BI-WEEKLY REPORT ON ECONOMIC ISSUES, FEBRUARY 17, 2010

UNCLAS SECTION 01 OF 04 ISLAMABAD 000437

SENSITIVE
SIPDIS

REF: ISLAMABAD 410

E.O. 12958: N/A
TAGS: ECON, ETRD, EFIN, EAGR, EINV, ENRG, PREL, PK
SUBJ: BI-WEEKLY REPORT ON ECONOMIC ISSUES, FEBRUARY 17, 2010

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TOP STORIES
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1. (SBU) Government releases $42 million to cash-strapped Pakistan
State Oil (PSO). On February 15, Business Recorder reported that
the government had disbursed the funds in order to support the
company, which is "on the verge of collapse" because of extensive
debt. According to the article, PSO management was unhappy with
what they considered a "meager sum" as they were expecting to
receive over $141 million from the Ministry of Finance. PSO
representatives fear they will be unable to continue servicing the
power sector without an immediate injection of additional funds into
the company. Pakistan State Oil currently owes over $1 billion to
local oil refineries.
(Comment: This is not first, and almost certainly not the last
time, that PSO has had to press the Ministry of Finance to release
funds. Until the circular debt issue is fully resolved and the
energy sector reformed, PSO will continue to have to scrounge to
meet its payment obligations as it waits on payments from Pakistan's
power companies. End Comment.)

2. (SBU) IMF sets a 5.1 percent budget deficit target for fiscal
year 2009-10. On February 17, The News reported that the IMF agreed
to increase Pakistan's budget deficit target from 4.9 percent to 5.1
percent. As part of this initiative both parties agreed that the
GOP would neither increase nor implement any new taxes. In
addition, the IMF decreased the tax revenue target from $16.42
billion to $16.2. The IMF is expected to release Pakistan's 5th
tranche of funds totaling $1.21 billion some time next month.
(Comment: Contacts at the IMF confirmed this change in the budget
deficit target. Even with the more liberal budget deficit target,
the GOP will have a hard time meeting the IMF requirement, primarily
due to increased military spending and debt servicing. End
Comment.)

3. (SBU) Inflation increases to 13.6 percent. On February 11 The
News reported that inflation had increased by 3.16 percent compared
to December 2009. According to the director of the Top Lines
Securities (TLS) brokerage firm, this rise in inflation is
attributed to recent hikes in power tariffs, and increases in
commodity prices. (Comment: The State Bank Pakistan had already
predicted that the GOP would miss the IMF's 9 percent inflation
target. End Comment.)

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4. (SBU) Limited rainfall in Sindh likely to spoil wheat crop. On
February 7, Business Day reported that Sindh's lower agricultural
belt, which includes Sanghar, Hyderabad, Mirpurkhas and Nawabshah,
is facing a serious dry spell. Water levels in Sindh are at the
lowest point of the last decade. According to officials at the
Water and Power Development Authority (WAPDA),the flow of water
from the canals is 20 percent less than the average for this season.
(Comment: While water flows from the canals remain relatively low
nationwide, recent rains have helped to dampen concerns regarding
the prospects of the 2010 wheat crop. End Comment.)

5. (SBU) GOP proposes capital gains tax (CGT). Business Recorder
reported on February 13 that the government had invited stakeholders
to provide their input on the imposition of a capital gains tax
(CGT). Representatives from the Karachi Stock Exchange (KSE)
suggested that the GOP implement the tax gradually, starting with a
5 percent CGT this fiscal year with an incremental increase to 10
percent by fiscal year 2014-2015. KSE also said that the CGT should
only be applicable to short-term capital gains on holdings of less
than six months. (Comment: The KSE is proposing an incremental
increase in the CGT to ensure that portfolio investment inflows and
investment activities are not disrupted. End Comment.)

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STOCK EXCHANGE
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6. (SBU) The Karachi Stock Exchange (KSE)-100 Index ended the week
of February 12 at 9,813.08, up 0.44 percent over the previous week's
close. Overall market capitalization increased slightly from $33.09
billion to $33.25 billion. The week initially opened on a tentative
note as the bomb blast in Karachi the previous Friday kept investors
hesitant. Foreign portfolio investment, which has been relatively
muted for the last few weeks, gathered some steam towards the end of
the week with a net foreign portfolio investment inflow of $3.62
million. (Comment: Contacts at KSE and local brokerage houses said
the past week saw a roller coaster ride in the KSE index, which is
highly susceptible to both economic and political developments in
the country. According to these contacts, the inflation rate, which
was released last week, dampened investors' mood as it was higher
than expected. End Comment.)

7. (SBU) Lahore Stock Exchange (LSE). The LSE continues to hover

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just over the 3,000 mark. The index climbed 2.1 percent in the
first half of February, recovering from a modest decline in late
January. Market capitalization was up a strong 2.83 percent.

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POWER & WATER
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8. (SBU) Shell Petroleum decides to remove itself from the Pakistani
LPG business after 44 years of operation. On February 12, The News
reported that Shell made the decision as a result of the 73.8
percent decline in Shell Gas Pakistan's profits from October through
December 2009 compared to the same period in 2008. Shell Petroleum
Company Limited is currently seeking potential investors to purchase
67.91 percent of its LPG shareholdings in Pakistan. Comment: In
recent months at least two major energy sector companies have
expressed interest in divesting from Pakistan; AES and Shell. End
Comment.)

9. (SBU) The Government of NWFP building six small dams in Nowshera.
On February 14 Business Recorder reported that the total project
cost will be $18 million. The dams would be used to irrigate 14,633
acres of agricultural land and 4 percent of the water will be used
to supply drinking water for local residents. Construction on the
dams is wrapping up and all six are projected to become operational
by June 2010.

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TRANSPORTATION & SHIPPING
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10. (SBU) Advance scanner system installed at city's port. On
February 10, Daily Times reported that the GOP had recently
installed the Rapiscan Eagle Gantry scanner system at Karachi Port.
This scanner will enable port authorities to detect smuggled
weaponry and drugs, and is capable of rapid, automated scanning of
containers, cargoes and vehicles.

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AGRICULTURE
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11. (SBU) Government decides to monitor sugar mills' production. On
February 13 Business Recorder reported that the Ministry of

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Industries has instructed the provincial governments to depute
officials to all local sugar mills to monitor their daily
production. Representatives from the Pakistan Sugar Mills
Association (PSMA) were in an uproar over the decision and have
deemed the measure as "an anti-business move." The GOP's decision
is attributed to the ongoing shortage of sugar on the local markets
and the government's desire to ensure that millers are reporting
their production numbers accurately. In early January, the GOP had
given the green light to the private sector to import sugar duty
free. In spite of these tax breaks, the private sector has imported
no sugar to date. According to a February 17 article in Business
Recorder, private sector representatives have no incentive to import
sugar into the country because of the price disparity between the
prevailing local price of sugar and the costs of importing sugar.
(Comment: The GOP is hoping that this latest initiative will help
discourage the hoarding and the smuggling of sugar into neighboring
countries; however, all of these problems result from the GOP's
policy of maintaining sugar prices artificially low compared to
international market prices. The GOP will continue to face similar
issues until it decides to finally let market forces set the price
of local commodities. End Comment.)

12. (SBU) The establishment of industrial zones in Bostan,
Balochistan, may damage agricultural tube wells. On February 3,
Daily Jang Quetta reported that local populations from Bostan met
with the acting speaker Balochistan Assembly and the Senior
Provincial Minister regarding concerns over the proposed
establishment of an industrial zone in Bostan. They argued that
Bostan is an agricultural area, and the establishment of an
industrial zone in the area will damage the water table. (Comment:
Contacts in Bostan said that the declining underground water level,
the main source of water in the area, is the key concern of people.
They added that agriculture in the area had suffered in recent years
given that a large number of tube wells had gone dry while the
remaining tube wells have to go deeper every year. The
establishment of industries in the area will require a large amount
of water, which would compete with the scarce water available for
agricultural purposes. End Comment.)

PATTERSON