The Asset | 28 March 2018
Belt Road-strain on Pakistan’s finances exposes flaws in the grand scheme
by Jonathan Rogers
Pakistan’s public finances and currency are in a state of disarray, with part of the blame being laid at the door of the country’s engagement with China’s Belt Road project. The country’s current account worsened substantially last year on the back of a sharp increase in imports due to trade activity related to the Belt Road initiative.
This in turn has put pressure on the Pakistan rupee, which was the worst performer in the Asian currency complex last year and which has experienced downside revaluation pressure since December, with two sharp legs down met with a depletion of the central bank’s foreign exchange reserves.
There are echoes of the Asian financial crisis of the late 1990s in that Pakistan wears a heavy external debt burden denominated in US dollars, which is estimated to run to 30% of GDP. Tenor and currency mismatch on welters of external debt stymied Asian economies during the Asian crisis as managed pegs were abandoned in the face of mass capital flight.
That narrative is playing out in Pakistan, which has run down its reserves to US$12.1 billion in attempt to hold the peg, although few market participants expect the peg to hold and most expect a formal devaluation to occur, possibly followed by an IMF bailout – which would come three years after Pakistan last sought the assistance of the multilateral lender.
Pakistan had signed up to Belt Road-related projects to the tune of US$60 billion, including plans to build power plants and a railway linking Western China with the Pakistani Indian Ocean port of Gwadar. But political dial back prompted the Pakistani government to withdraw from a joint venture with China to develop the Diamer-Bhasha dam in Kashmir last November.
That pullback apparently came as the Pakistan authorities baulked at the use of Chinese companies and labour that was stipulated under the terms of the Belt Road agreement. Above and beyond the politics, the economics would strain Pakistan’s balance of payments given that the bulk of the work would appear on the import side of the country’s trade balance with China.
The developments in Pakistan cast a shadow over the Belt Road initiative and come in tandem with a raft of cancelled projects in countries on the Belt Road route.
Myanmar last November cancelled plans to build a US$3 billion refinery due to financing difficulties; Thailand in 2016 cancelled a planned US$15 billion high-speed railway due to the concentration of Chinese firms in the project at the expense of local contractors; while in December Sri Lanka was forced to sell a majority stake in a port in Hambantota to a Chinese SOE following a failure to repay a US$1.5 billion project loan from Beijing, amid local gripes that Beijing was overwhelmingly favoured in the terms of the deal.
As countries on the Belt Road route which run current account and trade deficits face the risk of capital flight as the US Federal Reserve tightens short-term interest rates, the strain on currencies will intensify and ploughing on with Belt Road projects which pile up imports and push deficits further into the red might be a bridge too far for many of them.