DCM MEETS WITH STATE BANK GOVERNOR AKHTAR

C O N F I D E N T I A L SECTION 01 OF 04 ISLAMABAD 003532

SIPDIS

E.O. 12958: DECL: 11/07/2018
TAGS: ECON EFIN EINV ETRD ELAB PGOV PREL PK
SUBJECT: DCM MEETS WITH STATE BANK GOVERNOR AKHTAR

Classified By: Anne W. Patterson for reasons 1.4 (b),(d).


1. (C) Summary: In a November 5 meeting, State Bank of Pakistan
(SBP) Governor, Dr. Shamshad Akhtar confirmed that negotiations with
the IMF are stuck on the issue of how much to raise interest rates.
The GOP plans to make a decision on this issue November 12. She
expressed surprise on being advised that the Friends of a Democratic
Pakistan is not a pledging conference. Akhtar voiced frustration
about interference by Finance Advisor Tareen, President Zardari, and
Zardari's corporate friends in state bank affairs. She repeated that
she will leave when her term ends on December 31. End Summary.



2. (C) On November 5, DCM and ECONOffs met with State Bank of
Pakistan Governor Dr. Shamshad Akhtar in Islamabad. Noting that she
was in Islamabad for a few days waiting for the President to return
from Saudi Arabia, she said "it is hard to say what the outcome of
[his] trip will be." Akhtar was extremely candid during the free
flowing conversation and expressed frustration with both the lack of
attention focused on the IMF negotiations from President Zardari and
the lack of willingness to negotiate on the part of the IMF.

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FRIENDS OF PAKISTAN
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3. (C) Akhtar noted that the next meeting by the Friends of a
Democratic Pakistan (FODP) is November 17. She initially said that
she hopes that Friends "come through" with donations. When the DCM
replied that the FODP is not a pledging conference and "would not
provide any cash infusion", Akhtar questioned, "Does the President
know this? This is the first time I have heard this." The DCM
explained that FODP members have been very clear in explaining this
to senior GOP leadership on numerous occasions. The DCM further
stated that the group is interested in supporting the long-term
economic and political stability of Pakistan but is not and has never
been described as a donors' conference.

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IMF NEGOTIATIONS- INTEREST RATES ARE STICKING POINT
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4. (C) DCM emphasized that "any solution for Pakistan rests with
the IMF." Ahktar described the IMF program negotiations in Dubai as
constructive and stated that "most of the issues had been thrashed
out there." She noted that the key unresolved issue is how high to
raise interest rates and presented five reasons why sharply raising
rates is inappropriate for Pakistan at this time.


5. (C) Akhtar noted that it is very difficult to raise rates when
globally rates are being cut. She said, "it is very clear that what
is going on in the region will hurt the competitiveness of Pakistan."
Akhtar then noted that "we have already raised rates" and implied
that Pakistan wasn't getting credit for the previous rate adjustments
on May 22, and July 19, cumulatively a 3.5 percent increase this
year. She stated, "We have already done it and I hoped they would
see what we have done as pre-commitment" Akhtar noted that rather
than immediately raising rates, it is more appropriate to coincide an
interest rate move with the release of the next semi-annual monetary
policy announcements in January. At that time the SBP will review
the situation and may raise rates again.


6. (C) Akhtar conceded that core inflation has been high but she
believes that policy changes and the effects of lower fuel prices are
now beginning to reduce inflationary pressure. She stated that "We
are not disputing that core inflation has gone up," but it takes time
for policy and fuel price changes to pass through. "We need to allow
six months or more. In our assessment, inflation will come down."
Akhtar noted that the SBP will continue to promote the tighter
monetary policy it has had since 2005. She also noted that the GOP
has a limited ability to curb inflation.


7. (C) Akhtar said that anything less than 600 percent of
Pakistan's IMF quota was "not adequate given the situation, density
and size of Pakistan's economy." Noting that if Pakistan's package is
USD 9.6 billion or 600 percent of quota it would be the 'smallest by
far" of the IMF packages but yet Pakistan has been "the worst hit

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country." She noted that packages for other countries are
substantially larger, such as USD 25 billion for Hungary and 800
percent of quota for Ukraine. Akhtar was candid in her opinion that
the Deputy Director of the IMF is very biased and is trying to base
these programs on his experience in Brazil. She noted that there
can't be any one model and further commented that mistakes have been
made in these programs in the past, giving the example of Indonesia.
She also referenced her recent conversations with the state bank
governor of Portugal who is allegedly frustrated with the IMF
narrow-mindedness as well.


8. (C) EconCounselor asked if perhaps some clarity might be given
to the interest rate issue with the IMF if there were a general
government commitment to increase interest rates in January since the
Governor herself hasn't been reappointed yet. Akhtar noted that she
expected whomever was in office would commit to raise interest rates.
DCM asked if the IMF or the GOP were considering whether
disbursements could be made in separate installments, conditional
upon interest rate increases. Akhtar claimed that this had never
been discussed.


9. (C) Akhtar noted general concern with the Fund's prescriptions.
While discipline is needed, she said the IMF needs to have a mix of
policies and should have some flexibility for trade-offs. Akhtar
commented that the minutes of the IMF Board meeting on Pakistan
acknowledged that this is an emergency and that IMF staff should not
"kill the patient." She urged everyone to read the minutes of the
board meeting where the IMF was cautioned to not impose harsh
conditions but rather "this was supposed to be an owner-driven plan."
She said she told the IMF that she would comply with their
requirements -- "put a gun to my head and I will raise rates" -- but
that it is not in Pakistan's interests to raise rates. "I sincerely
believe this is the wrong time."

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POLITICAL ECONOMY SHOULD NOT BE UNDERESTIMATED
-------------- -


10. (C) Akhtar further noted that the political economy of Pakistan
makes further rate increases very difficult. She claimed that there
are serious problems with the corporate sector, who are demanding 4-5
percent reductions from the 13.5 percent rate. Noting that every day
you can see another press statement from another industrial group
which has met with the Prime Minister or President, Akhtar stated
"they refuse to meet with me now because they are very annoyed with
my policy" to increase interest rates. While she has not been
receptive to their pleas, the President and Prime Minister have been
listening.


11. (C) Akhtar believes there is some merit to the argument that a
decline in business activity would cause a reduction in exports,
which would further widen the trade deficit, and require additional
financing. Industry must be allowed to continue or Pakistan will see
massive layoffs and unemployment. Akhtar stated that "now with
energy cuts, production is hurt but manufacturing is the bread and
butter of our country and we can't let exports go down." Akhtar
noted the banking sector is already making significant layoffs and
stated that "Price stability is important but legally I must be
concerned with employment too."

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THE END OF AN ERA
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12. (C) Akhtar's term ends on December 31, 2008. She disclosed that
due to problems with the President Zadari and Financial Advisor
Tareen, she is not interested in reappointment and will leave by
January 1. She said that "Zardari is surrounded by people with
private interests," and further she noted with dismay that there are
press reports indicating that she will be out by November 15. Akhtar
seemed frustrated by the lack of high level focus on the IMF and
noted that at one time she had a good discussion with Zardari on how
to convey the right signals and that the IMF was the only true
recourse. Stating "I brought the IMF to the table," she said that
despite the constant discussion and public announcements of plans A,
B, and C, "the government has only one plan-- to get money." "The
politicians said the IMF is bad, and that interest rates are bad.

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Now the corporate sector is talking about organizing protests. If
you continue to play to the gallery, this is what you get."

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AUTONOMY OF THE CENTRAL BANK DECLINING
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13. (C) Akhtar was very forthright in sharing her concerns that
Zardari and his financial team were moving to reduce the autonomy of
the central bank. She expressed her opinion that Finance Advisor
Tareen is trying to consolidate all of the control of financial
matters under his authorities. Noting that the independence of the
SBP has long been a bedrock in Pakistan's system under Musharraf and
was recognized internationally as very strong, Akhtar was very candid
in stating that "Zardari is too dependent on Tareen" and that Zardari
needs to be "briefed on the dangers" of having "one advisor provide
all." According to Akhtar, Tareen officially ceded control of the
bank he owns to his brother but functionally still runs it. She said
Tareen wants to run both the Finance Ministry and the SBP. "Somebody
has to independently brief the President, because in the end he will
get hurt" by biased advice.


14. (C) Akhtar stated "If I were at the IMF, I would have pushed for
central bank independence. With independence, [rational rates] would
have followed. Who can dispute central bank reform?" Akhtar noted
that at present the SBP cannot impose limits on government officials
borrowing from the SBP despite their claims that they will try to
lower borrowing. She thought it is unfortunate that enhancing
central bank autonomy was compromised early in IMF program
negotiations. Akhtar said it was "squashed at the technical level."
Noting that India's lack of central bank autonomy is setting a poor
example, Akhtar implied that senior GOP leadership sees the Indian
Prime Minster making decisions on interest rates and thinks "why not
do that here too?" Akhtar claimed that she's been trying to "convey
a message" to Zardari but there is a "lot of noise on the issue."

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NEXT STEPS
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15. (C) Akhtar said the government must decide what to do on
interest rates. She said they are currently in a dialogue with the
corporate sector but will make a decision by November 12 on whether
to request the negotiated program. No further rounds of negotiations
are planned though she later noted the amount and rate of disbursal
of funds still "needs to be fine tuned." The decision will have to
be made after the President and his 100 person delegation return from
Saudi Arabia. Negotiations are "on track except for this one item."


16. (C) The DCM asked if the SBP could raise the composite T-Bill
rate without raising the discount rate, and whether this change can
be immediately implemented. Akhtar responded, "Yes, the Finance
Minister and I agree" on the need to raise T-Bill rates, independent
of discount rate decisions. Akhtar noted that electricity rates will
also be raised by December 31 but did not indicate the percent of
increase.

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CENTRAL BANK FINANCING OF DEFICIT
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17. (C) Turning to the question of continued borrowing by the
central government to finance the deficit, Akhtar said the GOP has
committed that, starting in November, net borrowing over the fiscal
year will be zero. She noted the GOP intends to achieve net zero
borrowing on a quarterly basis, but they have already borrowed
heavily between July and October. Akhtar reported that the GOP
argues that the "war on terror has drained more resources than
expected." Akhtar explained that the budgeted deficit was 4.7
percent of GDP but the IMF proposed 3.5 percent of GDP. The
compromise was 4.3 percent of GDP if external money was obtained but
now it was looking like the IMF and GOP agreed to reduce the budget
deficit to 3.9 percent of GDP. However, since IMF financing cannot
be used for direct budget support, other sources will be necessary to
mitigate the impact of development spending reductions. "Unlimited
borrowing is the root of inflation" she claimed.


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FINANCIAL SECTOR STABILITY
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18. (C) Turning to financial sector stability, Akhtar noted the SBP
has set up a dialogue between bankers and brokers and "now, when
margins are invoked, we will not see a rush because banks will use a
one year term facility." Further, the SBP extended collateral
regulations to include real estate. She acknowledged that there is
still concern about the prospect of foreign portfolio investors
withdrawing funds from the market and draining away exchange reserves
when the floor in the Karachi Stock Exchange is removed.


19. (C) Akhtar said the banking sector is also being brought under
pressure now. Over 145 billion rupees (USD 17.9 million at 80.9
Rupees per dollar) have been withdrawn on rumors and Akhtar expressed
dismay that on rumors even the GOP withdrew funds of
government-owned, public sector enterprises. "All of this was
sentiment driven." Akhtar noted that she moved quickly to stabilize
the situation and to mobilize deposits, including through television
appeals. She said that she moved aggressively to add liquidity to
the banking system. She reported that foreign exchange rates have
stabilized. Akhtar expects liquidity will improve, and with a cash
infusion, foreign reserves will rise.

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AML/CFT
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20. (C) When asked about the status of a terms-of-reference required
to place an AML/CFT technical advisor from the USG, Akhtar said "I
cleared it and told them to move it." She said that the GOP looks
forward to further cooperation and she would have the terms of
references forwarded immediately to the Embassy. Akhtar said that
legislation to strengthen Pakistan's enforcement of AML/CFT laws has
Cabinet-level approval and will go to Parliament for ratification.
Akhtar thought the draft legislation had already been shared with the
USG but offered to make it available immediately.


PATTERSON

H:\Econ\Macroeconomic\11-5-08 SBP Gov Meeting.doc