Spearhead Analysis – 27.02.2018
By Farrukh Karamat
Senior Research Coordinator, Spearhead Research
The United States of America in a unilateral move on December 6, 2017 formally recognized Jerusalem as the capital of Israel. On December 16, 2017 more than 120 countries defied the US claim to vote in favor of a United Nations General Assembly resolution for the United States to rescind its decision to recognize Jerusalem as the capital of Israel. Pakistan was amongst the countries which co-sponsored the resolution, with Dr. Maleeha Lodhi emphasising that Pakistan had ‘rejected the US decision terming it illegal and leading to chaos and instability being fueled in the Middle East’. Prior to the resolution being passed President Donald Trump threatened to cut off financial aid to countries that voted in favor. A total of 128 countries backed the resolution, which is non-binding, nine voted against and 35 abstained. Twenty-one countries did not cast a vote.
The US Ambassador to the United Nations, Nikki Haley, categorically stated, “The United States will remember this day in which it was singled out for attack in the General Assembly for the very act of exercising our right as a sovereign nation…..We will remember it when we are called upon to once again make the world’s largest contribution to the United Nations, and so many countries come calling on us, as they so often do, to pay even more and to use our influence for their benefit.” The 64 countries who voted no, abstained or did not cast a vote were then invited to a January 3, 2018 ‘thank you’ reception at the White House.
On New Years’ 2018 President Trump tweeted: the US “has foolishly given Pakistan more than 33 billion dollars in aid over the last 15 years, and they have given us nothing but lies & deceit, thinking of our leaders as fools.”
These were ominous warnings for having been one of the countries that voted vociferously for the motion in the United Nations, Pakistan should have been prepared for stern reprisal from the United States. This came in shortly afterwards, with the United States putting forth a motion to place Pakistan on a global terrorist-financing watch-list through the Financial Action Task Force (FATF).
This comes at a time when the country is experiencing rising deficit levels and its foreign exchange reserves are coming under increasing pressure. The current account deficit has increased to US$9.156 Billion from US$6.182 Billion in the year-ago period. Foreign exchange reserves have fallen to US$18.956 Billion in January 2018, from US$22.242 Billion in January 2017. The reserves with the State Bank of Pakistan at US$12.794 Billion provide barely three months of import cover. Fiscal deficit stood at 2.2 per cent of GDP in the first half of FY 2017-18 and is expected to rise faster in the second half of the fiscal year. Exports have shown double-digit growth, but continue to be outpaced by faster import growth. In the July-January period, exports grew 11 per cent year-on-year, while imports rose by 19 per cent. The government continues to borrow to finance the budgetary gaps and the pace of obtaining commercial loans has accelerated.
Amidst all this Pakistan’s relations with the USA are strained in the wake of the developments over the past three months. Now the US is exerting its muscle, which is likely to create economic difficulties for Pakistan. Perhaps the FATF is the start of many more such actions from the USA. To understand the potential impact of being placed on the ‘watch list’ it is important to understand what FATF actually stands for.
As per FATF website it “is an inter-governmental body established in 1989 by the Ministers of its Member jurisdictions. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. The FATF is therefore a “policy-making body” which works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas.”
The FATF works on the basis of a set of recommendations for combating money laundering and terrorist financing and “proliferation of weapons of mass destruction”. First issued in 1990, the FATF recommendations were revised in 1996, 2001, 2003 and most recently in 2012 to ensure their relevance in a rapidly evolving global financial eco-system. The FATF monitors the progress of its members in implementing necessary measures, reviews money laundering and terrorist financing techniques and counter-measures, and promotes the adoption and implementation of appropriate measures globally. In collaboration with other international stakeholders, the FATF works to identify national-level vulnerabilities with the aim of protecting the international financial system from misuse. For this purpose, FATF’s decision making body, the FATF Plenary, meets three times a year.
The FATF works with 40 recommendations under the following headings:
A – AML/CFT POLICIES AND COORDINATION
B – MONEY LAUNDERING AND CONFISCATION
C – TERRORIST FINANCING AND FINANCING OF PROLIFERATION
D – PREVENTIVE MEASURES
E – TRANSPARENCY AND BENEFICIAL OWNERSHIP OF LEGAL PERSONS AND ARRANGEMENTS
F – POWERS AND RESPONSIBILITIES OF COMPETENT AUTHORITIES AND OTHER INSTITUTIONAL
G – INTERNATIONAL COOPERATION
In addition, there are nine special recommendations (stated below) providing a comprehensive framework to detect, prevent and suppress the financing of terrorism and terrorist acts. These 40 + 9 Recommendations, provide the international standards for combating money laundering (ML) and terrorist financing (TF).
- Ratification and implementation of UN instruments
- Criminalising the financing of terrorism and associated money laundering
- Freezing and confiscating terrorist assets
- Reporting suspicious transactions related to terrorism
- International co-operation
- Alternative remittance
- Wire transfers
- Non-profit organisations
- Cash couriers
Pakistan is not new to the FATF watch list, as it was placed on this list from 2012 to 2015. However, as things stand currently. Pakistan is not placed on the High-risk and other monitored jurisdictions and remains a member country of the Asia/Pacific Group on Money Laundering (APG).
Pakistan has been making efforts to avoid being placed on the dreaded ‘watch list’ and being dubbed non-compliant with terrorist financing regulations by the FATF, as this could have serious implications for a fragile economy. At the same time the United States has adopted a tougher stance over the alleged relationship of Pakistan with Islamist militants and their ‘selective crackdown’ on such organisations, and the Trump administration had withheld financial assistance of around US$2 Billion. Pakistan has vehemently denied any involvement with such organisations. The Government in response to the US initiative to place Pakistan on the watch list, prior to the plenary meeting stated that they were working with the “U.S., UK, Germany and France for the nomination to be withdrawn.”
The FATF held its meeting and a jubilant Foreign Minister tweeted that Pakistan had not been placed on the watch list in the plenary session. However, it later transpired that a decision had in effect been taken to include Pakistan in the watch-list by June 2018. This provides a respite of three months to Pakistan and adopt measures to avoid such a move by the FATF. While the government continues to assert that there will be no negative impact on the economy of such an adverse action as the fundamentals remain strong, the truth is far from that.
It is imperative to understand that Pakistan needs to allay the fears of the FATF to ensure that it is not placed on the list. It will inflict far-reaching reputational and economic damage on the country. Merely stating that we can weather out the storm is nothing more than political and emotional rhetoric. The world has changed and the regional situation is evolving rapidly, and Pakistan needs to be cognizant of the dynamics. Far from playing a blame-game, the government needs to take concrete actions and the start could have been an effective and timely implementation of the National Action Plan (NAP), which has been all but shelved and forgotten.
Pakistan should also not be under any delusion about its relationship with the United States and how far the US could go to isolate Pakistan. This was evident during the voting at the FATF session when the initial motion failed due to the opposition by Turkey, Saudi Arabia and China. However, the USA then sought a second vote on the matter where China and Saudi Arabia chose to remain silent, while Turkey voted against the motion. Pakistan stands on a tightrope and needs to take aggressive corrective measures to ensure that it is not placed on the watch list in June. While China’s decision to withdraw its support might appear surprising, it could have been motivated in part by Pakistan’s inaction against terror groups. China, is using regional and international public forums to indicate its seriousness to the Pakistani authorities. In September 2017, the BRICS summit (including China) declared a number of militant groups allegedly based in Pakistan a regional security threat. Recently news has surfaced that China has been holding talks with Baloch militants to “protect the US$60 Billion worth of infrastructure projects it is financing as part of the China-Pakistan Economic Corridor (CPEC).”
It is clear that a geopolitical agenda cannot be outright dismissed as the US is facing difficulties in Afghanistan, and India is working with the USA to isolate Pakistan. Compounding the issue is the economic weaknesses being experienced by Pakistan and a costly ongoing war against terrorism. Being placed on the watch list could impact trade flows, and effect the forex and stock markets.
Pakistan needs to reassess its foreign policy to come up with a balanced relationship within the region and globally. The world has moved on from 2012-15 when despite being on the FATF watch list Pakistan managed to negotiate the US$6.6 Billion EFF with the IMF and continued to trade with the world. This time the USA is in no mood to allow any leeway to Pakistan and with growing regional isolation, despite the ongoing CPEC initiative, Pakistan could find it to be costlier and more difficult to continue with business as usual.
An immediate outcome post-June could be a downward revision in Pakistan’s credit rating raising the cost of borrowing for a country that is increasingly reliant on borrowing to plug the budgetary gaps. In turn the rise in perceived risk could hurt foreign direct investment and foreign portfolio investments. With the closure of Habib Bank’s New York branch Pakistani banks are already under increased scrutiny and the FATF action could see Pakistani banks facing heightened regulatory pressure and difficulty in conducting financial transactions.
The move by the FATF has come at a time when there was speculation that Pakistan was considering launching an Amnesty scheme to allow Pakistanis to bring back funds held in overseas Banks to bolster the dwindling reserves. Perhaps, FATF was a preventive move to nip such initiatives in the bud, and place heightened financial pressure on the country.
The government has responded by indicating that there would be changes to the rules for keeping a stricter check on forex flows. As a result, remittances and local foreign currency accounts could be impacted if the tax-exempted, no-question-asked status of inflows is withdrawn. Also, if the government disallows the funding of foreign currency account with forex bought from the open market, it would squeeze growth of such accounts in the short run, affecting the size of forex holding.
Some of the specific risks that Pakistani businesses could face if put on the FATF grey list include:
- Requiring financial institutions to apply specific elements of enhanced due diligence.
- Introducing enhanced relevant reporting mechanisms or systematic reporting of financial transactions.
- Refusing the establishment of subsidiaries or branches or representative offices of financial institutions or otherwise taking into account the fact that the country that does not have adequate AML/CFT systems.
- Limiting business relationships or financial transactions with the country or persons in the country.
- Prohibiting financial institutions from relying on third parties located in the country concerned to conduct elements of the CDD process.
- Requiring financial institutions to review and amend, or if necessary terminate, correspondent relationships with financial institutions in the country concerned.
- Requiring increased supervisory examination and/or external audit requirements for branches and subsidiaries of financial institutions based in the country concerned.
- Requiring increased external audit requirements for financial groups with respect to any of their branches and subsidiaries located in the country concerned.
Such measures would not only raise the cost of doing business, but make it more difficult to undertake transactions. This at a time when Pakistan is looking to enhance its footprint in the regional trade could have far-reaching ramifications. The government needs to focus its attention on FATF and avoid any chance of being placed on the watch list. This requires a multi-pronged approach based on compliance, control, economy, foreign policy and the ongoing fight against terrorism. Belligerent and emotional rhetoric could do more harm than good, and saner heads (if there are any) need to prevail.