HOW PAKISTAN'S ECONOMIC TROUBLES AFFECT AFGHANISTAN

UNCLAS SECTION 01 OF 02 KABUL 002968 DEPT FOR SCA/FO, SCA/RA, AND SCA/A DEPT PASS AID/ANE DEPT PASS USTR FOR GERBER AND KLEIN DEPT PASS OPIC FOR ZAHNISER DEPT PASS TDA FOR STEIN AND GREENIP USOECD FOR ENERGY ATTACHE CENTCOM FOR CSTC-A NSC FOR JWOOD TREASURY FOR LMCDONALD, ABAUKOL, BDAHL, AND MNUGENT OSD FOR SHIVERS COMMERCE FOR DEES, CHOPPIN, AND FONOVICH SENSITIVE SIPDIS E.O. 12958 N/A TAGS: ECON EFIN AF PK SUBJECT: HOW PAKISTAN'S ECONOMIC TROUBLES AFFECT AFGHANISTAN REF: J. WOOD-DELL EMAIL OF 10/8/08 ¶1. (SBU) Summary. Afghan exporters are complaining about the impact of depreciation of the Pakistani rupee on their bottom lines. Meanwhile, Afghan importers are taking advantage of the same situation, reportedly stocking up on imported goods to sell later if/when domestic prices rise. Pakistan's economic difficulties are thus already having a negative impact on Afghanistan's balance of payments, though it is too soon to quantify this. The extent of the macro impact on Afghanistan depends on how protracted and severe the crisis next-door will be. Most contacts expect the situation in Pakistan to stabilize before Afghanistan suffers major damage. These and other bilateral economic issues will be discussed at the Joint Economic Committee meeting tentatively set for November 25-26 in Kabul. End summary ¶2. (SBU) Afghan economic policymakers are beginning to consider, and some are worrying about, the impacts on the Afghan economy of current economic difficulties in Pakistan. Sorting out the macroeconomic impacts is not easy, given both POSITIVE and negative effects, the prevalence of informal economic ties, the uncertainty of the course ahead for Pakistan, and weak statistical capabilities. ¶3. (SBU) Afghan exporters are already dealing with and angry about the depreciation of the Pakistani rupee against the afghani. According to the head of the Export Promotion Agency of Afghanistan (EPAA),Suleman Fatimie, Afghan exporters try to secure a certain value for their sales in U.S. dollars, to which the afghani is virtually pegged. (Note: the rupee has declined from about 60 to the dollar one year ago to over 80 now.) He says that owing to depreciation of the rupee, exporters are earning 30 percent less in dollar/afghani terms for their goods than they did one year ago. EPAA is especially concerned about the impact on exports to Pakistan of carpets and fruits and vegetables, from which Afghanistan earns an estimated $300 million per year, roughly 3 percent of its (licit) GDP. ¶4. (SBU) Pakistan is obviously crucial to Afghanistan's international economic fortunes, given the importance of transit trade, though Fatimie points out that of total Afghan exports to Pakistan, 70 percent are destined for end-use in the Pakistani market and just 30 percent for transit to third markets. He fears things could get even worse if Pakistan should face default. Should recession in Pakistan reduce total demand for Afghan goods, the effects could, indeed, go beyond the financial impact of rupee depreciation. But Fatimie says the GIRoA does not yet have data showing a drop in the volume of Afghan exports to Pakistan. ¶5. (SBU) The trade impacts are, of course, not solely, and maybe not even mainly, negative. Rupee depreciation should help to moderate inflation in Afghanistan, which has been running at almost 40 percent year on year. Afghanistan already has a large trade deficit with Pakistan, suggesting that the POSITIVE currency effect on the import side could outweigh the negative currency effect on the export side. Even exporters, many of whom rely on imported inputs from Pakistan, should enjoy this benefit. Afghan consumers could enjoy a break from recently soaring food prices (assuming Pakistan is able to maintain food exports). ¶6. (SBU) As elsewhere, consumers and importers are less well organized than producers. In the face of exporter pressure, EPAA organized an October 23 forum for them to present their concerns to Minister of Commerce and Industry (MOCI) Farhang, who agreed to relay their concerns to the full cabinet. According to Fatimie, the GIRoA will also raise concerns about rupee depreciation in the Afghanistan-Pakistan Joint Economic Committee, now scheduled to meet KABUL 00002968 002 OF 002 in Kabul November 25-26. That would presumably require support from the Finance Ministry, which co-chairs the GIRoA delegation with MOCI, but a deputy minister we consulted at MOF seemed unconcerned about the macro impacts of Pakistan's difficulties and said he had not heard complaints from any exporters. ¶7. (SBU) According to the IMF resrep, Pakistan's troubles are already causing both Afghanistan's bilateral trade deficit with Pakistan and its global current account deficit to widen. Afghan importers, he says, are taking advantage of rupee depreciation to stock up on imported goods, including food, which they will sell later in the winter when prices for these goods rise. The volume effect outweighs the cheaper afghani price of imports, producing a net increase in the value of imports. Remittances from Afghans living in Pakistan, an important component of capital inflows here, will decline, exacerbating the balance of payments impact. ¶8. (SBU) Our contacts here agree the extent of the impact on Afghanistan depends on how protracted and severe the crisis is next-door. According to EPAA's Fatimie, a full-blown debt crisis in Pakistan "would take Afghanistan down with it." The IMF resrep agrees that a real implosion would be "devastating" to Afghanistan, but he does not/not believe that is the most likely scenario. He is optimistic that the GOP and IMF will agree on a new Fund program that will stabilize the Pakistani economy and thus limit, in time and extent, the negative consequences for Afghanistan. WOOD