China Economic Friend or Trade Enemy of Pakistan?

China: Pakistan's Economic Ally or Trade Foe?

The Free Trade Agreement (FTA) 

In February 2009, Pakistan and China signed a Free Trade Agreement (FTA) that significantly boosted trade between the two nations. In 2002, trade was valued at only $1.3 billion, but by 2020, it surged to $20 billion. Out of this, China’s exports to Pakistan accounted for $18 billion, while Pakistan’s exports to China reached just $2 billion. China benefited more, leveraging around 60% of the FTA’s advantages, while Pakistan utilized only about 4%. In the FTA’s second phase, China offered duty-free export opportunities for 363 items from Pakistan, raising total trade to $27.82 billion in 2021. China’s exports to Pakistan reached $24.23 billion, and Pakistan’s exports to China saw a 69% rise to $3.6 billion.

China's Loans to Pakistan 

Between 2000 and 2017, China lent Pakistan $34.4 billion. Initially, from 2002 to 2012, 84% of these loans supported Pakistan’s central government projects. However, with the launch of the China-Pakistan Economic Corridor (CPEC), China adjusted its strategy, extending loans beyond federal agencies. Approximately 90% of the funds for CPEC projects have been issued as loans, which Pakistan must repay with an average interest rate of 3.76% annually.

Chinese loans generally carry about a 4% interest rate, comparable to commercial bank rates but significantly higher than concessional loans from entities like the World Bank, France, or Germany. Repayment periods for Chinese loans are also shorter, often under ten years, compared to concessional loans that typically offer repayment terms of up to 28 years. Chinese state-backed loans also commonly include a condition for the borrowing nation to maintain collateral in offshore accounts to ensure repayment.

 

In March, Pakistan repaid $2.3 billion to China, only to re-borrow it with stricter terms in June. China now requires Pakistan to remain in the IMF program to secure future loans. After the World Bank and the Asian Development Bank, Pakistan’s largest loan provider is China, to whom interest payments are regularly made.

 

The Burden of Projects like Orange Line and CPEC 

Projects like the Orange Line train and various CPEC undertakings have proven financially challenging due to their high maintenance costs, often surpassing even the interest rates on the loans. The Orange Line Train project, for instance, was funded with $1.6 billion, half of which was borrowed from China. Punjab’s government will repay the loan between 2024 and 2036, paying 19 billion rupees annually in interest on Pakistan’s first light rail project. The debt service cost has risen from 17 billion to 20 billion rupees, creating a long-term financial strain. Even if the ticket price for the metro was set at 240 rupees, repaying the debt would remain challenging—an improbable feat with current fares at just 20 rupees.

 

In the coming year, Pakistan will need about $41 billion in new loans to cover operational costs, a requirement projected to reach $80 billion within two years if economic policies remain unchanged. In this context, China’s willingness to lend without imposing structural reforms has raised concerns. Currently, the majority of Pakistan’s debt burden comes from Chinese loans, which, while marketed as supportive, may be increasingly unsustainable.

 

Oversight and Debt Management Issues 

Chinese loans have become a major weight on Pakistan’s economy, often with stricter terms compared to Chinese agreements with other countries. In March, despite Pakistan’s dire financial conditions, China demanded repayments on schedule. Moreover, there appears to be little oversight over how Chinese loans are used, with new loans often issued without a full assessment of past investments, leading to corruption and mismanagement.

 

IMF and CPEC 

With a 25% stake in the IMF, the U.S. has considerable influence over its lending conditions. The IMF offers loans at a much lower interest rate, around 1%, with repayment terms often extended depending on circumstances. Primarily intended to address balance-of-payments issues, IMF loans aim to alleviate short-term fiscal challenges, contingent on Pakistan’s ability to increase exports and enhance its repayment capacity.

 

Pakistan has engaged with the IMF in 14 financial programs since 1980, including a $6.7 billion loan in 2013. Although seen humorously as a "rite of passage" by some, the repeated IMF loans reflect a broader trend: rather than pursuing economic reforms, successive governments have relied on IMF bailouts to temporarily stabilize their finances, effectively deferring obligations to future administrations. Reliance on IMF aid has come to be viewed as a "badge of honor," though this dependency has stretched for more than six decades. As one critic put it, no Pakistani leader, however "legendary," holds more influence over the country's economy than the IMF.

 

The IMF notes that Pakistan’s debt to the Chinese government stands at $23 billion, with an additional $7 billion borrowed from Chinese commercial banks. While IMF loans provide essential short-term relief, some view them as a safer financial route for Pakistan’s economy than high-interest Chinese loans.

 

Future Concerns and Debt Sustainability 

IMF oversight has consistently raised issues with China’s financial support to Pakistan, including recent objections to Pakistan’s repayment of $50 billion to Chinese IPPs (Independent Power Producers). It’s reported that the IMF may soon impose restrictions on Pakistan from taking additional Chinese loans, potentially causing temporary financial difficulties but encouraging a more sustainable economic path.

 

Although China claims friendship with Pakistan, the reality suggests otherwise, with Pakistan increasingly enmeshed in Chinese debt. Sri Lanka’s recent economic crisis, in part due to its reliance on Chinese commercial loans, serves as a cautionary tale. Pakistan’s growing dependence on Chinese credit could lead to a similar fate if left unchecked.

 

The Real Challenge: Sustainable Debt Management 

The issue isn’t just the volume of loans but Pakistan’s limited capacity to service this debt. With stagnant export growth and costly loans, the economic burden intensifies. Although Pakistan’s debt-to-GDP ratio is far below Greece's (nearly 300%) or Japan’s (around 250%), the main issue lies in ineffective debt utilisation. Rather than investing in profitable projects, funds have been diverted to politically motivated ventures and government spending, which has exacerbated Pakistan’s fiscal challenges.

References:

How Chinese loans trapped Pakistan's economy