FeaturedNationalVolume 13 Issue # 21

Chinese loans: A boon or a trap?

According to a report, Pakistan expects to obtain fresh Chinese loans worth $1-2 billion to help it avert a balance of payments crisis. Lending to Pakistan by China and its banks is about to hit $5bn in the fiscal year ending in June, as per recent disclosures by officials and the finance ministry data.

The spike in China’s lending comes as borrowing from other sources has become difficult. It may be added here that in February, Washington initiated moves that saw Pakistan placed on a global terror financing watch list, amid fears in Islamabad that it will hurt the economy. The new Chinese loans that are being negotiated will help bolster Pakistan’s rapidly-depleting foreign currency reserves, which tumbled to $10.3bn two weeks back from $16.4bn in May 2017.

Over the past nine months Pakistan has enacted a series of measures to combat its current account deficit, including hiking tariffs on more than 200 luxury items and devaluing its currency by about 10pc. In the six months to end of March, Pakistan took bilateral loans worth $1.2bn from China. During this period the government also borrowed about $1.7bn in commercial loans, mostly from Chinese banks. In April, Pakistan’s central bank borrowed another $1bn from Chinese commercial banks to buffer its reserve. In the same month, a group of Chinese commercial banks lent $1bn to Pakistan’s government.

The decline in reserves and a sharp widening of Pakistan’s current account deficit have prompted many financial analysts to predict that after the general election, Islamabad will need its second International Monetary Fund (IMF) bailout since 2013. The last IMF assistance package was worth $6.7bn. Beijing’s attempts to prop up Pakistan’s economy follow a deepening in political and military ties in the wake of China’s pledge to fund badly-needed power and road infrastructure as part of the $57bn China-Pakistan Economic Corridor (CPEC), a key link in Beijing’s Belt and Road initiative.

Apparently, the new Chinese loans are aimed to boost Pakistan’s sharply declining foreign currency reserves, which tumbled to $10.3bn last week from $16.4bn in May 2017. While loans may be a momentary relief for our current reserves, they have unpleasant consequences for Pakistan’s balance of payments and already large deficit. The widening of our current account deficit makes it likely that after the elections, Islamabad will need its second International Monetary Fund (IMF) bailout since 2013.

Although Pakistan’s economic growth has soared to nearly 5pc, the fastest pace in 13 years, the structural problems with the economy are coming to the fore. It is similar to 2013. The gloomy macroeconomic outlook prompted the IMF earlier this month to downgrade its economic growth forecast for Pakistan to 4.7pc for the next fiscal year ending in June 2019, way below the government’s own ambitious target of 6.2pc.

So far, all the measures appear to have had a limited impact on Pakistan’s economy and foreign exchange reserves continue to nosedive. In the past three weeks, reserves have declined by $1.2bn and now stand at two months’ worth of import cover. The collapse of the reserves is mainly due to the central bank’s efforts to maintain an artificially strong rupee over the past few years. The currency is now trading at about 115.50/116 to the US dollar, down 9.8pc in last six months after two separate devaluations since December.

The new Chinese money is in the nature of a temporary relief until August or September, when a new government will come into office and the country may have to opt for a new IMF programme. Pakistan may also seek help from Saudi Arabia which lent $1.5bn to Pakistan in 2014 to shore up its foreign currency reserves.

Due to declining exports, the current account deficit widened to $14bn in the first 10 months of the current fiscal year. Dollar-denominated debt repayments in 2018 are also expected to top $5bn. Part of the problem for Pakistan has been a multi-year consumer boom accompanied by huge imports of Chinese machinery for CPEC projects, which has increased pressure on the current account deficit. More recently, a jump in the oil price has compounded the problem. No doubt, exports have gone up in the last two months, helped by the devaluation in the rupee, and that should help ease the current account deficit. But there is trouble ahead as oil prices climb.

According to experts, the growing tendency to rely on loans from China to finance the current account deficit needs to be curbed before matters get out of control. Borrowing on commercial terms from state-owned Chinese banks as a way to finance the growing external sector deficit is fast becoming the new norm, a fact that has very troubling implications for the country.

As it is, Pakistan is under double pressure of current account deficit and its sharply decreasing currency reserves. The collapse of the reserves is mainly due to the State bank’s efforts to maintain an artificially strong rupee over the past few years. The approach to fix the rupee rate could further bolster the deficit, as devaluation of the rupee can lead to an increase in exports.

Experts have raised questions regarding the consequences of rising indebtedness to China. The government seems to have no comprehension of the long-term ramifications of such actions. Apparently, these are not understood fully. The explanations being offered appear reasonable on the face of it, but that may or may not work out. According to this narrative, we are borrowing in the short term to invest in long-term increases in competitiveness, and once those investments begin to yield results, the adverse terms of trade will be reversed and the debts incurred today will automatically pay themselves off.

Such optimism is clearly misplaced.  Successive governments in Pakistan have a record of taking the money without worrying about the consequences or the strings that might come attached. The example of the Musharraf regime comes readily to mind in this context. This time recourse to the IMF is being postponed with the help of bilateral loans from China with no idea of how far we intend to go down this tricky road. This is the price of failing to undertake structural reforms.

Regarding Chinese loans, we seem to have entered uncharted waters. The fear is that as these loans grow, the deficits will persist. And no one knows where all this will lead to.