CPEC: What is the cost of financing anyway

Ammar Habib Khan 02:21 PM | 26 Sep, 2018
CPEC: What is the cost of financing anyway
There has been a lot of confusion, and misinformation regarding the cost of Chinese debt funding. A tweet by former Senator, Farhatullah Babar implied that the cost of funding is 14%.

Lijian Zhao, Deputy Chief of Mission (DCM) and Minister Counsellor at Chinese Embassy responded with another calculation, which was also technically incorrect.

In this space, I will try to explain the gibberish in a manner which can be understood by a five-year-old child.  Let's say we have a Project X, which is a part of CPEC.  In order to build Project X, we need capital, and that capital can be raised through two sources, viz. Debt, and Equity. We may also assume that the cost for building Project X is USD 100 – of which USD 30 is being raised as equity, while USD 70 is being raised as debt.

Raising Debt simply means borrowing from a Bank, or any Financial institution, for a certain period of time, at a certain interest rate. So Project X goes to a Bank, or consortium of Banks, and tells them that it wants USD 70 for developing the project in 3 years, during which they will not be paying any interest, or principal amount.

However, after the project is completed, they will repay the loan, as well as the interest in equal instalments over a period of 10 years. The total duration of the loan adds up to 13 years. Since the Project is not generating any revenue during the construction period, it keeps on accumulating an amount known as ‘Interest During Construction’, which is paid off after the project is developed.

The Bank also says that we can lend you the funds at LIBOR+3.5 percent.  LIBOR here is the London Inter-Bank Offer Rate – simply put it is the base rate at which most borrowing in USD takes place. The 3-month LIBOR rate currently is 2.34 percent. As the project is in a high-risk jurisdiction, the Bank also charges are certain to spread over the base rate to cover its risk – that spread is 3.5 percent. Interest Rate on such a loan as of today would be 5.84 percent.

The Bank being wary of financing a project in a high-risk jurisdiction also wants a guarantee that there will not be a default, and the amount being lent will be repaid, with interest.  In this case, the Project approaches Sinosure – an agency which insures projects, in order to make them bankable.  The premium for such an insurance in the case of Pakistan is a maximum of 7 percent, as being suggested by Mr. Lijian Zhao. However, this premium is paid up front, and is applicable on the amount of loan, as well as all interest that is to be paid during the next 13 years, in the case of Project X.

Now we can assume that everyone agreed to the terms above, and Project X was able to borrow USD 70 from the Bank.  Since we know that 3 years is the construction period, Project X cannot pay interest, so an amount of USD 4.09 per year (USD 70 * 5.84%) is accumulated as ‘capitalized interest’ – which basically becomes additional borrowing for the project.  For three years, the capitalized interest would be USD 12.26, resulting in the total loan of USD 82.26 (Initial loan of USD 70 plus capitalized interest of USD 12.26).

It is estimated that over the 10 years of duration of the loan following completion, Project X would pay approximately USD 31.6 in interest.  Sinosure Premium then amounts to USD 8.57 (7% * (31.6 + 82.26)).  Now add this USD 8.57 to the earlier debt of USD 82.26, resulting in a cumulative debt of USD 90.2.

To recap, we started with USD 70, but after adding Interest During Construction, and Sinosure Premium – we ended up with a total loan amount of USD 90.2.  This effectively means that only USD 70 were used for the Project, but the remaining amount was either premium or other interest costs.

Keeping our initial amount of USD 70 as a base (since that was the amount we actually needed), the effective interest rate calculated for a 10 year period is about 11.7 percent – much higher than the initial cost of 5.84 percent. The reason behind such an escalation is because the Sinosure premium is paid up front, rather than staggered over the life of the loan. As the amount is paid up-front, it front-loads the project, creating an additional debt burden.

The effective rate calculation is at a sweet middle point of what is suggested by the two gentlemen in their respective tweets. The calculations have been simplified to make the explanation easier, such that it can be understood by everyone.  A lot of other costs have been discarded for the sake of simplicity.

It is essential that a more level-headed, and apolitical approach is used in assessing costs and benefits associated with CPEC projects. The ‘actual’ cost of debt needs to be weighed against the potential benefits of certain projects, and in most cases, the infrastructure and energy stimulating benefits far outweigh the point-in-time cost estimates of most projects.

Ammar Habib Khan
Ammar Habib Khan

Ammar Habib Khan has a Masters in Macroeconomic Policy, he is a Risk Manager & Energy Economist by Profession


Today's currency exchange rates in Pakistan - Dollar, Euro, Pound, Riyal rates on March 31, 2023

KARACHI - Following are the foreign currency exchange rates for US Dollar, Saudi Riyal, UK Pound Sterling, U.A.E. Dirham, European Euro, and other foreign currencies in Pakistan open market on March 31, 2023 (Friday).

Source: Forex Association of Pakistan. (last update 09:00 AM)

Currency Symbol Buying Selling
US Dollar ‎USD 283.8 286.6
Euro EUR 306 309
UK Pound Sterling GBP 347.5 351
U.A.E Dirham AED 77.2 79.9
Saudi Riyal SAR 75.6 76.4
Australian Dollar AUD 187.5 189.9
Bahrain Dinar BHD 753.99 761.99
Canadian Dollar CAD 206.5 208.7
China Yuan CNY 41.25 41.65
Danish Krone DKK 41.26 41.51
Hong Kong Dollar HKD 36.11 36.46
Indian Rupee INR 3.45 3.56
Japanese Yen JPY 2.15 2.22
Kuwaiti Dinar KWD 925.67 934.67
Malaysian Ringgit MYR 62.85 63.45
New Zealand Dollar NZD 175.57 177.58
Norwegians Krone NOK 26.33 26.63
Omani Riyal OMR 736.34 744.35
Qatari Riyal ‎QAR 77.92 78.62
Singapore Dollar SGD 209.5 211.5
Swedish Korona SEK 26.5 26.8
Swiss Franc CHF 308.25 310.75
Thai Bhat THB 8.28 8.43

Today's gold rates in Pakistan – 31 March 2023

KARACHI - The price of a single tola of 24-karat gold in Pakistan is Rs 208,200 on Friday. The price of 10 grams of 24k gold was recorded at Rs178,500.   

Likewise, 10 grams of 22k gold were being traded for Rs163,624 while a single tola of 22-karat gold was being sold at Rs 190,849.

Note: The gold rate in Pakistan is fluctuating according to the international market so the price is never been fixed. The below rates are provided by local gold markets and Sarafa Markets of different cities.

City Gold Silver
Lahore PKR 208,200 PKR 2,470
Karachi PKR 208,200 PKR 2,470
Islamabad PKR 208,200 PKR 2,470
Peshawar PKR 208,200 PKR 2,470
Quetta PKR 208,200 PKR 2,470
Sialkot PKR 208,200 PKR 2,470
Attock PKR 208,200 PKR 2,470
Gujranwala PKR 208,200 PKR 2,470
Jehlum PKR 208,200 PKR 2,470
Multan PKR 208,200 PKR 2,470
Bahawalpur PKR 208,200 PKR 2,470
Gujrat PKR 208,200 PKR 2,470
Nawabshah PKR 208,200 PKR 2,470
Chakwal PKR 208,200 PKR 2,470
Hyderabad PKR 208,200 PKR 2,470
Nowshehra PKR 208,200 PKR 2,470
Sargodha PKR 208,200 PKR 2,470
Faisalabad PKR 208,200 PKR 2,470


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