Karachi, June 29, 2018 (PPI-OT): Strategy: FATF “grey-listing” – Much ado about nothing
The Foreign Office has reportedly indicated that Pakistan has been added to the Financial Action Task Force (FATF) “Grey-list”, taking another round of international “arm-twisting” to implement reforms to its financial system. While there is no official FATF terminology segregating countries/jurisdictions under grey or black lists, Pakistan has never been identified as posing a severe risk to the international financial system (a.k.a. black list according to our understanding) since 2008. Going by news reports and assuming the most likely scenario of Pakistan’s inclusion in the watch list of monitored economies, we take cues from the 2008-14 period (public identification/monitoring status) where we believe it to be a non-event in terms of crucial flashpoints on the macro-front, namely: 1) Foreign ownership of equities, 2) economic assistance, 3) worker’s remittances and 3) foreign exchange reserves.
Reflective of the same, the benchmark index has recovered strongly, gaining 1.8% in the last two trading sessions. Post clarity regarding the FATF decision (expected by Saturday 30th), we fell investor’s risk-reward profile should align with more dominant economic (interest rate hikes, further devaluation prospects) and political (Accountability Court’s deadline to decide on the corruption references against Sharif family, 2018 National Polls) themes. In this backdrop, our preferred plays include MCB, HBL, PPL, LUCK, DGKC, NML, HASCOL and ASTL.
Pakistan continues to strengthen its AML/CFT framework: In the backdrop of a US foreign policy with narrowing space for Pakistan and post the first Plenary meeting of FATF in Feb 2018, news reports started highlighting that FATF has decided to place Pakistan back on its watch list for AML/CFT weaknesses where these news reports have been more disparaging with a tinge of exaggeration (particularly in regional and local outlets) which are baseless and not rooted in published reports or international organizations of repute (OECD, WB, IMF and Basel Institute of Governance).
However, parsing through all FATF publications CY18TD including documentation released by the FATF after its Feb 2018 meeting shows that Pakistan is not mentioned at all, particularly in a negative light or deficient category. That said, Pakistan has not taken the threat of being included in the watch list lightly as it has since scrambled to enforce actions against non-compliant agents, introduce various legislations, reforms and protocols to strengthen its AML/CFT framework.
International standards are not created equal: On a broader note, comparing Pakistan’s rankings on similar global international AML/CFT benchmarks by global agencies (Basel Institute, OECD), we find domestic regulations (post 2015) as being stringent enough to counter long-term structural deficiencies (grey financial flows, hawala/hundi, low financial inclusion and sub-par lending practices), placing Pakistan higher than regional and frontier market peers. Recent efforts by the GoP have been more proactive in market by Pakistan’s inclusion in the OECD’s Multilateral Convention on Mutual Administrative Assistance in Tax matters giving weight to GoP’s “big-ticket” measures (amnesty schemes, increasing declarations of foreign assets, raising the tax net).
Foreign participation largely immune: Removing outliers (early 2009 period post market freeze), foreign ownership of equities gradually increased during the review period ranging between a little over 6% in 2008 to over 8% by end-2014 (foreign ownership of total all share market cap). In absolute Pak Rupee /US$ terms, foreign ownership increased by 2x/22% during this period.
Economic Assistance to continue: During this period, disbursements by bilateral/multilateral agencies have averaged US$1.3bn/US$2.3bn annually (excluding the 3-year SDR4.4bn/US$6.2bn IMF program approved in Sep 2013). Even though disbursements remained weak during the 2011-2013 period, it is unlikely that Pakistan’s status under the FATF had a tangible bearing on economic assistance. That said, overall assistance (including capital raising through floating foreign bonds, commercial borrowing and the IMF) improved substantially during the 2008-2014 period.
Worker’s Remittances should endure: Despite higher KYC/AML/CFT protocols which should raise the cost of transactions, inward remittances increased by 3x over the review period, indicating that inclusion in the FATF grey list did not have a material impact on the cost of remittances.
Low risks to FX outflows: FX reserves during the 2008-2015 increased by ~2x to US$18.6bn at the end of FY15 from US$11.3bn in FY08. This also indicates that the government was able to keep an adequate level to support imports and other official outflows. Reserves also received a boost in FY13 after Pakistan signed a 3-year IMF program worth ~US$6.2bn.
Outlook: Risk of Pakistan becoming a sanctioned country which would include a reconsideration of all business relationships with Pakistan by global financial institutions (e.g. North Korea and Iran) is an extreme case and holds a very low probability, in our view. Additionally, parsing through global financial standard authorities rankings, Pakistan is given an AML index score of 6.64 (out of ten where lower is better) giving 4/46 rank in South Asia/Globally out of 6/146 countries by The Basel Institute for Governance.
Moreover, recent efforts by the GoP have been more proactive in addressing these deficiencies where Pakistan’s inclusion in the OECD’s Multilateral Convention on Mutual Administrative Assistance in Tax matters (news reports indicate information sharing with tax authorities to commence from Sept’18) gives weight to GoP’s “big-ticket” measures (amnesty schemes, increasing declarations of foreign assets, raising the tax net).