In China We Trust

Pakistan needs approval from both China and the IMF of its economic plans

Pakistan’s Prime Minister, Shehbaz Sharif, concluded a five-day official trip to China over the weekend. The highlight was his meeting with Xi Jinping, the President of China and the General Secretary of the Chinese Communist Party (CCP). ??

The timing of the trip is unusual, coming a week or so before the government is to present the national budget for fiscal year 2024/25. One would assume the Prime Minister would be too busy to undertake such an important foreign trip at this time. Yet, actually, this trip was about the budget. But before I get to that, it’s important to understand how China’s role as a key Pakistani ally has evolved over time. ?

Thank you, India

How did communist China under Mao in the 1960s become friends with a capitalist Pakistan closely aligned with the US in particular, and the West more generally? Well, we have our Eastern neighbour to thank for it.

In 1962, under Nehru, India made the strategic mistake of going to war with China (and losing) over the disputed region of Aksai Chin. This prompted the Chinese to view Pakistan in a new light: a potential military ally to keep India off balance. And thus it has remained since, whereby Pakistan and China serve each other’s security interests against a common military adversary. This is the reason why Chinese military assistance to Pakistan since the 1960s has remained broad-based and continuous, while that from the US has been sporadic and specific in nature. ???

Enter CPEC

The security-centric nature of the Sino-Pakistani relationship was transformed in 2015, when President Xi visited Pakistan to launch the China-Pakistan Economic Corridor (CPEC). Since then, about US$ 25 billion worth of Chinese investment has poured into Pakistan, mainly to set up power plants and build transport infrastructure.

In addition, China has lent Pakistan substantial sums as bilateral loans to support the latter’s balance-of-payments. As I detailed in File 02, China today is Pakistan’s single largest external creditor, although its share is much smaller than that of the debt held by Western multilateral institutions combined. Nevertheless, the fact is that whereas historically Pakistan only had the US as its sole external financial patron, it now has a second one in China.

The road to Washington through Beijing?

Instead of creating leverage, this has complicated things for Pakistan. The US and China are in open global competition for supremacy, which translates into a competition for influence in Pakistan – a nuclear power and the world’s fifth most populous country.

Pakistan now has to involve China - as one of its key creditors - in its plans for taking loans from the IMF. The government is engaged in discussions with the Fund for a sizeable new, multi-year loan programme. In these discussions, the IMF has reportedly asked Pakistani authorities to secure some debt relief measures from China to create fiscal space, which I believe was the real reason for Prime Minister Sharif’s trip. Specifically,

• The government may have asked China to restructure about US$ 15 billion owed to various Chinese entities that set up power generation projects under the CPEC.
• Spreading out these payments over a longer period will reduce some future pressure on foreign exchange reserves (helping limit depreciatory pressure and hence imported inflation) and allow the government to limit impending increases in utility prices during 2024-25, a key IMF condition.
• Pakistan is probably also negotiating to secure more bilateral loans from China, and roll over some existing ones, to fulfil its external financing requirements in 2024-25, for which IMF and other multilateral funding alone will be insufficient.

What to watch out for ??

• My assessment is that China will provide some concessions in the form of profits (for its firms) or interest payments (for its government) restructuring to Pakistan. This will help Pakistan secure a new IMF programme, likely starting in July.
• Although I don’t expect Pakistan to undergo a broader external debt restructuring exercise like Sri Lanka, one similarity with that case will be China’s willingness to support Pakistan’s engagements with its Western creditors to maintain external solvency. ?
• In return for all this, China is likely to push the current government to revive the CPEC project, which has largely remained stalled since 2018. However, I expect limited progress due to Pakistan’s large fiscal and current-account deficits, and Uncle Sam’s frown over the prospect. ??

About the author

Waqas A. Rana is a development economist and founding partner at Shared Pathways, an international development consulting and advisory firm. His core area of interest is the study of economic growth strategies for developing countries. Outside of work, he likes to read literature from around the world, lift weights, run, and hike. He can be reached at: [email protected]