One of Pakistan’s continuing challenges for the last seven decades has been economic management. Influx of huge amounts of American aid, waiver of Pakistani debts have been buttressed by Saudi largesse, 12 International Monetary Fund (IMF) low-interest loans and high-interest Chinese loans. However, Pakistan’s economy has yet to achieve stability.
For the last few years there have been those who view the China Pakistan Economic Corridor (CPEC), under China’s Belt and Road Initiative (BRI) as the panacea and way out for Pakistan.
On the occasion of Pakistan’s 72nd Independence Day, leading Pakistani-American economist, Atif Mian, Professor at Princeton, laid out – in a series of tweets- what are the challenges Pakistan faces and why CPEC is not a simple cure.
Dr Mian is John H. Laporte, Jr. Class of 1967 Professor of Economics, Public Policy and Finance at Princeton University, and Director of the Julis-Rabinowitz Center for Public Policy and Finance at the Woodrow Wilson School. He has taught at University of California, Berkeley and the University of Chicago Booth School of business.
Professor Mian’s work focuses on the connections between finance and the macro economy. His latest book, House of Debt, with Amir Sufi builds upon powerful new data to describe how debt precipitated the Great Recession. The book was critically acclaimed by The New York Times, Financial Times, The Wall Street Journal,The Economist, and The Atlantic among others.
We have reproduced those tweets below:
“On Pakistan’s Independence Day 2018, why is the country still far from economic independence? (e.g. seeking its largest bail out ever this year). I will focus on last 5 years as an example. It will get a bit technical but I will try to be clear. Economic growth is almost entirely a function of ‘domestic’ productivity growth. What matters is investment in building your institutions and people. Instead Pakistani governments have increasingly looked ‘outside’ in what I would call an attempt at “import-led” growth. It doesn’t work.”
“The idea is to borrow from outside, and task another country with building your infrastructure or institutions, and hope some magic others. The latest example starts in 2013, when PML-N comes to power and decides to outsource growth to China. I will explain why it doesn’t work. “When government funds large infrastructure projects through China’s Belt and Road Initiative (CPEC in Pakistan), the external debt rises from USD 62 to 90 billion. The borrowing raises domestic demand “artificially”, making Pakistan more expensive and less competitive globally. “This is a variant of the famous “Dutch disease” and Pakistan suffered an extreme version of it. Poof? Real effective exchange rate (Pakistani prices relative to trading partners) increased by 20 plus % and total exports did not increase over past 5 years. To make matters worse, Pakistan’s “in-law” finance minister strips away independence of the central bank and sets the terrible policy of keeping the exchange rate appreciated. Now Pakistan has the Dutch disease, on steroids.”
“Meanwhile there is a blanket ban on any objective assessment of CPEC. Ask a question, and you would be accused of conspiring against national interest. Media feeds the frenzy that it is a “game changer” and a big bubble develops in the port city (currently largely sand) of Gwadar. Real estate bubbles further artificially raise domestic demand, & given the senseless exchange rate policy, it makes the Dutch disease sclerotic. Notice we haven’t even gotten into whether the huge borrowing is “sustainable”, the damage is being done before any repayment is due.”
“So let us talk about debt sustainability now. The first thing to remember is, you are borrowing in dollars, while most revenue from the projects are in rupees (think domestic transportation use and local energy consumption). This is a big problem for two reasons. First, the whole enterprise is exposed to exchange rate (ER) risk. A future depreciation of the currency, which is almost certain to happen given the inane ER policy, will jeopardize profitability. Second, the country must generate sufficient additional exports to pay back, or else it will be forced to become poorer in order to generate an export surplus to pay back. This, again, makes things more difficult given the Dutch disease in the first place. Another big question on sustainability is that the borrowing and spending deals are highly opaque. No one really knows what’s going on. For example, what is the cost of capital in CPEC? A loan contract may report a “concessional” rate of 2%. But is it really 2%? Consider this: There is no open bidding and Chinese companies decide everything. They charge USD 100 for equipment, but put in place lower quality equipment worth only USD 80. Guess what, the “true” cost of capital just went up to (2+20)/80=27.5%! There is a lot China and Pakistan can gain from each other. But deals have to be structured properly, with proper macro-prudential framework. Unfortunately, none of that was done. The government wanted a shiny new road real bad before the next election, which they lost anyways.”
Prof Mian ends his thread of tweets with: “Let’s hope for better economic sense this time.”