OVER the past few months, greater transparency has led to more details emerging regarding some important aspects of the China-Pakistan Economic Corridor (CPEC). The transparency is much more institutionalised now, with at least two official and quasi-official websites dedicated to CPEC up and running, detailing the projects and their status. However, a lot of the required data and information is still available in a less structured fashion than desirable, with sketchy bits — which are sometimes contradictory — coming from the media.
Nonetheless, what is available has allowed analysts and commentators to make more informed assessments of at least two areas that have previously been flagged as being of concern: the impact of CPEC’s foreign exchange liabilities on Pakistan’s balance of payments, and the tariff of the power projects being set up.
Balance of payments: An estimate of the potential foreign exchange outflows on account of CPEC projects has already been worked out by Dr Ishrat Husain and appeared in this newspaper. According to Dr Husain’s estimates, the total outflow on account of debt servicing and profit repatriation (dividends etc) would amount to an incremental $3.5 billion annually. This would be in addition to the other, non-CPEC related foreign exchange outflows and liabilities that Pakistan will have to service or pay in the normal course of things.
My own estimates are broadly in line with Dr Husain’s, with the difference being that I have included the impact of imported fuel needed to run the power plants. According to official projections, a total of 8,910MW of electricity is to be added under the CPEC projects in the Early Harvest phase by 2022. (This total excludes non-CPEC projects such as the Resgasified Liquefied Natural Gas-based projects at Balloki and Bhikki, and the Neelum-Jhelum and Tarbela IV additions. Also excluded are the Gwadar and Rahim Yar Khan power projects for which no status or expected dates of completion are available). Of these, 6,240MW will be coal-fired out of which 2,640MW (the two Thar coal projects) is expected to be reliant on indigenous coal, while the rest will be based on imported fuel.
Two key concerns have been allayed by greater disclosure.
In addition, to arrive at estimates of the net outflow, I have also adjusted for savings on the import of furnace oil that will not be required once the more fuel-efficient coal-fired power plants come on stream and displace generation from the older, less efficient plants run on residual fuel oil (RFO). According to estimates from the Ministry of Water and Power, as well as the Planning Commission, up to 3,000MW could potentially be switched from power plants using RFO to the newer, coal-fired plants. However, I have conservatively used 2,000MW as the quantum of substitution.
Making assumptions on the plant factor (60 per cent), the international price of coal ($80 per short tonne) and oil ($50 per barrel of Brent), a capital structure of 75pc debt and 25pc equity, commercial debt in US dollars carrying all-in financial charges of 8.5pc with a seven-year tenor, and a guaranteed return on equity of 17pc in US dollars, the foreign exchange outflows generated by the CPEC projects are expected to be as follows:
Debt servicing will step up to an estimated $2.5bn a year by 2022 (including on the concessional government-to-government loans of $11bn for non-power infrastructure). Fuel imports will total approx. $200 million a year to run the plants, and if the savings on RFO import is incorporated, net fuel imports will be lower by over $1bn a year. Profit repatriation and other outflows (such as for operations and maintenance contracts and political risk insurance) are expected to total around $1bn per annum.
Put together, the overall impact of the CPEC projects on the balance of payments is expected to be an additional $2.2bn per annum. Even after making two key assumptions more adverse ie, increasing debt in the capital structure to 80pc, and raising the guaranteed return on equity to 27pc, the impact on overall outflows is not significantly higher, which rise by an additional estimated $200-300m.
It is important to recognise that this is the gross impact on the external account, without taking into consideration any positive effect on Pakistan’s exports or foreign direct investment inflows. Both these variables are expected to witness improvement, though the magnitude of the same can be a matter of debate.
The bottom line is that Pakistan’s balance of payments is not likely to come under substantial stress due to CPEC projects. What is likely to put the external account under strain is the quantum of non-CPEC related energy imports, mainly on account of import of LNG. This could run into several billion US dollars a year as Pakistan’s exploited natural gas reserves deplete sharply.
Electricity tariffs: Another concern widely expressed with regard to the power projects under CPEC is that they will produce expensive electricity. This perception has gained ground due to a lack of awareness regarding the exact terms of the power purchase agreements with the independent power producers being set up under CPEC. Details regarding the final tariff, the guaranteed rate of return on equity built into the tariff, and whether any explicit or implicit sovereign guarantees have been extended, are somewhat opaque and hard to locate. However, according to the Ministry of Water and Power, the average electricity tariff is likely to fall from 9.6 cents to around 9.1 cents as a result of the CPEC power projects. This should be a matter of relief to industry, especially the export sector.
Despite the positive news on two key areas of concern, there are other lingering concerns with the way the CPEC portfolio is structured and the way it has been ‘negotiated’. These will be addressed subsequently.
Published in Dawn, March 31st, 2017