VZCZCXRO6367
RR RUEHLH RUEHPW
DE RUEHIL #5328/01 3540731
ZNR UUUUU ZZH
R 200731Z DEC 07
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 3977
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 4142
RUEHNE/AMEMBASSY NEW DELHI 2497
RUEHLO/AMEMBASSY LONDON 6919
RUEHML/AMEMBASSY MANILA 2908
RUEHKP/AMCONSUL KARACHI 8444
RUEHLH/AMCONSUL LAHORE 4381
RUEHPW/AMCONSUL PESHAWAR 3003

UNCLAS SECTION 01 OF 02 ISLAMABAD 005328 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: EFIN ECON EINV PREL PK
SUBJECT: PAKISTAN FACES FISCAL PROBLEMS DUE TO SWELLING DEFICIT 
 
Summary 
------- 
 
¶1.  (SBU) Summary:  High international oil and food prices and 
political unwillingness to decrease or eliminate subsidies in an 
election year are contributing to a projected increase in Pakistan's 
fiscal deficit from 4 to 4.9 percent for FY2008.  GOP expenditures 
on energy and food subsidies have risen over 100% since the July 1 
beginning of the fiscal year. The biggest contributor is oil; prices 
at the pump have not increased since January 2007, while the 
international price of oil has increased over 50 percent.  The 
caretaker government has little power to take this issue on; the 
next government will find its options limited by a growing fiscal 
deficit.  If delays in making payments to the oil marketing 
companies continue, Pakistan may also have problems attracting 
future investments in oil and gas sector.  End summary. 
 
Oil Subsidies 
------------- 
 
¶2.  The last increase in gasoline prices was in January 2007, when 
international oil prices hovered around $55 per barrel.  In an 
election year, the GOP has made a deliberate decision to absorb the 
price differential.  The caretaker government (in power for 
approximately two months) has also taken a pass on resolving the 
problem, despite Ministry of Finance pleas to take action now. 
Pakistan's Finance Minister, Salman Shah has acknowledged publicly 
that fiscal deficit will rise significantly if this increase is not 
passed on. The Ministry of Finance has already revised its fiscal 
deficit projection to 4.6 % of GDP and believe that it may rise 
further to 4.9 % in a few months. 
 
¶3.  (SBU)  In FY 2007-2008 the GOP budgeted $245 million in 
subsidies for the oil  marketing companies (OMCs) and refineries, 
projecting oil prices at $55 per barrel. With international oil 
prices now above $90 a barrel, the cumulative margin between market 
and pump prices cost the GOP approximately $473 million through 
November 2007. The GOP has already made payments of $213 million to 
the OMCs, but another $360 million is still outstanding. Chevron 
Pakistan alone is owed $53 million.  The Embassy has taken up 
Chevron's case with the Ministry of Finance so that the company can 
receive payment prior to the end of its fiscal year December 31. 
Chevron has put an anticipated $15 million investment on hold. 
(Note:  Chevron does not have any exploration activities in 
Pakistan, only downstream investments.  End note.) 
 
Power Subsidies 
------------------- 
 
¶4.  (SBU) The GOP budgeted $406 million in subsidies for the power 
sector in the FY 2007-08. Subsidies paid by October 2007 amounted to 
$246 million for the Water and Power Development Authority (WAPDA) 
and $62 million the Karachi Electric Supply Corporation (KESC). 
Ministry of Water and Power contacts told Econoffs that total 
subsidies by the end of the fiscal year expected to total $950 
million, 133% higher than budgeted. The Ministry of Water and Power 
has asked the Federal Government to make arrangements for additional 
funds. 
 
Wheat Subsidies 
---------------- 
 
¶5. (SBU)  According to the Finance Ministry, the GOP placed nearly a 
million metric tons (mmt) in international wheat orders worth $450 
million in November and December at an average cost of $450 per mmt, 
compared to domestic average price of $220 per mmt. The expected 
final cost to the government is approximately $250 million. The 
government continues to subsidize imported wheat to keep food 
inflation under control.  With food price inflation running over 10 
percent annually, bread and butter issues remain the top concern in 
the minds of Pakistani voters. 
 
Funding the deficit 
------------------- 
 
¶6.  (SBU)  The Finance Ministry sources said that fiscal deficit 
stood at 1.6 percent of GDP versus the target of 0.9 percent for the 
first quarter (July-September 2007) of the current fiscal year, 
making it impossible to meet the overall fiscal year goal of four 
percent.  The oil and power subsidies were the major factors causing 
fiscal deficit to surpass the first quarter target. The full year 
fiscal deficit target of 4 percent of GDP is unlikely to be achieved 
 
ISLAMABAD 00005328  002 OF 002 
 
 
due to actual subsidies for oil and power exceeding planned and 
budgeted ones. The GOP's FY2007-08 budget assumed that oil prices 
would be $55 per barrel.  With crude oil prices ranging between $90 
and $100 per barrel, the government is paying out energy subsidies 
of $230 million every month.  The caretaker economic team is very 
concerned, but not finding much GOP support for substantial price 
increases. 
 
¶7. (SBU) The State Bank unsuccessfully tried to limit GOP's Central 
Bank borrowing, but could not stop the government from borrowing $2 
billion from July through November 24, well in excess of the annual 
$704 million target. Excessive Central Bank borrowing is not only 
increasing inflationary pressures, but is also eroding the State 
Bank's financial position. 
 
Comment 
-------- 
 
¶8.  (SBU) Comment:  The GOP should have been phasing in gasoline and 
power price increases throughout 2007, but could not find the 
political will.  The caretaker government, in power for only two 
months, is unlikely to make unpopular decisions affecting food or 
fuel prices ahead of the January elections.  As a result, the new 
government will face some tough choices -- either perpetuate the 
current subsidy regime with the negative budgetary and macroeconomic 
implications or spend some of its political capital to rein in 
subsidy spending.   Until now, Pakistan has had a good reputation 
for macroeconomic management, which has contributed significantly to 
its attractiveness as a destination for foreign capital.  It is not 
yet clear what economic policies a new government will pursue; most 
party election manifestos are long on fiscally untenable promises. 
The USG will need to stay engaged in close consultation with the GOP 
on economic policies.  End comment. 
 
PATTERSON