VZCZCXRO9314
RR RUEHLH RUEHPW
DE RUEHIL #1035/01 0680359
ZNR UUUUU ZZH
R 080359Z MAR 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 5665
INFO RUEATRS/DEPT OF TREASURY WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 4171
RUEHBUL/AMEMBASSY KABUL 8296
RUEHDO/AMEMBASSY DOHA 1512
RUEHNE/AMEMBASSY NEW DELHI 2965
RUEHKP/AMCONSUL KARACHI 9213
RUEHLH/AMCONSUL LAHORE 5054
RUEHPW/AMCONSUL PESHAWAR 3760

UNCLAS SECTION 01 OF 02 ISLAMABAD 001035 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: ENRG ECON PREL PGOV PK
SUBJECT:  PAKISTAN'S FISCAL DEFICIT PUTTING ECONOMIC STABILITY AT 
RISK 
 
Summary 
------- 
 
¶1.  (SBU)  Summary:  The IMF expects the fiscal deficit for the 
current fiscal year to be as high as 6.5 percent of GDP, far 
exceeding the 4 percent target.  A nearly $1 billion shortfall in 
tax collection, larger than budgeted expenditures, below target 
privatization receipts, and the projectization of the $200 million 
in U.S. budget support are responsible for the above target budget 
deficit.  Deficit financing options are limited, and the GOP has 
resorted to excessive borrowing from the Central Bank to finance the 
growing budget gap. This is fuelling inflationary pressures with 
July-January inflation at 8.6 percent, compared to the 6.5 percent 
target.  As a result, the incoming government will need to make 
difficult choices to preserve macroeconomic stability. End summary. 
 
GOP will miss fiscal deficit target 
----------------------------------- 
 
¶2. (SBU)  The GOP will miss its 4 percent fiscal deficit target by a 
large margin. According to the IMF, the fiscal deficit will be 6.5 
percent of GDP for the current fiscal year, compared to the current 
fiscal year target of 4 percent of GDP.  The shortfall is estimated 
at $10.4 billion (Rs.650 billion), or $4.0 billion (Rs.250 billion) 
above the $6.4 billion (Rs. 400 billion) budget deficit target. A 
revenue shortfall combined with excess expenditures is contributing 
to the larger than targeted fiscal deficit. 
 
¶3.  (SBU)  According to the IMF, there will be a $960 million (Rs.60 
billion) shortfall in tax revenues, which have grown by 10 percent 
through July-January FY08 against the targeted 22 percent growth 
rate. General sales tax was the only category which recorded a 
significant growth of 15.78 percent. The income tax dipped by 4.55 
percent, while customs duties increased at the marginal rate of 1.48 
percent. Zero rating of the textile sector has led to tax leakages. 
In addition, the financial sector did not perform as well as it did 
last year, resulting in lower income tax collection. 
 
Privatization program stalled 
----------------------------- 
 
¶4.  (SBU)  Privatization proceeds budgeted at $1.2 billion (Rs.75) 
billion are also likely to fall short, as no major privatizations 
are scheduled for FY08. The privatization proceeds stood at only 
$133.2 million in July-January FY08.  Following the Supreme Court 
ruling (under former Chief Justice Chaudhry) to reverse the Steel 
Mill privatization, the entire program came to a halt. The GOP 
floated global depository receipts (GDRs) for a number of public 
sector companies (e.g. Pakistan Telecommunication Company before 
privatization, Oil and Gas Development Authority) in the 
international equity markets as a substitute for direct ownership 
transfer. In FY07 Pakistan earned $1.37 billion from capital market 
transactions, including global depository receipts of Oil and Gas 
Development Company Ltd. and United Bank Ltd. and other public 
offerings of public sector enterprises. These transactions were a 
significant source of foreign exchange. The domestic political 
instability and rise in country risk have made GDRs less attractive 
to both domestic and foreign investors.  As a result, the GOP opted 
to wait and has not floated any GDRs during the last six months. 
 
But non-tax revenues likely to meet targets 
------------------------------------------- 
 
¶5.  (SBU)  Fortunately, non-tax revenues are likely to meet their 
targets. The GOP budgeted $370 million (Rs.23.17 billion) for 
coalition support fund reimbursements, rather than the $1.28 billion 
budgeted (Rs.80 billion) in the previous fiscal year.  Given the 
reimbursements already dispersed this year, and those in the 
pipeline; this target is likely to be met. However, the loss of two 
hundred million dollars for budgetary support does contribute to the 
GOP fiscal deficit.  As a result, the Ministry of Finance is 
encouraging the Embassy to assume projects already budgeted rather 
than designing new projects.  In other non-tax revenue items, the 
GOP has budgeted State Bank profits at $960 million (Rs.60 billion), 
and dividends from public enterprises at $1.25 billion (Rs.78.7 
billion). The State Bank has already contributed $752 million to the 
GOP exchequer to finance the budget deficit in the first quarter of 
FY08. 
 
Increased energy, food subsidies contribute 
 
ISLAMABAD 00001035  002 OF 002 
 
 
------------------------------------------- 
 
¶6.  (SBU)  Expenditures are exceeding their target due to increased 
spending on energy and now food subsidies. According to the IMF, 
prior to the March 1 fuel price increases, oil subsidies ran at 1.5 
percent of GDP, or close to $2.4 billion (Rs.150 billion). According 
to the GOP, oil subsidies are $2.17 billion (Rs.136 billion).  We 
note that there is a discrepancy between GOP and the IMF estimates 
of oil subsidies. Our calculations show that the GOP will save only 
$197 million after fuel price increases through the June 2008 end of 
the current fiscal year. The full cost of these subsidies is not 
reflected in the GOP budget statistics since the oil marketing 
companies effectively finance a portion of the fuel subsidies.  The 
GOP regularly delays payments to the oil marketing companies. 
According to the IMF, the oil marketing companies have taken out 
short-term loans amounting to $800-960 million (Rs.50-60 billion) 
from commercial banks to finance new fuel purchases. The GOP has not 
accounted for this money in the budget, but has provided sovereign 
guarantees to the commercial banks for the full amount of the loans. 
 
 
GOP borrowing from the State Bank sets new records 
--------------------------------------------- ----- 
 
¶7.  (SBU)  GOP borrowing from the State Bank of Pakistan (SBP) are 
already at record levels with four months of the fiscal year 
remaining. The half percent increase in the cut off yield for 
treasury bills and the rise in the discount rate to 10.5 percent 
have not reduced GOP bank borrowings. Despite resistance from the 
State Bank governor, the GOP is continuing to depend on the SBP to 
finance its fiscal deficit. Government borrowing from the State Bank 
of Pakistan to finance the budget stood at $3.79 billion (Rs.237.1 
billion) for July-January FY08 versus $1.13 billion (Rs.70.9 
billion) for the same period last year. The below-target performance 
from tax revenues and privatizations, combined with larger than 
targeted expenditures have left the GOP with few options other than 
borrowing from the State Bank of Pakistan.  In addition to oil 
subsidies, wheat subsidies are also likely to influence the fiscal 
deficit.  The GOP has imported wheat amounting to $208 million in 
July-January FY08.  Since September 2007, the GOP has placed orders 
for the purchase of 1.7 MMT of wheat valued at $801.5 million. The 
estimated government subsidy on this imported wheat is $480 
million. 
 
Comment 
------- 
 
¶8.  (SBU)  Pakistan has established a solid macroeconomic framework 
in the last five to eight years, taking advantage of political 
stability, good policy choices, a successful privatization program, 
and growing exports. The global environment was also congenial to 
emerging economies.  A new government, high international commodity 
prices, an economic slow down in Pakistan's biggest export market, 
and decreased international liquidity will test whether Pakistan can 
preserve its good macroeconomic fundamentals.  So far, the economy 
has shown resilience in the face of both domestic and external 
shocks, indicating the underlying strength of the economy. Despite 
the increases in international commodity prices and the GOP's recent 
decision to begin to pass them along to consumers, growth is still 
forecast to reach a respectable 5-6 percent this year.  However, we 
do not believe that this growth is necessarily sustainable, given 
high subsidies to the domestic sector, continued low rates for tax 
collection, and the growing fiscal deficit.  The rise in the fiscal 
deficit is likely to raise Pakistan's country risk and may lead to 
further downgrades in its ranking by international credit rating 
agencies. This in turn may reduce foreign inflows, especially the 
FDI inflows and adversely affect GDP growth. End comment. 
 
PATTERSON