VZCZCXRO3685
RR RUEHLH RUEHPW
DE RUEHIL #5139/01 3390148
ZNR UUUUU ZZH
R 050148Z DEC 07
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 3630
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 4139
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUEHNE/AMEMBASSY NEW DELHI 2397
RUEHLO/AMEMBASSY LONDON 6846
RUEHML/AMEMBASSY MANILA 2901
RUEHKP/AMCONSUL KARACHI 8283
RUEHLH/AMCONSUL LAHORE 4255
RUEHPW/AMCONSUL PESHAWAR 2843

UNCLAS SECTION 01 OF 03 ISLAMABAD 005139 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: EFIN ECON EINV PREL PK
SUBJECT: PAKISTANI ECONOMY WEATHERS STATE OF EMERGENCY 
 
Summary 
 
¶1. (SBU) The imposition of a state of emergency and political 
uncertainty has markedly affected Pakistan's ability to attract and 
retain portfolio investment, its exchange rate and the wholesale and 
retail business. There have been large outflows from the stock 
exchange; foreign investors have withdrawn USD200 million from the 
equity markets during the last two months.  The State Bank has 
intervened twice in the inter-bank market to stabilize the exchange 
rate. However, other economic indicators continue to perform well. 
Inbound foreign direct investment crossed the one billion dollar 
mark in July-October, and recorded close to 4 percent growth in this 
period. Worker remittances are up over 41 percent in October. 
According to independent economists, Pakistan's central bank is not 
contemplating any capital or foreign exchange controls. Though 
Moody's and the Standard and Poor have downgraded Pakistan's outlook 
from stable to negative, they have maintained the investment grade 
for Pakistan.  End summary. 
 
----------------------------------- 
Economic Policy:  Business as Usual 
----------------------------------- 
 
¶2. (SBU) Imposition of the state of emergency has had no impact so 
far on the GOP's economic policy.  There have been no policy 
changes, and former de facto Finance Minister Salman Shah has been 
appointed Finance Minister in the caretaker government to underline 
that it is business as usual as far as Pakistan's economy is 
concerned.  He will remain in that position until a new government 
is formed after the January 8 elections.  Analysts noted no capital 
restrictions have been imposed. 
 
¶3. (SBU) Asad Qureshi, the State Bank of Pakistan Executive 
Director, told Econoff that SBP is not contemplating capital 
controls.  It is not likely to substantially intervene in the 
foreign exchange market to support the rupee if foreign investors 
panic and head for the exits in the coming weeks. Instead, the 
central bank is likely to commit its foreign exchange reserves 
sparingly, and in a "strategic manner" to ensure orderly conditions 
in the exchange markets. 
 
¶4. (SBU) In a November 25 speech, State Bank of Pakistan Governor, 
Dr. Shamshad Akhtar, said that Pakistan's economic prospects have 
remained strong despite recent political events, turmoil in the 
international financial markets, decreased liquidity due to the 
sub-prime mortgage dislocations, the depreciation of the dollar, and 
the surge in oil prices. Pakistan's economy has been resilient thus 
far to these external shocks because of its underlying financial 
health and strong macroeconomic fundamentals. 
 
¶5. (SBU) Pakistan's key economic institutions continue to function 
normally. Since the imposition of the state of emergency, Pakistan 
signed an FTA with Malaysia and also approved the much anticipated 
petroleum policy to stimulate exploration in Pakistan (septel).  The 
State Bank of Pakistan (SBP) conducted a successful T-bill auction 
and mopped up PRs35 billion (USD 573 million) with the same cut-off 
yields of 9.1 percent as before, with a total participation of PRs55 
billion (USD901 million). On the international bond market, 
investors are now demanding a higher risk premium on grounds of 
security and political uncertainty. The 10-year Eurobond yield 
(issue 06/17) rose sharply to 9.20 percent from pre-emergency levels 
of 8.35 percent. Local bond yields have remained largely stable, at 
10.1 percent for ten year bonds. 
 
--------------------------------------------- - 
Rating Agencies Downgrade Outlook, but Maintain Investment Grades 
--------------------------------------------- -- 
 
¶6. (SBU) Following the November 3 imposition of a state of 
emergency, Moody's and Standard and Poor (S and P) cut Pakistan's 
outlook from "stable" to "negative" - primarily driven by the 
negative political developments. The country's investment grades 
have, however, been maintained at B1 and B+ due to Pakistan's good 
macroeconomic performance. While these ratings downgrades are 
closely monitored by international investors, analysts have been 
quick to point out that unlike previous states of emergency imposed 
in 1996 and 1999, there are no restrictions on capital movements, 
investment, or the exchange rate. Fears that Pakistan might face a 
mass exodus of foreign capital and experience turmoil in the 
financial and foreign exchange markets have not materialized. 
 
 
ISLAMABAD 00005139  002 OF 003 
 
 
---------------------------- 
Remittances Surge in October 
---------------------------- 
 
¶7. (SBU) Overseas Pakistanis sent home a record USD 580.2 million in 
October 2007 - up by 41.3 percent over the same period last year. 
This surge in remittances inflow reflects the growing confidence of 
expatriate Pakistanis on the current and future prospects of the 
economy.  During the first four months (July-October) of the current 
fiscal year, workers' remittances stood at USD 2.08 billion - up by 
26.6 percent over the same period last year. 
 
--------------------------------------------- ---- 
FDI Crosses the Billion-Dollar Mark but Portfolio Investment Drops 
Significantly 
--------------------------------------------- ---- 
 
¶8. (SBU) Foreign direct investment (FDI) crossed one billion-dollar 
mark.  According to State Bank of Pakistan, foreign direct 
investment during July-October increased by 3.9 percent to 1.3 
billion dollars. In addition, Hong Kong-based Hutchison Whampoa, and 
UAE-based International Petroleum Investment Co, have signed 
multi-billion dollar agreements for the development of a deep water 
container terminal and the largest refinery in Pakistan 
respectively, which indicates the global players' confidence on the 
Pakistan economy. Hutchison plans to invest USD1 billion on this 
project while U.A.E Petroleum Investment Company will invest USD5 
billion on the refinery which will be completed by 2011. 
 
¶9.  (SBU) However, there have been large outflows from the Special 
Convertible Rupee Accounts (Note: These accounts represent the 
portfolio investment inflows converted into rupees for investment in 
Pakistan's stock exchanges.  End note.)   Over the past two months 
(September 7 - November 7), there was net outflow of USD188.4 
million from these accounts.  Outflows were USD353.9 million, while 
inflows were USD165.5 million. Portfolio investment declined by 31.3 
percent to USD310.6 million dollars during July-October 2007, 
compared to the same period last year.  Ministry of Finance Economic 
Adviser, Ashfaque Hasan Khan, blamed the large portfolio outflows on 
the sub-prime fallout and global credit squeeze, rather than the 
imposition of emergency. 
 
¶10. (SBU) Sherani remarked that portfolio investors are watching the 
political situation carefully, and particularly U.S. actions.  If 
investors believe that the U.S. will break with Musharraf, or if 
Bhutto boycotts elections, this could cause greater portfolio 
investment outflows.  Any sudden, massive outflows would have 
serious negative repercussions on the exchange rate and on the 
Karachi Stock Exchange, given the estimated USD4.8 billion stock of 
foreign portfolio investment.  Habib and Askhari bankers told 
Econoff that all project finance transactions are on hold until the 
political situation becomes clearer.  They thought that pending 
projects would not go through until after the January 8 elections. 
 
------------------------------- 
The Rupee Hits a Three Year Low 
------------------------------- 
 
¶11. (SBU) The rupee hit a three year low on November 14, losing 22 
paisas against the dollar due to political uncertainty.  This was 
the first major rupee depreciation in the last three years. The 
outflow from the stock market caused the fall in the rupee's value. 
From November 12-14, there was an outflow of USD88 million from the 
stock exchanges. The SBP injected USD70 to USD80 million in the 
inter-bank market during this period to stabilize the value of 
rupee. The State Bank of Pakistan once again intervened in the 
inter-bank market to prop up the Pak rupee as it fell to a 37 month 
low of Rs61.30 against US dollar on November 20th. The SBP was 
active in the market as banks were trying to buy dollars to cover 
the November 19th transactions. The SBP sold dollars in both spot 
and forward markets. As a result, the rupee strengthened by 35 
paisas and closed at Rs 61.00 per dollar on November 20th. The SBP 
is intervening in the inter-bank market but not aggressively, since 
it judges that there is only a modest imbalance between supply and 
demand. Ministry of Finance Economic Adviser, Ashfaque Hasan Khan, 
however, said that there is no pressure on the rupee and the State 
Bank of Pakistan is intervening in the market to expand the band in 
which rupee should trade following IMF Article IV consultations. 
(Comment:  The IMF maintains that the rupee is pegged to the dollar 
and Pakistan needs to expand the trading band for rupee.  End 
Comment.) 
 
ISLAMABAD 00005139  003 OF 003 
 
 
 
------------------------------------ 
Oil Price Increases Still Manageable 
------------------------------------ 
 
¶12. (SBU) Pakistan is successfully weathering the rupee's 
depreciation and increases in oil prices so far.  Khadim Ali Shah 
Bukhari at Karachi's Brokerage House, told Econoffs that the impact 
of oil price shock is manageable and could be funded through a mix 
of reserve withdrawals and external debts.  Pakistan can easily 
raise USD4 billion while keeping the external debt-to-GDP ratio 
constant at 27.5% in FY2008.  However, he questioned whether 
Pakistan's ability to fund its large and growing oil import bill is 
sustainable, given the recent surge in oil prices and decreases in 
foreign inflows. 
 
--------------------------------------------- --- 
Auto Sales Down; mixed reports on wholesale and retail business 
--------------------------------------------- --- 
 
¶13. (SBU) According to the Pakistan Automobile Manufacturing 
Association, automobile sales have slowed markedly in the first four 
months of the current fiscal year, increasing only 4.1 percent, 
compared to 32 percent 5-year compound growth rate.  Sales increased 
14.8 percent in October. This slowdown in sales can be attributed to 
high interest rates for car loans, which have increased to 16-17 
percent from 7 percent in 2004. 
 
¶14. (SBU) Reports on the effect of the state of emergency on retail 
sales are mixed.  The Chairman of the Karachi Wholesale Grocers 
Association was quoted in the media as saying wholesale business has 
dropped by 25 percent since the October 18 Karachi bombing and 
November 3 imposition of the state of emergency. However, one 
Association member told EconOff that he could not quantify the drop 
in business. He commented that retailers have stopped holding stocks 
due to uncertain conditions, which have slowed retail sales.  The 
Retailers Association claims that their sales have dropped by 50 
percent. 
 
------- 
Comment 
------- 
 
¶15. (SBU) Lingering uncertainty could slow private foreign fund 
inflows. If foreign inflows slow, Pakistan's large current account 
deficit would need to be financed at least in part though reserve 
drawdowns and external debt disbursements, which could, in turn, put 
additional pressure on the exchange rate. Pakistan's current account 
deficit decreased to USD 2.99 billion in July-October FY2008 from 
USD 3.51 billion during the same period last year. The improvement 
in current account balance is mainly due to increases in current 
account transfers and exports, which grew 10.7 percent during this 
period.  Merrill Lynch currently expects Pakistan's macroeconomic 
environment to remain stable and GDP growth to remain at 6.9 
percent, driven by domestic consumption.  The government has also 
expressed confidence publicly and privately in its ability to meet 
its FY2008 economic targets. 
 
¶16. (SBU) Comment continued:  Despite the large stock of foreign 
portfolio investment in equities and their tendency to flee, foreign 
exchange reserve adequacy remains comfortable at this point in time. 
 Portfolio-related outflows are likely to continue to cause stress 
on the rupee in the short term, at until the January 8 elections. 
Continued oil price increases combined with slow export growth, 
however, pose a greater threat to Pakistan's balance of payments. 
Current reserves of USD 14.7 billion will cover six months of 
imports. We are watching carefully to see whether the current 
political uncertainty begins to adversely affect the FDI and 
remittances inflows, which so far have discounted the uncertain 
conditions and continued increase.  If FDI and remittances begin to 
drop, oil prices continue to increase, and exports are slow, then 
Pakistan will have to make some serious economic policy adjustments. 
End comment. 
 
PATTERSON