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R 110136Z APR 08
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RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
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RUEHKP/AMCONSUL KARACHI 9537
RUEHLH/AMCONSUL LAHORE 5283
RUEHPW/AMCONSUL PESHAWAR 4011

UNCLAS SECTION 01 OF 03 ISLAMABAD 001532 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: ENRG ECON PREL PK
SUBJECT:  PAKISTAN'S FISCAL DEFICIT PUTTING ECONOMIC STABILITY AT 
RISK 
 
Ref:  2007 Islamabad 5256 
 
Summary 
------- 
 
¶1.  (U)  Summary:  Pakistan's Finance Minister Ishaq Dar gave the 
Cabinet the bad news on Pakistan's economy, followed by a press 
conference where he made very clear his plans for government 
austerity. During the press conference, he accused the Shaukat Aziz 
government of fudging figures and mismanaging the economy.  Dar said 
that the new government will have to take stringent measures in the 
next 75 days, including increases in oil prices and imposition of 
new taxes to put the economy on the right track. He highlighted 
Pakistan's USD 8.3 billion in budget overruns, which will cause the 
fiscal deficit to significantly exceed its target. Dar hinted that 
he would seek USD 2.5 billion in economic assistance to bridge the 
current account deficit, which will also surpass its target 
significantly.   End summary. 
 
Budget overruns total USD 8.3 billion 
------------------------------------- 
 
¶2.  (SBU)  Dar has spent his first weeks in office assessing the 
gravity of the Pakistan's economic problems.  According to Dar, 
budget overruns total  USD 8.3 billion (Rs 522 billion), which the 
government needs to find a way to finance by June 30 to contain the 
fiscal deficit at six percent of GDP in the current fiscal year 
versus four percent target. (Comment:  In comparison, total budget 
expenditures for the 06-07 fiscal year totaled USD 23.41 billion. 
End comment.)  Dar said that if the government does not contain 
spending, the fiscal deficit could rise to the unsustainable level 
of 9.5 percent of GDP. 
 
Energy, military, wheat expenditures over budget 
--------------------------------------------- --- 
 
¶3.  (SBU)  Major contributors to the off-budget expenditures are 
petroleum product subsidies (USD 2.2 billion), non-payments to Water 
and Power Development Authority (WAPDA) for electricity (USD 1.2 
billion), and defense expenditures overruns (USD 1.2 billion).  Dar 
highlighted that the previous government did not make budget 
allocations for these expenditures.  In addition, the outgoing 
economic team overestimated wheat production and permitted wheat 
exportations at USD 200 per ton, less than half the then world 
price.  As a result, the GOP was then forced to import wheat at USD 
470 per ton to meet the large shortages (reftel). This misstep cost 
the government USD 720 million (Rs 45 billion), which was not 
budgeted. Dar conceded that the Public Sector Development Program 
had to be cut to allow the government to handle growing financial 
difficulties.  (Comment:  Dar's accounting still leaves USD 2.0 
billion in unspecified expenditures.  End comment.) 
 
¶4.  (U)  Dar hinted that the government will seek foreign aid to 
pull through until the end of the fiscal year on June 30. The 
government plans to request USD 2.5 billion to increase foreign 
exchange reserves to USD 15 billion from the current USD 13.5 
billion. Dar added that the new government has already received USD 
300 million in free oil from Saudi Arabia to finance the fiscal 
deficit. He also promised that the government will not borrow from 
the banking sector to meet its expenditures. 
 
Revising economic projections downward 
-------------------------------------- 
 
¶5.  (SBU) Dar said that the economic situation is so alarming that 
the government had revised downwards all its macroeconomic targets. 
The GDP growth rate target has been revised downwards from 7.2 
percent to 6 percent. (Comment:  We believe that Dar is overly 
optimistic.  Financial analysts and the IFIs were looking at growth 
rates of 5-5.5 percent prior to Dar's stocktaking of the current 
fiscal situation.  End comment.)  The fiscal deficit target has been 
revised upwards from 4 percent to over 6 percent of GDP. The tax 
revenue target has been lowered from USD 16.4 billion (Rs 1025 
billion) to USD 15.84 billion (Rs 990 billion). The inflation rate 
target has been raised from 6.5 percent to 10 percent, and current 
 
ISLAMABAD 00001532  002 OF 003 
 
 
account deficit target increased from 5.5 percent to 10 percent of 
GDP. 
 
¶6.  (SBU)  Dar added that the growth in money supply (M2) is 
fuelling inflationary pressures. The money supply is projected to 
grow by 19 percent, causing overall inflation to rise by 10 percent 
and food inflation by 14 percent. The country's bond spread is 
likely to reach 600 basis points by June 30, 2008 versus the 
projected 200 basis points, due to political and economic 
uncertainty. (Comment:  Currently the spread is 549 basis points 
over LIBOR (London Inter-Bank Offering Rates) End Comment.). Defense 
expenditure projections have been revised upward from USD 4.4 
billion (Rs 275 billion) to USD 5.6 billion (Rs 350 billion) for the 
fiscal year 2007-08 as compared to USD 4.04 billion (Rs 252.6 
billion) in 2006-07. 
 
¶7.  (SBU)  The agriculture growth target has been revised to 3.8 
percent from 4.8 percent, whereas the large scale manufacturing 
sector growth rate target is lowered to 7.5 percent versus the 
original target of 10.5 percent. The figures released April 9 by the 
Federal Bureau of Statistics, show that the large scale 
manufacturing (LSM) registered dismal growth of 5.29 percent during 
July-January 2007-08 compared to the same period last year. 
(Comment:  It would be difficult for the new government to achieve 
even the revised target of 7.5 percent due to current energy 
shortages and high input costs. End comment.) 
 
Government debt at unprecedented levels 
--------------------------------------- 
 
¶8.  (SBU) Distancing the new government from its inheritance, Dar 
highlighted that government debt has reached unprecedented levels in 
the last eight years. It rose only to Rs 2946 (USD 47.13 billion) 
billion from 1947 to 1999, but will climb to USD 91.12 billion (Rs 
5695 billion) by June 2008, showing an increase of USD 43.98 billion 
(Rs 2749 billion) in the last eight years. "Those who claim to have 
broken the begging bowl have actually enlarged it," Dar observed. He 
said external debt has climbed to USD 42.5 billion from USD 37.5 
billion in 1999 despite significant inflows. He commented Pakistan's 
credit rating may be downgraded because of its fiscal problems. 
 
¶9.  (U) Dar promised that this information will be presented to the 
parliament, the National Assembly Standing Committee on Finance and 
the Public Accounts Committee for scrutiny. Shaukat Aziz and his 
entire team will be asked to explain and answer the questions about 
these figures. 
 
No specifics on economic strategy 
--------------------------------- 
 
¶10.  (U) The new government's economic strategy will the focus on 
dealing with energy crisis by increasing generation capacity and 
conserving energy, arresting the spiraling inflation, promoting 
growth in the agriculture and the manufacturing sectors and 
increasing spending on pro-poor programs and targeted social 
protection programs, according to Dar. (Comment:  We have yet to see 
specifics on these programs.  End comment.) 
 
Comment 
------- 
 
¶11.  (SBU) Comment:  President Musharraf leveled similar allegations 
of economic mismanagement when he assumed power in 1999.  However, 
the new government is faced with real challenges of large fiscal and 
current account deficits, domestic energy shortfalls, surging 
inflation, decreased revenues and a large monetary overhang due to 
record borrowings from the central bank. The GOP has few vehicles 
for financing this deficit, with Central Bank financing at record 
levels, bond spreads too high to make an international bond issue a 
possibility, and neglible privatization receipts. These economic 
problems, however, are also due to exogenous factors such as the 
sharp rise in international commodity prices, and not just to 
missteps of the previous government of not passing on rising 
international costs directly to consumers. 
 
 
ISLAMABAD 00001532  003 OF 003 
 
 
¶12.  (SBU)  Comment continued:  The new Finance Minister has only 
listed the problems without specifics on their resolution, beyond 
asking for international assistance. The good news is, that with its 
back against the financial wall, the new government may be poised to 
take unpopular measures including passing on oil price hikes to 
consumers and imposing new taxes in the coming budget. Dar has told 
us (septel) that the military will have to reduce its procurement, 
suggesting that the Ministry and Parliament are going to exercise 
much tighter oversight of the military budget.  We will continue to 
watch the growth numbers carefully, particularly if the government 
does continue to phase out fuel and power subsidies.  End comment. 
 
Patterson