PAKISTAN LOAN STATUS REPORT - ADB AND WORLD BANK

UNCLAS SECTION 01 OF 02 ISLAMABAD 002895

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EAID EFIN ENGY PREL PGOV PK
SUBJECT: PAKISTAN LOAN STATUS REPORT - ADB AND WORLD BANK


1. (SBU) Summary: Although the media reported the Asian Development
Bank (ABD) will disburse USD 500 million in budgetary support to the
GOP by September 30, an ADB official informed the Embassy the loan
remains contingent on an International Monetary Fund (IMF) comfort
letter which the ADB has not yet received. In order for the initial
ADB disbursement to occur by September 30, the ADB needs to receive
the IMF letter by September 5. The Embassy's assessment is that the
GOP now understands the gravity of the economic crisis. The rate of
depletion of State Bank of Pakistan (SBP) foreign exchange reserves
has decreased by approximately 33 percent in the two weeks ending
August 22. However, in the absence of further bilateral and
multilateral assistance, the economic reform measures the GOP is
currently undertaking may be too little, too late. At the current
rate of depletion of reserves, if the GOP does not move quickly to
cut subsidies further and gain better control of government
spending, the ADB loan will only postpone a balance of payments
crisis for a month. Moreover, an ADB official has noted the status
of a World Bank loan the GOP expects to receive is uncertain and may
not be on the horizon in the short term. End Summary.

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SEPTEMBER LOAN DISBURSEMENT POSSIBLE
BUT IMF COMFORT LETTER CRITICAL
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2. (SBU) The August 31 edition of the Business Recorder reported the
Asian Development Bank (ABD) will disburse before September 30 USD
500 million of a total USD 1.3 billion "Accelerating Economic
Transformation Program" loan. In a September 1 conversation with
EconOff, an ADB economist said the ADB is still awaiting an IMF
comfort letter. When and if the ADB receives this letter, it will
be circulated to the ADB Board, and there will be a three-week
period for consideration. Thus, in theory, the disbursement can
still occur by September 30, but the clock is ticking. Factoring in
processing time, in order for disbursement to occur by the end of
this month, the ADB needs to receive the IMF comfort letter by
September 5.

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DETAIL OF ADB PROGRAM
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3. (SBU) The ADB told the Embassy that past economic growth in
Pakistan has come through large fiscal, trade, and investment
deficits; it has not been accompanied by structural changes
necessary to support long-term growth. The ADB official noted their
program is, in part, budgetary support but, unlike an IMF program,
it is not aimed primarily at macroeconomic stabilization. Rather,
it is more medium- and long-term focused.


4. (SBU) According to our ADB interlocutor, the basic premise of
this program is that Pakistan needs transformation in three main
areas. The GOP, he said, must first address distortions in the
economy, particularly in the energy and agricultural sectors. This
will involve restructuring the pricing and procurement system for
wheat, reforming electrical subsidies to resolve the circular debt
issue, and better targeting subsidies so that they benefit the
poorest and most vulnerable in society. Second, the Government
needs to strengthen financial intermediation to facilitate
structural transformation. Here, the GOP needs regulations aimed at
promoting consumer confidence, more effective management of
financial risks, and deepening financial intermediation. Third, the
ADB believes that over the medium and long term, the production and
trade structures must be transformed so that Pakistan can compete in
the global economy. To do this, the ADB program will work to help
Pakistan deepen its industrial base, make the agricultural sector
more productive, make food processing more efficient, enable greater
value creation in the service sector, develop greater export
sophistication, and attract private sector investment.


5. (SBU) The ADB explained that the USD 500 million disbursement
represents funding for the first or four subprograms that make up
the "Accelerating Economic Transformation Program". These funds are
to be used to establish targeted safety nets for the poor, increase
wheat price support from Rupees 425 to Rupees 650 per 40 kilograms,
and reduce electrical subsidies by Rupees 88 billion (USD 1.3
billion) in FY2008-09. They are also meant to strengthen financial
intermediation by developing effective frameworks to regulate
financial conglomerates and handle anti-money laundering activities,

ISLAMABAD 00002895 002 OF 002


and establishing Real Time Gross Settlement for interbank
transactions.

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COMMENT
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6. (SBU) State Bank of Pakistan (SBP) foreign exchange reserves
decreased USD 381.8 million for the period August 8-August 15 and
USD 254.7 million for the period August 15-August 22. Comparing the
latter to the former period, the rate of depletion of reserves
decreased by approximately 33 percent. Although this can in part be
attributed to a decrease in world oil prices, GOP reform measures
may be beginning to have a positive impact on the economy. Still,
if the GOP does not move quickly to cut subsidies further and gain
better control of government spending, the ADB loan would only
postpone a balance of payments crisis by about a month. In addition
to the ADB loan, the GOP is counting on a USD 500 million World Bank
loan to help overcome the current financial crisis. According to
the ADB, it is unclear whether the Bank intends to make the loan at
this time. In ADB meetings with World Bank officials last week in
Islamabad, the ADB told us the Bank was quite troubled by recent
further deterioration of Pakistan's macroeconomic indicators and
appeared somewhat reluctant to go forward with the loan at present.



7. (SBU) Comment Continued: From recent meetings the Ambassador has
had with Finance Minister Qamar and other high ranking GOP
officials, it is clear the GOP now understands the gravity of the
economic situation. There are numerous stories in the Pakistani
press everyday detailing GOP reform efforts. Indeed, in the
September 1 edition of Dawn newspaper, the Prime Minister himself
defended the removal of subsidies and noted the GOP is "taking bold
decisions to phase out subsidies in order to rehabilitate the
economy." Unfortunately however, in the absence of further
bilateral and multilateral assistance, these steps may be too
little, too late. End Comment.

PATTERSON