BUDGET DEFICIT NUMBERS LOWER BUT SLOW GROWTH AHEAD

C O N F I D E N T I A L SECTION 01 OF 02 ISLAMABAD 001758

SIPDIS

E.O. 12958: DECL: 05/05/2018
TAGS: PGOV EFIN ECON PREL PK
SUBJECT: BUDGET DEFICIT NUMBERS LOWER BUT SLOW GROWTH AHEAD

Ref: Islamabad 1532

Classified by: Ambassador Anne W. Patterson, reasons 1.4 (b) and (d)

Summary
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1. (C) Summary: Private sector economists, the Ministry of Finance
Special Advisor and IMF Resident Representative all expressed concern
over Pakistan's record USD 8.3 billion budget deficit, but for
different reasons. Citibank's Aziz Rahman was concerned that Finance
Minister Ishaq Dar's overstatement of Pakistan's projected budget
deficit would scare off foreign investors, while ABN Amro's Sakib
Sherani did not have any confidence that the new government could
find a middle ground between responsible fiscal policy and the
populist measures promised by both the PPP and PML-N during the
electoral campaign. Ministry of Finance Special Advisor Dr. Ashfaque
Khan estimated Pakistan's budget deficit at 6.5 to 7 percent of GDP,
lower than Dar's projection of 9.5 percent of GDP. IMF Resident
Representative Henri Lorie (please protect) predicts that the budget
deficit might reach as much as 8 percent of GDP by the June 30 end of
the current fiscal year and growth may slow to three percent next
year. End summary.

No agreement on budget deficit numbers
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2. (C) EconOffs met with Citibank Vice President Aziz Rahman, ABN
Amro Senior Economist Sakib Sherani, Special Advisor to the Finance
Minister Dr. Ashfaque Hasan Khan and IMF Resident Representative
Henri Lorie regarding their views on the state of Pakistan's economy.
Aside from sharing the view that the size of Pakistan's budget
deficit was unfortunate and that Finance Minister Dar overstated
Pakistan's economic troubles in his April 9 press conference
(reftel),each economist had different views on Pakistan's current
economic situation.


3. (C) IMF Resident Representative Henri Lorie predicted that the
fiscal deficit will likely reach 8 percent of GDP, lower than Finance
Minister Dar's pessimistic prediction of 9.5 percent of GDP. Lorie
arrived at the 8 percent estimate by totaling fuel expenditures (USD
2.3 billion),debt servicing overruns (USD 1.5 billion),payments by
the Water and Power Development Authority (WAPDA) to power
companies(USD 60 million),research and development subsidies for the
textile sector (USD 700 million) and revenue shortfalls (USD 620
million). (Comment: We believe that Lorie seriously underestimated
the payments by WAPDA for provision of power to the independent power
companies, and that these payments may be as much as USD 50-60
million per month. End comment.)


4. (C) Dr. Khan was more conservative in his budget deficit
estimates, in part because he excluded payments to oil marketing
companies. His rationale is that these payments cannot be counted as
expenditures until they are actually made under Pakistan's cash-based
accounting system. Pakistan's flawed assumptions on the price of oil
and lack of political will to pass on these increases are the root of
Pakistan's fiscal woes, he said. The Government of Pakistan (GOP)
set a USD 65 per barrel Arab light crude benchmark price for its
current year budget calculations, but the average price for oil
during the July - March period was USD 81.20, resulting in USD 3
billion in additional oil import costs. The GOP budgeted USD 7.94
billion for oil imports but the total bill is likely to reach USD
10.94 billion by the June 30 end of the current fiscal year.

Current account deficit running down reserves
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5. (C) Lorie predicted that the current account deficit would rise to
USD 13 billion by June 30, after a record USD 9.9 billion for the
first nine months of the current July 1 - June 30 fiscal year. Lorie
expected that Pakistan's reserves will drop to USD 8 billion as a
result. He was not optimistic that Pakistan would find significant
new sources of foreign currency receipts to bolster its reserves in
the short term. He was pessimistic about jump starting Pakistan's
stalled privatization process, commenting that he has already seen
turf issues emerge between Privatization Minister Naveed Qamar and
Finance Minister Ishaq Dar. (Note: Qamar, a leading member of the
Pakistan Peoples Party, was originally slated to be Finance Minister,
only to lose out to the Pakistan Muslim League - Nawaz's (PML-N)
candidate Ishaq Dar in governing coalition negotiations. End Note.)


6. (C) When asked, Dr. Khan confirmed press reports about foreign

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budget support. The Saudi government has pledged USD 300 million;
China has promised to transfer USD 500 million at a "nominal"
interest rate; and the Asian Development Bank has committed USD 600
million. Lorie confirmed that the GOP has not requested IMF financial
assistance. (Comment: However, should the entire USD 1.3 billion
arrive, it is only a drop in the budget compared to Pakistan's needs.
End comment.)

GDP growth will decrease
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7. (C) While GDP growth this fiscal year will not meet the seven
percent target, Lorie commented that the economy is still doing well
as evidenced by the 18 percent growth in private sector credit
between March 2007 and March 2008. (Comment: This growth occurred
before the GOP began to pass on fuel and electricity price increases
to consumers March 1. End comment.) He expects FY 2007-2008 growth
at between five and six percent. However, Lorie forecasts growth at
three percent for FY 2008-2009, due to the rising cost of energy and
agricultural commodities.


8. (C) ABN Amro Economist Sakib Sherani painted a more optimistic
growth scenario for next year, with growth estimated at 5.6 percent.
Sherani did not foresee Pakistan departing from its consumption-led
growth model. The services sector, one of Pakistan's growth engines,
is unlikely to repeat its good performance because of the impact of
increasingly frequent power cuts. The large scale manufacturing
sector underperformed during July-January 2008, growing at 5.3
percent versus the target rate of 10.5 percent per year. Sherani
suggested that Pakistan follow Brazil's model to balance fiscal
responsibility and populist policies.

No to tight monetary policy to control inflation
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9. (C) Special Advisor Khan stated that during spring 2008 meetings
in Washington, IMF officials recommended that the GOP tighten
monetary policy to control inflation. While he acknowledged that
Pakistan's loose fiscal policy had done little to help control the
growth of the money supply, Khan disagreed with the IMF's
recommendation. He said that the composition of Pakistan's consumer
price index (40 percent for food and 15 percent for energy) means
that a tight monetary policy would have little effect on inflation.

Investors adopt wait and see attitude
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10. (C) Citibank Vice President Rahman believes that portfolio
investment is picking up slightly, but that Finance Minister Dar's
overstatement of the fiscal deficit has dampened investor sentiment.
Rahman believes that while Pakistan's credit rating will likely be
downgraded, international credit agencies are taking a wait and see
attitude for the short term.


11. (C) Special Advisor Khan confirmed that Pakistan will float a
USD 500 million equity bond, tradable with Oil and Gas Development
Company shares. The equity portion of the bond will reduce the
spread enough for the issue to be profitable. However, there is not
enough time to float the bond before the end of the current fiscal
year. ABN Amro, JP Morgan and Barclay's are all working on the bond
issue.

Comment
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12. (C) Whether Pakistan's budget deficit is seven or nine percent
of GDP is not the principal problem. Slowing growth and an absence
of economic policy beyond bridging the budget deficit is a greater
concern. Whatever happens, growth will slow next year as the economy
absorbs higher prices for energy and food, which together make up
over half of the consumer price index. Continued inflation will
create additional pressures on the new government for populist
measures, whether continued subsidies on food and fuel or new
programs, that the government simply does not have money to pay for.


13. (C) Slower growth may well also mean decreased tax revenues at a
time when Pakistan desperately needs to increase and broaden its tax
base. Pakistan also needs to look at increasing competitiveness in
the textile sector and seriously encouraging its non-traditional
export sectors. End Comment.

PATTERSON