PAKISTAN MISSES MAJOR ECONOMIC TARGETS: HIGHLIGHTS FROM THE

UNCLAS SECTION 01 OF 03 ISLAMABAD 002106 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ETRD ECON PREL PK SUBJECT: PAKISTAN MISSES MAJOR ECONOMIC TARGETS: HIGHLIGHTS FROM THE ANNUAL ECONOMIC SURVEY ¶1. (SBU) Summary: Finance Minister Naveed Qamar released on June 9 the Economic Survey for the 2007-08 fiscal year. The document, released one day before the fiscal year 2008-09 budget, reported that all major economic indicators for the first ten months of the current fiscal year (July 07 to April 08) are currently below target. Economic growth for the year will come in around 5.8 percent, well below a target of 7.2 percent. The fiscal deficit is projected to be seven percent of GDP versus a target of four percent; Government of Pakistan (GOP) borrowing from the State Bank of Pakistan (SBP) reached an all-time high of USD eight billion (Rs 544 billion) for the first ten months of the fiscal year. As of early May 2008, the GOP had USD 13.98 billion in outstanding debt to the SBP, or nine percent of GDP. Pakistan's trade deficit rose to USD 17 billion, up from USD 11 billion last year. Savings and investment both declined, further impacting overall GDP growth. End Summary. ¶2. (SBU) Finance Minister Naveed Qamar rolled out the Economic Survey for the 2007-08 fiscal year on June 11. The document, released one day before the fiscal year 2008-09 budget, utilizes data from the first ten months of the current fiscal year. (Note: All data references in this cable cover the first ten months of the fiscal year, and comparisons are for the equivalent period during the 2006-2007 fiscal year. Pakistan's fiscal year runs from July to June. End Note.) The survey report concluded that Pakistan missed all of its major economic targets for the current fiscal year, including GDP growth, agricultural production, industrial and manufacturing growth, inflation, fiscal and current account deficits and the trade balance. Survey data indicates that economic growth for the current fiscal year will come in at around 5.8 percent versus an annual target of 7.2 percent. ¶3. (SBU) Referring to last ten months as "challenging," Finance Minister Naveed Qamar blamed "unexpected" political and economic conditions, both domestic and international, for the below-target economic performance. Qamar stated that the Government of Pakistan (GOP) was currently facing dual challenges: "getting economic growth back on track" and implementing "correct and viable" economic policies that protected Pakistan's most vulnerable groups. Qamar blamed the lack of financial discipline for the country's macroeconomic imbalances. Both growth and investment have declined; the current account, fiscal and trade deficits have all risen; and decreased foreign exchange reserves have put pressure on the Pakistani rupee. Expressing hope that Pakistan would receive increased budgetary support from "friendly countries and international donors," Qamar estimated that the GOP would receive close to USD three billion by the June 30 end of the current fiscal year. ¶4. (SBU) The services sector remained the driving economic force during the current fiscal year; 75 percent of annual GDP growth can be attributed to gains made by the services sector. The manufacturing sector recorded a modest 5.4 percent growth versus 8.2 percent growth last fiscal year. Large-scale manufacturing and construction sector growth rates both fell well below target. The rising cost of international commodities, nation-wide energy shortages and periodic social and political unrest all contributed to below-target manufacturing growth. The agricultural sector also performed poorly, recording 1.5 percent growth versus a target of 4.8 percent. A sharp decline in the production of major crops, coupled with power and water shortages, is partly to blame for the below-target performance. ¶5. (SBU) Inflation, as measured by changes in the Consumer Price Index (CPI),averaged 10.3 per cent during the first ten months of the current fiscal year. The Ministry of Finance cited commodity price inflation and excessive borrowing from the State Bank of Pakistan as being particularly troublesome. Food price inflation for the first ten months of the current fiscal year rose 15 percent versus 10.2 percent last year with non-food inflation rising 6.8 percent. ¶6. (SBU) Pakistan's annual fiscal deficit is currently estimated at USD 10.9 billion or seven percent of GDP. The rising cost of ISLAMABAD 00002106 002 OF 003 subsidies, particularly for fuel and energy, and an increased debt service burden are mainly to blame. The current account deficit, including official transfers, widened 75.6 percent to USD 11.6 billion, versus last year's deficit of USD 6.6 billion. The current account deficit currently stands at 6.9 percent of GDP, up from 4.6 percent during the same period last year. Total investment dropped slightly to 21.6 percent of GDP, down from 22.9 percent last fiscal year. While public sector investment remained steady at 5.7 per cent of GDP, private sector investment decreased from 15.6 per cent to 14.2 per cent of GDP. National savings accounted for 13.9 per cent of GDP versus 17.8 percent last fiscal year. National savings financed 65 per cent of fixed investment during the first ten months of the current fiscal year, down from 77.7 per cent last year. ¶7. (SBU) The State Bank of Pakistan continued to pursue a tight monetary policy, raising the discount rate on three occasions and increasing both the cash reserve requirement and statutory liquidity requirement. Growth in the money supply slowed from 14 percent to nine percent from July 2007 to May 10, 2008. Credit to the private sector grew by 14.9 percent during the first ten months of the current fiscal year versus 12.2 percent during the same period of last year. Monetary tightening, which began in April 2005 to curb inflation, has also impacted domestic investment, one factor in below target manufacturing growth. ¶8. (SBU) Pakistan's trade deficit currently stands at USD 16.8 billion, up from USD 11 billion last year. Exports grew by 10.2 percent, totaling USD 15.3 billion with all export categories but textiles recording gains. Textile exports, accounting for 57 percent of all exports, dropped by 2.5 percent. Export gains were unable to match the rising cost of imports, totaling USD 32.1 billion. Imports grew by 28.3 per cent due to the surging cost of oil and commodity prices. Pakistan's total foreign exchange reserves, including those held by both the State Bank of Pakistan and commercial banks, stood at USD 12.3 billion as of May 2008, down from a June 2007 high of USD 15.6 billion. ¶9. (SBU) The Pakistani rupee, after more than four years of relative stability, depreciated against the dollar by 6.4 percent during the July 2007 to April 2008 period. Pakistan's external liabilities rose USD 5.4 billion during the first nine months of the current fiscal year, the largest increase in more than a decade. Pakistan currently owes USD 45.9 billion, 80 percent of which is due to bilateral and multilateral lenders. Almost all of Pakistan's external debt is medium and long-term. Worker remittances remained a bright spot, increasing 19.5 percent to a total of USD 5.3 billion for July 2007-April 2008. Comment - - - - ¶10. (SBU) This has been a difficult year for Pakistan's economy, as it has been buffeted by increases in international commodities prices and political pressure to increase spending on subsidies and development. As a result, Pakistan's macroeconomic indicators remain worrisome after the fiscal and current account deficits have reached an unsustainable seven percent of GDP. While the GOP anticipates USD three billion in additional financial inflows before the June 30 end of the fiscal year, Pakistan still faces difficulty in financing its deficits. Since the IBRD loan was included in this USD three billion anticipated inflow, we expect the GOP will face a larger than expected financing gap. ¶11. (SBU) Comment continued: Although GDP growth of 5.8 percent looks respectable, it is important to note that growth has been almost entirely in the services sector. Past growth has been more broad-based, with the agricultural, manufacturing and services sectors all contributing. Despite tight monetary policy, inflation remains in the double digits. The GOP is now forced to make tough choices between spending and fiscal discipline. With all macroeconomic indicators continuing to move in a negative direction, growth will likely slow further in the coming fiscal year, increasing pressure on the government to increase taxes, decrease subsidies and stop excessive borrowing from the State Bank of ISLAMABAD 00002106 003 OF 003 Pakistan. End Comment. PATTERSON