CPEC, currently handles under 1 million tonnes ! Acute water shortages make expansion unviable. The port project was based on the assumption of continued western sanctions on Iran making Chabahar port (which provides easier access to Central Asia and Afghanistan) a non-starter. Chabahar is not only a better option – which India is investing in, but China too is hedging by looking at investments in Chabahar and associated infrastructure. Moreover, strained Afghan-Pakistan ties and a Baloch insurgency reduce the possibility of any meaningful traffic through Gwadar.   

There is nothing significant that Pakistan can export through the CPEC highway to China. However, goods produced in Xinjiang, particularly Cotton & cotton products which are 57% of Pakistan’s exports, can now be undercut by Xinjiang’s cotton, which will be subsidized and transported at low cost to both the Pakistani market and its export partners through Gwadar !

Pakistan’s failure to share in the financing of projects in Gwadar has resulted in China taking over land for a tax free industrial zone (as in Sri Lanka), a naval base etc. China has exited projects it deems unviable, even after signing agreements. Hence a gas plant in Gwadar will now only be built by the Chinese and not operated. Thus Pakistan pays for an unviable road/ port project and provides security to it, to enable China to eventually destroy their exports and a good part of their domestic industry, with subsidized tax free Chinese products. How China deals with its close ally should be an eye opener to those suggesting India be more accommodating to the Chinese.

The economic gains accruing to China from the CPEC (albeit at high risk if Pakistan defaults) suggest that CPEC is not Chinese charity done due to a special relationship with Pakistan. They have made bigger investments in Venezuela . Chinese investments in Myanmar, Sri Lanka and Bangladesh on a per capita basis, are bigger than CPEC. China has offered to spend almost the same amount as CPEC to build a new capital in Egypt !
In this context, strengthening a military relationship with Pakistan, or encircling India, would not be the primary objective of China through the CPEC, though it’s a consequence we have to deal with.

While there is a lot of consternation from reports about Chinese naval bases in Gwadar, Sri Lanka etc. I would assume that the placing of a couple of ships, thousands of miles from any support and in the Indian Navy’s backyard, would represent a bigger risk to the PLAN, than a threat to India. The release of a picture of a Chinese submarine at Gwadar, misses the point that a submarine’s deterrence lies in the enemy not knowing where it is.   

India’s strategy should be to delay the CPEC, increasing the costs to Pakistan and forcing a choice between a balance of payments crises, or pulling out of the CPEC. A failed CPEC along with other failed Chinese overseas investments, could exacerbate the mounting danger to China’s economy, from excess debt and a growth slowdown.