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UNCLAS SECTION 01 OF 03 LAHORE 000020 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EAID EFIN EINV PGOV PREL PK
SUBJECT: PUNJAB'S DEFICIT SPENDING POSES CHALLENGES FOR NEXT IMF 
REVIEW 
 
REF: 09 LAHORE 143 
 
¶1. (SBU) SUMMARY: An August 2009 deal to finance Punjab 
province's deficit received sudden attention from the media in 
January, despite the absence of new issues arising from that 
deal - yet.  The size of Punjab's growing deficit, however, 
raises concerns about the next review of Pakistan's finances 
under the IMF Stand-by Arrangement (SBA).  Punjab's fiscal year 
(FY) 2008-2009 shortfall of $600 million seriously jeopardized 
Pakistan's compliance with the IMF SBA at the time.  The 
provincial deficit this year could top $800 million.  The 
province's FY 2009-2010 budget calls for robust spending 
increases, while assuming a correspondingly significant rise in 
revenue; however, revenues are falling well short of budget 
plans, particularly income from taxes.  Punjab is cutting some 
expenditures, but actually increasing others.  If provincial and 
federal authorities maintain overly optimistic revenue 
projections, Punjab could post another substantial, unfunded 
deficit at the end of FY 2009-2010.  END SUMMARY. 
 
- - - 
MEDIA SEES NEW CONTROVERSY IN OLD FINANCIAL DEAL 
- - - 
 
¶2. (SBU) For  three consecutive days starting from January 7, 
the media reported an alleged conflict in President Zardari's 
cabinet over a Government of Pakistan (GOP) letter to the IMF 
announcing a debt financing scheme between the Government of 
Punjab and the State Bank of Pakistan (SBP).  The nationalist 
English daily "The Nation" carried an article claiming that 
Finance Minister Shaukat Tarin approved the deal without 
informing Prime Minister Gilani or President Zardari, and that 
Zardari was "astonished" and unhappy about being caught unaware. 
 The same article noted that the Prime Minister's secretariat 
vigorously denied any such conflict between Tarin, Gilani, and 
Zardari.  Although the GOP notice to the IMF was new, it was 
describing an agreement negotiated between the provincial 
government and SBP back in August 2009 after the close of FY 
2008-2009, according to contacts in both the provincial and 
federal government. 
 
- - - 
PUNJAB'S FISCAL YEAR 2008-2009 YEAR END DEBT 
- - - 
 
¶3. (SBU) At the end of the last Pakistani fiscal year, June 30, 
2009, Punjab had a substantial "overdraft" or short term line of 
credit (LoC) with the SBP.  The LoC is a routine cash-flow 
management facility, typically paid off upon receipt of revenues 
from the central government.  Revenue from the central 
government accounts for approximately 85 percent of provincial 
government income.  After fiscal year-end revenue 
reconciliation, Punjab still had an outstanding balance of over 
$600 million.  The debt stood as unfinanced deficit spending. 
Apprehensive about fiscal space for Punjab to start FY 
2009-2010, the SBP agreed to convert the balance into a 
four-year, low interest loan.  (Note: The size of Punjab's 
deficit raised serious concerns during a subsequent IMF review 
of Pakistan's finances.  End note.) 
 
¶4. (SBU) Punjab Finance Secretary Tariq Mahmood Pasha claimed to 
EconOff on January 21 that Punjab's FY 08-09 year-end deficit 
came as a surprise.   He asserted that right up to June 2009, 
federal officials were projecting robust revenues for Punjab. 
In the end, federal receipts were $393 million short of 
expectations.   Pasha said that Punjab was also missing $48 
million in delayed hydroelectric power profits and over $155 
million from the aborted effort to privatize the Bank of Punjab. 
 Bank of Punjab shares lost over 90 percent of their value in a 
matter of weeks as the bank and its former chief became engulfed 
in a massive fraud scandal, scuttling privatization plans. 
Pasha was puzzled by the recent media frenzy.  He chalked it up 
to "politics," but also worried about the "misperception" that 
the province was "bankrupt" in the middle of the current fiscal 
year. 
 
- - - 
IMPOSING FISCAL DISCIPLINE: A NEW CAP ON PROVINCIAL BORROWING 
- - - 
 
 
LAHORE 00000020  002 OF 003 
 
 
¶5. (SBU) Converting Punjab's overdraft (and guaranteeing 
Balochistan province's LoC balance) was tied to an agreement 
between the GOP and the IMF to implement a new cap on all 
provincial LoCs, according to Pasha.  The cap is to equal six 
week's worth of salary and pension obligations; as much as $321 
million is available to Punjab.  The cap was intended to impose 
a measure of fiscal discipline and help Pakistan meet IMF's 
deficit target of 4.9 percent of GDP, currently estimated at 
$8.7 billion. Pasha said the province was routinely running an 
outstanding balance of roughly $202 million for one month's 
total of salaries and pensions, before central government 
revenue was received to pay it off.  The LoC mechanism works 
exactly as planned, and Pasha is satisfied that there is no cash 
flow problem.  Punjab has also been making its regular monthly 
payments on the 2009 loan deal, over $12 million per month. 
 
- - - 
BUT PUNJAB IS STILL RUNNING A UP A LARGE DEFICIT 
- - - 
 
¶6. (SBU) Pasha's confidence about cash-flow notwithstanding, 
public records from the SPB and Punjab Finance Department 
indicate that Punjab has a substantial deficit, with no apparent 
financing in place to cover it.  The SPB first quarterly report 
shows the province with a $377 million shortfall.  The report 
states, "Punjab experienced enormous deterioration in the 
overall balance, turning from surplus into deficit."  It was the 
only province with a deficit.  Punjab is not using the SBP 
overdraft to pay its bills, so it must rely on commercial loans, 
budgetary support from the international donor community, or 
possibly borrowing from other government accounts.  A 2005 World 
Bank report observed that Punjab has history of borrowing out of 
the retirement system (called the General Provident Fund) to 
help cover current account expenses. 
 
¶7. (SBU) Punjab's FY 2009-2010 budget was unrealistic from the 
beginning (ref A).  It called for substantial increases in 
spending, supported by a significant rise in revenues, plus an 
$825 million deficit that the federal government could never 
afford to support under the IMF Stand-by Arrangement.   The new 
overdraft account limit of $321 million appears to signal the 
federal government's tolerance level for the provincial deficit. 
 
 
- - - 
ROBBING DEVELOPMENT TO PAY EXPENSES, AND STILL FALLING SHORT 
- - - 
 
¶8. (U) The Punjab budget called for a 14 percent increase ($457 
million) in current account expenditure, and spending has been 
right on plan through the first five months of the year 
according to Finance Department data.  Development expenditure 
has been reduced to 55 percent of budgeted outlays through 
November, shaving $416 million off of the spending plan over 
five months.  The provincial and federal governments frequently 
cut development funding to help cover current expense deficits, 
and if the revenue budget was accurate, Punjab would be in good 
condition. 
 
¶9. (U) Unfortunately, both federal transfers and 
provincially-generated revenues have been significantly below 
Punjab's ambitious expectations.  Punjab Finance Department 
reports show provincial receipts through the first five months 
of the current fiscal year are $163 million below plan.  At that 
pace, annualized provincial revenue would be $392 million below 
budget.  Federal transfers, which account for 85 percent of 
provincial income, look similarly weak.  SPB reports show first 
quarter transfers to Punjab were 11 percent below the provincial 
forecast, at $879 million.  Federal transfers to Punjab could be 
as much as $438 million below the province's plan by the end of 
the fiscal year.  Combined with the province's own revenue gap, 
Punjab's annual income could well be $830 million below budget. 
 
- - - 
PUNJAB HOPES TO IMPROVE TAXES AND COLLECTION, SUPPORTS VAT 
- - - 
 
¶10. (SBU) Pasha said Punjab was looking for possible new sources 
of income, but when pressed for details on timing and amounts, 
 
LAHORE 00000020  003 OF 003 
 
 
neither he nor his staff could offer specifics.  He said the 
provincial government is considering floating bonds, launching a 
Real Estate Investment Trust (REIT), and even securing 
commercially available financing.  (Note: These same options 
have been under consideration at least as far back as a 2003 
World Bank examination of Punjab's debt burden.  Progress has 
been slow because of the province's high existing debt burden, 
narrow sources of revenue, and limited financial management 
talent, combined with Pakistan's political instability in 
general.  End Note.) 
 
¶11. (SBU) Provincial Additional Finance Secretary Zarak Mirza 
said that an overhaul of property taxation was almost complete, 
but he was not sure when it could be approved by the Chief 
Minister.  Mirza also noted that the Punjab Resource Management 
Program (PRMP) was putting the final touches on a finance 
department capacity-building roadmap that would help improve tax 
collection in the future.  He went on to ask for USG assistance 
with implementing the PRMP plan.  Finance department leaders 
were also supportive of moving to a federal Value Added Tax 
(VAT), as they expected it to enhance provincial income. 
 
¶12. (SBU) COMMENT: Recent media attention on Punjab's deficit 
financing may be just highlighting old news, but it does suggest 
a potentially serious problem for future IMF SBA reviews. 
Punjab officials could or should have recognized revenue 
problems in fiscal year 2008-2009, well before the June 2009 
"surprise."  With increased expenses, flat revenue, and a 
challenging economic climate, the province appears to be facing 
a similar fiscal problem for FY 2009-2010.  It is highly 
unlikely that their proposals for increasing income, with less 
than five months left in the current fiscal year, will be enough 
to meet the shortfall.  The federal government seems prepared to 
finance a deficit up to $321 million, but Punjab exceeded that 
after just three months.  Unless provincial spending is sharply 
reduced, Punjab's deficit could be as much as $800 million at 
the end of June 2010, with serious repercussions for future IMF 
SBA reviews.  END COMMENT. 
CONROY