PML-N government’s economic efforts so far have primarily been confined to the increase in forex reserves and the setting up of power and other infrastructure. And for both it has been relying on external loans.
These loans are not limited to public sector, and may have some participation of private sector as well. At the outset, one must say that there is nothing wrong with debt, as long as the return on debt is higher than the cost of debt. And in that vein, let’s delve on some back-of-the-envelope calculations to gauge the productivity of the loans sought so far in terms of generation foreign exchange.
First and foremost is the $6.6 billion Extended Finance Facility (EFF) from the IMF. The EFF is for balance-of-payment support and cannot be deployed to any direct productive use. The loan was inevitable and is in twelve equal quarterly tranches, of which three have been disbursed. Repayments will commence from 2016 and will be in twelve equal biannual installments of roughly $640 million each.
Then there is the $12 billion loan coming in the shape of country partnership strategy from the World Bank in five years, of which a billion dollar is already in the kitty. This is a very good deal negotiated by Finance Minister Ishaq Dar, because it is purely a concessionary loan with repayments schedule spanned over thirty years with five years of grace period at a nominal rate of 2 percent. Hence, let’s just sweetly ignore its outflows in our ensuing computation.
Last month, the country’s economic observers were overwhelmed by the response of global debt market that helped raise $1 billion each (four times the target) in 5-year and 10-year Eurobond papers. This means that we have to pay the principal back in 2019 and 2024, respectively, while yearly coupon payment on each is roughly $80 million.
This loan has been conveniently used to retire government’s borrowing from the SBP. Yes, it helped in balancing the monetary assets and it may ease demand-induced inflationary pressures. But, it would have no direct benefit in terms of enhancing industrial productivity or generating employment.
Last, but not the least are the big chunks of loans or investment promises (MoUs) originating from China. There are talks of $32 billion in seven years, of which $20 billion would be deployed in power projects whereas the rest would be used in building roads, bridges and similar infrastructure.
The latter will likely be government-to-government transaction through the financing of Exim Bank of China without any international bidding, and the return on these projects—like motorways—are either social or too long term to generate foreign exchange in the next twenty years.
Keeping historic terms of conditions by Exim Bank to Pakistan or other countries, these loans would be at lower rates (3%) and would have an amortization schedule of fifteen years. In a nutshell, we assume these loans to commence equally in seven years from today with repayments starting from 2015 and terminating in 2034.
Then there are $20 billion amount project loans or investment also coming through Exim Bank. A part of it is for the extension of Chashma Nuclear Plant (government-to-government) and the other major chunk would probably go towards numerous coal-based power plants. These IPPs, including some Greenfield projects from both private sector and the government, of which some are replacements of existing government operated gencos.
Big groups including Nishat, Sapphire, Atlas and others are interested in these projects while the big fish of power sector, Kapco and Hubco, may also have their fair share as well. The Punjab government is eying two to four coal-based power plants (660MW each); while the Federal Government is attempting to set a big energy park up at Gadani, Balochistan.
Let’s assume that $20 billion projects will add 15,000MW in seven years to the grid at the cost of $1.2-1.3 million per MW. The existing constrained peak demand is at 17,000MW while the supply is limited to 10,000MW. Let’s also assume that demand will grow at six percent per annum to reach 25,000MW by 2021 and that the addition of 15,000MW through these projects will be sufficient to bridge the demand-supply gap by then.
Isn’t it awesome! But wait, since there is no free lunch, let’s compute the strain of these loans on external accounts. The country’s external debt, including $32 billion from China, IMF ($6.6bn), WB ($12bn) and Eurobond ($2bn), would soar by $52.6 billion in seven years. This will almost double our existing external debt ($61bn or 24% of GDP) to $114 billion or 38 percent of GDP by 2020, assuming two percent annual growth in GDP in dollar terms.
Now let’s see its economic impact on imports and exports in the next twenty years. Seventy percent of $20 billion investment in power plants will go back to the outside world (most probably China) in terms of machinery imports (turbines, generators, boilers, etc) and its installation while the rest would be domestic component. Hence, straight away imports are increased by $14 billion over the span of 7-10 years. Then the fuel import ($3.4bn per year once the additional 15,000MW commence) which would be half of furnace oil in today’s price assuming all the new plants are on coal.
The most interesting and intriguing part is the impact of increase in power generation by 150 percent to 25,000MW on the exports and imports through increase in consumption and production. The current size of manufacturing sector is at $31 billion (12% of GDP at $260bn), and let’s say it would increase in a staged manner by 150 percent or $46.5 billion while keeping everything else constant by 2024. Based on the census of manufacturing industries 2005-6, the coefficient of imports to total production is 0.34, which means that the share of imports in the abovementioned $46.5 billion jump would be $15.7 billion by 2024.
Now, let’s run similar calculations on the enhancement in exports based on today’s industrial performance. From the same census of manufacturing industries, exports (minus food exports) coefficient to production (including small scale) is 0.24 and its impact of increase in production would culminate to $11.2 billion by 2024.
The data clearly depict that trade deficit will worsen with improved production. Plus, 60 percent of our electricity consumption is domestic or commercial, so productivity gains are nil, while it has a strain on oil imports and debt repayment. It has been recognized that enhanced manufacturing activity has a lot of spillover on domestic economy-–but the consideration here is the external balance, hence the focus on trade balance.
Then, within the 40 percent industrial consumption pie, imports are prone to increase more than exports. This is because major chunk of our industry caters to domestic demand which would require the import of raw materials. Those industries in the business of exports would also need additional imports to meet the requirements of capacity enhancement. History also suggests that enhancement in production capacity has an adverse impact on trade balance; average trade deficit in the 90s ($2.2bn) increased manifolds to an average deficit of $14.7 billion ever since.
The solution out of this predicament: the PML-N government should concurrently design policies to diversify exports and add new avenues of exports through fiscal incentives. Otherwise, the net impact on our external accounts of this $52.6 debt is positive till 2018, which is coincidentally the scheduled end of tenure for this government. After that, it’s all in the red (see chart).
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