VZCZCXRO1618
RR RUEHLH RUEHPW
DE RUEHIL #3461/01 3081101
ZNR UUUUU ZZH
R 031101Z NOV 08
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 9584
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHML/AMEMBASSY MANILA 3060
RUEHBUL/AMEMBASSY KABUL 9343
RUEHNE/AMEMBASSY NEW DELHI 3974
RUEHLO/AMEMBASSY LONDON 9006
RUEHKP/AMCONSUL KARACHI 0545
RUEHLH/AMCONSUL LAHORE 6279
RUEHPW/AMCONSUL PESHAWAR 5123
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUEAIIA/CIA WASHDC
RUEKJCS/SECDEF WASHINGTON DC

UNCLAS SECTION 01 OF 02 ISLAMABAD 003461 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958:  N/A 
TAGS: ECON EFIN ETRD PREL PGOV PK
SUBJECT: BANKS REQUIRED TO HOLD FEWER RESERVES 
 
Summary 
¶1.  (SBU)  The State Bank of Pakistan (SBP) reduced the cash reserve 
requirement of banks in Pakistan by 100 basis points to 5 percent, a 
4 percent drop in the last three weeks.  The reduction in cash 
reserve requirement and statutory liquidity requirement carried out 
earlier combined have generated the additional liquidity of Rs.270 
billion (USD 3.3 billion at 81.05 Rupees per dollar) in the 
inter-bank market.  The SBP has also changed the definition of 
"loans advanced" by banks to exclude export refinance and power 
sector loans.  Citibank sources estimate this measure will add 
Rs.200 to 250 billion (USD 2.5 billion to 3.1 billion) in additional 
liquidity.  The SBP has been taking these measures to deal with the 
liquidity shortages in the inter-bank market, which according the 
SBP Governor are partly due to excessive government borrowing from 
the central bank.  The Governor also said that Pakistan's economic 
ailments originated from large fiscal and external deficits, which 
in turn are partly due to high commodity prices.  Soaring inflation 
is eroding the competitiveness of industry and the purchasing power 
of masses.  End Summary. 
 
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CASH RESERVE REQUIREMENT REDUCED. . .AGAIN 
------------------------------------------ 
 
¶2.  (SBU)  The State Bank of Pakistan further reduced the Cash 
Reserves Requirement (CRR) by 100 basis points to 5 percent on 
November 1.  The CRR has come down from 9 percent to 5 percent in 
the last three weeks.  Every one percent reduction in CRR generates 
an estimated Rs 30 billion (USD 270 million) additional liquidity in 
the inter bank market.  The SBP also instructed banks that time 
deposits will not require any cash reserve.  The combined impact of 
reductions in CRR and exempting the time deposits of 1 year tenor 
will generate Rs.270 billion (USD 3.3 billion) in additional 
liquidity.  The SBP has also changed the loans definition to exclude 
export refinance, loans to the power sector, and textiles and 
apparel sectors, which has reduced the Advance Deposit Ratio (ADR) 
from 75 to 57 percent.  According to Citibank sources this change in 
policy will add an estimated Rs.200 to Rs.250 billion (USD 2.5 
billion to 3.1 billion) to the inter bank market. 
 
¶3.  (SBU)  The SBP Governor, Dr. Shamshad Akhtar, announced the 
policy change at the launch of Saudi-owned Samba Bank in Karachi on 
November 1.  (Comment: Two other Saudi-owned banks already have 
branches in Karachi or Islamabad)  Banks were facing liquidity 
shortages for the last two months, which caused the overnight rates 
to peak at 40 percent in the inter-bank market.  Akhtar said that 
the stress on liquidity stemmed from high public sector borrowing 
from the banking system, withdrawal of government deposits, seasonal 
cash withdrawals for Eid (Eid is a holiday that marks the end of 
Ramadan and fell in September), low growth in deposits, and 
precautionary withdrawals.  Steadily, public confidence is being 
restored and banks are regaining lost deposits. 
 
--------------------------------------------- ----- 
FISCAL DEFICIT AND COMMODITY PRICES FEED INFLATION 
--------------------------------------------- ----- 
 
¶4.  (SBU)  Akhtar  said that the burden of fiscal expansion was 
clearly unsustainable and the level of stress of the current 
macroeconomic burden can be judged by the growing recourse to the 
central bank financing of the budget,  the visibly  sharp decline in 
foreign exchange reserves and the depreciation in the rupee.  The 
Federal Board of Revenue (FBR) collected Rs 349.8 billion in tax 
revenue during July-October 2008-09 versus target of Rs 329.3 
billion and against Rs. 271 billion collected in the same period of 
last fiscal year.  The tax revenue is up by 29 percent in the first 
four months of the current fiscal year compared to the same period 
last year, exceeding the target by 6.2 percent. 
 
¶5.  (SBU)  Pakistan, being an open and highly import-dependent 
economy, has been hit by the surge in global commodity prices.  High 
commodity prices exacerbated Pakistan's economic ailments through 
sharp growth in the domestic fiscal deficit (due to subsidies) and 
the external deficit.  According to Akhtar, the FY08 oil import bill 
was equivalent to 6.9 percent of GDP or almost 80 percent of the 
external current account deficit.  During FY08, the average price 
per barrel was USD 94.4 while in the first quarter of FY09 average 
price reached close to USD 115.5.  Unless addressed, this high 
inflation will hurt the future competitiveness of Pakistan economy 
 
ISLAMABAD 00003461  002 OF 002 
 
 
and has already significantly eroded the purchasing power of the 
poor. 
 
-------------------- 
ROOM FOR IMPROVEMENT 
-------------------- 
 
¶6.  (SBU)  Governor Akhtar said the central bank legislation in 
Pakistan has some outdated provisions, which need to be 
appropriately amended to provide more autonomy to SBP, along with 
proper accountability, to pursue clearly defined goals of monetary 
and financial stability.  Akhtar also warned that the financial 
sector is too bank-centric, and the outreach and growth of the 
Non-Bank Finance Companies (NBFCs) and the insurance sector have 
languished in recent years.  NBFCs face direct competition from 
banks and are not likely to grow significantly until their funding 
sources and costs are streamlined.  At the same time, growth in the 
insurance sector is weak, and private pension funds have only 
recently started to gather some pace. 
 
Comment 
¶7. (SBU) Comment.  Lowering reserve requirements is an expansionary 
monetary policy that decreases the amount banks are required to hold 
to meet depositors' claims and expands the effective amount of 
currency in circulation.  This policy will reduce upward pressure on 
interest rates, yet it comes at the cost of feeding the 27 percent 
inflation that is eroding the competitiveness of Pakistan's economy 
and the purchasing power of its people, while marginally weakening 
the historically stable banking sector of Pakistan.  The Government 
of Pakistan must address the causes of the current liquidity crisis 
-- the fiscal and trade deficits -- rather than chasing the symptoms 
with increasingly ineffective quick fixes.  End Comment. 
 
PATTERSON