PAKISTAN'S INACTION MAKES DEFAULT MORE PROBABLE

UNCLAS SECTION 01 OF 02 ISLAMABAD 003403

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PREL PGOV PK
SUBJECT: PAKISTAN'S INACTION MAKES DEFAULT MORE PROBABLE


1. (SBU) Summary. Over the past ten days foreign exchange reserves
dropped 13 percent to USD 3.52 billion on October 27. Fuel
subsidies have been quietly phased out but electricity subsidies are
on pace to exceed the budgeted funds for FY 2008-09. Credit-default
swaps (CDS) spreads on Pakistan's USD 2.7 billion of
dollar-denominated bonds outstanding have jumped making Pakistan one
of the riskiest debts in the world. Moody's downgraded Pakistan's
sovereign debt rating and may downgrade further based upon the
timeliness, adequacy, and prospects for sustainability of an IMF
program. End Summary.

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FOREIGN RESERVES DWINDLING
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2. (SBU) Foreign reserves of Pakistan's Central Bank are down to USD
3.52 billion (equivalent to 29 days of imports based on Post
calculations) as of October 27, from USD 4.03 billion just ten days
ago.

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RISKIEST DEBT IN THE WORLD
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3. (SBU) Credit-default swaps (CDS) on Pakistan's USD 2.7 billion of
dollar-denominated bonds outstanding have jumped to 5,106 basis
points according to CMA Datavision, an increase of 1,620 basis
points from yesterday. It now costs USD 5.1 million annually to
protect USD 10 million of the country's debt from default for five
years.

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ENERGY SUBSIDIES
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4. (SBU) While not announced publicly, the Government of Pakistan
(GOP) has eliminated all fuel subsidies as of October 16, due to the
drop in international pricing. Current retail prices are as
follows: Petrol Rs. 81.68 (USD 1.00 at 81.35 rupees per dollar);
Light Diesel oil: Rs 60.00 (USD 0.74); Kerosene: Rs 61.87 (USD
0.76); High Speed Diesel Rs 68.14 (USD 0.84). The GOP has kept the
prices of diesel and petroleum unchanged since September 15, despite
drastic falls in the international crude oil prices. On October 28,
the Ministry of Petroleum proposed a reduction of Rs 5 (USD 0.06)
per liter for both diesel and petroleum to the Ministry of Finance.
Petroleum product prices are due to come under official review by
the Cabinet at the end of this month. Pakistan's Oil and Gas
Regulatory Authority (OGRA),calculates and reviews prices of
petroleum products each fortnight. The current retail prices for
petroleum allow the GOP to overcharge consumers by about Rs 30 per
liter (USD 0.37). For FY 2008-09 the GOP had budgeted Rs 140 billion
(USD 1.72 billion) for fuel subsidies.


5. (SBU) Due to the recent decision to suspend a tariff increase on
electricity, the GOP has assumed a greater portion of electric
subsidies than planned in the FY 2008-09 budget. While the GOP had
planned Rs. 65 billion (USD 799 million) to be paid in electricity
subsidies, they have already spent Rs 26.250 billion (USD 322
million) in the first fifteen weeks of the fiscal year according to
Ministry of Petroleum Section Officer Waqar Asgar Rana. The GOP has
also budgeted Rs 1.7 billion (USD 20.9 million) in subsidies for
natural gas in FY 2008-09 according to Alltaf Hussain Deputy
Executive Director for Finance at the Oil and Gas Regulatory
Authority.

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DOWNGRADED AND OUTLOOK GRIM
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6. (SBU) Moody's Investor Service downgraded Pakistan's sovereign
bond rating from B2 to B3. A ratings downgrade would typically
raise the cost of new borrowing but Yousef Ahmad, Director for
Citibank in Pakistan noted that commercial credit is functionally
unavailable to Pakistan and its existing sovereign securities are
currently traded at a discount of 60 to 65 percent. In the public
statement Moody's analyst for Pakistan, Aninda Mitra, explained that
the "rating action was prompted by the continuing erosion of the
country's external liquidity position, which has remained
inadequately addressed by policy adjustments and has suffered from

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delays in assistance from key bilateral and multilateral creditors."
Pakistan has a USD 500 million global bond obligation due in
February 2009 which market participants consider its greatest
near-term test.


7. (SBU) Moody's continues to keep Pakistan on review for further
downgrade due to uncertainty about the size, timeliness and
durability of an IMF program, an option the Government of Pakistan
continues to describe as a last resort. "Even if an IMF assistance
package were to avert a near-term default, Pakistan's intrinsic
ability to generate greater access to foreign exchange has dimmed,"
says Mitra. He adds that "Insufficient macro-economic adjustments,
weak prospects for structural reforms, and a chronic shortage of
foreign exchange were likely to heighten Pakistan's need for
medium-term balance-of-payments support, or raise the risk of a hard
economic landing."

PATTERSON