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UNCLAS SECTION 01 OF 02 ISLAMABAD 000305 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV ETRD EAID PGOV PREL PK
SUBJECT:  STATE BANK GOVERNOR: LACK OF CREDIT STIFLING PAKISTAN'S 
GROWTH; DISCOUNT RATE TO STAY AT 15 PERCENT 
 
¶1. (SBU) Summary.  On January 31, the State Bank of Pakistan (SBP) 
released its Monetary Policy Statement which maintained the discount 
rate at 15 percent for the next six months, causing disappointment 
to many in the private sector who were hoping for an easing of 
rates.  SBP Governor Salim Raza told DCM on February 9 that tight 
liquidity due to high interest rates and a reluctance of the banking 
sector to lend will seriously dampen economic growth.  Raza will 
keep interest rates high, however, until inflation comes down, which 
is starting to occur in the food and consumer indices, although rent 
and wage inflation remains unchanged.  Raza is proud of the 
discipline the GOP has shown in meeting its IMF targets, and said 
they deserved a higher loan amount from the Fund if they continue 
their good performance.  Embassy Legal Advisor gave Raza the revised 
Terms of Reference for the placement of a Treasury advisor in the 
Financial Monitoring Unit, and Raza promised to get back to us.  End 
Summary 
 
¶2. (SBU)  In a February 9 meeting with DCM, Economic Counselor and 
Embassy Legal Advisor, State Bank of Pakistan (SBP) Governor Salim 
Raza discussed how the global contraction in capital flows was 
particularly devastating for developing countries.  Pakistan's 
situation of slowing economic growth combined with high inflation 
left the GOP unable to stimulate growth by government spending.  The 
only option was increased lending by the banking sector, since 
commercial paper and bond markets do not exist in Pakistan. 
However, the banks - which are recording higher levels of 
non-performing assets, particularly in the consumer and textile 
areas - are investing in government securities and holding more cash 
rather than giving new loans. 
 
¶3.  (SBU)  The SBP has injected $2 billion in additional liquidity 
in the past quarter by relaxing the banks' reserve requirements 
(from nine to five percent); however, this has not shown up in 
larger amounts of bank loans, he said.  The IMF wants the private 
loans to increase by $6-7.5 billion, but Raza is doubtful if even 
half that amount is achievable.  (Note:  In the past three months, 
for example, private sector credit increased by only $590 million, 
compared to $2.4 billion for the same period a year previously.  End 
Note.) Commenting that the banking sector has been almost completely 
privatized, Raza said that the SBP could only use moral suasion to 
convince them to lend more. 
 
¶4.  (SBU)  On January 31, the SBP announced that the discount rate 
would remain at 15 percent for the next six months, disappointing 
many in the private sector who had been squeezed by commercial rates 
of over 20 percent.  (The discount rate was raised from 12 to 13 
percent in July, and to 15 percent in November.)  Raza said he was 
comfortable with this decision ("I have no problem keeping interest 
rates where they are"), and would try to hold the line to keep 
inflation in check. 
 
¶5.  (SBU) The increase in the discount rate has encouraged banks to 
participate in Treasury bill auctions, and enabled the SBP to shift 
its government debt burden to the private banks.  In the six 
auctions held since November 13, the GOP has raised over $6 billion, 
helping it to meet its December IMF targets of less dependence on 
the central bank.  Raza attributed the success of these auctions to 
the fact that the SBP no longer sets the interest rate it will 
accept but lets the market determine it.  The down side of this 
policy is the crowding out of the private sector. 
 
¶6.  (SBU)  Raza said squeezing out inflation is of paramount 
importance.  Wholesale and consumer price indexes have begun to 
drop.  For example, the sensitive food index, which comprises 
products important to the poorest stratum of society, has fallen by 
5 percent.  However, core inflation (rents, wages) remains stubborn, 
dropping almost imperceptibly in December (from 19.6 to 19.5 
percent) because, he noted, inflationary expectations are difficult 
to eradicate quickly. 
 
¶7.  (SBU)  Raza expressed satisfaction with the GOP's meeting its 
IMF targets on incremental borrowing and levels of reserves.  He 
said the next IMF review would be forward looking, concentrating on 
the strength of the banking system and whether the GOP would be able 
 
ISLAMABAD 00000305  002 OF 002 
 
 
to maintain discipline in the face of coming challenges.  He said he 
was looking forward to a constructive discussion with the IMF on how 
not to "slow down the whole system" due to high interest rates.  "If 
we can keep up discipline, we should ask for [the terms given to] 
Turkey or Hungary," referring to the larger loan amounts they 
received from the Fund in their structural readjustment programs. 
 
¶8.  (SBU)  SBP Policy Statement:  In its Monetary Policy Statement 
for the third quarter of FY09, in which the discount rate was 
maintained, the SBP estimated lower GDP growth due to energy 
shortages, lower demand for exports, less available consumer finance 
and pending circular debt issues.  The SDP believes the balance of 
payments position is still vulnerable due to a slow down in global 
demand.  First half statistics showed that large scale manufacturing 
remained negative (down 5.6 percent), affected by lower demand, less 
consumer financing and energy shortages.  The external current 
account deficit remained high, at $7.3 billion, as lower oil prices 
had not yet been factored in.  The average oil price in the first 
half was $109, but benefits will show up later in the fiscal year 
when import contracts are renegotiated. 
 
¶9.  (SBU)  Comment:  An articulate, polished man with over thirty 
years of banking experience - many of them with Citibank's London 
office - Raza projects the self-assurance of a political insider. 
The concern remains, however, that his close ties with Financial 
Advisor Shaukat Tarin, also a former Citibank executive, will put at 
risk the independence from the Finance Ministry that the central 
bank fiercely maintained under former Governor Shamshad Akhtar, a 
technocrat from the Asian Development Bank.  Indeed, Raza's decision 
to end SBP involvement in setting interest rates for Treasury bill 
auctions marks a central bank capitulation in one of the battles 
that had characterized the fractious SBP-Finance relationship during 
former Governor Akhtar's tenure. 
 
 
PATTERSON