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UNCLAS SECTION 01 OF 03 ISLAMABAD 000318 
 
C O R R E C T E D  C O P Y 
REMOVE SENSITIVE CAPTION 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN EAID PGOV PK
SUBJECT: PAKISTAN -- SIX MONTH MACROECONOMIC REVIEW 
 
ISLAMABAD 00000318  001.2 OF 003 
 
 
¶1. (U) Summary:  Pakistan's economy is poised to stage a modest 
recovery, turning in a GDP growth rate of nearly 3 percent in 
Pakistan's 2010 fiscal year (FY10).  There was a sharp drop in 
consumer price inflation in the first half of the fiscal year, but 
in coming months, as global commodity prices spike and domestic 
electricity subsidies are phased out, the inflation rate is likely 
to pick up again.  Trade and current account balances improved 
substantially, despite a fall in exports, thanks to a dramatic 
decline in imports in the first half of the fiscal year.  While 
foreign direct investment dropped significantly, a substantial 
increase in remittances still managed to support the balance of 
payments.  As mandated by IMF conditions, the GOP contained its 
borrowings from the central bank for budgetary support, but instead 
turned to massive borrowings from commercial banks, washing out any 
benefits from restrained central bank borrowings.  Other sources of 
concern for the IMF during its up-coming review will likely be 
Pakistan's on-going shortfall in tax collection, huge borrowings 
from banks for commodity financing and massive cuts in development 
expenditures to finance defense spending.  Overall, the large build 
up in external and domestic debt remains the primary risk to 
Pakistan's economic stability and prospects for economic growth. 
End Summary. 
 
- - - - - - - - 
GDP Growth Rate 
- - - - - - - - 
 
¶2. (U) The State Bank of Pakistan (SBP) currently projects that the 
real gross domestic product (GDP) growth rate in Pakistani FY10 
(Note: July 1, 2009 to June 30, 2010) will likely be between 2.5 
percent and 3.5 percent.  If these projections bear out, the GDP 
growth rate will be close to the annual target of 3.3 percent and 
will also be higher than the 2.0 percent growth seen in FY09.  The 
SBP expects that the services sector will be the driving force 
behind this growth. 
 
- - - - - - - - - - - - - - 
Major Economic Indicators 
- - - - - - - - - - - - - - 
 
¶3. (U) Some key economic indicators improved in the first half of 
the current fiscal year as compared to the previous year. 
Remittances continued to surge and reached $4.53 billion in the 
first half of the current fiscal year, growing by 24.4 percent.  The 
SBP estimates workers' remittances will total between $7.8 billion 
and $8.8 billion in FY10.  A decrease in the trade deficit and this 
growth in remittances both contributed to the massive decline in the 
current account deficit from $7.84 billion in July 2009 billion to 
$1.75 billion in December.  A revival in import demand from the 
manufacturing sector and rising commodity prices may limit the 
improvement in the current account balance going forward.  Although 
both exports and imports are down, the fall in imports more than 
balanced the drop in exports.  In the first half of FY10, exports 
decreased by 7.8 percent from the same period last year, falling 
from $10.09 billion to $9.3 billion, while imports dropped by 17.9 
percent from 18.3 billion to $15 billion.  Total exports are 
projected to range between $18.5 billion and $19 billion, while 
imports are likely to range between $30.5 billion and $31 billion in 
FY10.  Exports showed a 13 percent year-on-year increase in 
December, which, if sustained, bodes well for Pakistan's trade 
balance. 
 
- - - - - - 
Inflation 
- - - - - - 
 
¶4. (U) Average consumer price inflation has decreased significantly 
to 10.3 percent in the first half of FY10 from 24.4 percent in the 
same period last year.  Tight monetary policy and sharply controlled 
monetization of the fiscal deficit eased the demand pressures that 
have plagued the economy in the previous three years, reducing the 
inflation rate sharply.  The SBP, however, projects that the 
inflation rate will be between 10 and 12 percent in FY10, exceeding 
the annual target of 9 percent for the year.  Rising international 
fuel prices and cuts in electricity subsides have led the GOP to 
adjust the prices of key fuels upward, which should strengthen 
inflationary pressures. 
 
¶5. (U) A major economic challenge for Pakistan is the improvement of 
the tax-to-GDP ratio.  Tax collection has only increased 4.7 percent 
year-on-year during the first half of FY10 and the Federal Board of 
 
ISLAMABAD 00000318  002 OF 003 
 
 
Revenue Chairman Sohail Ahmet told Emboffs that his organization 
will not be able to meet the tax target agreed to with the IMF. 
Identifying tax exemptions and a slowdown in economic growth as the 
major reasons for the expected shortfall in tax collection, he cited 
the example of the sugar industry, which has been exempted from 
taxes this year in order to lower sugar prices.  Total tax revenues 
stood at $6.87 billion in the first half of FY10, compared to $6.56 
billion in the same period last year. (Note:  In FY09, the 
tax-to-GDP ratio dropped by 1 percentage point from FY08 to 8.8 
percent.  End Note.) 
 
- - - - - - - - 
Fiscal Deficit 
- - - - - - - - 
 
¶6. (U) The SBP projects that the fiscal deficit will range between 
4.7 percent of GDP to 5.2 percent of GDP.  The GOP contained its 
borrowings from the SBP and retired $266 million of debt to the 
central bank between July 1, 2009 and January 9, 2010, compared to 
borrowings of more than $3.36 billion in the same period last year. 
This restrained borrowing only applied to the SBP, however, as the 
GOP borrowed nearly $2.43 billion from commercial banks between July 
1, 2009 and January 9, 2010, compared to the retirement of $231 
million in the same period last year. 
 
- - - - - - - - - - 
FDI on the Decline 
- - - - - - - - - - 
 
¶7. (U) Foreign direct investment (FDI) is down by 57 percent to 
$1.01 billion in the first half of the current fiscal year compared 
to $2.35 billion in the same period last year.  Finance Ministry 
contacts maintain that two large transactions in the telecom and 
banking sectors artificially inflated FDI last year (Note: the 
purchases of Instaphone and Union Bank.  End note.)  Portfolio 
investment has performed well, up by 244.5 percent to $272.1 million 
in the first half of the current fiscal year versus a loss of 188.3 
million in the same period last year. 
 
¶8. (U) Thanks in large part to the IMF Stand-by Arrangement, 
Pakistan's foreign exchange reserves have improved substantially, 
moving from a low of $3.52 billion in October 2008 to $11.4 billion 
in January 2010.  Unrealized expectations of foreign economic 
assistance, however, have left foreign reserves lower than 
anticipated.  Also concerning is a buildup in domestic and foreign 
debt.  Pakistan's external debt rose to $53.79 billion in September 
2009 from $44.46 billion in the same period last year, while 
domestic debt rose to $50.82 billion in December 2009 from $42.24 
billion in the same period last year.  This large build up in debt 
could compromise Pakistan's economic stability and future economic 
growth. 
 
- - - - - - 
IMF Review 
- - - - - - 
 
¶9. (U) The areas most likely to raise IMF concerns during the 
February 8-15 review are the shortfall in tax collection and 
excessive GOP borrowings for commodity operations.  Tax collection 
has fallen short of the target by 25 percent in the first half of 
the current fiscal year.  The GOP believes it will be able to reduce 
future shortfalls through new measures such as the Audit Plan and 
the Tax Enforcement Plan, which includes provisions for identifying 
and prosecuting the estimated 8,000 tax evaders who spend large 
amounts on foreign travel, but do not pay taxes in Pakistan. 
However, Finance Ministry sources anticipate that tax collection 
will decrease by between $95 million and $120 million due to the 
Supreme Court's revision in the oil pricing formula. 
 
¶10. (U) The GOP has borrowed the huge amount of $3.6 billion for 
commodity operations, which has increased public sector exposure and 
crowded private sector credit.  Since public sector organizations 
carry out commodity operations, including the purchase of wheat and 
sugar, the large borrowings effectively increased the GOP's 
contingent liabilities and will be a source of concern for the IMF 
during the upcoming review. 
 
¶11. (U) The GOP allocated $4 billion for defense expenditures in the 
FY10 budget, however Pakistan's defense expenditures will likely 
exceed this budget allocation by $774 million by the end of the 
fiscal year.  To cope with the increased defense spending, the GOP 
 
ISLAMABAD 00000318  003 OF 003 
 
 
is cutting down its development expenditures by more than 40 
percent. 
 
¶12. (U) Both the State Bank and the Finance Ministry expect the 
inflation rate to grow in coming months due to a spike in global 
commodity prices.  The IMF may again ask the SBP to tighten its 
monetary policy to contain inflation, especially as the SBP has 
reduced the policy rate by 250 basis points since April 2009, easing 
monetary policy.  These policy measures were supported by 
substantial moderation in demand pressures. 
 
- - - - - 
Comment 
- - - - - 
 
¶13. (U) Pakistan's economy has shown great resilience in the face of 
the country's current war and its on-going law and order problems. 
The GDP growth rate, though much lower than other countries in the 
region, such as India, is still in positive territory despite 
Pakistan's security problems.  Similarly, a sharp reduction in 
inflation, contained government borrowing from the State Bank, a 
substantial contraction in external imbalances and exchange rate 
stability are all likely to preclude economic volatility.  However, 
major risks, including a decreased overall volume of trade, poor tax 
growth, lower than expected receipt of aid and, in particular, the 
increased fiscal deficit, continue to threaten economic revival. 
 
PATTERSON