Is Pakistan China’s Venezuela? – Bloomberg Gadfly

Might this be China's new Venezuela?

Beijing's frenzied drive to create a modern Silk Road puts Pakistan front and center, much as Venezuela was once a target of lending by China Development Bank as the nation sought to secure oil supplies.

Of the $6 billion to $7 billion of current development projects in Pakistan as part of the China-Pakistan Economic Corridor, Beijing has provided the bulk of financing -- local funding amounts to just $470 million.

Like its sister policy banks, CDB is charged with fulfilling China's long-term economic vision, as exemplified by President Xi Jinping's One Belt, One Road drive to build highways, power plants and ports across emerging Asia.

Money In, Money Out

Highways and urban renewal feature high on China Development Bank's loan-to list

Source: China Development Bank annual report, 2016

Late last month, CDB agreed on a $1.5 billion power plant and wharf deal in Hub, in Baluchistan province, southwestern Pakistan. Along with the Export-Import Bank of China, CDB led a consortium that's funding the coal-fired plant being jointly built by Hong Kong-listed China Power International Holding Ltd.

Policy lenders' disbursements shouldn't matter much to markets, as long as these banks don't tap investors who expect a commercial return. But CDB and its smaller siblings, Agricultural Development Bank of China and Export-Import Bank, rely on market funding rather than deposits. CDB, for example, has a $30 billion bond issuance program and is now seeking investors for two new offshore notes.

Let's revisit CDB's Venezuela adventure.

The bank is on the hook for billions of dollars of lending to the hyperinflation-plagued Latin American nation. Last May, Venezuela engineered a default under which it deferred paying principal, honoring only the interest, on outstanding debts of at least $24 billion. Already, some of the projects undertaken with Chinese money, including a partly built high-speed railway, have been vandalized and abandoned.

Even as it struggles for repayment, China is lending Venezuela money, perhaps endorsing Keynes's adage that great indebtedness is a problem for the bank, not the borrower.

China clearly is worried. Earlier this month, the China Banking Regulatory Commission released new rules requiring policy banks to shore up their capital by January. The combined assets of the three reached 25 trillion yuan ($3.8 trillion) in the third quarter, equivalent to those of the nation's largest commercial bank, Industrial & Commercial Bank of China Ltd. Talk about systemic risk... 

Last week's bond rout upset the funding plans of these quasi-sovereign lenders. CDB excluded a 10-year note deal from its auction, while Export-Import Bank deferred a three-part sale. If the market shakeout persists for one or two more years, the policy banks will see large losses and may need to ask the Ministry of Finance to replenish capital, Justina Lee of Bloomberg News reported.

Bond Rout

China Development Bank's 10-year yield spiked last week as borrowing costs rose nationwide

Source: Bloomberg

Meanwhile, Pakistan shows signs of discomfort with the relationship. The government balked at China's intention to introduce the yuan as legal tender in the Gwadar Port free zone. And Islamabad said it will finance the Diamer-Bhasha dam itself, calling China's offer to construct, operate and maintain the project unacceptable.

China's desire to use the yuan is perhaps understandable. The Pakistan rupee is eerily stable, apart from a sudden 3.1 percent dip in early July, even as the nation's foreign-exchange reserves deteriorate. The International Monetary Fund reckons the currency is 10 to 20 percent overvalued, and says Pakistan's current-account deficit may widen to 3 percent of GDP as Chinese money flows in. 

Eerily Stable

Pakistan manages the rupee more closely than China acts to stabilize the yuan

Source: Bloomberg

Pakistan views China's push for the yuan as an infringement of its sovereignty. The reality is that this is about good risk control. Professions of brotherly love are all very well, but Beijing needs to avoid another Venezuela.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the authors of this story:
Nisha Gopalan in Hong Kong at [email protected]
Shuli Ren in Hong Kong at [email protected]

To contact the editor responsible for this story:
Paul Sillitoe at [email protected]

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