Commentary: Implications of Pakistan on the Financial Action Task Force (FATF) Grey List

The Financial Action Task Force (FATF)

The ‘Group of Seven’ countries, commonly referred as G-7, was conceptualised prior to the 1973 oil crisis. It started with an informal meeting between the US Secretary of the Treasury and finance ministers of Germany, France and UK on 25 March 1973. In mid 1973 the US proposed Japan and thus it emerged as a Group of Five. In 1975, at a summit held in France, it became the Group of Six. In 1976 Canada was invited to join the Group and it finally became a member.

The organisation was founded to facilitate shared macro-economic initiatives by its members in response to the collapse of the exchange rate in 1971, the energy crisis of the 1970’s and the ensuing recession. After the 1994 summit in Naples, Russian officials held separate meetings with G-7 leaders. The European Union also attends all meetings. In March 2014, after Russia’s annexation of Crimea, meetings with Russia ceased. China, despite its high GDP, does not form a part of this group as it is not an advanced country and has a low per capita income.

The G-7 countries represent 62 percent of the global net wealth totaling $280 trillion. They also represent 46 percent of the global nominal GDP evaluated at market exchange rates and 32 percent of the global purchasing power parity GDP. They are the leading exporters and enjoy a very high credit rating. The FATF also known by its French name, ‘Groupe d’Action Financiere’. It is an inter-governmental organisation which was founded on a G-7 initiative in 1989. It was established to combat money laundering. The FATF comprised the G-7 member states and eight countries. In 1991 and 1992 the membership was increased to 28, in 2000 to 31 and currently it composes of 37 members. Russia, China and India are members of FATF. Pakistan is not a member of the FATF. FATF has also granted observer status to various organisations including Saudi Arabia.

The FATF’s primary policies are the ‘Forty Recommendations’ on money laundering since 1990 and the nine ‘Special Recommendations’ on terrorism financing in 2001. These were revised in 1996 and 2003 respectively. In February 2004, the FATF published a reference document ‘Methodology for Assessing Compliance’ with these recommendations.

Pakistan on the Grey List: Implications

Pakistan’s Foreign Office confirmed on 28 February 2018 that FATF has put Pakistan on the Grey List with effect from June 2018. One has to go back to 2009 when FATF made a statement concerning financing of terrorism and money laundering by Pakistan. Pakistan was urged by FATF to implement a permanent anti-money laundering ordinance and implement anti-money laundering and counter-finance measures on terrorism networks. Pakistan failed to create that framework and therefore it was grey listed from 2012 to 2015. Though Pakistan was under considerable pressure during this period, in post-2015 period, Pakistan managed to hoodwink the world from the issue, while President Barrack Obama was withdrawing US troops and equipment from Afghanistan through Pakistan.

Things have changed with President Donald Trump’s candid statement about Pakistan’s failure to check terrorism. Apart from suspending aid to Pakistan, the US, along with UK, Germany and France proposed, on 20 February, 2018, to put Pakistan on the Grey List. Pakistan worked very hard to get at least four members to oppose the proposal. They decided to send 1000 soldiers to Saudi Arabia to make them agree to oppose the deal along with China and Turkey. But the US won over Saudi Arabia by giving it a full membership of the FATF. China too conveyed to Pakistan there was no point in fighting a lost battle. Thus Turkey alone opposed the proposal on 22 February 2018. Accordingly, Pakistan will have to prepare a framework, which if it does not meets the requirement, will lead to downgrade of Pakistan’s economic transactions with most global financial institutions. In case Pakistan fails to submit an Action Plan by June 2018, or if the FATF does not accept the Action Plan, then Pakistan will be black listed by the FATF - like North Korea and Iran.

There are mixed reactions regarding the effect of FATF putting Pakistan on the Grey List with regard to its economy. There are reports which state that during the last occasion when Pakistan was put on the Grey List during 2012 to 2015, the impact was minimal. But at that time the US gave them protection; this time the tables have turned and US is aiming at restraining Pakistan’s support to terrorism.

Being placed on the FATF Grey List carries no direct legal or financial implications but brings extra scrutiny from regulators and financial institutions that can chill trade and investment as also increase transaction costs. In a Reuters’ report, Mike Casey, a partner at the law firm Kirkland & Ellis in London, said that being put back on the Grey List would heighten Pakistan’s risk profile and some financial institutions would be wary of transacting with Pakistani banks and other financial institutions. Amid intense pressure from global regulators in recent times banks have been retreating from high risk countries to guard against money laundering and terror financing. In September 2017, Pakistan’s biggest lender Habib Bank was fined $ 225 million and forced to shut its US operations by the New York Regulator due to compliance failures over money laundering. There is therefore a possibility that foreign banks like Standard Chartered, Citibank and Deutsche Bank, who deal with corporate clients, are closely watching the situation and may pull out of Pakistan’s business. Pakistan’s State Minister for Finance, Rana Afzal has said, “It reduces our credibility in the world. which is unfair.”

Pakistan’s economy is in an unhealthy state. The International Monetary Fund (IMF), has warned Pakistan about its macro-economic instability amid widening fiscal and external deficits. In a report of 26 March 2018 by Hitshamul Haque in the Express Tribune of 26 March 2018, it is reported that the Pakistan Government has accepted the IMF’s pre-condition to let the Pakistani rupee depreciate by over 4 percent to qualify for any fresh bailout package that is needed to avoid default of loan repayments. The Government of Pakistan is expected to take up the issue with the IMF in Washington in April 2018. There is a likelihood of further depreciation before June 2018.

A point that strikes is the possibly of a balance of payments crisis in Pakistan. The Government is looking for an emergency $ 6 to 7 billion IMF assistance. The current situation is precarious and the FATF Grey List is going to make issues tougher. Even if an IMF package is given, it will compel Pakistan Government to implement taxation and energy related reforms besides cutting development budget to restrict fiscal deficit which could go as high as 8 percent. The root cause of the fiscal problem is reported to be the Seventh National Finance Commission award that gave 57.5 percent share to the provinces. This was further aggravated due to the 18th Constitution Amendment which empowered provinces without enhancing their capacity and wisdom to manage resources. Thus the problem can only be solved by strict financial control alternatives. Pakistan would also have to look towards commercial loans from China which would be extremely stiff and difficult to digest

Saudi Arabia and China

Saudi Arabia is very close to Pakistan and has been providing financial support as also buying defence equipment from it. However, issues have undergone a change after Crown Prince Mohammed Bin Salman has started asserting as a pro-Western leader who would like to move in accordance with the policies of the US. In such a scenario, Saudi Arabia would aid Pakistan only if it stops terrorist funding and receives the green signal from Uncle Sam.
China is already providing commercial loans at very high interest to Pakistan. Pakistan is aware that China is making great profits in Pakistan at the cost of Pakistani people. Aid received from China is providing temporary relief at best while helping only the Chinese Government. By leveraging its geo-strategic location over which the US logistics chain for operations in Afghanistan passes through, Pakistan also earns a lot from the US but that advantage may not last long.

Impact on Terrorist Operations against India

The economic situation in Pakistan being bleak, it would compelled to dry up terrorist funding to the Haqqani network, Afghan Taliban, Jammat-ud-Dawa, Lashkar-e-Taiba, Jaish-e-Mohammed and 69 more groups. An official announcement to this effect has been made, and now with FATF placing it on the Grey List, Pakistan has to prove to the US that they are not funding terrorism. US may consider sending supplies to Afghanistan through alternated means, thus making Pakistan lose substantial revenue for supporting terrorist groups.

With lesser funds available to the Pakistani terror groups operating against India, there could be a marginal difference on the terror attacks in the State of Jammu and Kashmir. But since funding of terrorists comes from multiple sources there would still be sporadic terror actions. The pressure from the US should therefore be further increased to make Pakistan stop tolerating terrorists on its soil. Iterative checks on funding will gradually bring Pakistan on course thereby allowing resolution of terrorism issues. President Donald Trump needs to be credited for being blunt about Pakistan’s double game with the US. The harder he comes down on Pakistan, the more Afghanistan and India stand to benefit.

Conclusion

The FATF declaring Pakistan on its Grey List is a positive step in curbing terrorist funding and money laundering by Pakistan. Pakistan’s economy is in doldrums and it has no alternative but to take steps to stop terror activities. It is good for India that President Donald Trump has come down heavily on Pakistan. However, the US’ persistence will compel Pakistan to stop terrorist support on Pakistani soil only when further steps are taken to make Pakistan go beyond just responding to the FATF guidelines.

Given Pakistan’s innate intransigence, that possibility is, at this point of time, seems to be remoter.

(Views expressed are of the author and do not necessarily reflect the views of the VIF)