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 - - - - ¶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 - - - - - - - - - - - - - - - - - - - ¶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 - - - - - - - - - - - - - - - - - - - - - - - ¶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 ISLAMABAD 00001758 002 OF 002 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 - - - - - - - - - - - - ¶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 - - - - - - - - - - - - - - - - - - - - - - - - ¶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 - - - - - - - - - - - - - - - - - - - ¶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 - - - - ¶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