VZCZCXRO5000
RR RUEHLH RUEHPW
DE RUEHIL #1269/01 1610905
ZNR UUUUU ZZH
R 100905Z JUN 09
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 3169
INFO RHEHNSC/NSC WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHDC
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/DEPT OF ENERGY WASHDC
RHMFISS/CDR USCENTCOM MACDILL AFB FL
RUEAIIA/CIA WASHDC
RHEFDIA/DIA WASHINGTON DC
RUEHDO/AMEMBASSY DOHA 1658
RUEHLO/AMEMBASSY LONDON 0614
RUEHML/AMEMBASSY MANILA 3183
RUEHNE/AMEMBASSY NEW DELHI 5062
RUEHBUL/AMEMBASSY KABUL 0463
RUEHLH/AMCONSUL LAHORE 7410
RUEHKP/AMCONSUL KARACHI 1808
RUEHPW/AMCONSUL PESHAWAR 6353

UNCLAS SECTION 01 OF 02 ISLAMABAD 001269 
 
SIPDIS 
SENSITIVE BUT UNCLASSIFIED 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD PREL PK
SUBJECT: Central Bank's Third Quarter Report - Growth Fragile, 
Inflation Stubborn 
 
¶1. (SBU) Summary:  On June 4, the State Bank of Pakistan released 
its third quarterly report (through March 30), which projected GDP 
growth for the fiscal year at 2-3 percent, a prediction unchanged 
from the previous quarter.  Large-scale manufacturing, the engine 
that funds tax collection, fell by almost 8 percent in the first 
nine months of the fiscal year.  Inflation has remained stubbornly 
high - year on year over 17 percent as of April, compared to an IMF 
target of 11 percent, although food inflation has come down sharply 
from 34 percent to 17 percent.  Inflation, deterioration in external 
accounts, and declining industrial output have all contributed to 
lower growth, although this is offset to some extent by the strong 
performance of the agricultural and services sectors.  Although 
overall macroeconomic indicators have continued to improve since 
November (the current account deficit, foreign exchange reserves, 
the exchange rate, fiscal discipline), major economic weaknesses 
persist and could hamper economic recovery.  End Summary 
 
¶2.  (SBU)  Agriculture and Services Perform:  The State Bank of 
Pakistan's third quarterly report predicts that the agriculture 
sector will perform quite well, as evidenced by record wheat and 
rice harvests and the prospect of good overall yields in lentils, 
oilseeds, and horticultural crops.  These high growth rates are due 
to higher government purchase prices and favorable weather, although 
there has been lower water availability and a decline in fertilizer 
usage.  The livestock sector benefited from improved fodder, 
following the extended monsoon and winter rains, as well as the 
absence of any major outbreaks of disease during FY09. 
Notwithstanding a slowdown in the trade, transportation and 
communication sub-sectors, the services sector overall is also 
expected to perform well. 
 
¶3.  (SBU)  Manufacturing Slumps:  In March, growth in large-scale 
manufacturing (LSM) was negative for the tenth consecutive month. 
LSM growth dropped by 7.6 percent from July through March, compared 
with a 5 percent increase a year earlier.  This remains a major drag 
on prospects of improving real GDP growth.  While the decline in LSM 
growth is a reflection of weaker domestic and external demand, other 
domestic factors have contributed significantly as well: 
infrastructure bottlenecks (e.g., power and gas shortages), 
increasing risk aversion by banks, and persistent inflation. 
 
¶4.  (SBU)  Stubborn Inflation:  Headline inflation - measured by the 
consumer price index (CPI) - dropped to a 17.2 percent annual basis 
in April from its peak of 25.3 percent in August 2008.  In 
particular, a sharp decline in food inflation, from 34.1 percent in 
August to 17.0 percent in April, provided relief to the poorest 
sectors of society.  The decline in inflation was due to favorable 
international prices, as well as a slow-down in domestic demand. 
The latter, in particular, reflected the State Bank's monetary 
tightening, as well as the complementary improvement in fiscal 
discipline since November 2008. 
 
¶5.  (SBU)  By April 2009, broad money growth (time deposits, current 
deposits and currency in circulation) was still quite weak, at 1.9 
percent year-to-date, down sharply from 8.4 percent in the same 
period last year, reflecting the continued fall in domestic demand. 
Because of this, the SBP projects the drop in inflation will be even 
sharper in the next few months. 
 
¶6.  (SBU)  Tax Receipts Fall Short:  Recent discussions with 
Ministry of Finance officials indicate that the budget deficit for 
the first three quarters of FY09 is likely to be 3.1 percent of GDP, 
compared with 4.7 percent in the same period last year.  There will 
likely be a shortfall in tax receipts for FY09 as well; in the first 
ten months of the fiscal year, tax receipts amounted to $11.23 
billion, compared with $9.54 billion in the same period in 2008, an 
increase of almost 18 percent.  This falls short of the 24 percent 
growth required to attain the IMF's target of $15.6 billion for the 
fiscal year.  As of April 30, total tax collection had reached 71.9 
percent of the year end target. 
 
¶7.  (SBU)  Current Account Improves; Capital Accounts Deteriorate: 
The improvement in Pakistan's overall external account that began in 
 
ISLAMABAD 00001269  002 OF 002 
 
 
November 2008 has continued.  A large part of this is due to the 
23.5 percent contraction in the current account deficit, primarily 
due to a fall in imports.  Unlike the improvement in the current 
account, however, capital and financial accounts deteriorated 
sharply during the first ten months of FY09.  While loan inflows 
revived to a large extent after IMF Stand-By Arrangement, foreign 
investment inflows continue to decline. 
 
¶8.  (SBU)  Foreign Exchange Reserves Up:  The relative improvement 
in Pakistan's external accounts was reflected in its foreign 
exchange reserves, which have gradually improved since the Stand-By 
Arrangement was agreed.  By April 30, foreign exchange reserves had 
returned to the level of end-June 2008, or $11.4 billion, after 
hitting a low of $6.8 billion in October 2008.  This also alleviated 
pressure on the exchange rate, helping it to stabilize between 78.8 
and 80.86 rupees per dollar. 
 
¶10.  (SBU)  Fiscal Deficit Under Strain:  The fiscal deficit for the 
year through March was reported at 3.1 percent of GDP, which is 
consistent with the annual target, but there are significant issues 
with the sustainability of this trend.  The growth in tax 
collections has already slowed, and may decline further in the 
fourth quarter of FY09.  Non-tax revenue receipts are also expected 
to weaken.  Rising international prices are expected to diminish the 
proceeds of the Petroleum Development Levy, for example, which had 
supplied the GOP with billions of rupees in revenue over the past 
year as domestic oil prices were not lowered along with 
international prices.  The government's expenditure budget will also 
be stretched by the ongoing war on terror and the need to support 
internally displaced persons (IDPs) fleeing the conflict areas.  The 
current improvement in the fiscal picture is the result of a 
temporary sharp cut on development spending, which is neither 
sustainable nor desirable in the long term. 
 
¶11.  (SBU) Comment:  The State Bank of Pakistan's economic reports 
are highly regarded by multilateral agencies and academics due to 
their independent assessment of the economic situation.  The current 
report characterizes the improvement in macro-economic indicators as 
"tenuous" and rightly points out underlying risks.  For example, 
gains in the current account balance can be eroded quickly if 
remittances falter and there are further drops in foreign 
investment.  There will likely be more slippage in the fiscal 
deficit targets if tax collection efforts do not improve.  The level 
of international commodity prices plays a large role in Pakistan's 
fight against inflation, and increases in electricity prices 
mandated by the IMF will also contribute to inflationary pressures. 
 
PATTERSON