VZCZCXRO2200 
RR RUEHLH RUEHPW 
DE RUEHIL #2052/01 1571443 
ZNR UUUUU ZZH 
R 051443Z JUN 08 
FM AMEMBASSY ISLAMABAD 
TO RUEHC/SECSTATE WASHDC 7258 
INFO RUCPDOC/DEPT OF COMMERCE WASHINGTON DC 
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC 
RUEATRS/DEPT OF TREASURY WASHINGTON DC 
RHEBAAA/DEPT OF ENERGY WASHINGTON DC 
RUEHRC/USDA FAS WASHDC 4218 
RUEAIIA/CIA WASHDC 
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL 
RHMFISS/CDR USCENTCOM MACDILL AFB FL 
RUEKJCS/SECDEF WASHINGTON DC 
RUEHBUL/AMEMBASSY KABUL 8689 
RUEHDO/AMEMBASSY DOHA 1545 
RUEHNE/AMEMBASSY NEW DELHI 3364 
RUEHKP/AMCONSUL KARACHI 9846 
RUEHLH/AMCONSUL LAHORE 5590 
RUEHPW/AMCONSUL PESHAWAR 4330

UNCLAS SECTION 01 OF 03 ISLAMABAD 002052 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ETRD ECON PREL PK
SUBJECT: STATE BANK CONCLUDES PAKISTAN'S ECONOMY SHOWING INCREASING 
SIGNS OF STRESS 
 
¶1. (SBU) Summary: In its third quarter fiscal year 2008 report, the 
State Bank of Pakistan (SBP) highlighted the multiple pressures on 
the national economy from rising fiscal and current account deficits 
and inflation. As a result, the SBP has used USD 4.8 billion in 
reserves, putting downward pressure on the exchange rate. Pakistan 
currently has enough reserves to cover 18.1 weeks of imports, down 
from a previous import cover cushion of 30 weeks. Additionally, 
weak economic growth has reduced the likelihood that the Government 
of Pakistan (GOP) will reach its annual tax target of USD 15.3 
billion (Rs.1.025 trillion). The decrease in estimated revenue 
collection, combined with higher fuel and food subsides, has pushed 
government borrowing from the SBP to over USD 8.2 billion (Rs.550 
billion) or 5.5 percent of GDP. This borrowing is exerting further 
pressure on inflation, which will likely be compounded with price 
increases for fuel, wheat and other basic commodities. The SBP 
believes, however, that structural reforms and financial 
liberalization over the last fifteen years have created a 
substantially stronger and more resilient economy. End summary. 
 
Economy Showing Signs of Stress 
- - - - - - - - - - - - - - - - 
 
¶2. (U) The State Bank of Pakistan (SMP) released its third quarter 
fiscal year 2008 performance report on May 31. (Note: Pakistan's 
fiscal year runs July 1 - June 30. End Note.) According to the 
report, Pakistan's economy is showing increasing signs of stress. A 
combination of adverse domestic and international developments has 
led to a deterioration in most macroeconomic indicators. Real GDP 
growth in FY08 is expected to drop below six percent for the first 
time in five years. Annual inflation is poised to return to double 
digits. Both fiscal and current account deficits as a percentage of 
GDP are forecast to rise substantially, with the current account 
reaching an all-time high. The weakness in the external account is 
also reflected in the drop in foreign exchange reserves and the 
depreciation of the rupee against the dollar. 
 
¶3. (U) Despite the deterioration in key macroeconomic indicators, 
the SBP believes that Pakistan's economy is still fundamentally 
sound because of structural reforms and liberalization measures 
taken over the last fifteen years. As a result, a renewed GOP focus 
on further reforms and corrective measures could quickly 
reinvigorate economic growth. 
 
Production Down Across the Board 
- - - - - - - - - - - - - - - - - 
 
¶4. (SBU) According to the SPB, below target performance of major 
crops will contribute significantly to a slowdown in agricultural 
growth during the year. While the agriculture sector, on the whole, 
may post a positive growth rate due to the anticipated strong 
performance of livestock and minor crops such as lentils, below 
target performance by major crops (wheat, rice, barley, sugar cane 
and cotton) will push aggregate agricultural growth below the target 
of four percent. 
 
¶5. (SBU) High international commodity prices, inadequate energy 
supplies and lingering political uncertainty all contributed to 
slower growth in large scale manufacturing (LSM) in FY08. The 
sector grew by 4.8 percent in the first nine months of the current 
fiscal year versus 9 percent in the same period last year. The 
largest contribution to LSM growth came from a sharp rise in sugar 
production. Excluding this sub-sector, the LSM growth rate dropped 
to 3.3 percent in the July 2007 to March 2008 period. The SBP 
expects that the manufacturing sector will improve in the coming 
months as multiple industries, including paper, tires, petroleum 
refining, fertilizer and cement plan to expand capacity. With the 
exception of cement, most of these expansion plans are aimed at 
reducing import dependency. Pakistani cement exports to the Middle 
East, India and Afghanistan have risen sharply over the last year. 
 
 
¶6. (SBU) Expansionary fiscal policy has overshadowed and weakened 
the impact of the Bank's efforts to maintain a tight monetary 
policy. As of May 10, the GOP had borrowed a record USD 8.2 billion 
(Rs. 551 billion) from the SBP, compared to only USD 683 million 
(Rs. 45.7 billion) in the same period last year. The total 
outstanding stock of borrowings from the SBP has doubled over the 
last year and currently stands at USD 14 billion (Rs. 940.6 
billion). The newly elected government has pledged to broaden the 
nation's tax base and decrease expenditures, publicly indicating an 
intention to diversify deficit financing mechanisms and reduce 
dependence on the State Bank. 
 
Inflation and Deficits 
- - - - - - - - - - - 
 
¶7. (U) The rise in international commodity prices pushed domestic 
inflation to its highest level in five years. The inflation growth 
rate for the first nine months of the current fiscal year is 
currently at 9.8 percent, up from 7.8 percent in 2007 and 8.2 
percent in 2006. Pakistan's Consumer Price Index (CPI) increased 
17.2 percent from the same time last year, driven by both food and 
non-food sub-groups. Food prices in April 2008 were 25.5 percent 
higher than in April 2007; food price inflation in May 2008 will top 
26 percent. 
 
¶8. (U) Pakistan's merchandise trade deficit widened to a record high 
of USD 16.8 billion for the first nine months of the current fiscal 
year, 37.8 percent higher than the fiscal year target. The deficit 
was fueled by both a surge in imports and below-target export 
growth. Increased food and petroleum imports contributed to more 
than half of the overall rise in prices. While the 10.2 percent 
annual export growth rate during the July 2007 to April 2008 period 
was an improvement over the previous fiscal year, it is 
significantly lower than the 12.4 percent growth target. Export 
growth was led by non-textile sectors; textile exports decreased by 
2.5 percent during the period. 
 
¶9. (U) The current account deficit expanded by 74.8 percent during 
the first nine months of the fiscal year, as compared to the same 
period last year. Continuing liquidity problems in international 
financial markets have led to a decrease in foreign inflows, making 
financing the deficit more challenging. However, strong growth in 
remittances as well as bilateral and multilateral budgetary support 
provided some relief. 
 
FDI Declines While Reinvested Earnings Rise 
- - - - - - - - - - - - - - - - - - - - - - 
 
¶10. (U) Foreign Direct Investment (FDI) declined by 16.7 percent 
during the first nine months of the current fiscal year, following 
three years of more than 100 percent growth. Investment in 
telecommunications, power, petroleum and financial services declined 
while investment in cement and oil and gas exploration increased. 
Most of the decline in FDI is a result of a shortage of new 
investments and increased country risk. Reinvested earnings grew by 
twelve percent, from USD 751 million to USD 837 million. The SBP 
commented that higher reinvested earnings reflect long term investor 
confidence in Pakistan and the profit potential of key sectors such 
as financial services, oil and gas exploration and cement. 
 
Reserves Depletion Decreases Reserve Adequacy Ratios 
- - - - - - - - - - - - - - - - - - - - - - - - - - - 
 
¶11. (U) Reserves declined sharply beginning in October 2007, 
mirroring a sharp rise in the current account deficit. As of May 
23, the State Bank held $9.06 billion in reserves with commercial 
banks holding an estimated additional $2.3 billion. Reserves have 
decreased by close to USD 5 billion from an October 2007 high of USD 
16.4 billion. The depletion of foreign exchange reserves has also 
eroded the reserve adequacy terms of weeks of imports. Pakistan 
currently has enough reserves to cover 18.1 weeks of imports, down 
from a June 2007 import cover cushion of 30.6 weeks. The SBP 
depleted its own reserves; commercial bank reserves remained stable 
at approximately USD 2.3 billion throughout the fiscal year. 
 
The Rupee Regains Some Ground 
- - - - - - - - - - - - - - - 
 
¶12. (U) After remaining stable for more than four years, the 
Pakistani rupee lost significant ground against the U.S. dollar, 
depreciating by 13.4 percent from July 2007 to May 21, 2008. The 
steep decline in the rupee's value as well as high foreign exchange 
market volatility prompted the SBP to intervene on May 23, 
increasing the discount rate by 150 basis points to 12 percent and 
imposing a 35 percent margin requirement for import letters of 
credit. 
 
¶13. (SBU) Comment: The State Bank of Pakistan is understandably 
focused on last quarter's growing current account and fiscal 
deficits. We agree with the SBP that the only solution to 
Pakistan's growing account deficit is to increase exports and 
attract foreign investment and other inflows. Since over 50 percent 
of imports are food and fuel, and another 43 percent are industrial 
and agricultural inputs, clamping down on imports is not an option. 
While efforts to augment electricity generation capacity will 
increase machinery imports, increased FDI will depend on a reliable 
supply of energy. 
 
¶14. (SBU) Comment continued: As the report points out, Pakistan's 
inflation worries are far from over as international commodity 
prices continue to rise. With the budget for fiscal year 2008-09 
due on June 10, we will monitor whether the new government is able 
to make difficult but necessary decisions, including the phasing out 
of fuel subsidies and the removal of price supports to bring 
domestic wheat prices more in line with the international market. 
End comment. 
 
PATTERSON