CABINET OKAYS IMF PROGRAM BUT NOT SMOOTH SAILING WITH

UNCLAS SECTION 01 OF 03 ISLAMABAD 003658

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON ETRD EAID EFIN ENGY PK
SUBJECT: CABINET OKAYS IMF PROGRAM BUT NOT SMOOTH SAILING WITH
PUBLIC


1. (SBU) SUMMARY. The Federal Cabinet approved the economic
stabilization plan and directed the Ministry of Finance to finalize
negotiations with International Monetary Fund (IMF). The Planning
Commission received reports on both short-term stabilization and
medium-term economic recovery. The reports will facilitate an
indigenous action plan and a roadmap for donor negotiations.
However, recommendations like taxing agriculture are already facing
stiff resistance. Meanwhile, the Government has again delayed a
decision on an expensive campaign promise of reinstating 8,764
government workers fired for political affiliation. Market leaders,
however, report improved sentiments since Pakistan approached the
IMF. END SUMMARY.

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CABINET APPROVES IMF PROGRAM
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2. (SBU) Local press reports that on November 19, the Federal
Cabinet approved the economic stabilization plan and directed the
Ministry of Finance to finalize negotiations with IMF for reaching a
formal agreement. The special Cabinet meeting concluded that
accepting IMF facility was the only option to stabilize the economy
and work toward development and prosperity. The Advisor to the
Prime Minister on Finance, Shaukat Tareen, briefed the meeting on
the latest interactions between the government and the IMF. Tareen
told the Cabinet the IMF will accept Pakistan's "home-grown Economic
Stabilisation Plan." Tareen told the Cabinet that the Standby
Facility will be spread over 23 months, involving USD 7.6 billion at
an interest rate of 3.51 percent to 4.51 percent, with a minimum of
USD 3.2 billion credited to the State Bank of Pakistan (SBP) account
in New York immediately after IMF Board approval. Foreign Minister
Qureshi told the Ambassador, November 20, that the discussion in the
cabinet had been spirited. He said that Dr. Hafez Pasha briefed the
Ministers and advised that the IMF program tracked closely with his
panel's assessment (see below).

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T-BILL AUCTION SHOWS COMMITMENT TO REFORM
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3. (SBU) One of the central components of Pakistan's program
discussions with the IMF has been to allow interest rates to become
positive again, in real terms, by raising the policy interest rate.
Among the economic distortions the low policy rate caused was a
reliance on central bank financing of the federal deficit. The IMF
closely watched the T-bill auction on November 19, to make sure the
target of Rs75 billion (USD 951 million at 78.88 rupees per dollar)
was fully subscribed. The SBP sold a total of Rs103.5 billion (USD
1.3 billion). SBP sold Rs101.6bn (USD 1.29 billion) in 3 month
bills and Rs1.9bn (USD 24 million) in 6 month bills at 13.85 percent
and 14.01 percent respectively. It rejected all bids for 12-month
bills. COMMENT. IMF and donors consider this a successful auction,
as the full targeted amount was sold, although the SBP appears to
have targeted the shorter end of the yield curve for lower rates.
END COMMENT.

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ECONOMIC STABILIZATION PLAN RECEIVED
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4. (SBU) On November 18, Prime Minister Gilani officially received
the report Pakistan's Planning Commission requested from the "Panel
of Economists" formed in September. The panel, headed by Dr. Hafiz
Pasha, was instructed to prepare a short term economic stability
report and a medium term growth strategy. Pasha is a well known
economist of Pakistan and a former Planning and Development
Minister. Gilani said that the report will help policymakers to
formulate an indigenous action plan and give them a clear roadmap
for donor negotiations. The report discusses the issues of
non-competitive industry and consequently non-competitive exports, a
distorted price structure which encourages consumption over
production, large fiscal and current account deficits, and a need
for social safety nets for the poor.


5. (SBU) One of the important panel suggestions is to have adequate
and well-targeted social safety net programs in anticipation of the
slowdown in economic growth and resultant unemployment. Pakistan
must tighten monetary and fiscal policies, especially by raising

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interest rates and cutting development expenditures. The economists
believe development expenditure cuts will help to free up resources
for social safety nets, especially to protect the poor during the
expected economic slowdown.


6. (SBU) The panel proposed a number of stabilization measures,
including taxing the services and agricultural sector, taxing the
real estate and capital gains to generate revenue and also to curb
speculation, cutting development expenditures, letting the exchange
rate depreciate further to overcome overvaluation, correcting the
price structure in order to encourage production and
competitiveness, and adding a clause to the Fiscal Responsibility
and Debt limitation law to restrict the government borrowing from
the State Bank.


7. (SBU) The economists estimate that 75 billion in additional taxes
can be generated through imposition of regulatory duty on non
essential imports, imposition of excise duty on non essential
consumer goods and services, and an agricultural tax. Another
suggestion is to start only those development projects that have
high employment intensity. They recommend that the focus should be
on ongoing projects that have already been implemented.

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PARLIAMENT OPPOSES AGRICULTURE TAX
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8. (SBU) Much of the domestic criticism of the IMF program is the
accusation that the IMF will require a federal agricultural tax.
The Business Recorder reports that in the National Assembly on
November 18, the ruling as well as opposition legislators said any
move to tax agriculture will be resisted tooth and nail and that
every farmer would take to the streets. The parliamentarians said
high diesel and other input costs had made life harder for the
growers. The Business Recorder reports that on November 19, Tareen
explained that contrary to the general impression in the country,
IMF has never asked specifically for levying a tax on the
agriculture sector. Tareen said the IMF only asked for improved tax
enforcement and increasing the tax to GDP ratio from 11 percent to
15 percent.


9. (SBU) A panel of Pakistani economists prepared a proposal to
widen the tax base by including the agricultural sector. At this
time there is no detailed proposal, just a recommendation and a
broad outline. The proposal would apply generally to all farmers
but particularly the mid to large feudal landlords. One tentative
formulation in discussion within the Government is to exempt all
landholdings up to a threshold from any taxation and then apply a
decreasing marginal tax rate for the remaining acres. For example,
if the tax is to be levied on land holdings of more than ten acres,
then a farmer with 100 acres would pay no taxes on 10 percent of the
total income (the first ten acres). The remaining 90 percent of
declared income would be taxed based on a declining marginal
schedule based on the amount of land in use; in the example the
remaining 90 acres. Thus, the larger the landholding the more
favorable this particular proposal becomes.


10. (SBU) Government technocrats and the urban industrialist class
support the general proposal and have repeatedly supported such
initiatives. The landholders are protesting. The former Minister
for Industries, Jehangir Tareen, opposed any such idea even before
it was made public. He spoke against it again on November 3, in an
Aaj TV program, arguing that the agriculture sector was already
paying many taxes and imposition of new tax will gravely discourage
the growers. At the activist's level, the Farmers Association's
President, Zahid Hussain Gardezi has also condemned any such
proposition. He described it as an obstruction that will depress
and demoralize the farmers. Gardezi said that policymakers make
recommendations without stakeholders input. Many legislators in the
National Assembly have criticized the proposal, saying that the
economic panelists lack even an elementary understanding of the
agriculture sector in Pakistan and were overly focused on the little
revenue it would generate.


11. (SBU) The proposal has not entered the legislative process.
After this broad outline prepared by the panel of economists, the
government will prepare a detailed proposal that would be presented
to the IMF Board. After consulting with the IMF, the Ministry of

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Finance (MoF) will work directly under the supervision of the joint
task force on the agriculture tax. This task force work under a
Policy Board of the Planning Commission and is expected to have
technocrats, professionals, politicians and farmer representatives.
Prime Minister Gilani and President Zardari will jointly chair the
Policy Board. Unless legislators demand direct input, the MoF will
work on the proposal as a technical matter and will directly prepare
and present its recommendations to the Cabinet for approval.


12. (SBU) COMMENT: The probability that the proposal will progress
is low. Similar proposals in the past have been unsuccessful.
International financial institutions have repeatedly pushed for an
agriculture tax but the powerful lobbies of the feudal landlords
prohibited it. Large landholders are heavily represented in nearly
all of Pakistan's political parties including the party currently in
control of the government (the Pakistan People's Party). Gilani and
Zardari each own significant landholdings and reportedly have poor
tax compliance records. END COMMENT.

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COMMITTEE CONSIDERS REINSTATEMENT OF WORKERS
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13. (SBU) On November 5, the Cabinet decided to delay any decisions
on the reinstatement of workers until further evidence is gathered
about individual causes of dismissal. On July 2, the Cabinet
decided in principle to reinstate workers of public sector
organizations and corporations fired in 1996-1997 on the basis of
their affiliations with PPP. Local press reports that as many as
8,764 employees may have their seniority and financial benefits
restored from the date of termination. A committee headed by the
Minister for Inter Provincial Co-ordination, Raza Rabbani, has been
tasked to consider the modalities of the reinstatements and prepare
recommendations for the Cabinet. Rabbani reports to Post that the
committee met to discuss on November 18, but has not formulated
recommendations on the amount of pay, benefits, or promotions
workers would receive. The committee does not even know how many
people would benefit but requested the number of employees fired for
political reasons during the three-year period from ministries.


14. (SBU) On November 5, Information Minister Sherry Rehman
explained the commitment to rehire the workers. She said, "The PPP
had pledged in its manifesto to reinstate the fired workers and it
would implement the decision regardless of the financial
implications. Finances would be carved out in the light of proposals
of the committee."

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AMBASSADOR MEETS WITH CITIBANK EXECUTIVES
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15. (SBU) On November 19, the Ambassador met with Arif Usmani
(Managing Director and Citi Country Officer),Mir Aziz Rahman
(Director and Head of Global Corporate Banking),and Yousaf Ahmad
(Vice President and Bank Head) from Citibank. The executives said
markets have become relatively calm since November 14, approximately
when Pakistan officially approached the IMF for a Stand-by
Agreement. They observed less precautionary hoarding of cash and
fewer investments based on speculation.


16. (SBU) Usmani noted that, while the corporate banking market has
been profitable, the small business and consumer credit portfolios
are facing heavy losses. He explained that since Pakistan lacks
credit agencies, banks are unaware of borrower's other debts. The
rapid increase in interest rates, from 7 percent to 15 percent, is
exposing just how overextended some borrowers are. In response to
the EconCounselor's inquiry into the strength of the textile sector,
Rahman replied that reports are varied. Of the sixty or so major
names, twenty or so have serious issues while the remainder are
doing quite well. Ahmad said many of the smaller companies are
highly leveraged and will suffer from rate increases. Usmani
attributed it to poor management; saying "conditions are bad, but
you have to manage them."

PATTERSON