After being deferred twice due to Covid-19, the Financial Action Task Force (FATF) plenary meeting is now scheduled for 21-23 October 2020. Leading up to this plenary meet one of its constituent bodies, the Asia Pacific Group, met to review the pending cases, like that of Pakistan, pertaining to its jurisdiction. As if on cue, there was news of Pakistan’s vigorous efforts at passing new laws in compliance of its Anti-Money Laundering/ Countering Financing of Terror (AML/CFT) obligations. Parallelly, there is increased speculation about whether Pakistan would be “black listed” or if it would remain on the “grey list” or manage to revert to the so-called “white list”.
This sequence of events has been continuing for nearly two years now, since Pakistan regressed to its “grey list” position in June 2018. As Pakistan continues to fail to meet the successive deadlines set by the FATF, the threats from the organisation are becoming shriller and, in response, so are protestations from Islamabad.
Is there a political cost?
Figure 1 below shows that Pakistan has a long-term trend of current account deficit leading to constant pressure on balance of payments. But contrary to expectation, during the period 2012-15, its current account position was only a shade better as compared to its historical average and showed some degree of stability.
Figure 1: Current account trend of Pakistan
Figure 2 below shows that the debt maturity period had no particular trend from 2012-15 but started decreasing after 2015. It shows that Pakistan’s quality of debt deteriorated and became more short term post 2015, which is counter-intuitive. Similarly, the interest rate has been rising after 2015 after moving up and down from 2012-15. The grant component of foreign loans also decreased since 2015. This indicates that Pakistan is relying more on short-term high-interest loans, which are riskier.
Figure 2: Debt maturity in year, average interest rate on debt, element of grant
Similarly, as per Figure 3 below, Pakistan’s debt service to exports position and reserves to external debt stock position improved between 2013-15 as it had decreasing debt servicing obligations to exports and increasing forex reserves cover for that debt. After 2015, this started deteriorating. The percentage of concessional debt, which is generally preferred as it has low interest rates, has been going down since 2013.
Figure 3: Quality of debt servicing indicators
As Figure 4 below shows, Pakistan’s interest payment to exports ratio and interest payment to Gross National Income (GNI) ratio improved till 2014 and has been deteriorating since then. For part of the period when Pakistan was grey listed, its debt sustainability as measured by interest outgo was actually improving; since 2014 this has been going down.
Figure 4: Sustainability of interest payments
The above figures show that for the large part of 2012-15, Pakistan’s macroeconomic parameters interest rate, quality of debt and its sustainability, governing its external sector were largely stable or had a secular trend. They also reveal that these parameters had started deteriorating much before June 2018. This shows that grey listing had a minimal impact on economic performance and it is largely ineffective in imposing economic costs on the target jurisdiction. This finding further corroborates the analysis as to why grey listing by the FATF remains largely ineffective in bringing any real change in Pakistan’s behaviour.
A related question which needs answering is: if grey listing is really ineffective, then why is Pakistan making any effort after all at passing laws or making perfunctory changes? And what accounts for the media buzz inside Pakistan regarding grey listing this time?
The answer may lie in the fact that the country’s economic parameters have been deteriorating for some time and its economy is currently very vulnerable. On a more ominous note, Figure 5 shows that starting from mid-2019, Pakistan is required to service huge amount of external debt in dollars. These include maturing of old-time debts now as well as short term debts incurred lately. This makes Pakistan’s economy particularly vulnerable over the next few years and any likelihood of progression to black listing will be particularly problematic. This timeline also underlines the fact it is not the grey listing per se but Pakistan’s persisting economic weakness coupled with the threat of possible black listing, which is worrying its government.
Figure 5: Future debt servicing liabilities of Pakistan
This is not to say that grey listing may not have any impact on Pakistan’s economy. The idea of “naming and shaming” by FATF may have a cost. As FATF works with the International Monetary Fund (IMF) and the World Bank as well, the IMF has also been putting conditionalities linked to FATF-related compliances before giving bail-out packages. However, grey listing doesn’t seem to be the main cause of Pakistan’s economic woes though it may be exacerbating an already present malady.
Another related question is: what are the costs of black listing by the FATF? Some literature indicates the not-so-serious monetary effect of black listing and also calls for even tougher a FATF regime for non-cooperative jurisdictions. By and large, however, there is a larger consensus that black listing leads to severe consequences for the target economy. Currently, only Iran and North Korea are placed on the FATF black list, which may indicate its seriousness.
Weakness in FATF regime: A case for different shades of grey
It appears that as far as severity of consequences is concerned, the black list is a quantum jump over the grey list. It is a serious escalation with very high costs. For an already weak economy like Pakistan, it could even lead to large scale turmoil and default. Akin to the nuclear option, this leads to a very high threshold for black listing.
This structural weakness in the FATF is also reflected in the somewhat brittle or simplistic categorisation structure of different jurisdictions into so-called white, grey and black. This straightjacketed view may not permit a flexible and graduated response. The reason is a very substantial jump in international commitment when putting some country on to the black list. Madeleine Albright, former US Secretary of State, once called Pakistan an “international migraine”. To put it bluntly, the international community may be trying to avoid turning a migraine into a brain tumour by black listing. But Pakistan is also aware of this dilemma, that the only option available to the FATF after the grey list is one it may not be willing to take. So in place of gaining leverage the FATF is actually losing it through this structure. This high threshold provides considerable space for manipulation and manoeuvre to a country like Pakistan. Another deficiency already considered is the natural difficulty faced by most organisations in dealing with hybrid regimes like Pakistan, the FATF being no exception.
Analysing the problem faced by the FATF and risk associated with all the available options, some scholars have tried to take the middle ground and suggest keeping Pakistan in the grey list only. Their basic argument is that Pakistan has definitely not done enough to move from the grey to the white list. Black listing may lead to it being a pariah and this may have severe consequences.
The drawback with this approach is that, first, it does not solve the problem and, second, it undermines the effectiveness of FATF as an institution. As timelines are being missed, news of geopolitical considerations playing an increasing role in FATF meetings keep coming out. News of voting based on geopolitical consideration undermines the consensus-based technical nature of the FATF deliberations. Thus, status quo may not be the solution.
A possible option worth exploring may be to generate policy options for graduated but firm response while moving between the grey and black lists, that is, there may be a scope for darker shades of grey. Though the FATF has adopted a risk-based approach, the grey list shows countries as diverse as Mauritius, Pakistan, Syria, Jamaica, Iceland and Barbados being clubbed together. They all may have some strategic deficiencies vis-à-vis the FATF standard, but, qualitatively, do they pose the same degree of risk? For example, the FATF targets weapons of mass destruction (WMD) proliferation, corruption, money laundering and terror finance. There is, however, a difference in risk between political corruption leading to money laundering and nuclear weapon proliferation or financing terror. The present system lumps all such jurisdictions with different qualitative risks in one grey list basket. Differentiating may help the FATF better assess the risk posed by Iceland or Jamaica as opposed to, say, Pakistan.
There may be those jurisdictions in the grey list that have the will to implement the FATF Recommendations but may lack the necessary technical or administrative capacity. At the other extreme, jurisdictions may have the capacity but would be unwilling in intent. A necessary categorisation that captures this crucial aspect may be made in the grey list. Countries willing to act but lacking capacity should be given technical support. But countries like Pakistan, which largely lack the will to implement, may be put in the darker shade of grey and sanctioned more severely. This should help in better targeting.
After categorising the severity of the source of risk followed by whether the country has the necessary capacity/will, or not, a graduated response may be designed in consultation with different constituents like credit rating agencies, banks, IMF and World Bank, etc. This approach may provide more flexibility in tackling jurisdictions that may be undermining the FATF by repeatedly giving assurances but not acting on them in any substantial way.
The time may be right for such a discussion because the FATF is already in the process of undertaking a strategic review of its methodology of assessment by 2021. It is committed to making the FATF more effective by strengthening risk-based elements of the assessment process.
Going by its record of policy innovation and flexibility, it is safe to assume that the FATF will again rise up to the challenge.
https://theprint.in/opinion/pakistan-is-hoodwinking-the-world-on-terror-funding-fatf-grey-list-needs-to-go-darker/522490/
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