FATF: Complacency not an option

On the external front, there are two kinds of diverging sentiments growing - one is emanating from the IMF/WB where an improved macro picture is well received in DC. On the flipside, recently concluded FATF session in Paris is portraying a rather bleak picture on our compliance against 27 points action plan. Although, the two tales are mutually exclusive, one could have bearings on other.

If we are dragged to the FATF's so-called black list, the benefits of macro stabilization may get diluted. The much awaited portfolio investment in government papers, commonly known as hot money, may not come in big chunks. And if we continue to remain in grey list for another 1-3 years, the money may start flowing in, the sword will keep on hanging to not make us comfortable. The chances of remaining in grey list are high, and that will not let us get complacent.

It is an interesting situation. The vibes in DC during this writer's visit to IMF/WB annual meetings were encouraging; as various officials have on record and off record shown satisfaction on the macroeconomic stabilization efforts and have said in many words that performance is better than expectations. The excitement is on the opening up of international capital market flows to Pakistan which had dried down in 2007-8. The improved score on ease of doing business is a manifestation.

The story is shaping well on this front. The word of caution is however warranted on the compliance of AML/CFT which is closely monitored by FATF. The government officials were giving the impression that there was no problem in compliance, but successive FATF communications are showing a different picture. Even today, the government officials are confident on compliance of current action plan. The crux of the statement is that Pakistan has largely addressed only 5 out of 27 action plans and if substantial performance is not shown till Feb-20, the FATF will take action.

FATF never uses the word grey or black list in its official communique, but you can imply the status from wordings. If considerable actions are not taken, the warning is to move to black list. The question is what is the implication of black list? To understand its implication, we need a peek in the history. Pakistan in the past had remained part of high risk jurisdiction - commonly known as black list, in 2008 and the country was acknowledged on showing sufficient progress in 2010 and was upgraded to grey list. That was short-lived as we were moved to black list in 2012 before falling again in grey in 2014, and finally out of it in 2015.

The issue of being in black list was never taken seriously by local analysts' community in the past. Had there been any substantial implication, it would have been highlighted in 2008 or 2012. The question is why so much hue and cry today. Well, FATF is somehow political and some fear that political forces in powerful countries are against Pakistan.

This is the kind of wakeup call for us. The government has to get its act together. Having said that, if past is any guide, becoming part of black list again is not the end of the world. We have seen worse when sanctions were imposed in 1998 after nuclear tests.

But FATF language was not that strict and media hype was not there in the past. It is surely a sentiment dampener now, especially when the efforts are to reopen the global capital flows in Pakistan which were stopped in 2007-8 - kind of coincided with us getting into the black list. Though, there were other reasons for stoppage of foreign flows such as adverse macros and deteriorating energy and security position back then.

The economic recovery today is hinged upon accumulation of foreign exchange reserves - getting hot money and issuing Euro and Sukuk bonds and to be followed by FDI and surge in exports and remittances. The quantum of flows SBP and MoF are eyeing upon is unprecedented in Pakistan and that would somehow be linked to FATF observations.

The question is how would FATF react in upcoming meetings. If we do not show any action, the country can be dragged to black list. However, if we substantially work on actions required, the chances of being in grey list will remain till Oct-20 and then another action plan - though less stringent, for APG group may resurface, and that will take another 1-3 years of scrutiny. This may imply that Pakistan could remain in grey list till 2022.

Now club this with portfolio investment (hot money), if we get $4-5 billion of this money in the next 12-18 months, the stickiness of money will depend upon our FATF compliance. The sword will stay out and the risk will stay high - there is no way government can get complacent.