PAKISTAN FACES FISCAL PROBLEMS DUE TO SWELLING DEFICIT

UNCLAS SECTION 01 OF 02 ISLAMABAD 005328 SIPDIS SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ECON EINV PREL PK SUBJECT: PAKISTAN FACES FISCAL PROBLEMS DUE TO SWELLING DEFICIT Summary -------------- ¶1. (SBU) Summary: High international oil and food prices and political unwillingness to decrease or eliminate subsidies in an election year are contributing to a projected increase in Pakistan's fiscal deficit from 4 to 4.9 percent for FY2008. GOP expenditures on energy and food subsidies have risen over 100% since the July 1 beginning of the fiscal year. The biggest contributor is oil; prices at the pump have not increased since January 2007, while the international price of oil has increased over 50 percent. The caretaker government has little power to take this issue on; the next government will find its options limited by a growing fiscal deficit. If delays in making payments to the oil marketing companies continue, Pakistan may also have problems attracting future investments in oil and gas sector. End summary. Oil Subsidies -------------- ¶2. The last increase in gasoline prices was in January 2007, when international oil prices hovered around $55 per barrel. In an election year, the GOP has made a deliberate decision to absorb the price differential. The caretaker government (in power for approximately two months) has also taken a pass on resolving the problem, despite Ministry of Finance pleas to take action now. Pakistan's Finance Minister, Salman Shah has acknowledged publicly that fiscal deficit will rise significantly if this increase is not passed on. The Ministry of Finance has already revised its fiscal deficit projection to 4.6 % of GDP and believe that it may rise further to 4.9 % in a few months. ¶3. (SBU) In FY 2007-2008 the GOP budgeted $245 million in subsidies for the oil marketing companies (OMCs) and refineries, projecting oil prices at $55 per barrel. With international oil prices now above $90 a barrel, the cumulative margin between market and pump prices cost the GOP approximately $473 million through November 2007. The GOP has already made payments of $213 million to the OMCs, but another $360 million is still outstanding. Chevron Pakistan alone is owed $53 million. The Embassy has taken up Chevron's case with the Ministry of Finance so that the company can receive payment prior to the end of its fiscal year December 31. Chevron has put an anticipated $15 million investment on hold. (Note: Chevron does not have any exploration activities in Pakistan, only downstream investments. End note.) Power Subsidies -------------- ¶4. (SBU) The GOP budgeted $406 million in subsidies for the power sector in the FY 2007-08. Subsidies paid by October 2007 amounted to $246 million for the Water and Power Development Authority (WAPDA) and $62 million the Karachi Electric Supply Corporation (KESC). Ministry of Water and Power contacts told Econoffs that total subsidies by the end of the fiscal year expected to total $950 million, 133% higher than budgeted. The Ministry of Water and Power has asked the Federal Government to make arrangements for additional funds. Wheat Subsidies -------------- ¶5. (SBU) According to the Finance Ministry, the GOP placed nearly a million metric tons (mmt) in international wheat orders worth $450 million in November and December at an average cost of $450 per mmt, compared to domestic average price of $220 per mmt. The expected final cost to the government is approximately $250 million. The government continues to subsidize imported wheat to keep food inflation under control. With food price inflation running over 10 percent annually, bread and butter issues remain the top concern in the minds of Pakistani voters. Funding the deficit -------------- ¶6. (SBU) The Finance Ministry sources said that fiscal deficit stood at 1.6 percent of GDP versus the target of 0.9 percent for the first quarter (July-September 2007) of the current fiscal year, making it impossible to meet the overall fiscal year goal of four percent. The oil and power subsidies were the major factors causing fiscal deficit to surpass the first quarter target. The full year fiscal deficit target of 4 percent of GDP is unlikely to be achieved ISLAMABAD 00005328 002 OF 002 due to actual subsidies for oil and power exceeding planned and budgeted ones. The GOP's FY2007-08 budget assumed that oil prices would be $55 per barrel. With crude oil prices ranging between $90 and $100 per barrel, the government is paying out energy subsidies of $230 million every month. The caretaker economic team is very concerned, but not finding much GOP support for substantial price increases. ¶7. (SBU) The State Bank unsuccessfully tried to limit GOP's Central Bank borrowing, but could not stop the government from borrowing $2 billion from July through November 24, well in excess of the annual $704 million target. Excessive Central Bank borrowing is not only increasing inflationary pressures, but is also eroding the State Bank's financial position. Comment -------------- ¶8. (SBU) Comment: The GOP should have been phasing in gasoline and power price increases throughout 2007, but could not find the political will. The caretaker government, in power for only two months, is unlikely to make unpopular decisions affecting food or fuel prices ahead of the January elections. As a result, the new government will face some tough choices -- either perpetuate the current subsidy regime with the negative budgetary and macroeconomic implications or spend some of its political capital to rein in subsidy spending. Until now, Pakistan has had a good reputation for macroeconomic management, which has contributed significantly to its attractiveness as a destination for foreign capital. It is not yet clear what economic policies a new government will pursue; most party election manifestos are long on fiscally untenable promises. The USG will need to stay engaged in close consultation with the GOP on economic policies. End comment. PATTERSON