VZCZCXRO4848
RR RUEHLH RUEHPW
DE RUEHIL #1953/01 1491145
ZNR UUUUU ZZH
R 281145Z MAY 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 7104
INFO RUEATRS/DEPT OF TREASURY WASHDC
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RUEAIIA/CIA WASHDC
RUEKJCS/SECDEF WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHRC/USDA FAS WASHDC 4215
RUEHBUL/AMEMBASSY KABUL 8615
RUEHDO/AMEMBASSY DOHA 1539
RUEHNE/AMEMBASSY NEW DELHI 3282
RUEHKP/AMCONSUL KARACHI 9764
RUEHLH/AMCONSUL LAHORE 5503
RUEHPW/AMCONSUL PESHAWAR 4245

UNCLAS SECTION 01 OF 03 ISLAMABAD 001953 
 
SENSITIVE 
 
SIPDIS 
 
E.O.  12958:  N/A 
TAGS: EFIN ETRD ECON PREL PK
SUBJECT:  STATE BANK OF PAKISTAN ANNOUNCES TIGHTER 
MONETARY POLICY; STOCK MARKET SUFFERS SHARP LOSSES 
 
Summary 
------- 
 
¶1. (U) Summary:  The State Bank of Pakistan Governor Dr. Shamshad 
Akhtar announced a series of measures to tighten monetary policy, 
drain excessive liquidity from the system, and decrease imports to 
firm up the rupee in a May 22 speech.  Most of the new measures, 
which are effective immediately, are designed to stem further 
increases in the current account and fiscal deficits and to rein in 
inflation.  These measures include: a requirement that importers put 
a 35 percent down payment to open letters of credit (except for food 
and oil imports), a 150 basis point (1.5 percent) increase in 
discount rate to 12 percent, and a 100 basis point (one percent) 
hike in the statutory liquidity ratio and cash reserve requirement 
to 19 and 9 percent respectively.  In addition, all banks must pay 
five percent interest on savings deposits beginning June 1.  The 
Karachi Stock Exchange KSE-100 index lost 615.26 points on May 23, 
its second largest decline.  End Summary. 
 
SBP tightens monetary policy again 
- - - - - - - - - - - - - - - - - - 
 
¶2. (SBU)  State Bank of Pakistan (SBP) Governor Dr. Shamshad Akhtar 
announced a series of measures to further  tighten monetary policy 
in a May 22 speech.  The SBP normally issues monetary policy 
statements twice a year, in January and in July.  However, the 
widening current account and fiscal deficits, soaring food 
inflation, and steady depreciation of the rupee forced the SBP to 
act in advance of formulation of the new budget. The SBP hopes that 
these new measures will slow inflation, reduce aggregate demand, and 
stabilize the exchange rate. 
 
¶3.  (U)  The new measures include: 
 
-- a 150 basis point (1.5 percent) increase in the SBP's discount 
rate to 12 percent effective May 23, 2008; 
-- an increase in the Cash Reserve Requirement (CRR) for all 
deposits up to one year maturity by 100 basis points (one percent) 
to 9.0 percent; 
-- maintaining the CRR for deposits of over one year maturity 
unchanged at zero percent; 
-- an increase in the Statutory Liquidity Requirement by 100 basis 
points (one percent) to 19 percent of the total time and demand 
liabilities; and 
-- imposition of 35 percent letter of credit cash margin on all 
imports except for oil and food. (Note: Previously importers could 
open a letter of credit with no cash down.  End note.) 
 
Banks Required to Pay Higher Rates on Deposits 
- - - - - - - - - - - - - - - - - - - - - - - - 
 
¶4. (SBU)  In an effort to encourage savings deposits, the SBP will 
require that all banks pay a minimum five percent interest rate on 
savings products effective June 1. Savings deposits constitute 63 
percent of the total number of countrywide deposit accounts. The 
interest rate for saving accounts was 2.1 percent. (Comment:  The 
real interest rate for savings will still remain negative due to the 
increasing inflation rate.  Pakistan has very few profitable savings 
vehicles for individuals unwilling to risk the stock market.  End 
comment.) 
 
Current account deficit unsustainable 
- - - - - - - - - - - - - - - - - - - 
 
¶5. (SBU) The SBP projects the current account deficit in the range 
of 7.3 - 7.8 percent of GDP, which is much higher than the initial 
projection of 5 percent for FY08. The rising current account deficit 
indicates that, despite decent export performance, significant 
import demand pressures still exist.  Oil, food and textile inputs 
account for 43.4 percent of imports, and international prices for 
these commodities have been increasing steadily.  Agricultural 
inputs represent another 15 percent, and machinery exports account 
for 16.3 percent of imports.  (Comment:  Press reports frequently 
blame the current account deficit on "luxury imports."  Since the 
majority of Pakistan's imports are food, fuel, inputs, or machinery, 
 
ISLAMABAD 00001953  002 OF 003 
 
 
there appears to be little justification for this argument.  End 
comment.) 
 
Drop in foreign inflows 
- - - - - - - - - - - - 
 
¶6. (SBU)  The GOP assumed growth in foreign exchange inflows when it 
made its FY08 balance of payments projections, given FY07's positive 
results. However, liquidity constraints in global financial markets 
and the domestic political uncertainty have negatively impacted net 
foreign inflows. The growing external current account deficit along 
with slowdown in foreign direct investment and foreign portfolio 
outflows has resulted in drawdown of reserves by USD 3.7 billion 
from July 1 - May 16. 
 
KSE-100 loses 615 points 
- - - - - - - - - - - - - 
 
¶7.  (SBU)  The Karachi Stock Exchange KSE-100 lost 615.26 points to 
close at 13,011.74 on May 23. This was the second largest KSE 
decline. Market capitalization declined by USD 2.7 billion.  Market 
volumes were also down, with 154.75 million shares traded on May 23, 
compared to 191.5 million May 22. The KSE-100 index lost 1221.15 
points during the week of May 19-23.  Analysts ascribed the near 
record losses to the SBP's measures to decrease liquidity and 
continued political uncertainty. 
 
Exchange rate depreciates significantly 
- - - - - - - - - - - - - - - - - - - - 
 
¶8. (SBU) Decreasing foreign inflows combined with speculation in the 
foreign exchange market have led to the rupee's 14.9 percent 
depreciation from July 2007 to date.  Since April 1, the rupee has 
depreciated by over 11 percent.  According to the SBP, tighter 
monetary policy and structural changes to limit the GOP's ability to 
use the Central Bank to fund its fiscal deficit should help stem the 
rupee's decline. 
 
¶9. (SBU) Pakistan's budget deficit is projected to be significantly 
higher than the original FY08 budgetary estimates. By December 2007 
(latest available data), the budget deficit had grown to USD 5.1 
billion (Rs356 billion), nearly the entire full year USD 5.7 billion 
(Rs399 billion) target. The stock of outstanding GOP treasury bills, 
an instrument through which government borrows from SBP, has reached 
USD 13.66 billion (Rs945.9 billion), or almost 9.4 percent of GDP). 
This is the highest level in Pakistan's 60 year history, and is more 
than double last year's level of USD 6.53 billion (Rs452.1 billion). 
As a result, the SBP's efforts to manage monetary policy have been 
made more difficult. 
 
Inflation doubles 
- - - - - - - - - 
 
¶10. (SBU) Overall inflation has almost doubled in last four months, 
rising from 8.8 percent in December 2007 to 17.2 percent in April 
¶2008. More disturbing is the increase in food inflation, which rose 
to 25.5 percent from 12.2 percent during the same period. Non-food, 
non-energy inflation has jumped from 7.2 percent in December 2007 to 
10.8 percent in April 2008. The SBP expects inflation at over 11.0 
percent for FY08, substantially higher than its FY08 target of 6.5 
percent. 
 
Amend the Fiscal Responsibility Law 
- - - - - - - - - - - - - - - - - - 
 
¶11. (SBU) The State Bank has advised the government to amend the 
Fiscal Responsibility and Debt Limitation Act 2005 to incorporate 
appropriate provisions to limit the GOP's ability to borrow from the 
SBP. The GOP has continued to borrow from the central bank outside 
this legislation, eroding fiscal discipline and making it difficult 
to effectively tighten monetary policy. In FY08, the SBP has 
financed approximately 80 percent of the GOP fiscal deficit. 
 
Comment 
------ 
 
ISLAMABAD 00001953  003 OF 003 
 
 
 
¶12. (SBU) Comment: The GOP faces a dilemma to preserve growth, 
attract continued foreign inflows, and close its fiscal and current 
account deficits.  The SBP is trying to do its part, but its new 
measures are likely to have little impact if the GOP does not impose 
fiscal discipline in the new budget.  Past efforts at tightening 
monetary policy -- as recently as the January 2008 1.5 percent 
interest rate increase -- have been undercut by the GOP's inability 
to rein in spending and continued increases in international 
commodity prices.  Until Pakistan can implement significant energy 
saving measures or bring on-line new energy sources, its fuel import 
bill will continue to rise. The GOP's ability to continue to phase 
out energy subsidies will be key to resolving its fiscal woes, but 
is likely to cut growth. The new budget, which should be released in 
early June, will be key to answering how Pakistan plans to resolve 
its growing economic problems.  End comment. 
 
PATTERSON