A cautionary tale

CPEC is an opportunity to break out of a legacy of underperformance

A cautionary tale
The State Bank governor recently told Reuters that he was unaware as to how much of the projected $46 billion inflow for the China-Pakistan Economic Corridor was debt, equity and in kind. His comment, also corroborated by the director general of the Debt Office at a conference, is confounding, and has generated significant debate. A parade of the country’s economic experts, including Dr Hafeez Pasha, Saquib Sheerani and Wajid Rana, weighed in by raising serious concerns about the scale of Pakistan’s future indebtedness and its ability to service it. They point to the country’s feeble growth and propensity towards fiscal and current account deficits. As Pakistan is poised to begin implementing many of the CPEC projects, this controversy points helpfully to a broader issue of indebtedness and troubling lack of strategic leadership and operational coordination.

Let me explain from my layman’s perspective: countries with insufficient domestic savings (GDP–consumption) have no option but to raise growth capital in the form of equity or debt from foreign entities/countries willing to invest. This importation of foreign capital results in a current account deficit – not in itself a bad thing since it suggests that others are willing to risk their money in one’s country. Of the different types of repatriable foreign capital, foreign direct investment is considered to be the most stable, followed by portfolio investment into the capital markets (as it can be more easily liquidated) with countries shouldering greatest risk by taking on debt, and especially the short term variety. If the capital inflow is in the form of debt, the related investment must be prudent and productive so that it contributes to GDP growth, and enables revenues to be generated for its repayment. A country must therefore keep account of both the amount as well as profile of its investment inflows (equity or debt), its balance of payments and its foreign exchange reserves, in order to have the ability to service its foreign debt obligations. Note that I talk here about foreign debt configured in hard currency. Domestic debt is an easier problem to resolve, as governments can always print their own currency for repayment (but at the cost of generating inflation).

Dr Pasha’s circumspection is not misplaced. Debt induces vulnerability and history is replete with examples of countries taking on large amounts of external debt and sinking into insolvency. Greece comes most immediately to mind as a recent example.

When countries do get it horribly wrong, as did Greece, the harsh austerity that follows visits tremendous pain and misery on its nationals. Some of the statistics from Greece are astounding. In the three years from 2005 to 2008, Greece grew its GDP from $248 billion to $355 billion, at a CAGR in excess of 12% pa. Then, as its debt crisis unfolded and it faced higher borrowing costs, it regressed in the next 5 years to $238 billion. The country has effectively seen no growth in the last 10 years, has an unemployment rate of 26%, has sharply increased taxes and reduced pensions and has a debt of $350 billion to boot (this is after an estimated 50% haircut by the original bond holders following a debt deal in 2012!).


Greece, being part of the EU, was counted as a developed Eurozone economy and was given a lot of leeway to accumulate a stupefying level of private and public debt at low interest rates. Its government also famously cooked the books to gain entry into the Eurozone by hiding its budget deficit, which was actually more than 12.5% against the prescribed 3%. In the end, its story of excess may not have any direct parallels to Pakistan, but there are some interesting similarities as well.

The two economies are of a similar size in terms of nominal GDP. Hitherto, Pakistan has not been an efficient user of foreign capital and has technically skirted perilously close to insolvency on many occasions. Each time it has faltered, it has had to resort to an IMF stabilization programme to bail it out and concede its sovereignty in economic matters. Like Greece, Pakistan has an inefficient public sector and bloated civil/military establishment, which the country can ill afford given its small revenue base and an endemic culture of tax evasion and corruption.  Both countries also suffer from a low domestic savings rate and uncompetitive export performance. However, the saving grace is that in the last many years, our borrowings have not exceeded 65% of our GDP (currently $246 billion) and our foreign debt is presently just $65 billion. Hence our expansionary transgressions would appear timid by comparison. If anything, we should be more concerned about fixing rather than lamenting what has tended to go wrong.
There is far too much dependency on China

I do not pretend to be an economist, but my corporate experience posits that corporate governance and management concepts can just as easily be applied to a country, and indeed should be. For sure, new investments need to be carefully assessed for benefit and priority and then structured and modeled to ensure their viability.  Nevertheless, risks within acceptable limits will need to be taken rather than fearing what might be from an accountant’s narrow perspective. This needs to be followed up by a single-minded commitment to ensuring excellent implementation – an unrealistic expectation skeptics would say but I am banking on Chinese self-interest to drive efficiency and purpose.

Whilst CPEC provides us an opportunity to break out of this legacy of underperformance and feeble growth, it is merely an enabler and will not by itself ensure sustained growth and prosperityThree things need to happen. First, the government needs to quickly introduce policies to create a growth dynamic within the country that is in synergy with CPEC, but acts as an additional stimulus to the economy. Whilst energy shortages are crippling, their resolution post-2018 will not magically transform the country. Other than infrastructure, not enough is being done to reorient the economy towards efficiency and cost competitiveness.  Second, as things stand, there is far too much dependency on the Chinese driving the CPEC agenda, to the point of complacency. We must remember that whilst China is the funder and co-investor, the balance sheet is Pakistan’s and it is the government’s responsibility to drive strategy choices and ensure prudence. The financial authorities therefore need to be on top of their game. Third, the country’s best managerial resources need to be co-opted at the nuts and bolts level of policy implementation and given requisite authority to ensure that these new initiatives do not founder on the rocks of bureaucratic incapacity and lassitude. Speaking from personal experience, the government’s administrative machinery requires serious reform as it is woefully behind the curve and is now incapable of dealing imaginatively and competently with modern day challenges.

Finally, as a society, we need to stop working at cross-purposes and put a stop to overzealous and unfair “accountability” and destructive politics. This is leads to insecurity and indecision at all levels and saps all the positive energy from the country. On the contrary, consensus on a national development agenda and a commitment to nurture respected and independent state institutions is a prerequisite across the political spectrum. Media too has to own up to its responsibility by being better informed to influence ideas with integrity and play its role in bringing about constructive societal change. The final outcome, good or bad will be entirely our own doing.

The author is a former CEO of Dawood Hercules Corporation Ltd