WITH RECORD HIGH Q1 BORROWING FROM THE STATE BANK, PAKISTAN

UNCLAS SECTION 01 OF 02 ISLAMABAD 003202

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EAID PREL PK
SUBJECT: WITH RECORD HIGH Q1 BORROWING FROM THE STATE BANK, PAKISTAN
SLIPS CLOSER TOWARDS FINANCIAL DEFAULT


1. (SBU) Summary. Despite numerous pledges to the contrary, the
Government of Pakistan's (GOP) borrowing from the State Bank of
Pakistan (SBP) is at a record high in spite of commitments to reduce
borrowing to net zero levels in every quarter. While the Federal
Board of Revenue has performed reasonably well in tax collection,
surpassing targets by a small margin, funds are insufficient to
finance increased spending. Although complete first quarter fiscal
data has not been publicly released yet, the increased SBP borrowing
indicates that the fiscal deficit could be much higher than
targeted. The rapid depletion of foreign exchange reserves has
created additional stress such as a large rupee depreciation and a
liquidity crunch in the inter-bank market. The inter-bank call
money rates have shot up to record levels and the State Bank of
Pakistan had to intervene in the market to provide liquidity to
banks. End Summary.

- - - - - - - - - - - - - - - - - - - - - - - - - - -
BORROWING FROM STATE BANK OF PAKSITAN AT RECORD HIGH
- - - - - - - - - - - - - - - - - - - - - - - - - - -


2. (SBU) GOP borrowing rose over 100 percent in the first 11 weeks
of the current fiscal year (July 2008-June 2009). According to SBP
data, the government borrowed PKR 170.19 billion (USD 2.16 billion)
from July 1 to September 20 from the SBP. The GOP retired PKR 3.73
billion (USD 47.4 million) to the SBP during the same period last
year. In the recent plan, "Economic Program of Pakistan:
Reinvigorating Hope and Ameliorating Peoples' Livelihood" dated
September 20, Ministry of Finance officials predicted a "likely
over-run" in the first quarter budget deficit target; however, these
GOP predictions called for an overrun of only 0.3 percent of GDP in
fiscal deficit. With an overall budgetary fiscal deficit target of
4.7 percent of GDP for the current fiscal year, the GOP has exceeded
all predictions with this estimated 1.47 percent of GDP budgetary
deficit in just the first quarter, which is much higher than the
quarterly fiscal deficit target of 1.17 percent.


3. (SBU) Analysts said that the government borrowing increased due
to the large underlying budget deficit which includes
debt-servicing, and a backlog of payments and subsidies. Commercial
banks were also feeling the liquidity crunch and were not
participating in auctions of government securities. The government
has time and again committed to bring quarterly net borrowing from
the central bank to zero in order to control inflation running at
over 25 percent.


4. (SBU) On October 6, the SBP injected PKR 53.9 billion (USD 685
million) into the banking system to save it from the extreme credit
crunch and high call money rates. The first work day after the
official three day EID holiday opened with a severe shortage of
liquidity which pushed up inter-bank call money rates to 32 to 40
percent. The situation could have been worse if the SBP had not
injected huge liquidity, PKR 53.9 million (USD 685 million),into
the system. However, several local press reports quote commercial
bank officials who claim that bank withdrawals during Ramadan and
EID were much more than the amount injected by the SBP.

- - - - - - - - - - - - - - - - - - - - - - - - - - - - -
RUPEE DEPRECIATION AT ALL TIME HIGH AND FOREIGN RESERVES FURTHER
DECLINE
- - - - - - - - - - - - - - - - - - - - - - - - - - - - -


5. (SBU) On October 6, the value of the rupee sank to a record low
as import payments drove the rupee to a low of 78.65 against the
dollar in early trades. The previous low was observed on Sept 22 at
78.55. Local currency dealers anticipate further depreciation due
to impending import payments. Foreign exchange reserves with the
SBP fell to USD 4.76 billion on October 6th from USD 4.86 billion on
September 30th. The deposit of the recent USD 500 million Asian
Development Bank loan is reflected in the marginal improvement of
foreign exchange reserves, which were USD 4.68 billion on September
27th before the disbursement.

- - - - - - - - - -
TAX REVENUES ARE UP
- - - - - - - - - -


6. (SBU) Tax revenue is up 23.5 percent during the first quarter
(July-Sept) of FY 09 over the same period last year. Showing 23.5

ISLAMABAD 00003202 002 OF 002


percent increase, the Federal Board of Revenue raised PKR 253.3
billion (USD 3.22 billion) in the first quarter versus PKR 205.13
billion (USD 2.61 billion) in the same period last year. The
revenue collection also surpassed the PKR 250 billion (USD 3.17
billion) target set for this quarter (July-September 2008). Domestic
sales tax collection increased by more than 50 percent showing that
the record inflation has helped the government to raise more revenue
from consumers. Additionally, sales tax collection on imported
goods grew by 17.1 percent, indicating that the newly imposed 30 to
35 percent additional customs duties on "luxury goods" has not
slowed import growth as expected. Overall, imports surged by 31
percent year on year in July-August 2008 mainly due to increased
imports of petroleum products as energy blackouts continue to plague
the country and more generators are installed nationwide.

- - - -
COMMENT
- - - -


7. (SBU) Pakistan's economy has recently felt only negatives
including a rapid depletion of its foreign exchange reserves, large
depreciation of its currency and substantial slowdown in foreign
inflows. As the GOP shops for assistance around the world,
commitments to stem borrowing from the State Bank of Pakistan and to
keep net borrowing at zero in every quarter of FY 09, have been a
constant mantra. However, record borrowing from the SBP in the first
quarter of the new fiscal year dampens expectations that the new
government's economic reform plan is feasible and that the GOP has
the discipline to implement the strict but necessary measures.

PATTERSON