BI-WEEKLY REPORT ON ECONOMIC ISSUES, 09 SEPTEMBER 2009

UNCLAS SECTION 01 OF 07 ISLAMABAD 002225



SENSITIVE

SIPDIS



REF: ISLAMABAD 1905



E.O. 12958: N/A

TAGS: ECON, ETRD, EFIN, EAGR, EINV, ENRG, PREL, PK

SUBJ: BI-WEEKLY REPORT ON ECONOMIC ISSUES, 09 SEPTEMBER 2009



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TOP STORIES

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1. (SBU) The Ministry of Finance has neared agreement with

commercial banks for the issuance of Rs. 85 billion in term finance

certificates (TFCs) to flush out "circular" inter-corporate debt in

the energy sector. The Ministry of Finance had originally sought

Rs. 90 billion but some banks balked at taking on more energy and

public sector debt. (Comment: The financial influx, which should

happen by September 16, most likely will not be sufficient to

completely flush the circular debt of the sector.)



2. (SBU) On Sept 1, the Business Recorder reported that President

Asif Ali Zardari issued directives to launch the women-friendly

'Benazir Behan Basti Program' (BBBP). Under the proposed program,

women holding Benazir Income Support Program cards would be given

government land to construct houses. Financial support to construct

the houses will reportedly be sought from Friends of Democratic

Pakistan.



3. (SBU) Pak-Afghan border crossing at Chaman sealed. Pakistani

Authorities sealed the border crossing at Chaman September 9 due to

disputes over inspections of vehicles entering Pakistan. Afghan

officials objected to the unloading of vehicles laden with fruit by

Pakistani authorities, while Pakistani officials reportedly had

reason to believe that weapons were being smuggled into the country

from Afghanistan. The border closure resulted in the suspension of

movement of supplies to NATO forces in Afghanistan. (Comment:

Although the border reopened September 10, this is the second time

in less than a month that a dispute involving the movement of

commercial vehicles has effectively blocked ISAF cargo.)



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BANKING AND FINANCE

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4. (SBU) The International Monetary Fund (IMF) urges the government

to raise revenues through a value added tax (VAT). The IMF mission

chief has told the government that in order to lower its dependence

on foreign aid, it has to either cut down on spending or raise

revenue. A VAT will be able to raise the tax-to-GDP ratio by 3 to 4

percent, on top of the current ratio of 9 percent, one of the lowest

in the world. (Comment: The GOP has sought U.S. technical

assistance in designing and implementing the VAT, which it plans to

introduce in FY11.)





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5. (SBU) Banking spreads, or the difference between banks' cost of

funds and their lending rates, dropped by 17 basis points to 7.35

percent in July 2009. According to data released by the State Bank

of Pakistan, banking spreads have been decreasing continuously from

a peak level reached in January 2009 of 7.78 percent. Financial

analysts comment that with the easing of monetary policy, 2009

lending rates have also come down from a peak of 14.66 percent, to

13.79 percent in July; however, Pakistan's banking spread and

interest rates are amongst the highest in the world. (Comment: The

SBP has justified the high interest because of higher inflation.

Large banking spreads in Pakistan reflect not only the interbank

risk but also significant bank markups.)



6. (SBU) Banking sector's profitability dropped 31 percent in first

half of FY09. Bank profitability fell due to higher provisions for

Non Performing Loans (NPLs) and higher expenses. Provisions for

NPLs swelled to Rs 36 billion, an 88 percent increase for the period

under review, and administrative expenses increased cumulatively to

Rs 74.4 billion, a 20 percent increase. (Comment: The domestic

economic slowdown on top of the global financial crises has resulted

in a higher number of non-performing loans, which are concentrated

both in the textile sector and in SMEs.)



7. (SBU) On August 24, Dawn reported that Meezan Bank Limited and

international NGO Islamic Relief have signed a memorandum of

understanding under which the former would assist the NGO to further

enhance its Islamic microfinance operations in Pakistan by capacity

building, training and product development support. (Comment:

Meezan Bank said they are in the early planning stage.)



8. (SBU) On August 23, Dawn and Business Day reported that the State

Bank has announced 'Payment and Settlement' systems of home

remittances under Pakistan Remittances Initiative (PRI). A

circular has been issued by the SBP stating their objective for

establishing automatic delivery of home remittances (transfers of

money back home to relatives and friends),in real time with

confirmation through mobile phone Short Message Service (SMS) to

remitters and beneficiaries. Other objectives are to develop a

robust and reliable ATM network to offer options to beneficiaries to

withdraw cash during after banking hours and on holidays, and

integrated and secured payment system infrastructures to make P2P

payments, payments at merchant sites, payment of utility bills, fund

transfers etc. (Comment: This is another step by the State Bank of

Pakistan to increase the flow of remittances through the formal

channel. The circular can be found at:

http://www.sbp.org.pk/press/2009/index2.asp During the first two

months (July-August) of the 2009-10 fiscal year (FY10) an amount of



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$1.525 billion was sent home by overseas Pakistanis, showing an

impressive 25 percent rise when compared with $1.219 billion

received in the same period last year.)



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STOCK MARKET

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9. (SBU) The Karachi Stock Exchange (KSE)-100 Index ended the week

of September 4 at 9,002.67, up 5.4 percent from the previous week

close. Overall market capitalization increased to $31.81 billion

from 30.24 billion. Net portfolio investment inflow was $86.2

million - a more than threefold increase over the previous week.

(Comment: Adnan Afridi, Managing Director of KSE, said breaking

9,000 was an important psychological barrier for investors. Since

reaching that benchmark, applications for several new IPOs were

announced. Afridi pointed out that the net foreign portfolio inflow

was higher than India's for the week.)



10. (SBU) Foreign investors inject $95m into stock market. Gross

buying by foreign portfolio investors (FPIs) was worth $142 million

while selling stood at $47 million resulting in record net buying of

$95 million in August 2009 which is the highest figure in any single

month over the last 17. The release of pending installment of IMF

loan and approval of additional funding built the confidence of

offshore fund managers. Due to the foreign buying, the benchmark

KSE-100 index moved up 12 percent in August. Foreigners share in

total volume at the KSE remained at nine percent last month.

(Comment: Pakistan's inclusion in the Frontiers Index and the

release of the $1.2 billion IMF tranche bode well for Pakistan's

stock exchanges. The relative undervaluation of Pakistani stocks

compared to the regional markets also played a role.)



11. (SBU) The Lahore Stock Exchange (LSE) Index soared nearly 18

percent in two weeks. Analysts attributed the bull-run to foreign

investment inflows sparked by a vote of confidence from the IMF,

Standard & Poor's upgrading Pakistan to B-, and modest new oil

discoveries. Market capitalization was up 10 percent and trading

has been heavy throughout the rally.



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ENERGY, POWER AND WATER

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12. (SBU) Sindh government and Engro Power Gen Ltd signed an

agreement for a joint venture on 60/40 basis to exploit Thar Coal

for energy generation. Under the agreement, the first project of



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the joint venture would be an open cast mining facility with an

annual capacity of 3.5 to 6.5 million tones. Engro has been given

the responsibility to carry out the feasibility study for a

600-1000MW Thar Coal-based power plant. (Comment: the World Bank has

reportedly agreed to provide technical assistance amounting to Rs

2.4 billion ($30 million) to the government of Sindh and Private

Power Infrastructure Board (PPIB) to exploit the Thar coal reserves

for energy. However, it is not entirely clear that the issues

surrounding provincial-federal jurisdiction over power plants of

more than 50MW capacity have been fully resolved.)



13. (SBU) Pakistan State Oil (PSO) needs Rs. 158 billion by October

31 to avoid Letter of Credit (L/Cs) default. PSO has again warned

the Ministry of Finance (MoF) that its letters of credit (L/Cs) for

oil imports will default, this time if the ministry does not arrange

the Rs 158 billion. According to a report in the Business Recorder,

net outstanding receivables by PSO against the Water and Power

Development Authority (Wapda),Hubco, Kapco and other customers

stood at Rs 83 billion as of August 31, 2009. (Comment: The L/C

problem just adds to PSO's woes. PSO is already in default to the

oil refineries amounting to Rs 12 billion, and on its receivables

side the power sector is its largest payee, having received furnace

oil from PSO worth Rs 2 billion a day. Due to PSO's non-payments,

the refineries have reduced their production, which has, in turn,

forced PSO to import refined oil at higher purchase prices. In a

conversation with the Executive Director Finance Yaqoob Sattar at

PSO, Sattar said that PSO has different payment terms with different

refineries. On average they have a 3-week credit line with most

refineries. After which the amount is said to be in default.)



14. (SBU) On August 25, Business Recorder reported that Gul Ahmed

Energy Limited (GAEL),an independent power producer (IPP),stopped

supply of 125 megawatts (MW) electricity to Karachi Electric Supply

Company (KESC) due to non-payment of at least Rs 3.25 billion in

debt. This is the second time within one month that GAEL has

stopped supply to KESC for non-payment. Without payment from the

utility, GAEL is unable to purchase fuel and pay operating expenses.

(Comment: GAEL confirmed the report. Delayed, or non-payment to

IPPs is an ongoing problem with KESC. Each month IPPs suspend

production up to several hours at a time causing shortages and

exacerbating the situation on an already under-supplied grid.)



15. (SBU) Indus and Jehlum daily river flows declined roughly 40

percent over the last two weeks, as mountain snowmelt and monsoons

tapered off, according to Water and Power Development Authority

(WAPDA) data. Water releases for irrigation and power have exceeded

inflows, and both Tarbela and Mangla reservoir levels have started



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to recede. (Comment: The GOP's failure to build more water storage

capacity is already sparking conflict between irrigation demands for

current rice, cotton, and sugar cane crops, and future water

requirements for sowing wheat in November. Additional demand for

hydroelectric power generation may tilt the balance toward current

crops.)



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TRADE

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16. (SBU) On August 25, the Daily Times reported foreign shipping

lines have increased terminal handling charges (THC) by around 30 to

35 percent, thereby negating the recent government reduction of port

charges. The increase in charges is heavily affecting local

traders, who termed the increase "unjustifiable" and condemned it.

Traders claim they are already paying various "fictitious" on-port

charges, including another THC being charged by the terminal

operators. (Comment: That shipping lines are charging terminal

handling fees at all speaks to the weakness of a system that should

have clear lines of authority for charging these fees, a power

fundamentally that rests with port authorities. Contacts at the

port and Karachi Chamber of Commerce and Industry (KCCI) underlined

the need to constitute a powerful watchdog from Customs to regulate

the shipping lines, agents and freight forwarders.)



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AGRICULTURE

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17. (SBU) On September 4, the Daily Times reported that 30 to 40

percent of the onion crop was damaged during the recent monsoon

rains in Sindh, and prices are expected to increase in the upcoming

months. The most affected districts are Sanghar, Tando Allayar,

Hyderabad and Mirpurkhas. Currently onion prices are stable in the

wholesale and retail markets in Karachi because of substantial

supply from Balochistan. The article added that the prices of onion

are also stable in Punjab and NWFP, which are receiving bulk supply

from Afghanistan. (Comment: While the Sindh Abadgar Board said that

rains certainly affected the onion harvest, it refuted reports of a

30-40 percent loss. The Board, however, estimated a 10-12 percent

loss.)



18. (SBU) Saudi Arabia is the latest Gulf State to express interest

in leasing large tracts of Punjab farmland, according to press

reports. The United Arab Emirates has been negotiating a possible

deal since April, when the government of Pakistan first announced



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that it would lease or sell millions of acres to foreigners in a bid

to attract foreign direct investment and to import modern

agriculture practices. A senior advisor to Punjab Chief Minister

Shahbaz Sharif said the provincial government was cooperating with

federal authorities on the program. Farmers' associations and some

analysts have opposed the idea, asserting that it would harm small

farm interests and jeopardize the country's already fragile food

security. (Comment: Pakistanis are right to be cautious, but blanket

objections are misplaced. The Gulf States intended to secure their

own food supplies with these investments, not necessarily enhance

Pakistan's connections to global markets. However, export-oriented,

modern agri-business investment can be an excellent way to improve

agriculture practices overall. Pakistan's crop yields are well

below potential, so there is no inherent conflict between domestic

food security and significant crop exports.)



19. (SBU) The federal and provincial governments launched a fruit

processing center in Multan. The project was a joint effort between

the Small and Medium Enterprise Development Authority (SMEDA) and

the Punjab Small Industries Corporation (PSIC). The facility's

suppliers are expected to be small growers in the area. The project

has an independent board of directors and is supposed to operate as

a self sustaining business. (Comment: Processing centers are badly

needed to stem post harvest losses that claim as much as 30 to 40

percent of Pakistan's fruit crops. The plant's success will depend

on whether it really functions as a competitive private enterprise,

or if it becomes part of a government farm income support scheme.)



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SUGAR

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20. (SBU) The Lahore High Court (LHC) entered the so-called "sugar

wars" September 3rd by ordering the Punjab government to maintain

the retail price of sugar at PKR 40 per kilogram (kg),almost 20

percent below the set price of PKR 47 per kg. Millers, wholesalers,

and retailers all balked at the decision, saying that they had

acquired stocks based on previous prices and could not be forced to

sell the sweetener at a loss. Not wanting to oppose the LHC ruling,

some retailers pulled sugar from their shelves according to

anecdotes from contacts and reports in the press, leading to

shortages throughout the province. (Comment: The LHC's intervention

is just another step on the government's spectacularly misguided

path of price controls. The Pakistan Muslim League - Nawaz

(PML-N)-led Punjab government scored political points in August when

it objected to the Pakistan People's Party (PPP) central

government's original sugar price, but the LHC has put the province



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in an awkward position by lowering the price further still.

Politically, the PML-N cannot appeal the LHC decision, but the

provincial government lacks the distribution infrastructure,

finances, and perhaps the desire to fulfill the court order. The

PPP central government is not eager to bail the PML-N out of its

dilemma.)



PATTERSON