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Choosing the right financing option for CPEC

CPEC and its importance

China-Pakistan Economic Corridor, or CPEC, is an initiative that has potential to take Pakistan’s economy to a significantly higher stage of development and bring unparalleled benefits to both Pakistan and China. This initiative is part of the One Belt One Road (OBOR) project that envisions connectivity between and within Asia and Europe while covering nearly 62 countries, and aims at addressing the infrastructure gap that has kept this vast region below its potential.


AHMED ALI SIDDIQUI (Director, IBA Centre for Excellence in Islamic Finance)


CPEC is a collection of infrastructure projects that are underway across the country and are valued at over US$60 billion – up from originally envisaged US$46 billion. The project will transform Pakistan’s economy, by modernizing its road, rail, air and energy transportation systems and will connect China’s mainland with Pakistani deep-sea ports of Gwadar and Karachi.

The CPEC is not only about the infrastructure of (trains, roads and pipeline) it will also connect Europe and Central Asian countries with the region providing a higher level of development, as well as cultural exchanges between China and Pakistan. China also stands to benefit from CPEC in a number of ways. With Gwadar operational, the distance of about 16,000 kilometers will be reduced to 5,000 kilometers, providing significant savings of shipping time and costs.

China and Pakistan: basic facts

The relation between China and Pakistan is a time-tested one. The two countries have strong diplomatic, political and military ties. China’s population is about 1.4 billion out of which nearly 20 million are Muslims. Its current Gross Domestic Product (GDP) is $12 trillion. It is one of the most globally integrated economies with annual trade surpassing $4 trillion, and a foreign direct investment (FDI) stock of $1.4 trillion.

On the other hand, Pakistan has a population of 210 million with nearly 97 percent Muslim population and a current GDP of about $0.3 trillion. While balance of trade of the country remains negative since the last five years, FDI increased in the year 2017 to Rs. 3,434.9 million. The per capita GDP of $1,630 puts Pakistan at number 147 globally.

Financing of CPEC projects

The major chunk of the CPEC will constitute of energy projects worth more than $35 billion. The entire portion of this amount will be financed by foreign investors who are guaranteed 17% return on their equity investment. On the other hand more than $15 billion have been allocated for infrastructure projects, Gwadar development, industrial zones and mass transit schemes. This portion will be financed through government-to-government loan, provided by the Government of China, on concessional rate of 2 percent interest to be repaid over a 20-25 year period.

Analysis of cpec financing under pakistan’s constitution

As stated above, CPEC financing, as currently planned, is fully interest-based. It is pertinent to analyze whether this conforms to Pakistan’s constitution. Islam was declared state religion in 1973 constitution. While all of the three constitutions state that steps should be taken to enable the Muslims of Pakistan to order their lives in accordance with the requirements of Shariah. Article 227 in 1973 constitution holds that, “All existing laws shall be brought in conformity with the injunctions of Islam and no law shall be enacted which is repugnant to these injunctions.” And also, “State shall eliminate Riba as early as possible” in Article 38 (f). Furthermore, Quaid-e-Azam, in his speech at the occasion of the inauguration of State Bank of Pakistan, had also expressed the desire for evolving an Islamic system of banking in Pakistan.

Global perspective of islamic banking

In order to comply with Shariah, Islamic Banking must meet certain criteria: The investment must be backed by real assets and some real economic activity must take place, hypothetical transactions, speculation, derivatives, sale of debt and transactions involving money over money (Riba) are prohibited in Islam. Therefore, a number of Shariah-compliant solutions have been proposed since the emergence of Islamic banking around the globe.

While most of the share in the banking industry is allocated to conventional system, the astounding growth of Islamic banking industry from $200 billion to $3 trillion during the course of 15-20 years, representing 80% of whole Islamic finance industry, has helped Islamic finance to surge at an average annual growth of 21% globally. The combined profit of participation banks crossed the US$10 billion mark. By 2019 collective profits are expected to touch US$37 billion as the industry continues its double digit annual growth.

Its bright prospects are also being shared by innumerable countries such as United Kingdom, France, Germany, Japan and South Africa. The largest among them is The American Islamic Finance House. Institutions such as J.P. Morgan and Standard Chartered have also started offering Shariah compliant Mutual Funds and deposits. Thus, Islamic banking product’s asset backed feature and consistent growth in 2007-08 despite of financial breakdowns across the globe have increased is desirability also among non-Muslim nations.


Islamic banking in China

China has yet has been the fastest growing economy. With nearly 20 million Chinese Muslims, the first Islamic financial institution founded in China was Hezhou Islamic Financing Company that provided both deposit and investment funds in 1987. In the year 2006, Bahrain-based Shamil Bank launched its US$100 million Shamil China Realty Mudarabah. This was the first-ever Chinese poverty fund for investment in Chinese real estate market. Similarly, Deutsche bank launched its first Shariah-compliant mutual fund which included Noor China Equity Fund. Likewise, Al-Rajhi investments (ARI), introduced Shariah-compliant investments in the Chinese market through its Shariah Investment Fund (SAIF), in partnership with Chinese Resources. A number of other organizations including CIMB Malaysia’ Islamic greater China Equity Fund have led to tremendous growth of Chinese Islamic banking sector.

Opportunities of islamic financing in CPEC

CPEC is seen as enormous opportunity for public-private cooperation to promote the use of Islamic financing particularly in areas of hydropower, infrastructure, energy, and construction by proponents of Islamic finance. Moreover, OBOR covers nearly 62 countries out of which 27 are Muslim nations who would highly appreciate Islamic mode of financing for belt. Islamic financing can be the best financing mode for infrastructure projects because they are real assets. However, despite of extensive promotion of Islamic banking in China and its tremendous growth in Pakistan, CPEC is still very faintly financed through Islamic banking.

Potential threats of non-islamic CPEC financing
  • Public resentment
    The belt covers nearly 27 Muslim countries. Alluding to the double digit growth of Islamic banking in Pakistan and around the globe, the probability of resentment from Muslim countries covered by the belt is quite high. According to a survey, 76% people in Pakistan said they would prefer Islamic finance if they had a choice with only 13-14% preferring conventional banking. Thus, it would not be exaggeration that nearly 75% of Pakistani-Muslims would condemn non-Islamic financing in CPEC.
  • Constitutional barriers
    As highlighted above in 3.1, all of our three constitutions are inclined to transform the banking system to Islamic. Also, constitutional enforcement to eliminate Riba as early as possible can be taken as a threat to almost 80 percent of interest based financing in CPEC.
  • Misalignment with SBP’s long term vision of shariah compliant banking
    SBP’s extensive inclination towards promotion of Islamic banking in the country, and establishment of various policies for the growth of Islamic banking sector, all of the banks in Pakistan are undoubtedly accepting the change. Nearly 21 out of 33 banks are either full-fledged Islamic banks, or Islamic banking Subsidiaries. Thus, alignment with SBP’s vision of Shariah-compliant banking would be fruitful for the boon of both Islamic banking sector and CPEC projects.
  • Constitutional barriers
    The Banking Companies Ordinance, 1962 does not allow the commercial banks to accept deposits and give loans on interest. This could create issue of recovery of interest from legal point of view.

The CPEC, a network of projects in Pakistan, is an attempt to link the two economies, and if designed and implemented properly, can be transformational both for Pakistan, Western China, and the region at large. However, the success of CPEC is when it is not against the value system of the country. Referring to the double digit growth of Islamic banking in Pakistan, the share of Islamic banking would increase by nearly 50%. In addition, constitutional restrictions and potential threats arising from conventional financing are facts that cannot be avoided.

Islamic banking can at large set off the potential threats arising from conventional financing; it is a much rational option to be considered when the major stake holder of the project is Pakistan comprising of 96% Muslim population. It would also protect the religious heritage of the country. Moreover, other Muslim countries affected by the OBOR initiative would also realize the benefits of Islamic financing in the region when most of them are those who restrict conventional banking within their countries. Besides, Islamic financing modes would also attract additional funds from Gulf regions that are mainly inclined towards Islamic modes of financing. Thus, steps must be taken by both countries in order to comply with the policies, culture and religious background of the Muslim countries in the OBOR region.

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