The China-Pakistan Economic Corridor (CPEC) is moving through a hilly path. First, Islamabad recently decided to take the USD 14bn investment in the Daimer-Bhasha dam out of the CPEC and announced it will ensure the financing by its own means, i.e. giving up the Chinese involvement in this touchy project located in Pakistani-controlled Kashmir. The official explanation put forward by Islamabad would refer to too harsh financing conditions from Chinese groups. Secondly, in early December, the Chinese embassy warned its 30,000 nationals based in Pakistan of increasing threats of terrorist attacks against them. A few low-key attacks have hit Chinese nationals earlier this year.

Impact on country risk

The CPEC is a major strategic and economic piece of China’s OBOR (One Belt, One Road) initiative. Recent events have highlighted the risks OBOR is likely to be confronted with in the future. At a security level, the CPEC goes through the Balochistan region and is a target for attacks by Baloch and Sindhi separatists, IS militants and Pakistani Taliban. Until now, their capabilities remain limited but they might grow in the medium term. The security warning is probably intended for Islamabad in order to flesh out its already strong 15,000 security forces around the CPEC. Also, the latter faces external opposition, chiefly from India which is suspicious about the Chinese presence in Pakistan, particularly in Gwadar, near the Indian Ocean.

At the economic level, financial sustainability of some projects and their impact on the domestic economy can be questioned. Although the CPEC drives the acceleration of real GDP growth and will contribute to addressing Pakistan’s wide infrastructure and energy bottlenecks, it also leads to a fast deepening of the current account deficit (via heightened imports), a decline in foreign exchange reserves (-21% since the end of 2016), depreciation pressures on the rupee (-4% against the USD in the past days), and it fuels external debt. The CPEC’s resulting rising economic imbalances might thus become unpopular and politically troublesome as they might force Pakistan to request an unpopular IMF programme again, preferably after the summer 2018 general elections.

Despite the latest setback that might be followed by others to preserve macroeconomic stability, the CPEC will remain a top economic project (USD 62bn committed by China) for both governments and will keep their ties tight. Nevertheless, managing security and economic costs will be a challenging goal for a ruling government which has to navigate through the mounting influence of Islamist parties under the alleged army support as the latter aims to weaken the ruling PML-N Party to get more influence. Therefore, in the run-up to the 2018 elections the current civilian government is uncertain to win, political risks are expected to increase on the back of potentially more political violence and deteriorating economic fundamentals.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com