CENTRAL BANK RAISES RATES TWO PERCENT AMID BLEAK ECONOMIC

UNCLAS SECTION 01 OF 02 ISLAMABAD 003558

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN ETRD PREL PGOV PK
SUBJECT: CENTRAL BANK RAISES RATES TWO PERCENT AMID BLEAK ECONOMIC
OUTLOOK


1. (SBU) SUMMARY. The State Bank of Pakistan (SBP) Governor, Dr.
Shamshad Akhtar, announced that the policy rate would be raised 200
basis points, from 13 percent to 15 percent, presumably in
acceptance of International Monetary Fund (IMF) conditionality.
However, Akhtar warned banks not to raise the lending rates further
because current rates already rose in anticipation of the rate
increase. The foreign exchange reserves of the SBP rose slightly,
to USD 3.545, but can finance imports of only 29 days. The Adviser
on Finance painted a dismal picture of the economy, including 3
percent GDP growth rate, and described the IMF as the only choice to
support Pakistan's balance of payments. Just released date show that
inflation continued to soar at 25 percent between July and October
despite reductions in international commodity prices largely due to
latent oil and food price effects. Import growth slowed to 2.4
percent in October with a 10.2 percent rise in exports. If
sustained, this trend could reduce the record high trade deficit of
USD 7.52 billion in July-October 2008. Remittances increased by
12.7 percent in July-October 2008 but the Money Changers Association
warned that investigations of exchange companies for illegal cross
border transfer of millions of dollars may negatively affect future
remittance inflows. END SUMMARY.

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INCREASE IN INTEREST RATES
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2. (SBU) On November 12, SBP Governor Akhtar announced in a live
teleconference that the discount rate will be raised 200 basis
points, from 13 percent to 15. The IMF has advised the policy rate
should be raised by 350 basis points to bring rates closer to
positive real terms. The November 5 T-bill auction outcome made it
clear that the SBP was set to raise the policy rate in accordance
with IMF conditionality. In the auction, SBP permitted the yield on
3-month T-bills to rise by 97 basis points to 13.53 percent.
Addressing bankers and industrial leaders at the SBP Head Office on
November 11, Akhtar warned the banks not to raise lending rates from
the current levels, otherwise, SBP would be compelled to either
mandate the Karachi Inter-bank Offer Rate or else abolish the system
altogether. According to participants, the consensus was that banks
have already priced in the expected 200 basis raise in SBP policy
rate in anticipation of IMF conditionality. Therefore, SBP wants
banks to refrain from raising it further when the discount rate goes
to 15 percent. Meanwhile, industry representatives have complained
that the mark-up rates are making the industrial sector
uncompetitive. They argued that if rates must rise, it should be
done gradually.

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ECONOMIC INDICATORS CONTINUE DOWNWARD TREND
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3. (SBU) On November 10, the Federal Bureau of Statistics reported
inflation and trade statistics for October 2008. The State Bank's
current foreign exchange reserves of USD 3.545 billion raised
slightly, but can finance imports for only 29 days. The consumer
price inflation edged up to 25 percent in October, nearing a
three-decade high, driven by 31.7 percent food inflation, against
9.31 percent in the same month last year. Even the non-food/
non-energy inflation was in double digits at 18.3 percent in October

2008. The consumer price inflation in July-October 2008 was up
24.64 percent year over year. Food inflation moderated a little bit
from the July-August figure of 34 percent, though it was still high
at 32.3 percent in July-October 2008 compared to 11.2 percent in the
same period last year. The non-food/ non-energy inflation was 16.7
percent in this period. The government has projected a 12 percent
inflation target for 2008-09, which seems highly unlikely to be
achieved.


4. (SBU) Imports continued their upward trend and increased by 24.86
percent to USD 14.28 billion year over year in July-October 2008.
While import growth slowed 2.45 percent in October compared to last
October, it is not significant compared to the plunge in
international commodity prices. Exports increased by 16.62 percent
year over year in July-October 2008, while their growth rate slowed
down to 10.24 percent in October. Eid festival and fewer working
days may have affected the exports growth in October. The export
growth rate, however, has exceeded the import growth rate in October
2008; if this trend is sustained then the trade deficit may

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decrease. The trade deficit was USD 7.52 billion in July-October
2008, up 33.3 percent year over year. The trade deficit, however,
narrowed to USD 1.94 billion in October, compared with USD 2 billion
in October last year -a decline of 2.91 percent. Prime Minister
Syed Yousuf Raza Gilani has already constituted a high-powered
committee, headed by the State Minister for Finance, Hina Rabbani
Khar, to monitor the flow of imports into the country and to also
suggest measures for moderating them.


5. (SBU) Remittances by overseas Pakistanis kept up their rising
trend as USD 2.34 billion was received during July-October 2008, an
increase of 12.71 percent (USD 264.5 million),over the same period
last year. The monthly average remittances for this period is USD
586.50 million as compared to USD 520.37 million for the same period
of last year.

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MINISTER PAINTS BLEAK OUTLOOK
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6. (SBU) On November 11, while briefing the Senate Shaukat Tareen,
Advisor to the Prime Minster on Finance, reflected this dismal
picture of the economy. He said inflation has reached 25 percent,
the rupee has depreciated over 30 percent, and economic growth has
decelerated to 3 percent. In the wake of all these factors, he
asserted Pakistan has also lost the support of its economic
partners. He said the country has become very weak institutionally
and whatever planning was done during the previous government was
without foundation. Insufficient emphasis was placed on production
and improving the agriculture sector, though 66 percent of
Pakistan's population is affiliated with agriculture. This resulted
in increased imports and an extra burden on reserves.


7. (SBU) Tareen said that Pakistan has decided to approach the IMF
in the next 10 to 15 days. He said that the country needs an inflow
of USD 5 billion immediately to manage the balance of payments. "If
Friends of Pakistan and other IFIs could not help us within the
stipulated period then we have no option except IMF." Tareen
stressed the need to strengthen macroeconomic indicators to control
inflation and ensure sustainable growth. To achieve these targets,
he said, the tax to GDP ratio will have to be increased to 15
percent from 10.5 percent within the next five to seven years.

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CRACK DOWN ON MONEY EXCHANGERS CONTINUES
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8. (SBU) The SBP also warned exchange companies that any exchange
company found to be in violation of SBP rules and regulations in
general and any undocumented transactions in particular, would lead
to strict action including suspension or cancellation of their
license. On October 10, the SBP suspended the license of the Khanani
and Kalia International (KKI) foreign exchange company after the
arrest of its owners on charges of illegally transferring millions
of dollars abroad. The license of the firm, KKI was suspended for
30 days for violating rules and regulations and its head office,
branches, franchises, payment booths and currency exchange booths
were debarred from undertaking any business during the period.


9. (SBU) Advisor to the Prime Minister on Interior, Rehman Malik
disclosed to the Senate on November 11, that just one computer
revealed illegal transactions of Rs 39 billion (USD 485 million at
80.35 rupees per USD) by KKI. Approximately twenty such computers
have been confiscated. He said they had developed a parallel
internet banking system, traces of which were found in Gujranwala,
where computers were confiscated following the detection of an
informal banking website. Though data was deleted, the cyber crime
investigators retrieved it. The investigation continues and more
people could be implicated. The president of the Forex Association
of Pakistan, Malik Bostan, said the action against the country's
biggest exchange company would hurt remittances from overseas
Pakistanis, which were expected to reach USD 7 billion by the end of
June 2009. Mr. Bostan said SBP should help resolve the issue.

PATTERSON