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Saturday, January 28, 2023
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Why is CPEC stalling?

Expectations of CPEC have been high since its inception, but the impact so far has been underwhelming as CPEC faces major challenges in Pakistan. While CPEC has not received the attention it should have and progress has been slow, there is still time to take corrective actions and leverage the benefits of this program.

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The CPEC initiative, launched in 2015, was divided into two phases. Phase-I focused on energy, infrastructure, and the development of Gwadar and its port. Phase-II was directed at Special Economic Zones, industry enhancement, export orientation, and socio-economic development. The initial outlay for CPEC projects was $46 billion. This was subsequently increased to approximately $69 billion as more projects were added.

CPEC Phase-II began in 2018 with a focus on B2B collaboration, socioeconomic development, and agriculture. Target areas included the development of Special Economic Zones (“SEZs”), agricultural cooperation, public-private partnerships for business prospects and employment opportunities, and the relocation of Chinese industries into Pakistan; other foci were developing vocational training institutes, improving water supply, and providing health and education in remote areas of Pakistan.

A major component of Phase-II was the development of SEZs. It was expected that foreign investment would flow into Pakistan and would reverse the tide of de-industrialization that occurred over the last decade. The Government of Pakistan had announced incentives, including tax concessions, to attract private Chinese investment in Pakistan through joint ventures with local industry. While nine priority SEZs were identified, there has been progress so far on only four, namely: (i) Rashakai SEZ, (ii) Dhabeji SEZ, (iii) M3 Industrial Zone, and (iv) Allama Iqbal SEZ. Other target areas of Phase-II, particularly agriculture, have made almost no progress.

Read more: China rejects rumors of CPEC slowdown during PTI rule

Expectations of CPEC have been high since its inception, but the impact thus far has been underwhelming. There are a number of reasons for this, for instance, Pakistan lacks one window operation for setting up a business. To establish a company, Chinese investors need to go to the Board of Investment, Security and Exchange Commission Pakistan, the relevant ministry, and the State Bank of Pakistan, through the authorized dealer (the bank). This process, when successful, takes a minimum of eight to ten months and requires detailed documentation at each stage, much of which has to be notarized and counselorized by the Pakistan Embassy in Beijing. For Chinese investors, this is a painful process.

It was expected that with the formation of the CPEC Authority (disbanded by the current government), the one-window solution would be addressed. In fact, it made matters worse by adding yet another layer to approval processes. Moreover, the Pakistan Government currently lacks the capacity to expedite projects. Further disruptions are caused by constant personnel changes at the Ministries responsible for monitoring and facilitating CPEC projects.

Visa & security obstacles faced by Chinese professionals 

During the Covid-19 pandemic, travel was restricted in many countries, including Pakistan and China. In China travel was restricted till very recently. During these years, the work visas of many Chinese employees working on projects in Pakistan expired and could not be renewed without a mandatory visit to the Pakistan Embassy in Beijing. The Chinese companies and the Embassy of China raised this concern at multiple forums to the current and previous governments, including the Prime Ministers, but no progress was made. The work visas could not be issued.

Several Chinese workers stayed in Pakistan on a Business Visa instead. The hindrance is that any worker on a Business Visa cannot open a bank account and remit salary to the family in China through official channels. Chinese employees were getting salaries in cash and remitting money home using money changers. The inability of the Government to resolve this issue, despite the extraordinary circumstances, has proven disheartening for Chinese companies and employees in Pakistan. All relevant government departments like SBP, CPEC Authority, Ministry of Planning, Ministry of Interior, PM office, etc., were involved, but to no avail.

Security is a big concern for Chinese investors, both State Owned Enterprises (SOE) and Private Owned Enterprises (POE). More so for SOEs, as their governance structure indicates that the senior management is responsible for the project investment and personnel security for all projects overseas. This became a major issue due to the fragile law and order situation in Pakistan, with incidents involving serious injuries and loss of lives of Chinese citizens. Furthermore, the Chinese citizens staying in Pakistan were confined to their residences and only allowed to go to certain locations deemed safe, such as Dolmen Mall in Karachi or Packages Mall in Lahore. In many cases, offices and residences were set up on the same premises to minimize movement.

Read more: Chinese experts halt work on KP projects due to security threat

This volatile law and order scenario not only created anxiety, frustration, and fear amongst the Chinese professionals and investors resident in Pakistan but also discouraged additional investment.

Slow progress on Special Economic Zones

The subsidies and other incentives outlined in the SEZ Act have not been appropriately formalized (SROs have only been issued for some by the FBR), especially in the case of the Gwadar Free Zone. The provision of utilities and key infrastructure to SEZs was the responsibility of the Pakistan Government: these have either not been provided at all or not provided in time.

In the case of the Allama Iqbal Free Zone, the factories being set up have their own power generation and gas provision arrangement, increasing the cost of doing business. In certain cases, the land area committed was not provided: for example, the land allocated to the Gwadar Free Zone is less than what was committed in the Concession Agreement.

As noted earlier, thus far no system has been put in place to facilitate the approval processes at any government department. Rather, approval from the management of each SEZ has been added as another layer to the already cumbersome processes for approvals.

Energy sector issues discouraging investment

While the energy projects initially gained traction, various issues have impeded further investment in energy-related projects.

Rising Circular Debt levels (currently standing at about Rs4.2 trillion for the entire energy sector, with approximately Rs2.3 trillion attributable to the power sector) have proven to be a major roadblock in terms of the overall Chinese interest in Pakistan’s energy sector. Dues to CPEC power sector projects as of September 2022 stood in excess of Rs220 billion.

After the issuance of the power sector investigation report in April 2020, the Government of Pakistan took unprecedented steps to renegotiate tariffs and existing power purchase agreements, adversely impacting foreign investor confidence, and raising concerns about the long-term contract sanctity.

In addition, the Government’s delayed implementation of some of its commitments under the CPEC Energy Cooperation Agreement, such as the establishment of the revolving account, delayed for over eight years, has also caused concerns. A revolving fund has finally been established, with Rs50 billion, named “Pakistan Energy Revolving Account” in December 2022 to conform with the CPEC agreement.

Read more: Halting the subversion of CPEC

Owing to the current economic turmoil and precarious foreign exchange reserve situation, most of the IPPs that have been in operation for the past three or four years are unable to repatriate dividends. These include major projects such as EPTL, Port Qasim, and Sahiwal Power Project.

In certain cases, the land area committed was not provided. For instance, the land being provided for the Gwadar Free Zone is less than what was committed in the concession agreement.

Lack of support for Chinese currency

Chinese companies, particularly within the SEZs, recommended that the Government of Pakistan allow them to have RMB accounts for specific purposes. For example, to be able to retain equity in RMB to source machinery or equipment from China. The conversion into PKR of equity proceeds and reconversion into RMB to pay for capital equipment has resulted in a minimum 1% loss due to the difference in bid-offer prices and remittance charges.

For example, on a transaction of ¥100 million, would involve a loss of ¥1 million, which is a significant amount. This is not accounting for any devaluation of PKR against RMB. The government proposed to Chinese companies that they change the SEZs into Export Processing Zones, along the lines of the Karachi Export Processing Zone. Such a change would require modification of the concession agreements and perhaps reinitiating of the permissions from Chinese authorities, including the National Development and Reform Commission (NDRC) and the State Council of China.

Major projects like ML-1 have not reached any maturity over the last five years.  The government had its own view on how the project should be conducted and went through multiple rounds of discussions without arriving at any conclusion. Currently, the government has put it on its priority list, but no substantial progress has been made. The situation is the same for projects like Karachi Mass Transit and Karachi Circular Railway.  Delayed and changeable decision-making by the GOP has reduced the interest of Chinese companies.

While Pakistan’s dependence on China for budgetary support and commercial and infrastructure investment has increased multi-fold, Pakistan has not moved forward with the direct pairing of PKR and RMB, despite repeated requests by the Chinese government. 28 countries, including Turkey and Malaysia, have a direct pairing of RMB with their respective currencies, but Pakistan still does not. The Government of Pakistan has requested more support from The People’s Bank of China (PBOC) through the RMB swap agreement but has not moved to enable Pakistani importers and exporters to use RMB.

Read more: Pakistan to trade in Chinese currency?

For example, while exporters can avail of ERF in USD, they cannot do so in RMB. In today’s environment, Shanghai Interbank Offering Rate (SHIBOR) is about 2% cheaper than LIBOR, hence exports into China in RMB would result in a lower cost of ERF for exporters and a lesser subsidy required from The State Bank of Pakistan. Pakistan needs to consider moving its exports to many Asian countries in RMB rather than USD. This would generate substantial goodwill and save on ERF financing.

China’s unwavering support to Pakistan

Despite all the issues outlined above, private sector investment has been coming from China in various sectors such as crockery, tile manufacturing, mobile phone manufacturing, and pesticides. These entities have set up factories in Lahore, M3, and Allama Iqbal industrial zones, where they have set up stand-alone units with their own power generation and gas supplies. Over 20 factories have been set up and more are in progress, each employing more than 500 local workers.

They continue to face challenges like security concerns and foreign exchange availability. Given the current restrictions on imports, some factories have had to curtail production due to the non-availability of raw materials and are now operating at less than 50% capacity. If the environment were to improve, we can see these factories expanding and exporting their products to regional markets.

While CPEC has not received the attention it should have and thus progress has been slow, there is still time to take corrective actions and leverage the benefits of this program. Tough decisions are necessary to bring about structural reforms and for the creation of policy frameworks that ensure not just the success and sustainability of CPEC, but also to attract the much-needed FDIs in Pakistan.

China’s support and its unwavering commitment to the betterment of Pakistan and its people are and must be truly appreciated.

Read more: CPEC: How it will impact Pakistani society?

The article is written by Sultan Allana in collaboration with Farhan Talib and Aliya Iqbal Naqvi. Sultan Allana is Chairman of HBL Ltd, Pakistan’s largest bank and the first one that was allowed branches in China and conducted transactions in Chinese currency.