China should ensure Pakistan doesn’t face financial crisis

China should ensure Pakistan doesn’t face financial crisis

Song Shengxia,

While Pakistan’s fast growing economy has made it a darling for foreign investment, the surge in the country’s fiscal deficit and public debts has increasingly become a source of concern for international investors and has led to doubts about its capability to repay its debts. Given the massive investment that China has made in the country as part of the China-Pakistan Economic Corridor (CPEC), China has a vested interest to ensure that the rising fiscal deficit in Pakistan not snowball into a major financial crisis. China should work closely with Pakistan to make sure that the projects it has invested in can generate tangible growth in Pakistan’s real economy, help the country properly manage its deficit level and put it on a sustainable growth path.

According to a recent report by Pakistan newspaper Dawn, Pakistan’s fiscal deficit surged to around 2.4 percent of GDP during the first half (July-December) of the fiscal year 2016-17, the highest in four years. The figure exceeded the 1.7 percent deficit-to-GDP ratio registered in the first half of the previous fiscal year when its full year deficit hit 4.6 percent. In 2014-15, the half-year deficit stood at 2.2 percent and full-year deficit at 5.3 percent. The government hopes to keep the deficit below 3.8 percent of the GDP during the full 2016-17 year.

There is broad consensus that the deficit ratio should not exceed 5 percent of GDP for developing countries otherwise it could lead to a sharp rise in the debt level and put pressure on the country’s currency to depreciate. The situation could lead to a vicious cycle where the downward pressure on the currency pushes up inflation, which further drives the currency to depreciate and induces a debt crisis. Pakistan’s deficit issue underlines the government’s weakness in controlling expenditures and generating revenues and should not be overlooked. There are lessons to be learned from the past, one of the most recent being Mongolia, who became mired in a debt crisis as its fiscal deficit climbed to around 15 percent of GDP in 2016, which has made it hard to repay foreign debts.

The worst-case scenario is the last thing China would desire in Pakistan. A surge in the country’s deficit would make it vulnerable to external shocks and would increase Pakistan’s chances of a debt default. As a major creditor and the largest investor in Pakistan, China has an obligation to safeguard its investments in Pakistan and ensure it can recoup its loans. More importantly, a majority of the projects China financed in Pakistan are part of the $51 billion CPEC, a flagship project of China’s One Belt, One Road initiative, which aligns the political, economic and strategic interests of both China and Pakistan. China cannot afford for these projects to fail financially.

China needs to develop a plan to help Pakistan properly manage its deficit and reduce an excessive build-up of debt. To do that, China and Pakistan should effectively implement the CPEC project, make it more inclusive and prevent inefficiency and corruption from undermining the project. Pakistan should also seize the opportunity to expand its economic base and boost the real economy in order to achieve long-term debt sustainability.

Meanwhile, China may need to diversify its ways of financing the CPEC projects. Currently, many projects are financed by Chinese government concessional loans. It is unrealistic and unsustainable to pin all hopes on government loans from China. Such a lending model is likely to drive up the debt level of the recipient country and toss it into a vicious cycle of inflation and currency devaluation. After all, economic and fiscal sustainability cannot be achieved by relying on concessional loans and aid. That requires China and Pakistan to develop a marked-based model to finance these projects and improve loan efficiency.

Additionally, one of Pakistan’s biggest challenges is the widening current account deficit which expanded to 90 percent in the first seven months of 2016-17. The ballooning current account shortfall reflects Pakistan’s growing trade gap with the rest of the world and that the country is seeing more capital outflows than inflows. As such, the country is in urgent need to boost its exports to reduce its trade deficits and develop manufacturing to attract foreign investments.

To be fair, given a GDP growth of almost 5 percent, there is still great potential in Pakistan. Financial magazine Barron’s Asia called for investors to forget India and instead profit from the “quiet rise” of Pakistan along with Sri Lanka and Bangladesh. Fitch Ratings recently put Pakistan’s long term default ratings at stable outlooks. It is possible for Pakistan to avoid a major debt crisis but it needs to work hard to improve its investment environment, launch fiscal reforms and curb corruptions without impeding economic growth in order to bring the economy on a sustainable path.



SOURCEGlobal Times