The China-Pakistan Economic Corridor (CPEC) has incurred adverse reactions in India over its strategic implications, but just what is the CPEC all about? In December 2014, the People’s Republic of China (PRC) established the Silk Road Fund (SRF) as a fund management company to extend investment and financial support to CPEC projects and to promote industrial cooperation with Pakistan. The SRF is a consortium of leading Chinese banks, including the China Exim Bank and the China Development Bank. It had an initial corpus of $10 billion that was subsequently raised to $40 billion. For CPEC projects, all SRF-financed loans will be insured by the China Export and Credit Insurance Corporation (Sinosure) against non-payment risks while the security of loans is guaranteed by the host state. There is no grant-in-aid component, unlike American handouts to Pakistan in the past, and PRC’s financing and implementing agencies will hold proportionate equity in the Pakistani host entity Rs strategic advantage profitably piggybacking on great business.

What projects does the CPEC cover? All 49 CPEC projects would be executed with the financial and logistical participation of the federal and state governments and the private sector of Pakistan on joint venture (JV) basis. CPEC’s two main components are developing a new trade and transport route from Kashgar in China to the Gwadar Port in Balochistan and special economic zones along the route, including power and motorway projects. The first-phase projects will receive $45.69 billion in concessionary and commercial loans, for which financial facilitation to PRC companies is being arranged by SRF. These include $33.79 billion for energy projects, $5.9 billion for roads, $3.69 billion for railway network, $1.6 billion for Lahore Mass Transit, $66 million for Gwadar Port and a fibre optic project worth $4 million.Some of these projects have been fast-tracked and many are likely to be commissioned by 2019.

Apart from Karot hydropower project, they include the upgrading of the 1,681 km Peshawar-Lahore-Karachi railway line ($3.70 billion), Thar coal-fired power plants of 1,980 MW ($2.80 billion), development of two Thar coal mining blocks ($2.20 billion), the Gwadar-Nawabshah natural gas pipeline ($2 billion); imported coal-based power plants at Port Qasim for 1,320 MW ($2 billion), a 900 MW solar park in Bahawalpur ($1.30 billion), the Havelian-Islamabad link of the Karakoram Highway ($930 million), a 260 MW wind farm at Jhimpir ($260 million); and the Gwadar International Airport ($230 million).How is PRC financing such gargantuan expenditure? Although it has had its fair share of bad bank loans, distressed stock market and a sagging renminbi, yet $1.22 trillion in US Treasury Bonds (as of July 2016) is no mean amount of a total of $4 trillion investments in the US alone in mid-2015. As of 30 September 2016, the average interest rate on US Treasury Bonds was 4.429 per cent, down from 4.673 per cent a year earlier. Against this, a conservative annual return (interest and return on investment) @ 30-35 per cent per annum makes a positive difference of about $300-350 million/annum to PRC entities for every billion dollar invested over US Treasury Bonds. Included in this is a conservative 10 per cent mark-up in prices of capital equipment (that is normal globally), debt servicing costs (excluding interest) of about 7 per cent and return of investment of about 20-25 per cent, all per annum. For $ 67 billion CPEC funds (Pakistan and Bangladesh), PRC could potentially earn about $20-23 billion per annum with average payback period @ a remarkable 3-5 years.

The Bank of China reported a low prime lending rate of 4.35 per cent as of September 2016 that has not changed in the last year, so the cost of domestic and repatriated capital is low.Just how expensive will SRF finance be for Pakistan? A framework agreement for energy projects under CPEC was recently signed between Sinosure and the water and power ministry of Pakistan to provide sovereign guarantees. Sinosure is charging a fee of 7 per cent for debt servicing added to the project’s capital cost. Such an add-on of $63.90 million for debt servicing and financing fees and charges of another $21 million would raise the capital cost of the Port Qasim 660MW power project from $767.90 million to $956.10 million. Interestingly, interest during construction will be at the rate of 33.33 per cent each for the first and second years, 13.33 per cent for the third and 20 per cent for the fourth year. In addition, 27.20 per cent return on equity is guaranteed, post-commissioning. Power is therefore least likely to be affordable, so the substantial upward tariff revision may meet with popular dissent as for motorway tolls.Pakistan’s Finance Ministry has already exempted a few motorway projects from customs duties and taxes. Pakistan’s Federal Board of Revenue (FBR) has, so far, granted exemption on withholding and sales tax to two Chinese firms on import of motor vehicles for CPEC motorway projects. States too are pitching in. The Punjab government has leased 4,500 acres of land to PRC companies for the second phase of the Quaid-e-Azam Solar Park of 900 MW, probably gratis.

Similarly, the Gwadar Port Authority (GPA) has assigned or will be shortly assigning 923 hectares (2300 acres) of tax and cost-exempt land to China Overseas Port Holding Company (COPHC) on a 43-year lease. None of these costs will be borne by the PRC and will add to the cost of CPEC’s implementation. This is in addition to the $248 million PRC has already spent on establishing Gwadar Port in 2007, also as loans.SRF has already signed an MoU with China’s Three Gorges Corporation and Pakistan’s Private Power and Infrastructure Board (PPIB) to develop a number of private hydropower projects like the 720 MW Karot hydropower project. Likewise for Pakistani companies, Sindh Engro Coal Mining Co, which is a joint venture of EngroPowergen Ltd and the Sindh government, is the leaseholder of Thar Block-II coalfields, while its affiliate/subsidiary Thar Power Company will construct a series of mine-mouth power plants with SRF assistance. One such plant will receive $1 billion from the Industrial and Commercial Bank of China (ICBC) with 75 per cent financing of the $2.6 billion project, 25 per cent of which will be equity held by the financing ICBC.Which agencies will undertake joint implementation for the PRC? Three Gorges Corporation for hydropower projects, Shanghai Electric (Group) Corporation in partnership with Sino-Sindh Resources that is a subsidiary of Global Mining (China) Ltd, Lucky Electric Power Company, Zonergy Co Ltd, China Construction Company, China State Construction Engineering Company, China Civil Engineering Construction Corporation, Syno Hydro Company, etc., all PRC-owned companies, private and public, are the principal contractors.

Sub-contractors would presumably be Pakistani which is where local corruption will hugely creep in, as in India, and appreciably reduce the value of the loans. Chinese supervisors would also have to be protected against local goons for which the Pakistani army is reported to be raising a division to protect CPEC assets, expenses of which will be on Pakistan’s exchequer. How does PRC benefit from CPEC-like investments? At a very modest 0.25 per cent annual accretion to PRC’s GDP in 2016 of $10.87 trillion owing to CPEC and similar non-West transnational investment may potentially add at least another $300-400 billion per annum to PRC’s GDP by 2020. In addition, equipment and building supplies manufacturers, now in distress, would not only generate new jobs but also witness appreciable upsurge in their share values and consequently earnings per share for investors, many of them in distress now. Is that why PRC’s SRF is being called the new East India Company?What is the flip side of CPEC-like PRC investments? For one, high rates of return on investment are proportionate to the gravest risks involved that all recipients would certainly face in varying measure.

The track record of mega corruption in sub-contracting, poor implementation and operation plagues nearly all of PRC’s client countries. As delays mount, so will commitment charges on loans and accumulated rate of return. Similarly, political compulsions in accepting high-tariff tolls for every km of new motorways, willingness to substantially raise power, water and telecom tariffs in a historical subsidy regime, land acquisition hurdles, relief and rehabilitation of the displaced, high maintenance costs (owing to less than average material used and terrain), etc., could add manifold to the Chinese debt of a recipient country.

By Shantanu Bose

(To be concluded)