Pakistan and China hail ‘brotherhood’ but IMF terms spell friction

Pakistan and China trumpeted their “all weather” friendship after their leaders met on the sidelines of the Shanghai Cooperation Organization summit on Friday, but analysts warn that Islamabad’s scramble to extricate itself from an economic crisis could stoke tensions.

Both sides’ readouts of the summit between Chinese President Xi Jinping and Pakistani Prime Minister Shehbaz Sharif were filled with flowery language. Sharif’s office said he emphasized that the nations’ “iron brotherhood had withstood the test of time” and reaffirmed “his personal resolve to take their bilateral relations to greater heights.”

China’s Foreign Ministry said Xi stressed that “the two countries have all along stood with each other through thick and thin. No matter how the international situation evolves, China and Pakistan are always each other’s trustworthy strategic partners.”

But hinting at concerns over recent attacks on Chinese interests in Pakistan and worries over payments to Chinese companies, Beijing’s readout added: “China hopes that Pakistan will provide solid protection for the security of Chinese citizens and institutions in Pakistan as well as the lawful rights and interests of Chinese businesses.”

Looming over the meeting were expectations that Pakistan will seek concessions on dues owed to Chinese power producers operating in the country under the $50 billion China-Pakistan Economic Corridor (CPEC) — part of Xi’s Belt and Road Initiative.

Cash-strapped Islamabad needs to do this to satisfy the International Monetary Fund and unlock more funding, as it rushes to reduce the risk of a debt default.

The government assured the IMF in July that it would strive to reduce capacity payments to Chinese independent power producers (IPPs) either by renegotiating purchase agreements or rescheduling bank loans. Capacity payments are fixed payments made to power plants for generating a minimum amount of electricity to ensure that demand is met. These companies produce costly electricity using imported fuel, and are said to be on the brink of default.

“The IMF anticipated that pressure would come from the Chinese IPPs that the entire loan installment be used to pay them,” Nadeem Hussain, a Boston-based author and economic policy analyst, told Nikkei Asia. “Hence, the IMF extended the current program on the condition that it would not go to the Chinese IPPs.”

The Washington-based lender released a long-pending tranche of $1.17 billion two weeks ago after Pakistan undertook a series of politically unpopular economic measures toward fiscal discipline. The bailout program, which began in 2019 but stalled, was also extended until next June, with additional funding set to bring the total value to about $6.5 billion, the IMF said in a statement.

But Pakistan owes $1.1 billion to Chinese IPPs for power purchases, contributing to the massive 2.6 trillion-rupee ($11 billion) debt stock in the country’s power sector. The IMF has long maintained that Chinese loans threaten Pakistan’s debt sustainability.

Xi, in the Chinese Foreign Minister readout of his meeting with Sharif, “stressed that the two sides must continue to firmly support each other, foster stronger synergy between their development strategies, and harness … the China-Pakistan Economic Corridor to ensure smooth construction and operation of major projects.”

Observers say Pakistan’s handling of the electricity issue is likely to irk China, noting that Sharif’s government committed to the IMF to reopen power contracts without taking the Chinese companies into confidence. Pakistan has also reneged on a promise to set up an escrow account to ensure smooth payments to Chinese IPPs.

“The Chinese [companies] have been absolutely upset for a very long time,” said Haroon Sharif, a former minister of state who spearheaded industrial cooperation with China under the previous government of Prime Minister Imran Khan. “The Chinese stance is that it’s a commercial agreement. No IPP is obliged to listen to the [Pakistani] government because the agreements were drawn under the law,” he said, referring to a system that predated the Khan government and paved the way for Chinese players to invest in the country’s power sector, setting the terms.

Resentment has been building for some time. CPEC projects were stalled for months after Khan took power in 2018, mainly due to graft allegations regarding the previous government’s dealings. There were also allegations that the arrangements unfairly benefited Beijing.

“The IPP framework is deeply flawed,” Haroon Sharif said. “The [Chinese] IPPs are averse to taking risks because the state guarantees a return on investment in dollar terms whether they are selling [electricity] or not.”

As a confidence-building measure, Islamabad did announce the release of 50 billion rupees to the companies by next week and assured the Chinese suppliers that all outstanding dues will be cleared by June next year. The announcement came ahead of Prime Minister Sharif’s meeting with Xi at the SCO and a planned visit to China in November, when he might raise concerns about the power deals.

The release of the funds may serve only as a Band-Aid.

The IMF is demanding that Pakistan rationalize payments to the Chinese IPPs in line with earlier concessions extracted from local private power producers, Haroon Sharif explained. Former Prime Minister Khan persuaded local IPPs to accept lower interest rates on outstanding bills before releasing staggered reimbursements in the form of debt instruments, like government bonds.

Chinese power producers, however, have fiercely opposed similar propositions in the past. In March, Chinese IPPs closed down operations due to unpaid dues, insisting they did not have money to import fuel. The government disbursed another installment of 50 billion rupees to get them to resume operations.

The IMF now wants Pakistan to negotiate an increase in the duration of bank loans from 10 years to 20 years, or to reduce the markup on arrears owed to Chinese IPPs from 4.5% to 2%, the ex-minister said.

He added that there is a lesson in this for China. “Chinese companies should deeply study macroeconomic fundamentals [before making any investments], and not blindly follow state guarantees,” Sharif argued. At the same time, he said, this will have a far-reaching impact on Pakistan’s future investment climate.