ISLAMABAD -- The uncertainty of an election in Pakistan tends to give the markets a prolonged case of the jitters. As the country prepared to vote in 2013, the rupee fell sharply, leading Pakistan to turn to the People's Bank of China for help. After China transferred almost $600 million into the depleted coffers of the Pakistani central bank, the sell-off abated.
Fast forward five years to the eve of the national elections this summer, which ushered former cricket star Imran Khan into office. China stepped in once again, extending its currency swap agreement with Pakistan and raising its line of credit, and another pre-election sell-off of the rupee was halted.
"The swap was our secret weapon" in 2013, recalls the then-head of the State Bank of Pakistan, Yaseen Anwar. "I brought in so much money to shore up the defense of the rupee."
The pre-election interventions were reminders of China's status as Pakistan's top trading partner and "all-weather friend." But once the voting was finished, the dire realities of the Pakistani economy remained.
Khan began his administration frantically seeking loans from Saudi Arabia and other gulf nations in hopes of avoiding a harsh bailout from the International Monetary Fund. But after failing to find alternatives, Pakistan was forced on Oct. 11 to ask the IMF for up to $12 billion in economic assistance -- marking the country's 13th bailout. The rupee dropped sharply ahead of the formal announcement.
The IMF request was made despite vocal opposition from Pakistan's former best friend, the U.S., which is also the fund's largest shareholder. U.S. Secretary of State Mike Pompeo had voiced hostility to an IMF package on the -- inaccurate -- grounds that the bulk of any financial assistance will go to repay Pakistani borrowings from Chinese banks.
Pompeo's comment came after months of tensions between the Trump administration and Pakistan. In the eyes of most Pakistanis, the U.S. is no longer the big brother it once was. The question that remains unresolved, however, is the extent to which Beijing has replaced Washington in the affections of the people of Pakistan. Is it a true friend, or just another colonial master, albeit one with an Asian face?
"Are they merely giving us fish, or are they giving us a fishing rod?" asks a senior executive with one of the biggest local banks in Karachi, referring to the traditional Chinese adage that it is better to enable people to provide for themselves than to give them handouts, creating a long-term relationship built on dependency.
Pakistan is by far the biggest beneficiary of Chinese largesse. The China Pakistan Economic Corridor alone, which is part of the mainland's Belt and Road Initiative, involves $62 billion of projects in the next few years. That amount is equivalent to some 20% of Pakistan's GDP last year, according to calculations from Nomura, and will potentially add 2.3 million jobs and an additional 2 to 2.5 points of GDP per year as the projects come online.
"Are they merely giving us fish, or are they giving us a fishing rod?"A senior bank executive in Karachi on China's intentions
But that is only part of the economic relationship between the two countries. Chinese money, Chinese companies, and Chinese people do everything from collecting the garbage in Pakistan's largest city of Karachi to providing the energy-poor country with desperately needed power plants.
Mainland companies are also building the port of Gwadar on the Arabian Sea, a road connecting that port to the Chinese border town of Kashgar and optic fiber cables that run beside it. Gwadar and its infrastructure will soon give the western provinces of China better access to the sea, and enable its ships to bypass the chokepoint at the Strait of Malacca.
To what extent, though, do these projects come with strings attached? The relationship is hardly an equal one. For every $1 to $2 of exports that go from Pakistan to China, China exports $5 to Pakistan, according to Asad Umar, Minister of Finance. Pakistan sells raw cotton and yarn to its big neighbor and buys shawls and sweaters in return.
It ships out cheap flip-flops and sandals and brings in expensive running shoes. Indeed, virtually the only input into Chinese-constructed infrastructure projects that is sourced locally is cement, which is too heavy and too low value-added to transport across great distances.
Pakistan's trade with China is symbolic of an economy that in many ways is going in reverse. Pakistani exports are down at least 20% from the peak in 2013, when they totaled roughly $25 billion. Its industry was once seen as more developed than India's but today Pakistan is being eclipsed by its larger neighbor and fast-growing rivals. Vietnam has increased its exports sevenfold in the last 15 years, while Bangladesh, once the basket case of Asia, has doubled its exports.
Pakistan's main exports are textiles and raw cotton, but it does not make higher value clothes -- despite the fact that it is capable of producing gorgeous fabrics and embroidery. Why does Pakistan not aspire to produce high-end clothing like Italy rather than basic garments like Bangladesh?
"Customers won't come to Karachi," says Mohammed Zaki Bashir, the CEO of Gul Ahmed Textile Mills. This is mostly due to security concerns.
Moreover, many businessmen, including those at the Pakistan Business Council, say the country's dismal trade figures don't accurately capture the scale of the imports from China as a result of misdeclarations and underinvoicing. For example, roughly 1.4 million motorcycle engines come from the mainland every year, but the official data only registers an implausible few dozen.
"We have become an import-from-China country," says one member of the Pakistan Business Council. "We are being wiped out."
Pakistan's GDP growth was a solid 5.8% in 2017, but its foreign reserves have been falling sharply in part because of its dependence on imports. This has made it increasingly difficult for Pakistan to repay its debt.
Miftah Ismail, a former finance minister, shares some of the concerns of many businessmen and politicians. Today, he sits in Karachi running his family's candy business. His candy-making machines are from Holland, even though the cost of Chinese equipment is half that of European manufacturers. "We all fear that when [the Chinese] scrap their factories at home, they will send them to Pakistan, and they will all be obsolete, inefficient, energy intensive and polluting," he says.
Debt trap diplomacy?
But the biggest concern for Pakistan's finances when it comes to China has to do with the fact that Chinese infrastructure projects aren't done gratis. They are largely financed with debt, not with equity.
Already some government officials are taking actions to reduce the future burden of Chinese debt. The railways ministry recently announced China's investment in Pakistan's railways had been cut by $2 billion. "Pakistan is a poor country that cannot afford huge burden of the loans," Sheikh Rasheed Ahmad, the railways minister, said, according to local press reports.
Abdul Razak Dawood, the cabinet minister in charge of commerce, industry and investment, says he favors extending the longevity of CPEC's ambitious timetable.
To be sure, the cost of that borrowing is far lower than it would be were these projects to be financed by local loans or Pakistan's underdeveloped capital markets. Still, it isn't clear how concessional the terms of much of that financing is in part because little of it is transparent.
"We don't understand the actual cost of the financing," admits the head of one international organization in Islamabad.
Even Umar refers to the lack of transparency when it comes to the amount of borrowing, as well as the terms and conditions, although he claims that the demands are not exorbitant. That in turn has given rise to widespread fears that Pakistan is being exploited -- a prime case of what Washington calls China's "debt trap diplomacy."
Pakistan is "by far the largest country at high risk" of all 68 countries that are recipients of Chinese Belt and Road capital to have issues with sustainability of that debt, according to the Washington-based Center for Global Development. That could result in potential balance of payments issues and pressure on the rupee.
"We Pakistanis need to be smarter," says the head of one international bank in Karachi, pointing out that some projects involve 17% government-guaranteed returns -- in U.S. dollars. "These problems are self-created."
That is especially the case with the Free Trade Agreement between the two countries. "There is a lot of heartburn," concedes Umar, the finance minister. "We did not do our homework. China did better homework than we did."
"We need a more level playing field," adds Dawood, the commerce minister. "We can't go on building this and that while our exports are not going up. We need to improve our current-account deficit and get our trade gap to a more reasonable level."
"Almost all the debt is from Western sources. China never put a gun to our head"Pakistan Finance Minister Asad Umar
Umar stresses that "Pakistan has an unsustainable debt problem -- not a China debt problem. Almost all the debt is from Western sources," he adds. "China never put a gun to our head."
Ismail, the former finance minister, is more hopeful. He notes that the duration of much of the debt from China is 25 years with a five-year grace period and a rate of 2%. The annual bill is less than $1 billion for the next several years, he calculates. "That won't break us," he adds. "By the time we have to repay more, we will also have received more investment. These projects will pay for themselves."
The Alibaba effect
Beyond the debate, China is already reshaping Pakistan in vital ways, including in the financial system. At Habib Bank, the biggest local bank, customers can now choose to finance their trade with Chinese entities in yuan rather than dollars, a prospect sweetened by the fact that the central bank will provide currency hedges. By contrast, for customers using dollars, the only choice is to go to the market for protection against adverse currency moves.
Habib Bank has a branch in Urumqi in western China, and will soon have another in Beijing. It also has close relations with the two Chinese banks that have branches in Pakistan, Industrial and Commercial Bank of China (ICBC) and Bank of China (BOC). "There is a desire for an alternative to the use of the U.S. dollar as a reserve currency in Asia on the part of China. ... We are happy to help wherever we can," says one of the bank's top executives.
When Islamabad officials talk about China's potential contribution to their country, they tend to think in terms of the mainland government and the big state-owned enterprises, such as China Railway Construction, China State Engineering Construction and China Mobile.
But the companies that could really help transform Pakistan are actually China's tech giants.
For example, Umar is planning a trade fair in China for early November to introduce potential Pakistani exporters to mainland importers. In May, Alibaba Group Holding bought Daraz, the biggest local e-commerce platform, from Rocket Internet, paying about $200 million in the process.
But at a time when most foreigners are reluctant to venture into Pakistan, a virtual marketplace bringing the two sides together can be far more effective than any government-orchestrated initiatives, especially since Alibaba is all about bringing small and midsize enterprises together.
In March, Alibaba's affiliate, Ant Financial, paid $184 million for a 45% share in Telenor Microfinance Bank, the premier small lender in the country, providing microfinance and related financial services to the unbanked. TMB developed Pakistan's first and largest mobile banking platform, Easypaisa.
The transaction is expected to close next month. In a country where only about 15% of the population has a bank account and there are just 60,000 residential mortgages, such an initiative can make a huge difference in pushing financial inclusion.
More importantly, where Alibaba goes, others follow. Karachi is abuzz with rumors of the latest local companies its great rival, Tencent Holdings, is considering backing.
To some extent the debate about whether China's role in Pakistan will prove positive for both sides is moot. Pakistan has few alternative options -- and they are all less attractive.
Khan admitted as much the night of his election: "Our neighbor is China, we will further strengthen our relations with it," Khan said as he declared victory in a televised statement. "The CPEC project which China started in Pakistan will give us the chance to bring in investment to Pakistan."
Moreover, at least today, there are more urgent worries. Prime Minister Narendra Modi of India faces voters next year, increasing the odds of anti-Muslim rhetoric, whether those Muslims are within India or across the border.
Pakistan is also in danger of becoming collateral damage in the U.S.'s efforts to isolate China. Executives at international organizations say they are under American pressure not to work with institutions like the Beijing-based Asian Infrastructure Investment Bank.
The sad truth is that Pakistan is still not strong enough to set its own course. "If we get our own house in order by ourselves we would not need external support," says Ishrat Hussain, who is an economic adviser to Khan and a former governor of the State Bank of Pakistan.
But that is not likely anytime soon.