BI-WEEKLY REPORT ON ECONOMIC ISSUES, 23 SEPTEMBER 2009

UNCLAS SECTION 01 OF 07 ISLAMABAD 002477



SENSITIVE

SIPDIS



REF: ISLAMABAD 2225



E.O. 12958: N/A

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

SUBJ: BI-WEEKLY REPORT ON ECONOMIC ISSUES, 23 SEPTEMBER 2009



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TOP STORIES

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1. (SBU) Consumer Price Index (CPI) drops to 10.7 percent in August.

The Business Recorder reported that inflation was lower for August.

It had declined steadily from October 2008's peak of 25 percent, to

11.2 percent in July. However, analysts are still cautious as

domestic oil prices could again rise. (Comment: Analysts also point

out that core inflation (the CPI basket of goods and services

excluding food and energy),though receding, is still high. The

State Bank of Pakistan (SBP) remains hesitant to cut interest

rates.)



2. (SBU) On September 11, Dawn and other papers reported that

overseas remittances totaled $780.5 million in August, a 31.8

percent increase over the same period last year. The SBP also

reported that monthly remittances are on pace to top FY09's (July

1-June 30) total of $9 billion (FY08 was $7.8 billion). The largest

inflows in August came from the UAE and the United States, with $324

million and $317 million respectively. (Comment: The increased

inflows are the result of a GOP crackdown on informal money changers

as well as the SBP's Pakistan Remittance Initiative (PRI) which has

simplified and expedited the formal money transfer system.)

3. (SBU) The conflict between the GOP, courts, and sugar mills

intensified, even as demand for sugar fell during the Eid holidays.

On September 24, the Lahore High Court (LHC) accepted a petition to

initiate contempt of court action against parties involved in

price-setting negotiations, including the Federal Minister of

Industries Manzoor Wattoo, and leaders of the Sugar Millers

Association. Pakistan's Supreme Court had already refused, on

September 16, to stay a LHC September 3 decision instructing the

Punjab government to ensure a retail price for sugar of Rs. 40 per

kilo, roughly twenty percent below the previous fixed rate.

Following that, on September 18, it agreed to review a petition from

the federal and provincial governments to overturn the price decree.

At the time of this writing, the Supreme Court is hearing a

preliminary report from the Competition Commission of Pakistan

(CCP),accusing sugar millers of illegal cartelization. (Comment:

Both the federal and provincial courts appear to be styling

themselves the champions of the people in a struggle against the

business and political elite. LHC's agreement to hear the petition

requesting the sugar miller's be held in contempt is a formality

that also gives the court an opportunity to demand that officials,

including federal bureaucrats, explain the sugar pricing mechanism



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in the country. Coming on the heels of the federal and provincial

governments' joint appeal of the LHC ruling, the provincial court's

actions feed the "masses as victims" narrative. Thanks to

escalating tensions, Pakistani sugar millers had to opt out of a

visit to the United States sponsored by the U.S. Trade Development

Agency to learn how U.S. mill operations generate excess electricity

for the national power grid. The fight is likely to result in more

mudslinging before the matter is resolved, and is only the latest in

a long string of disastrous interventions in markets.)



4. (SBU) President Asif Ali Zardari announces the "Waseela-e-Haq"

program under auspices of the Benazir Income Support Program (BISP).

BISP will now target socio-economic empowerment for women by

providing them greater opportunities for self-employment. It will

do this by selecting 731 families at random, through a monthly

drawing, giving them each Rs 300,000 to create a business. (Comment:

Random selection could rule out potential corruption or patronage

in granting the seed money, but it also limits the GOP's ability to

maximize fund benefits: there is no requirement that "winners" have

a sound business plan or even an idea on the drawing board. The GOP

does not intend to provide technical assistance, nor will it be

tracking the new businesses' success or failure.)



5. (SBU) Foreign Direct Investment (FDI) declined 57.4 percent in

July-August 2009. The SBP reports that FDI was down to $351 million

in the period July-August, a 57 percent decline from the $825

million recorded for the same period last year. This is in spite of

portfolio investment that posted a 134 percent increase brought on

by investors' attraction to high profit margins, some undervalued

equities, and improvements on the national front, namely increased

foreign exchange reserves and lower inflation. (Comment: Even with

relatively high profit margins and some improvement in macroeconomic

fundamentals attracting transactions at the exchange, foreign direct

investors are more reluctant to risk investment because of the high

cost of doing business in Pakistan mostly due to inadequate

infrastructure and the security problem.)



6. (SBU) The GOP released Rs. 85 billion to erase debt in the power

sector on September 19. The government raised the funds through the

sale of Term Finance Certificates (TFCs). (Comment: Though the

issuance of the TFCs and removal of arrears was a necessary first

step in resolving the debt crisis in the energy sector, the crisis

will not be resolved until tariff rates cover the cost of energy

production and distribution. The GOP agreed with the IFIs to raise



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tariffs in three tranches, beginning with 6 percent on October 1.)

7. (SBU) Ministry of Commerce (MoC) making plans for Reconstruction

Opportunity Zones (ROZs) in FATA, AJK, NWFP and Balochistan.

According to a working paper presented to the Planning Commission,

the MoC is moving closer to establishing a two-year Program

Management Unit (PMU) responsible for developing incentive packages

for investors, systematize enforcement procedures, guard against

unlawful transshipment of articles from ROZs, and coordinate with

donor agencies to identify projects within the ROZs. Solicitation

for a director and other PMU staff closes September 30. (Comment:

The MoC expects to establish the PMU in October with Rs. 80.6

million in funding.)

8. (SBU) Pakistan's cement industry is reacting to an 80 percent

decline in exports to India in recent months. The News reported

that the cement industry has been seeking alternative markets due to

the much lower sales to India. One Pakistani manufacturer has sent

consignments to Sri Lanka, South Africa, Namibia, Oman and

Mauritius, and others have begun looking to European markets.

(Comment: Cement exports to India have slowed due to increased

Indian capacity and competition. Shipping costs of heavy bulk goods

to distant foreign markets are often cost prohibitive. Profit

margins in these new markets would be significantly lower than sales

to India.)



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BANKING AND FINANCE

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9. (SBU) On September 11, Dawn reported that assets of Islamic

banking institutions in Pakistan reached Rs. 313 billion in June

2009, up from Rs. 278 billion the previous year. The investment

portfolio of Islamic banks has also increased to Rs. 195 billion, up

from Rs.185 billion in March 2009. The SBP hopes that by 2012,

Islamic financial institutions will account for 12 percent of all

banking in Pakistan. (Comment: Islamic banking institutions have

realized growth rates higher than conventional finance institutions

in the Middle East and Asia the past few years, benefitting from new

regulations and standards, and a higher awareness due to stepped-up

marketing by the banks.)



10. (SBU) On September 12, Dawn reported that the Securities and

Exchange Commission of Pakistan (SECP) has imposed requirements for

"Modarabas" (Islamic financial and investment partnerships) to guard

against money laundering, terrorist financing and other illicit

activities. According to these reports, Modarabas would be required



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to implement procedures to ensure due diligence screening of

customers, and to adopt "know-your customer" policies to be approved

by the board of directors of management companies, which are also to

be created. (Comment: Under Modarabas partnerships, one party

provides finance to another party for the purpose of carrying on a

business. The party who provides the finance is the 'Rabb-ul-Mal',

and the funded working partner is the 'Modarib'. This is another

welcome step forward in GOP efforts to increase accountability in

the banking sector.)



11. (SBU) On September 17, the News and other papers reported that

the SBP has re-engineered its treasury operations on foreign

exchange interbank deals, trade confirmations, and settlements to

bring them more in line with international best practices. All

banks have been advised of the proposed changes and have been urged

to ensure compliance. (Comment: For more information on the

specific changes please refer to

http://www.sbp.org.pk/tod/2009/C01.pdf)



12. (SBU) On September 25, Business Day, the News and other papers

reported that Pakistan's total liquid foreign reserves have

increased to an all-time high of $14.47 billion. On Sept 19,

foreign reserves held by the SBP stood at $10.94 billion and net

foreign reserves held by other banks in the country stood at $3.53

billion. (Comment: SBP reserves stood at only $4.9 billion a year

ago. Relative fiscal prudence, IMF inflows, and higher official

remittances have all contributed to the higher reserves.)



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STOCK MARKET

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13. (SBU) September 25 saw record turnover at the Karachi Stock

Exchange, for the last 1.5 year trading period. Habib Bank noted

that trading was boosted by the Friends of Democratic Pakistan

meeting in New York and the passage of the Kerry-Lugar Bill. Over

the two week period, the KSE index rose from 9,058 to 9,664, market

capitalization increased from $31.8 billion to $33.8 billion, and

net foreign portfolio investment inflows continued, totaling

approximately $45 million.



14. (SBU) On September 16, the media reported that the Karachi Stock

Exchange (KSE) adopted the Industry Classification Benchmark (ICB)

system, used for sector and industry classification and analysis.



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The system was first launched by London's FTSE and the Dow Jones

Indexes and is in use worldwide. (Comment: KSE has joined other

exchanges and global financial institutions which have integrated

ICB into their research, trading and investment workflows. The

adoption of ICB will also assist an overall strategy to introduce

derivative and structured products at the exchange.)



15. (SBU) The Lahore Stock Exchange (LSE) Index continued to climb

in recent weeks, surpassing 3,000 and doubling the market's position

since the beginning of the year. Market capitalization kept pace

with share prices and volume was heavy.



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PROVINCIAL FINANCES

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16. (SBU) The Punjab government converted an $850 million revolving

line of credit into a four-year term loan. The debt had piled up

largely because of deficit spending on subsidies for wheat, roti

(local bread),and sugar. The conversion to the term loan, arranged

with the State Bank of Pakistan (SBP),is largely designed to reduce

interest charges. Punjab will still have a line of credit, but a

senior Punjab bureaucrat stated that the new line is not nearly as

large as the old one, a resizing that reflects Punjab's inability to

curb spending. (Comment: Punjab's profligate ways will be subject to

increasing constraints, as future deficit spending on subsidies and

development projects in Punjab will have to be financed in advance

through loans or bonds either through commercial banks or the SBP,

neither of which will be cheap or easy.)



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ENERGY, POWER AND WATER

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17. (SBU) Water levels in the Tarbela and Mangla dams dropped

precipitously in September, according to Water and Power Development

Authority (WAPDA) data. Tarbela has been falling two feet per day,

and Mangla one foot per day. Large water releases that were made

for the current cotton and rice crops vastly exceeded inflows, which

were lower than normal for this time of year. (Comment: Current

demand has trumped any concerns about the future. If river flows

remain low, Pakistan could face a severe water shortage this

November when the next WHEAT crop is sown, precipitating yet another

wheat crisis.)



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18. (SBU) On September 20, the News and other papers reported that

owners of compressed natural gas (CNG) stations are worried about

GOP plans to switch off natural gas supplies for CNG use this coming

winter. Pakistan, in the face of a severe energy crisis, has been

cutting back on gas supplies to CNG filling stations, which are not

considered a priority industry. Around 2.4 million vehicles utilize

CNG however. (Comment: The GOP's plans to suspend supply to a

sector that consumes only six percent of the nation's total gas

supply indicates desperate measures to try and meet the growing

needs of the power sector. The CNG industry will be severely

impacted; not only will 2.4 million car owners be effected, 2500 CNG

station owners will be hard pressed to cover over Rs. 90 million

invested in retrofitting their facilities for CNG.)



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TRADE

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19. (SBU) On September 12, Business Recorder reported the country's

largest custom clearing system, Pakistan Customs Computerized System

(PaCCS),is in danger of being shut down unless a final agreement is

reached with its service provider, Agility, a leading Kuwait based

logistics operator. Agility has been providing service to the PaCCS

without pay since April 2009, due to expiration of its service

agreement with the Federal Board of Revenue. (Comment: PaCCS enables

importers and exporters to file customs declarations online, pay

duties at their nearest local national bank, and clear cargo without

visiting a customs office. It was put into place 3 years ago, and

has been well received by the terminals (the Ports of Karachi and

Qasim) who have enjoyed increased efficiencies and better

transparency. Despite its success, the GOP has refused to renew the

PaCCS operating contract. There are rumors that customs officials at

FBR are trying to find an alternative to PaCCS in order to game the

system and collect kickbacks. The terminal companies say that PaCCS

has effectively limited corruption.)



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AGRICULTURE

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20. (SBU) On September 25, Business Recorder reported on the

potential for significant cotton shortages throughout the country

due to an outbreak of the cotton leaf curl virus (CLCV). This



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deadly pest, caused from the use of uncertified and illegal

cottonseeds, has badly hit cotton crops across the country.

(Comment: The Sindh Abadgar Board (SAB) and Sindh Chamber of

Agriculture confirmed the report and said there are estimated CLVC

related damages of 5 to 10 percent in upper Sindh, and warned that

up to 70 percent of crops may have been affected in Punjab.)



21. (SBU) The GOP is predicting a one million-ton sugar shortfall in

the next year due to a low sugarcane harvest. The Business Recorder

reported that the poor harvest will be a result of this year's

'worst ever' treatment of sugar growers by mill owners who have

further depressed prices paid for sugar stocks. In view of the

situation, the GOP plans to bridge the gap with 0.7 million tons of

raw sugar imports in the upcoming crushing season, and the Economic

Co-ordination Committee (ECC) has allowed 0.3 million tons of raw

sugar imports by the private sector this year. (Comment: There is

some evidence that cane growers were actually paid a decent price

and were paid faster than most previous years (because the

government forced millers to do so). Agricultural acres in cane

production have indeed declined, but mostly because of the high

support price for wheat. Note further that cane yields, like most

other crops in Pakistan, are lower than they should be.)



PATTERSON