PAKISTAN FINALLY REQUESTS IMF PROGRAM, POST GETS SUMMARY

UNCLAS SECTION 01 OF 03 ISLAMABAD 003699 SENSITIVE SIPDIS REF: A. ISLAMABAD 03532 E.O. 12958: N/A TAGS: ECON ETRD EAID EFIN ENGY PK SUBJECT: PAKISTAN FINALLY REQUESTS IMF PROGRAM, POST GETS SUMMARY ¶1. (SBU) SUMMARY. At a meeting for G7 countries, the International Monetary Fund's (IMF) Resident Representative to Pakistan, Paul Ross, presented an overview of the Stand-By Agreement (SBA) Board members will consider on November 24. Ross emphasized that the program fits well with Pakistan's own reform strategy. Pakistan will borrow about USD 7.56 billion over two years, with USD 3 billion available three business days after Board approval. If donors do not provide additional funds the SBA can still work, but it would reduce Pakistan's overall growth potential. The SBA projects that foreign donors will need to provide USD 4 billion over the next two years. Ross identified several challenges to program success, including: persistent electricity subsidies, poor tax equity, weak social-safety nets, and rampant "law and order" problems. END SUMMARY. ¶2. (SBU) On November 21, EconCounselor and EconOff attended a briefing for G7 countries, by the International Monetary Fund's (IMF) Resident Representative to Pakistan, Paul Ross. Ross presented an overview of the program that Board members will consider at the anticipated November 24 meeting. Local representatives from Italy, the United Kingdom, Canada, Japan, Germany, and the United States asked numerous questions about the implications of the pending IMF program -------------- SBA DESCRIPTION -------------- ¶3. (SBU) Ross emphasized the congruity between the policy reforms planned by the Government of Pakistan (GOP) and the requirements of the SBA. For example, the GOP has already taken action on the elimination of fuel subsidies and introducing the Benazir Income Support Program (BISP). The design of the BISP, in particular the targeting and delivery, will be reviewed in the first half of 2009 in consultation with the World Bank. ¶4. (SBU) The SBA focuses on macroeconomic indicators with minimal prescriptions for specific policy adjustments, placing the responsibility for achieving the results on the GOP. For example, when asked whether the program contained guidance on food subsidies, defense spending, or a tax on the agricultural sector, Ross said that the program does not contain specific policy requirements, but the budget deficit is a central measure of GOP program performance. In discussions, Ross identified two major challenges to program success: reducing electricity subsidies in the short term and tax reform in the medium term. ¶5. (SBU) Ross said he was told that the November 19 Cabinet meeting to discuss the SBA was very lively but noted that despite strong initial concern, all but one minister left the meeting in favor of the program. Ross believes that this is the first time that the Cabinet was able to consider an IMF program before Board approval, which he thinks is an important milestone and will make implementation more successful. -------------- SBA DETAILS -------------- ¶6. (SBU) The SBA currently equals about USD 7.56 billion (500 percent of Pakistan's IMF quota or Special Drawing Rights 5.169 billion),with a USD 3 billion upfront disbursement. This initial amount would be available three business days after Board approval. The disbursements would be in 8 declining quarterly installments over the next 23 months, with a 2.25 grace period and planned repayment period of 2 to 4 years. The interest rate is variable, but will range between 4 and 6 percent (depending on amount disbursed) at current rates. ¶7. (SBU) According to the SBA, the GOP will shrink its fiscal deficit from 7.8 percent in Fiscal Year (FY) 08 to 4.2 percent in FY09, with a target of 3.3 in the medium term. The GOP has already increased the policy interest rate from 13 percent to 15 percent and may tighten monetary policy further. Gross Domestic Product (GDP) growth will drop from 5.8 percent of GDP last year to between 3 and 3.5 percent, rise to 5 percent in FY10, and rise gradually to 6.5 percent by FY13. Head line consumer price index inflation is ISLAMABAD 00003699 002 OF 003 currently 25 percent, but the goal is to reduce it to 20 percent on average by June 2009 and maintain 7 percent in the medium term. ¶8. (SBU) The first review of the SBA implementation will be in March with an IMF team visit in February. The SBA includes quantitative targets on: non-concessional borrowing, federal borrowing from the central bank, deficit spending, foreign exchange reserves accumulation, and central bank lending to the domestic banking sector. The SBA also includes structural adjustments of: improving the effectiveness of the central bank to monitor private banks, increasing social-safety net spending, improving central bank operational autonomy, eliminating foreign-exchange support for oil imports, resolving the circular-debt problem to the domestic energy companies, and consolidating treasury accounts from various commercial banks into one governmental account. It is important to note that IMF funds are not budgetary support, but will go directly into foreign reserves. While the GOP may smooth exchange rate volatility, the rupee will be allowed to float. Under the SBA, the GOP will need to meet monthly foreign exchange reserve targets to remain eligible for later disbursements. -------------- DONOR ASSISTANCE -------------- ¶9. (SBU) The IMF anticipates that foreign donors will need to provide additional funds and Ross noted that the SBA projects a need of an additional USD 4 billion over the next two years. The SBA projections only include donor money with a high degree of certainty and thus did not include any potential oil concessions from Saudi Arabia or other Middle Eastern countries. Ross said the SBA does include "about USD 4 billion" of programmed projects from the World Bank and the Asian Development Bank. ¶10. (SBU) Ross said that if donors do not provide the full USD 4 billion amount the SBA can still work but it would be more difficult, and noted that any shortfall in donor resources would require additional domestic resources which would reduce Pakistan's overall growth potential. Ross mentioned that the Chinese will likely give an additional USD 500 million soon. The program prescribes using additional funds first for social safety net expenditures (about .6 percent of GDP), then expanding development spending (.5 percent of GDP),then to build foreign exchange reserves. -------------- POTPOURRI -------------- ¶11. (SBU) Ross noted that specific reductions in military spending are not mentioned in the SBA but said that greater transparency in military spending would be an added benefit to the program. Ross was asked what he thought of the recent arrests of money changers. He observed that there has been a lot of foreign exchange leaving the country. This contributed to macroeconomic weakness which, in turn, lead to the eagerness of both the regulators and speculators. ¶12. (SBU) Ross responded to questions on evaluating the implementation of program elements, such as the Benazir Income Support Program and the reduction of electricity subsidies, by citing the macroeconomic target in the SBA that the IMF would track but said that the World Bank was responsible for monitoring. He said there will be coordination, but that there should be a division of labor based on comparative advantage. ¶13. (SBU) Ross noted that the State Bank of Pakistan (SBP) should have greater operational autonomy. To arrest the inflationary practice of central bank financing of the fiscal deficit, the SBP and Pakistan's Ministry of Finance agreed to a zero net borrowing policy. The SBP will phase out its current policy of providing foreign exchange for oil imports. The SBP will also improve commercial bank supervision and prepare contingency plans for small bank failures. Ross did not know who the GOP was considering for replacement of SBP's current Governor Dr. Shamshad Akhtar, whose term ends December 31. (reftel A) ¶14. (SBU) When asked whether the SBA required any action on the ISLAMABAD 00003699 003 OF 003 proposed stock market support mechanisms, Ross said any measures to remove the Karachi Stock Exchange (KSE) trading floor or the use of support measures for the KSE requires prior IMF consultation. He said a floor should not have been used, but now that it is in place removal is problematic. The use of public funds to support the stock market appears to assist only the wealthy while depleting scarce resources. If the floor remains in place, however, Pakistan may be removed from the major emerging market indices, forcing some institutional investors to divest. ¶15. (SBU) COMMENT. The SBA includes significant risks. The GOP will have to broaden the tax base by taxing the untaxed and under-taxed sectors, like agriculture and services. The National Assembly's resistance to date demonstrates this will be very difficult. Pakistan's lack of reliable energy and poor security situation threaten GDP growth rate and foreign investment prospects. Slow economic growth and higher prices have increased poverty levels, requiring well-targeted and implemented social safety net programs. ¶16. (SBU) COMMENT CONTINUED. Discussion following the meeting between the G7 representatives concerned a potential donors' conference. Among our counterparts, enthusiasm for a USD 4 billion package was low given the severity and range of domestic issues donors face and the inconsistent GOP support for the SBA. Various comments about how this donor's conference could possibly be kept separate from the efforts of the Friends of Pakistan underscore a need to clarify the process for a donor's conference as soon as possible. END COMMENT. PATTERSON