China: investment or loan?

The recent three-day official visit to China by Prime Minister Nawaz Sharif and his brother, Punjab Chief Minister Shahbaz Sharif led to the signing of projects valued at 42 billion dollars with the Chinese authorities. It is unclear whether this amount is over and above the 32 billion dollar memoranda of understanding signed last year between the two governments with the PML-N government, claiming at that time too, that it was foreign direct investment (FDI) and not a loan.
The distinction between FDI and a loan is crucial as it enables the PML-N stalwarts to argue that as the amount (interest and principal) is not required to be repaid no budgetary allocation is required. The FDI generates economic activity and thereby contributes to a rise in not only the country's Gross Domestic Product (GDP) but also generates employment opportunities. In other words the FDI is a win-win type of investment for a recipient country with developed and developing countries alike proactively seeking FDI. China is the largest recipient of FDI, out pacing the United States. In 2013 the FDI flow into China was 64.1 billion dollars, resulting in a 34.7 percent market share of FDI into the Asia-Pacific region. By contrast, FDI out of China in 2013 was 18.97 billion dollars, 10.7 percent of the Asia-Pacific share. With 42 billion dollar commitment to Pakistan the Chinese are in effect committing to two and a half times of their total 2013 FDI. This is unlikely and the more obvious conclusion is that identification of agreed projects would provide a time line for the FDI inflow into Pakistan.
There has been typically no press release from the Chinese government on which specific projects would receive their investment, which may partly be attributed to a wise decision to wait for Pakistan's private sector to show an interest in a joint venture and then to appraise the modalities of the inflow, however, Federal Minister for Planning, Development and Reforms exhibited no such cautionary inhibitions. In a press conference held on past Tuesday he identified several projects including: (i) 6600 MW in the Gaddani Power Park, (ii) 6600 MW for Thar, (iii) 900 MW for Khyber Pakhtunkhwa and (iv) smaller projects in Punjab though minister mentioned two of 1300 MW each. He added that work had begun on Diamer-Bhasha dam as well as Dasu. The coal project, he added takes at least 3 to 3.6 years while hydel projects take between 7 to 10 years. Thus a conservative estimate of Pakistan's over optimistic executive with respect to Chinese FDI inflows would be in excess of 4 billion dollars per annum say over a ten-year period or one-fourth of their total FDI outflow in 2013 each year for the next ten years. Again this sounds a bit too optimistic though time will tell if more than 500 to 600 million dollars can be absorbed by Pakistan in one year given past precedence. Be that as it may, a significant portion of FDI would remain in China to pay for technical expertise as well as procurement of very expensive equipment (with many nay-sayers pointing to the money ill spent by Rehman Malik in procuring Chinese surveillance equipment under the Safe Islamabad Project that remains unused). What amount of the 42 billion dollar FDI remains in China is not known until and unless the details of the agreement are released.
The two major investments in Pakistan by China have been in the nuclear energy field as well as the Heavy Engineering Complex Taxila but the amounts involved have been relatively small. In June 2008 Pakistan planned to build units 3 and 4 at Chashma, each 320-340 MW at a cost of 129 billion rupees, 80 billion rupees out of this was from international sources, principally China. A further agreement for China's help with the project was signed in October 2008, given prominence as a counter to the US-India agreement preceding it. The quoted cost was 1.7 billion dollars, carrying a foreign loan component of 1.07 billion dollars with Beijing financing 85 percent of the project. The two are scheduled for completion in 2016 and 2017 respectively. Thus the 42 billion dollars is a major increase and must be appreciated.
The next important question is under what terms and conditions would the loan be procured. This is relevant because irrespective of whether the loan would be extended to a private sector partner or the government the fact remains that remitting money to China would involve the State Bank of Pakistan and impact on our foreign exchange reserves. A project loan can be in the form of a grant by a bilateral donor, however, it is generally procured at market rate of return (plus service charges) from multilaterals. Thus project loans are the bread and butter of multilaterals. Grant assistance by multilaterals is linked to performance (determined though quantifying several indicators including governance) and need one add Pakistan's performance has been poor and grant assistance has been mainly used for technical assistance for project preparation as opposed to project implementation.
China's grant assistant to Pakistan has been very small compared to other bilaterals and peaked in 2010-11 at 249.5 million dollars for support of the 2010 devastating flood victims. The US assistance was as high as 1.2 billion dollars in the same year. By 2012-13 the grant assistance was 11.4 million dollars only with zero assistance for 2013-14 (July March) as per the Economic Survey 2013-14. Loans from China have also not been too large peaking at 151.6 million dollars in 2011-12 with accrued interest at 43.7 million dollars. The principal owed to China during 2005-06 was 18.9 million dollars and in 2013-14 118 million dollars. But the rate charged has been around 3 percent and the amortisation period around 15 years or in other words even though the loan has not been significant yet the rate charged is low.
Imran Khan accused the government of agreeing to 7 percent rate and Ahsan Iqbal in his press conference stated that if the rate is as high as Imran Khan maintains then he would retire from politics. A simpler response would have been to reveal the rate and Ahsan Iqbal's failure to do so led many to argue that it must be in excess of the usual 3 percent. However, it is unlikely that the rate would be much in excess of the 3 percent usual rate for Pakistan and in that context the 42 billion dollar loan must be supported. One of the reasons that enables the Chinese to advance a loan at much cheaper rates than multilaterals is because Chinese transaction costs are low and staff does not travel business class and stay at five star hotels like multilateral staff. In addition Chinese assistance is rarely connected to conditions though Ahsan Iqbal mentioned that there was a discussion on the issues that plague our energy sector including the circular debt and revealed that the government has provided guarantees that returns to the Chinese government would not be stalled.
How would Chinese FDI come into the country? There are four possibilities: (i) by incorporating a wholly-owned subsidiary or company anywhere; (ii) by acquiring shares in an associated enterprise; (iii) through a merger or an acquisition of an unrelated enterprise; and (iv) participating in an equity joint venture with another investor or enterprise. And without doubt it is envisaged that Chinese FDI would come through a joint venture with a private sector company. What would be the terms and conditions between the Chinese companies and their Pakistani counterpart (including the equity of each) is as aforementioned not known but the fact remains that many an international deal, including Reko Diq, have been successfully challenged in our courts and this explains why the Chinese government wants the Pakistan government's sovereign guarantee which, sources reveal, has been extended.
To conclude unless the actual agreement for projects is signed it is difficult to determine whether the 42 billion dollars is FDI or simply a loan or when, how and at what rate it would flow into the country. Be that as it may, however, much of all governments' prefer FDI over a project specific loan the fact remains that both generate economic activity, increase employment opportunities and have the potential to jump-start the economy and from that perspective the 42 billion dollar pledged Chinese FDI must be appreciated.
(The views expressed in this article are not necessarily those of the newspaper).