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FM AMEMBASSY ISLAMABAD
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RUEAIIA/CIA WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RHEBAAA/DEPT OF ENERGY WASHINGTON DC
RUEKJCS/JOINT STAFF WASHINGTON DC
RHEHNSC/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL

UNCLAS SECTION 01 OF 02 ISLAMABAD 000238 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD EAID PGOV PREL PK
SUBJECT: PAKISTAN STANDBY ARRANGEMENT: SO FAR SO GOOD, BUT 
TROUBLE COULD BE BREWING 
 
¶1. (SBU) Summary: IMF and Ministry of Finance contacts agree 
that, based on preliminary indications, Pakistan has 
performed well in fulfilling IMF performance criteria as 
required in Pakistan's November 24 Standby Arrangement (SBA). 
 After retiring $1.24 billion in debt, borrowing from the 
State Bank of Pakistan is lower than projected and the fiscal 
deficit is reduced, thanks to the IMF's $3.6 billion cash 
injection.  Signing the Standby Arrangement has stabilized 
economic performance: capital outflows are down and inflation 
has leveled off (but not appreciably decreased), in part 
reflecting lower fuel prices.  Finance contacts warned, 
however, that contradictory goals within the program itself 
could make it difficult for Pakistan to continue to meet 
benchmarks.  End Summary. 
 
So Far, So Good 
--------------- 
 
¶2. (SBU) IMF ResRep Paul Ross told Econoff in mid-January 
that he was "cautiously optimistic" about Pakistan's 
performance vis-a-vis commitments undertaken in the GOP's 
November 24 Standby Arrangement.  Stressing that data 
received thus far were preliminary, Ross said he felt 
reasonably confident that the GOP has met IMF benchmarks for 
borrowing from the State Bank of Pakistan (SBP) for budgetary 
support and foreign exchange reserves.  The exchange rate has 
been relatively stable since December and deposits have 
started flowing back into the banking system.  Ross said that 
the GOP had "worked hard" to contain the fiscal deficit in 
December but, without the actual GOP expenditure data, he 
could not be sure of the size of the deficit. 
 
¶3. (SBU) On structural benchmarks, Ross said the GOP's 
contingency plan to deal with problem banks was almost ready, 
and that plans for tax administration reform were also being 
developed.  Calling efforts to broaden the tax base an "acid 
test" for the GOP, Ross was less confident that the unified 
voices of the GOP economic team could outweigh the political 
clout of the entrenched, untaxed segments of the economy that 
have thwarted these reforms "for the last 20 years." 
 
¶4. (SBU) Ross's assessment of GOP performance on subsidy 
reform was mixed.  Fuel subsidies have already been 
eliminated, and the GOP is actually making windfall profits 
from taxes on fuel, as international prices fall but 
importers and distributors have been slow to pass on lower 
prices to consumers.  Electricity subsidies ) due to be 
eliminated by June 2009 ) will be much more difficult to 
tackle, however.  Earlier efforts to begin reducing 
electricity subsidies were only partially implemented and 
then abandoned in the face of an angry popular response to 
higher bills and the ongoing loadshedding. 
 
But Trouble Could Be Brewing 
---------------------------- 
 
¶5. (SBU) Special Secretary of Finance, Dr. Ashfaque Hasan 
Khan, told Post on January 20 that he largely agreed with the 
IMF's assessment of GOP performance thus far.  However, Khan 
had several worries for the second half of the 2009 Pakistani 
fiscal year that ends June 30.  He pointed out that the 
Fund's program requires Pakistan to increase tax collection 
from $16.2 billion to $17.6 billion at the same time as it 
imposes a one percent limit on the rate of import growth. 
Although tighter monetary policy will now help restrict the 
flow of imports, to compensate for skyrocketing import growth 
in July and August, Pakistan will have to achieve negative 
imports in the coming months to meet the IMF's one percent 
growth target.  As almost half of GOP tax revenue comes from 
customs duties on imports, Khan is skeptical that the GOP 
could meet its revenue-collection goal -) already a weak 
point for the GOP.  (Comment: Khan's comments are predicated 
on no changes in the tax structure.  If the GOP raised taxes 
on other things, like agriculture income, they would not 
depend so heavily on customs duties.  End Comment) 
 
ISLAMABAD 00000238  002 OF 002 
 
 
 
¶6. (SBU) Khan was also concerned with the IMF goal of a $6.4 
billion increase in the money supply in FY 2009.  With the 
government prohibited from increasing its borrowing from the 
SBP and investment lagging, Pakistan must rely on growth in 
private sector credit to achieve this target.  Khan thought 
this target unlikely, given the continued global economic 
slowdown and the fact that private sector credit has only 
increased by $1.6 billion in the first six months of the 
Pakistani fiscal year. 
 
¶7. (SBU) Khan said that almost every sector of the economy -- 
from large manufacturing to transport to finance and banking 
-- is shrinking this fiscal year.  Agriculture is the main 
potential bright spot for GDP growth.  Pakistan's current 
account deficit reached approximately $6 billion from 
July-October.  Despite lower deficits in October and 
November, Khan predicted that the current account deficit was 
likely to be $12.5-$13 billion for the year, higher than the 
IMF goal of $10 billion. 
 
Stubborn Inflation 
------------------ 
 
¶8. (SBU) Khan predicted that sugar and wheat will drive up 
inflation in Pakistan.  The GOP commitment to purchase wheat 
at the unrealistically high support price of $297/ton will be 
a major factor in maintaining Pakistan's 21 percent 
inflation; since that GOP decision was taken, world wheat 
prices have fallen to around $170/ton.  Khan asserted that 
large-scale farmers and importers have taken advantage of the 
disparity in prices by importing wheat that they will then 
sell to the government at a high profit.  To forestall this 
windfall, Khan said the GOP might impose a regulatory duty on 
wheat imports to equalize the price.  Khan said the rural 
poor will survive because they reserve some of the crop for 
their own consumption.  However, the urban poor will be hard 
hit by higher flour prices. 
 
¶9. (SBU) The sugar cane crop is predicted to total 
approximately 3.6 million tons in 2009 rather than the 
necessary 4.2 million tons.  This means that a kilo of sugar 
in 2009 could cost almost double what it did in 2008.  Septel 
reports on GOP authorization to allow sugar imports. 
 
"The World Has Changed Since November8 
-------------------------------------- 
 
¶10. (SBU) Khan expressed confidence that the GOP was sincere 
in its efforts to meet IMF conditionality.  He stressed, 
however, that the collapse in world agricultural and fuel 
prices made January 2009 "a different world" from October 
2008, when the terms of the Arrangement were being 
negotiated.  Calling the IMF program "essential,8 Khan said 
that it had eliminated much uncertainty in the market and 
stabilized the Pakistani economy.  These gains are fragile, 
Khan concluded.  The GOP will have to work closely with the 
IMF and others over the next six months to ensure open 
communication in light of Pakistan's evolving circumstances. 
PATTERSON