The China-Pakistan Economic Corridor, or CPEC, has been the focus of heated debate among observers of Asia — and, in particular, South Asia — since its announcement in 2013. Proponents of the project in China and Pakistan describe CPEC as a “gamechanger” that will uplift Pakistan and adjacent areas of China and perhaps even reshape the economic geography of the region. Critics of CPEC in India, the United States, and other Western countries portray it as a Chinese or Chinese-Pakistani strategic project with an economic facade.

The reality of CPEC, however, is far more complex. To address these misconceptions, here’s a primer on CPEC that responds to frequently asked questions about the initiative.

For a timeline of the “pre-history” of CPEC, click here.

What Is CPEC?

CPEC has been billed as a “$62 billion” economic connectivity initiative linking China’s landlocked western region of Xinjiang with Pakistan’s Arabian Sea ports: Karachi, Port Qasim, and Gwadar. (The CPEC “routes” are depicted in the map below.) Beijing has described CPEC as a “flagship project” of its broader Belt and Road Initiative or BRI. However, the size of CPEC remains in flux. And its relationship to the Belt and Road is unclear.

As of early 2019, approximately $18.9 billion in CPEC projects had been initiated or completed. So we can safely say at the moment that the value of active projects within the CPEC portfolio is in the tens of billions of dollars. And that’s a lot of money for a country like Pakistan, which has struggled to sustain foreign direct investment.

Since the announcement of CPEC in 2013, some projects have been added to the portfolio, while others have been removed.

Whether CPEC will reach or exceed $62 billion is not only uncertain, it’s also not that important. What is more important is the quality and impact of Chinese aid and investment — more specifically, whether they catalyze greater productivity in Pakistan, bolster and expand the country’s exports, and help drive sustained, rapid, and equitable economic growth, which has been elusive so far for Pakistan.

How Is CPEC Part of BRI?

Chinese officials have identified CPEC as a “flagship project” of the Belt and Road Initiative. But how exactly CPEC factors into BRI remains unclear. Beijing hasn’t explained what it means for CPEC to be a “flagship project” of BRI, though the term clearly connotes at least some symbolic importance for CPEC. The historic closeness of China and Pakistan is likely one reason why the corridor has been given such a status.

The decades-long partnership between the two countries confers expectations that CPEC should easily succeed. And there are reputational costs for Beijing should CPEC fail or be seen as failing.

However, beyond the realm of perceptions, there is little indication that CPEC alone will make or break the Belt and Road Initiative. The BRI has grown so amorphous, extending beyond its initial focus of Eurasia and Africa to the Arctic, South America, and even space. Indeed, some today see BRI as a grand strategy for China, though the motivations of actors in China — including provincial governments and state-owned enterprises — are diffuse. While CPEC’s scope is evolving alongside that of BRI, there’s a lot of redundancy built into the Belt and Road, and so it’s unclear how CPEC relates to other BRI corridors.

And while CPEC is said to be a “corridor” connecting China and Pakistan, we see little public discussion of what is being built on the Chinese side of the border. The projects included as part of the CPEC portfolio are all Pakistan-based.

What Are the CPEC Projects?

Presently, electric power projects make up the bulk of the CPEC portfolio, in terms of project costs. Formally, these projects are private investment, but the Pakistani state is indirectly liable for them, as explained in the next section.

The vast majority of these electric power projects are coal-fired power plants. CPEC’s emphasis on coal was in line with the national energy policy of the Pakistan Muslim League – Nawaz (PML-N) party, which ruled the country from 2013-18. The current coalition government in Islamabad, led by ex-cricketer Imran Khan, has emphasized a shift toward cleaner energy sources, and in particular, hydroelectric power.

Most of the remaining CPEC projects are road and rail infrastructure, which are primarily funded by sovereign loans. These infrastructure projects include a section of the Karachi-Lahore Motorway, a controlled-access highway connecting Pakistan’s two largest cities, and a realigned section of the Karakoram Highway, which links northern Pakistan to China. There are also two main rail projects: a commuter rail line in Pakistan’s second-largest city, Lahore; and a revamped main railway line (known as the ML-1), which stretches from Karachi to Peshawar, near the border with Afghanistan.

The CPEC projects that have gained the most attention relate to the port of Gwadar, located on Pakistan’s southwestern edge, in close proximity to Iran. In 2013, before CPEC’s launch, leasing rights for the Gwadar port’s commercial operations were transferred to a Chinese company. Through the CPEC framework, an expressway bypassing Gwadar’s residential areas connecting straight to the national highway network is being built. A free zone is being built. There are plans to build additional berths at the port. And a new international airport will be constructed.

The CPEC portfolio also includes a digital component — an optic fiber line from Xinjiang to northern Pakistan — linking to what China has branded as the “Digital Silk Road.”

Is the Pakistani Government Taking Out $62 Billion in Loans from China?

No, the Pakistani government is not taking out $62 billion in loans from China through CPEC. According to the World Bank, around 30 percent of CPEC expenditures is through loans taken out by the government of Pakistan. The vast majority — the electric power projects — is technically private investment. Independent power producers or IPPs — not the government of Pakistan — have taken out loans from banks to construct power plants in Pakistan. These IPPs are generally single-purpose vehicles in which a Chinese state-owned enterprise is at least the majority shareholder. And Chinese banks are doing the financing.

However, while the IPPs are directly liable for the loans, the government of Pakistan is indirectly liable. CPEC power plants are constructed through long-term power-purchasing agreements or PPAs. The Pakistani government is contractually obligated to purchase electric power from IPPs and even compensate them for idle capacity (i.e. capacity payments).

For the IPPs to repay their bank loans, they must receive payment for the power they’ve supplied to Pakistani government-owned regional distribution companies or DISCOs. But Pakistan’s electric power and broader energy systems have been plagued by rampant non-payment of bills, blatant theft by consumers, and a dilapidated grid.

Pakistan’s electric power sector is based on a “single-buyer model.” That single buyer is the government of Pakistan. But in recent decades, the industry has been unbundled and partially privatized. As Pakistan has built up electric power capacity to address growing demand, it has failed to address inefficiency, non-payment, and theft in the system. As a result, inter-company arrears — known in Pakistan as “circular debt” — have become an endemic problem. Pakistan’s circular debt, including payments owed to CPEC and non-CPEC IPPs, stood at $12 billion as of mid-2020 and could reach $25 billion by 2025. The circular debt, in other words, is a ticking time bomb. It will worsen as Pakistan builds up expensive electric power capacity through CPEC and outside of CPEC and does little to drive prices down and reform the system.

Will CPEC Boost Pakistan’s Economy?

Sustained, rapid, and equitable economic growth has proved to be elusive in Pakistan. And CPEC alone will not put Pakistan on that trajectory.

At the moment, CPEC is about building Pakistan’s capacity in infrastructure and electric power. While CPEC inflows did contribute to a rise in economic growth in Pakistan from 2015-18, culminating in a rate of 5.8 percent in the 2018-19 fiscal year, it exacerbated the disequilibrium or imbalance in the economy. CPEC contributed to a rise in imports (machinery and material for electric power plants and road construction) as exports not only lagged behind, but actually dropped in much of this period. The resulting balance of payments crisis forced Pakistan to return to the International Monetary Fund for the twenty-second time in 2019.

As I explained in 2018 for the South China Morning Post, Pakistan’s poor economic policies — not CPEC — were the cause of Pakistan’s current economic crisis. CPEC merely exacerbated the structural imbalances in an economy whose growth has been driven by consumption and government spending.

Boom-bust cycles are a feature of the Pakistani economy, as Masood Ahmed, president of the Center for Global Development, explains clearly in this brief. Growing domestic consumption, public spending, and inflows of aid (and, to a lesser extent, investment) drive Pakistan’s growth rate higher. Exports and foreign direct investment lag behind, causing stress on the current account. The imbalance between imports and exports grows and Pakistan — a net-energy importer — struggles to find the dollars to pay for its imports. To avert a default, Pakistan then turns to the IMF and is compelled to compress economic activity (i.e. slow down the economy).

Policy and institutional reforms are necessary for Pakistan to escape this cycle of boom and bust.

As I wrote for Foreign Policy earlier this year:

“The country’s import tariff policy, currently focused on revenue-generation and protecting low-productivity local companies, should be reformed to promote value-added exports. And Pakistan needs to enact legal and regulatory reforms that protect investors, allow for transparent dispute resolution, and encourage investment from beyond China.”

Alongside these reforms, electric power rates in Pakistan (through CPEC and non-CPEC IPPs) need to go down to make Pakistani exports more competitive. Special economic zones planned through CPEC can also serve as vehicles to grow and diversify Pakistan’s exports. But foreign companies are more interested in accessing Pakistan’s large domestic consumer market than leveraging Pakistani labor to export goods to third-party countries.

Is CPEC a Form of Debt-Trap Diplomacy?

There is little public evidence today that China aims to entrap Pakistan in debt and gain strategic concessions in exchange for debt relief. In at least one instance, China discouraged Pakistan from considering an infrastructure project it could not afford. Khawaja Saad Rafique, a previous railway minister in Pakistan, said that in the early stages of CPEC’s planning, Pakistani officials asked Beijing to construct a bullet train in their country. Chinese officials, he said, “laughed at us.”

Both countries have instead moved forward with upgrading the main railway line by more than doubling its speed from 40mph to 100mph. The financing terms for that project, the ML-1, have yet to be finalized. But it would be the single most expensive project in CPEC and vastly increase the debt the government of Pakistan is taking on through CPEC.

The size and questions about Pakistan’s ability to handle the fiscal burden have delayed the ML-1. And the cost estimates for the project have fluctuated from $7.2 billion when it was originally announced, later growing to $9.2 billion. More recently, it has dipped to $6.8 billion.

Beijing has opposed multilateralizing the ML-1 project, which is described as “strategic” by Chinese and Pakistani officials. The terms of Chinese financing may reveal their intent. If loan terms are adjusted to allow for a 20-year grace period, then the debt will become much more manageable for Pakistan. However, if China insists on earlier repayment, with a 7-10 year grace period, then a “strategic” project financed and constructed by Beijing alone under somewhat onerous terms would give weight to the debt-trap narrative.

What Is the U.S. Position on CPEC?

U.S. officials initially welcomed CPEC, but now the project has become enmeshed in the emerging U.S-China Cold War. In 2016, a spokesperson for the State Department said that CPEC “could contribute to stability and prosperity in Pakistan and the region.” However, the Trump administration took a more critical posture toward China and BRI upon coming into office. Several senior U.S. officials have since used the example of CPEC to criticize Beijing’s alleged predatory practices and flouting of global norms under BRI.

In October 2017, then-U.S. Secretary of Defense James Mattis alleged that CPEC runs through “disputed territory.” Months later, Mattis declared “great power competition” and the rivalry with “revisionist states” like China and Russia as the focus of U.S. national security. And in late 2019, then-Acting Assistant Secretary of State for South and Central Asia Alice Wells gave a public address singularly focused on CPEC. She said that Chinese-funded projects lacked transparency and rely “primarily on Chinese workers and supplies” and contrasted it with an “American” model of aid that she claimed was more responsible, sustainable, and transparent.

Posted by Arif Rafiq

Arif Rafiq is the editor of CPEC Wire. He is president of Vizier Consulting, LLC, a political risk advisory company, and a non-resident fellow at the Middle East Institute. Rafiq authored the first comprehensive public study on CPEC, "The China-Pakistan Economic Corridor: Barriers and Impact," published by the U.S. Institute of Peace. He can be reached via email at [email protected].

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