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RR RUEHLH RUEHPW
DE RUEHIL #1723/01 1221244
ZNR UUUUU ZZH
R 011244Z MAY 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 6759
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RUEAIIA/CIA WASHDC
RUEKJCS/SECDEF WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/USDA FAS WASHDC 4207
RUEHBUL/AMEMBASSY KABUL 8514
RUEHDO/AMEMBASSY DOHA 1523
RUEHNE/AMEMBASSY NEW DELHI 3197
RUEHKP/AMCONSUL KARACHI 9649
RUEHLH/AMCONSUL LAHORE 5398
RUEHPW/AMCONSUL PESHAWAR 4135

UNCLAS SECTION 01 OF 02 ISLAMABAD 001723 
 
SIPDIS 
 
SENSITIVE 
 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: EFIN ETRD ECON PREL PK
SUBJECT:  PAKISTAN RUPEE FALLS BUT NO CAPITAL FLIGHT 
 
Summary 
------- 
 
¶1.  (SBU) Summary:  Pakistan's rupee has lost ground against the 
dollar as the current account deficit continues to grow due to 
increased international commodity prices.  It hit a new low against 
the dollar on April 24, breaching the September 22, 2001 low. The 
State Bank of Pakistan (SBP) believes that the depreciation is due 
to a mismatch between supply and demand.  The bank did, however, 
intervene in the inter-bank market to stabilize the rupee value 
against the dollar and increase the amount of foreign currency that 
foreign exchange companies must release into the banking system.  We 
have seen no signs that the fall in the rupee is due to capital 
flight.  End summary. 
 
Rupee hits new low 
------------------ 
 
¶2.  (SBU)  The rupee closed at 64.50 (buying)/64.55 (selling) to the 
dollar on April 24, weakening from  64.32/64.37 on April 23, and 
sinking below the previous closing low of 64.46 on September 22, 
¶2001. Intervention by State Bank of Pakistan (SBP) lifted the rupee 
off a September 24 midday low of 64.68. In the open market, the 
rupee stood at 66.50 for buying and 66.75 for selling. The rupee 
remained under pressure from sustained high dollar demand, and 
closed at 64.52 (buying) and at 64.54 (selling) on April 29. In the 
open market the rupee recovered somewhat and stood at 65.00 (buying) 
and 65.10 (selling) on April 29. 
 
¶3. (SBU)  Part of the reason for the rupee's fall last week was that 
dealers were speculating that the State Bank of Pakistan would 
increase its discount rate by 100-150 basis points from the current 
10.5 percent to curb imports and high dollar demand as well as to 
counter inflation. 
 
¶4.  (SBU)  In an effort to decrease perceived speculation on the 
rupee, the State Bank of Pakistan on April 26 increased the amount 
of dollars that foreign exchange companies must now sell in the 
inter-bank market to 15 percent of the companies' foreign currency 
receipts, up from the previous 10 percent requirement.  At the same 
time, the companies must keep 25 percent of their foreign exchange 
in foreign currency deposits with commercial banks.  This change 
should moderate speculation on the rupee since the foreign exchange 
companies will need to release more dollars, increase liquidity, and 
also reduce the demand-supply imbalance that was contributing to the 
rupee's fall. 
 
Supply-demand imbalance 
----------------------- 
 
¶5.  (SBU) State Bank of Pakistan contacts attributed the rupee's 
fall against the dollar as an imbalance between demand and supply. 
However, they are relatively unconcerned since the rupee is falling 
slowly and stabilized after State Bank intervention in the 
inter-bank market.  In an interview with Reuters, Governor Shamshad 
Akhtar commented that "any intervention by SBP in exchange market is 
aimed at moderating the rate of exchange and preventing an abrupt 
fluctuation in the exchange rate rather than establishing a level 
for it." The State Bank Governor said the bank was exercising 
"strong vigilance" over financial markets and would "continue to 
support foreign exchange stability to curb excessive short term 
fluctuation." Some analysts speculate that the State Bank of 
Pakistan deliberately let the exchange rate depreciate against the 
dollar based on informal IMF recommendations made at the spring 
meetings (septel). 
 
Current account deficit plays a role too 
---------------------------------------- 
 
¶6.  (SBU) Citibank contacts also cited Pakistan's USD 9.9 billion 
current account deficit as another cause of the rupee's depreciation 
against the dollar. Citibank attributed increased demand from 
importers for dollars to compensate for rising international prices, 
particularly for oil payments, as contributing to the rupee's fall. 
"The demand for the dollar is huge, and the inflows are certainly 
not sufficient to demand," said a dealer at a local bank. "If the 
 
ISLAMABAD 00001723  002 OF 002 
 
 
situation persists, we may even see the rupee breaching the 65 per 
dollar mark in a few weeks," he said. 
 
But economic fundamentals still are good 
---------------------------------------- 
 
¶7. (SBU) State Bank contacts also remarked that Pakistan's long term 
economic fundamentals "still look good," although "short term 
economic conditions look gloomy, which are affecting the exchange 
rate." On April 28, the market was bearish with the KSE-100 index 
losing 161.92 points to close at 15,317.30, after gains the first 
part of the previous week.  Investors opted for profit taking due to 
uncertainty over the restoration of the Supreme Court judges issue 
and speculation over imposition of capital gains tax in the upcoming 
budget. In addition, the net inflows in Special Convertible Accounts 
dropped from USD 46.58 on April 16 to USD -7.03 million on April 
28th.  Though for the whole month of April the net inflows stood at 
USD 156.6 million. We have seen no indications of capital flight. 
 
¶8. (SBU) As the rupee continues to fall, forward dollar contract 
rates have increased.  Our contacts said that the increases reflect 
the eight point interest rate differential between the U.S. and 
Pakistan after U.S. authorities eased monetary policy and Pakistani 
authorities did the opposite. They also commented that there is no 
evidence that exporters are holding on to U.S. dollars longer to 
take advantage of the falling rupee.  If exporters withhold their 
dollars beyond a certain period, they must pay penalties to the 
State Bank of Pakistan. The SBP told us that it is not aware of even 
a single case where exporters have delayed foreign exchange 
payments. 
 
Comment 
------- 
 
¶9.  (SBU) Unfortunately the falling rupee and rising international 
commodity prices mean more bad news for consumers, as prices for 
imported food items including wheat and edible oil will continue to 
rise. Pakistan's food import bill has already increased by 43 
percent to USD 3 billion for July-March 2007-08 as compared to USD 
2.1 billion for the same period of last year. The overall slowdown 
in foreign inflows and the drop in foreign investment as compared to 
a year ago are also contributing to the rupee's fall. 
 
¶10.  (SBU) Since the currency's value is a psychological barometer 
of the country's economic strength, the drop is likely to further 
erode investor confidence.  However, we have not seen any evidence 
of capital flight.  The SBP is trying simultaneously to protect 
reserves from falling further and protect a weakening rupee, but 
this is just not possible absent help from multilateral agencies. 
The country's foreign exchange reserves fell by $392 million to 
$12.652 billion in the week that ended on April 19. We will continue 
to watch the rupee's movement, any evidence of capital flight, and 
the state of Pakistan's foreign currency reserves.  End comment. 
 
Patterson