VZCZCXRO6127
RR RUEHLH RUEHPW
DE RUEHIL #5022/01 3310419
ZNR UUUUU ZZH
R 270419Z NOV 07
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 3462
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 4136
RUEHNE/AMEMBASSY NEW DELHI 2329
RUEHLO/AMEMBASSY LONDON 6790
RUEHML/AMEMBASSY MANILA 2898
RUEHKP/AMCONSUL KARACHI 8185
RUEHLH/AMCONSUL LAHORE 4172
RUEHPW/AMCONSUL PESHAWAR 2735

UNCLAS SECTION 01 OF 03 ISLAMABAD 005022 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: EFIN ECON EINV PREL PK
SUBJECT: PAKISTAN CENTRAL BANK PROJECTS STRONG ECONOMIC GROWTH IN 
FY08 
 
 
Summary 
------- 
 
¶1. (SBU) The State Bank of Pakistan (SBP) released its annual report 
on the state of Pakistan's economy in October 2007 prior to the 
imposition of the November 3 state of emergency. The State Bank was 
pleased with the seven percent GDP growth rate in FY2007, 
particularly given the increase in international oil prices and 
gradual tightening of monetary policy.  The SBP projects that 
Pakistan's economy will continue to grow strongly in FY08, driven by 
robust growth in the agriculture and services sectors. The State 
Bank plans to continue its tight monetary policy, which should 
contain the demand pressures and check any rapid rise in inflation. 
Containing inflation, however, may prove difficult because of high 
international food and fuel prices. While the total stock of debt 
and liabilities rose, the ratio of total debt and liabilities to GDP 
continued to decline, one indicator of Pakistan's improved debt 
servicing potential.   Pakistan, however, is likely to face higher 
debt servicing burden in the future since repayments of the 
rescheduled non-ODA Paris club debt stock will resume in FY08 and 
the Euro and Sukuk bonds will mature in FY 2009 and FY 2010 
respectively.  End summary. 
 
SBP Projects Strong Economic Growth in FY08 
------------------------------------------- 
 
¶2.  (SBU) The State Bank of Pakistan (SBP) projects that the economy 
will continue to experience strong, broad-based growth in FY08, 
particularly in agriculture and services.  Continuation of tight 
monetary policy should help contain demand pressure in the economy, 
and keep domestic inflation close to the annual target of 6.5 
percent in FY08.  Key inflation risks are rising international 
energy prices and the high food commodity prices.  The domestic 
economy was partially insulated from higher international energy 
prices during FY2007 due to the government's decision not to pass on 
to customers the increase in the prices of key fuels.   This policy 
will be difficult to sustain if energy prices continue to increase 
further.  Domestic prices for key food staples have already been 
affected by rising international prices, and domestic food prices 
will increase further in FY2008 if harvests are below expectations. 
The SBP expects the current account deficit to be larger than the 
FY2007 figure in absolute terms.  However, the deficit is expected 
to fall as a share of GDP.  A further decline in import growth, 
together with a small improvement in export growth, and a robust 
rise in remittances underpins the projected improvement in the 
current account deficit in FY08.  (Comment:  Remittances rose 41.5 
percent in October 2007, compared to the previous year.  End 
comment.) 
 
SBP Lauds Investment Led Growth in FY2007 
----------------------------------------- 
 
¶3.  (SBU) Pakistan's economy recorded one of the fastest growth 
rates in Asia during FY2007. Real GDP grew 7.0 percent -- surpassed 
only by China and India. This was the third consecutive year in 
which growth was supported by rapid rise in real investment. 
According to the SBP, sound macroeconomic policies have successfully 
transformed the initial consumption-led growth impetus of a few 
years back to a greater role for sustainable investment-led growth. 
With the investment to GDP ratio at a record 23 percent, 
complemented by a surge in domestic private investment and record 
FDI flows, the economy looks well-poised to continue on a high 
growth trajectory in coming years.  (Comment:  While investment 
rates are at an all-time high for Pakistan, they are still low 
compared to China and India.  End comment.) 
 
¶4.  (SBU) Several key macroeconomic indicators showed substantial 
improvement in FY2007 compared to FY2006.  The national savings 
percentage of GDP rose from 17.2 percent to 18 percent; the external 
debt burden declined from 59 percent of GDP to 56.8 percent; and tax 
revenue increased from 9.5 percent to 9.6 percent of GDP, while the 
budget deficit stayed at last year's level of 4.3 percent of GDP. 
The SPB hopes that the improvements in these indicators will lead to 
increased growth in the coming years. 
 
¶5.  (SBU) However, Pakistan still needs to make progress on a number 
of indicators to ensure sustained economic growth.  The current 
account deficit widened in FY2007; the tax to GDP ratio is still 
very low at 9.6 percent; and inflation remained stubbornly high at 
7.8 percent, showing only a small decline from FY2006.  The decline 
in non-food inflation during FY2006 shows that monetary policy was 
 
ISLAMABAD 00005022  002 OF 003 
 
 
effective in containing demand-related inflationary pressures. The 
impact of the monetary tightening was somewhat overshadowed the 
higher than anticipated food inflation, which was 10.3 percent in 
FY2006.  Increasing international prices for basic food commodities 
and failure of domestic crops due to untimely rains contributed to 
high food inflation. 
 
Quake and infrastructure expenditures increase fiscal deficit 
--------------------------------------------- -------- 
 
¶6. (SBU) The fiscal deficit rose to 4.3 percent of GDP, well within 
range of the 4.2 percent target, despite increases in direct tax 
collections and non-tax revenues in FY2006.   The higher fiscal 
deficits in FY2006 and FY2007 are mainly attributed to increased 
spending relief and rehabilitation of the earthquake affected areas. 
 Strong growth in current expenditures also contributed to the rise 
in the deficit. The GOP's expansionary fiscal policy poses a 
dilemma.  On the one hand, the high fiscal deficit in recent years 
is driven primarily by development spending, particularly on 
infrastructure, which is necessary to sustain economic growth.  On 
the other hand, tax reforms have not significantly increased the tax 
base, even as tax revenues have increased because of sustained 
economic growth. 
 
The World Bank Categorizes Pakistan as Moderately Indebted 
--------------------------------------------- ----- 
 
¶7. (SBU) The SBP report highlighted that Pakistan was classified by 
the World Bank's Global Development of the Finance as a moderately 
indebted country in 2006, along with other 38 moderately indebted 
countries within a group of 211 countries.  Pakistan's total stock 
of debt and liabilities (TDL) rose by 10 percent from FY2006 to 
FY2007 to reach Rs 5,023.6 billion ($82.35 billion).  The growing 
current account deficit and a large fiscal deficit contributed to 
this increase.  Despite the growth in the TDL stock, the ratio of 
total debt and liabilities to GDP continued to decline which shows 
country's improved debt servicing potential.  Pakistan has already 
achieved its FY2013 goal of a 60 percent DL to GDP ratio for FY2007 
set out in the 2005 Fiscal Responsibility and Debt Limitation Act. 
 
 
¶8.  (SBU) Pakistan's domestic debt stock increased sharply in 
FY2007, registering a growth of 11.9 percent - much higher than the 
average growth of 7.7 percent during the preceding four years.  The 
share of short term debt continued to rise and reached 43 percent in 
FY2007.  The rising share of short term domestic debt means 
increased vulnerability to adverse short-term interest rate 
movements, potentially complicating future debt management. There 
was a sharp rise of 57.1 percent in interest payments on domestic 
debt in FY2007.  The maturing high-cost, zero coupon instruments 
(domestic saving certificates) issued in late 1990s was the major 
contribution to this increase. 
 
¶9. (SBU) Pakistan's external debt and liabilities (EDL) rose to US$ 
40.1 billion in FY2007, representing a US$2.9 billion increase over 
FY2006.  The rise in the EDL stock included inflows from IDA, ADB, 
and the issuance of a new Eurobond. Private loans also made sizeable 
contributions to the increase of the debt stock.  Despite this 
increase Pakistan's EDL to GDP ratio continued to improve.  This 
improvement in debt ratios led to improvements in sovereign ratings; 
Moody's up-graded Pakistan's foreign and local currency bond ratings 
to B1 from B2 in FY2007, before downgrading Pakistan following 
imposition of the November 3 state of emergency 
 
¶10.  (SBU) Pakistan continued to move toward longer term financing 
in FY2007.  A significant share of the inflows received during 
FY2007 had a long term maturity ranging from 15 - 40 years.  The 
improved maturity structure of loan inflows to some extent offsets 
the effects of the floating interest rate structure of these loans. 
During FY2007, 62.5 percent of new loan inflows had floating 
interest rates, including a US$750 million 10-year Eurobond and a 
substantial portion of Asian Development Bank inflows.  A higher 
share of flexible rate loans might translate into increasing debt 
servicing burden, should these interest rates rise appreciably. 
 
Resumption of Repayments May Stress Debt Servicing Capacity 
--------------------------------------------- ------ 
 
¶11. (SBU)  In the coming years, Pakistan is likely to face a higher 
debt servicing burden as repayments of the rescheduled non-Official 
Development Assistance Paris Club debt stock will resume in FY2008, 
 
ISLAMABAD 00005022  003 OF 003 
 
 
and the Eurobond issued in FY04 and Sukuk bonds issued in FY05 will 
mature and come due in FY2009 and FY2010 respectively.  In addition, 
interest payments on various Eurobonds issued recently are likely to 
add to debt servicing burden in coming years.  To maintain today's 
debt servicing capacity, Pakistan's foreign exchange earnings, 
particularly export earnings, and GDP need to grow faster. 
 
Financial Account Registers Record Surplus 
------------------------------------------ 
 
¶12. (SBU) As a result of a relative slowdown in the growth of the 
current account deficit and a record increase in investment inflows, 
Pakistan's external account surplus improved substantially to US$3.7 
billion in FY2007, compared to US$1.3 billion in FY2006.  Moderate 
growth in the current account deficit is attributed mainly to a 
sharp fall in the growth of imports (which compensated for an 
unexpected decline in exports) and a strong increase in remittances 
(that partially offset the rise in investment income outflows).  The 
financial account surplus increased substantially from US$5.8 
billion in FY2006 to a record US$10.1 billion in FY2007.  Increased 
equity flows were largely responsible for this improvement. 
Pakistan's overall reserves increased by US$ 2.5 billion in FY2007, 
compared to US$ 524 million in FY2006, one result of the substantial 
external account surplus. 
 
¶13.  (SBU) During FY2007, the Pakistan rupee depreciated by 1.14 
percent against the U.S. dollar from July 2006 - January 2007, then 
appreciated by 0.81% in the second half of FY2007.  In the first 
half of FY2007, the widening trade deficit drove the rupee 
depreciation while improved market related inflows helped the rupee 
to regain most of its lost ground later in the fiscal year.  The 
rupee saw a net depreciation of 0.31 percent in FY2007 against the 
U.S. dollar. 
 
¶14.  (SBU) Net dividend and profit outflows were $537 million in 
FY2007, compared to $433 million in FY2006, for an increase of 24 
percent. Telecoms, power, financial services and petroleum refining 
have recorded heavy profit and dividend outflows because of large 
foreign investments in these sectors in earlier years.  The telecom 
sector repatriated more profits and dividends, compared to 
reinvested earnings.  The financial services sector reinvested most 
of its earnings instead of repatriating them in profits and 
dividends.  The heavy FDI inflows in recent years are likely to 
result in large profit and dividend outflows in coming years unless 
they are reinvested, putting additional pressure on Pakistan's 
balance of payments.  In FY2007, more than $500 million in profits 
and dividends left Pakistan. 
 
Comment 
------- 
 
¶15.  (SBU) The robust growth in the economic activity and prudent 
management of country's debt has significantly improved debt 
servicing capacity during the past few years.  This is reflected in 
the fall in the ratio of country's stock of external debt and 
liabilities (EDL) to GDP from the 57 percent in FY01 to 28 percent 
in FY2007. Similarly, the ratio of EDL to export earnings also 
witnessed an impressive fall from the level of 416 percent in FY01 
to 237 percent in FY2007, one indication of Pakistan's higher debt 
repayment capacity. 
 
¶16.  (SBU) Notwithstanding these improvements, the sharp 
deterioration in country's current and fiscal account deficits 
during the last two years may well limit Pakistan's debt servicing 
capacity, especially if increases in both the current account and 
fiscal deficits continue.  The resumption of repayment on 
rescheduled debt and maturing of Euro bonds will put further 
pressure on Pakistan's debt servicing capacity.  The November 3 
imposition of a state of emergency is likely to slow foreign 
investment inflows, and has already driven the rupee to a three year 
low against the U.S. dollar.  Foreign inflows are also likely to 
fall, due to the political and economic uncertainty, which would be 
a drag on economic growth.  Pakistan is crucially dependent on 
foreign inflows to support its growth in view of low domestic 
savings and investment rates.  End comment. 
 
PATTERSON