PAKISTAN STANDBY ARRANGEMENT: SO FAR SO GOOD, BUT

UNCLAS SECTION 01 OF 02 ISLAMABAD 000238

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON ETRD EAID PGOV PREL PK
SUBJECT: PAKISTAN STANDBY ARRANGEMENT: SO FAR SO GOOD, BUT
TROUBLE COULD BE BREWING


1. (SBU) Summary: IMF and Ministry of Finance contacts agree
that, based on preliminary indications, Pakistan has
performed well in fulfilling IMF performance criteria as
required in Pakistan's November 24 Standby Arrangement (SBA).
After retiring $1.24 billion in debt, borrowing from the
State Bank of Pakistan is lower than projected and the fiscal
deficit is reduced, thanks to the IMF's $3.6 billion cash
injection. Signing the Standby Arrangement has stabilized
economic performance: capital outflows are down and inflation
has leveled off (but not appreciably decreased),in part
reflecting lower fuel prices. Finance contacts warned,
however, that contradictory goals within the program itself
could make it difficult for Pakistan to continue to meet
benchmarks. End Summary.

So Far, So Good
--------------


2. (SBU) IMF ResRep Paul Ross told Econoff in mid-January
that he was "cautiously optimistic" about Pakistan's
performance vis-a-vis commitments undertaken in the GOP's
November 24 Standby Arrangement. Stressing that data
received thus far were preliminary, Ross said he felt
reasonably confident that the GOP has met IMF benchmarks for
borrowing from the State Bank of Pakistan (SBP) for budgetary
support and foreign exchange reserves. The exchange rate has
been relatively stable since December and deposits have
started flowing back into the banking system. Ross said that
the GOP had "worked hard" to contain the fiscal deficit in
December but, without the actual GOP expenditure data, he
could not be sure of the size of the deficit.


3. (SBU) On structural benchmarks, Ross said the GOP's
contingency plan to deal with problem banks was almost ready,
and that plans for tax administration reform were also being
developed. Calling efforts to broaden the tax base an "acid
test" for the GOP, Ross was less confident that the unified
voices of the GOP economic team could outweigh the political
clout of the entrenched, untaxed segments of the economy that
have thwarted these reforms "for the last 20 years."


4. (SBU) Ross's assessment of GOP performance on subsidy
reform was mixed. Fuel subsidies have already been
eliminated, and the GOP is actually making windfall profits
from taxes on fuel, as international prices fall but
importers and distributors have been slow to pass on lower
prices to consumers. Electricity subsidies ) due to be
eliminated by June 2009 ) will be much more difficult to
tackle, however. Earlier efforts to begin reducing
electricity subsidies were only partially implemented and
then abandoned in the face of an angry popular response to
higher bills and the ongoing loadshedding.

But Trouble Could Be Brewing
--------------


5. (SBU) Special Secretary of Finance, Dr. Ashfaque Hasan
Khan, told Post on January 20 that he largely agreed with the
IMF's assessment of GOP performance thus far. However, Khan
had several worries for the second half of the 2009 Pakistani
fiscal year that ends June 30. He pointed out that the
Fund's program requires Pakistan to increase tax collection
from $16.2 billion to $17.6 billion at the same time as it
imposes a one percent limit on the rate of import growth.
Although tighter monetary policy will now help restrict the
flow of imports, to compensate for skyrocketing import growth
in July and August, Pakistan will have to achieve negative
imports in the coming months to meet the IMF's one percent
growth target. As almost half of GOP tax revenue comes from
customs duties on imports, Khan is skeptical that the GOP
could meet its revenue-collection goal -) already a weak
point for the GOP. (Comment: Khan's comments are predicated
on no changes in the tax structure. If the GOP raised taxes
on other things, like agriculture income, they would not
depend so heavily on customs duties. End Comment)

ISLAMABAD 00000238 002 OF 002




6. (SBU) Khan was also concerned with the IMF goal of a $6.4
billion increase in the money supply in FY 2009. With the
government prohibited from increasing its borrowing from the
SBP and investment lagging, Pakistan must rely on growth in
private sector credit to achieve this target. Khan thought
this target unlikely, given the continued global economic
slowdown and the fact that private sector credit has only
increased by $1.6 billion in the first six months of the
Pakistani fiscal year.


7. (SBU) Khan said that almost every sector of the economy --
from large manufacturing to transport to finance and banking
-- is shrinking this fiscal year. Agriculture is the main
potential bright spot for GDP growth. Pakistan's current
account deficit reached approximately $6 billion from
July-October. Despite lower deficits in October and
November, Khan predicted that the current account deficit was
likely to be $12.5-$13 billion for the year, higher than the
IMF goal of $10 billion.

Stubborn Inflation
--------------


8. (SBU) Khan predicted that sugar and wheat will drive up
inflation in Pakistan. The GOP commitment to purchase wheat
at the unrealistically high support price of $297/ton will be
a major factor in maintaining Pakistan's 21 percent
inflation; since that GOP decision was taken, world wheat
prices have fallen to around $170/ton. Khan asserted that
large-scale farmers and importers have taken advantage of the
disparity in prices by importing wheat that they will then
sell to the government at a high profit. To forestall this
windfall, Khan said the GOP might impose a regulatory duty on
wheat imports to equalize the price. Khan said the rural
poor will survive because they reserve some of the crop for
their own consumption. However, the urban poor will be hard
hit by higher flour prices.


9. (SBU) The sugar cane crop is predicted to total
approximately 3.6 million tons in 2009 rather than the
necessary 4.2 million tons. This means that a kilo of sugar
in 2009 could cost almost double what it did in 2008. Septel
reports on GOP authorization to allow sugar imports.

"The World Has Changed Since November8
--------------


10. (SBU) Khan expressed confidence that the GOP was sincere
in its efforts to meet IMF conditionality. He stressed,
however, that the collapse in world agricultural and fuel
prices made January 2009 "a different world" from October
2008, when the terms of the Arrangement were being
negotiated. Calling the IMF program "essential,8 Khan said
that it had eliminated much uncertainty in the market and
stabilized the Pakistani economy. These gains are fragile,
Khan concluded. The GOP will have to work closely with the
IMF and others over the next six months to ensure open
communication in light of Pakistan's evolving circumstances.
PATTERSON