At Profit, we have normally tried to stay away from politics as much as possible in our coverage of Pakistan’s economy. This is not as the result of some misguided belief that politics does not have a profound impact on business and the economy, but rather because we feel that there are already enough articles on Pakistan’s economy, published in local and foreign press that have the obligatory paragraphs about nuclear weapons, terrorism, and religious extremism. We would much rather talk to you about the “economy” part of Pakistan’s political economy.

But sometimes, the “political” is inescapable.

It is not simply the fact that Pakistan will get placed on the multilateral Financial Action Task Force’s (FATF) so-called “grey list” in June of this year, an action that is by its very definition at the intersection of the otherwise divergent worlds of counterterrorism and global finance. It is the fact that Pakistan’s civil servants and diplomats walked into a strategic blunder of epic proportions by failing to read the extent to which the tide of global power politics has turned against the country.

Because make no mistake: this is much more than about arcane rules and procedures at banks about anti-money laundering (AML) and countering the financing of terrorism (CFT). This is about the fragile foundations of Pakistan’s macroeconomic stability and the extent to which they are still dependent on the largesse of both Washington and Beijing. And if Islamabad does not swiftly and meaningfully change its behaviour, the government of Pakistan will begin to notice a sharp difference in tone and attitude during their next few conversations with the International Monetary Fund (IMF), especially later this year.

The technical details:

The FATF is a multilateral organisation originally created in 1987 by the G7 group of large industrialised nations to counter money laundering. After the terrorist attacks in the United States on September 11, 2001, the organisation added countering terrorism financing in its mandate. The FATF is headquartered in Paris.

The FATF technically has no legal powers and only consists of voluntary guidelines and cooperation agreements on AML/CFT regulations for banks and other financial institutions. In reality, however, its guidelines are being taken increasingly more seriously and have significant repercussions for a failure to comply.

At the apex of the organisational structure of the FATF is a group of countries that are directly members of the FATF, a group that includes the United States, most of Western Europe, China, India, Brazil, Turkey, and a few other countries. Other countries around the world are members of regional organisations that fall under that group. Pakistan falls into this second category of countries, which are not part of the policymaking process of the FATF.

The lists of jurisdictions ranked by their level of AML/CFT risk are maintained by the organisation’s apex body, which for convenience many journalists have taken to talking about as the “grey list” and the “black list”. The actual name of the grey list is “jurisdictions with strategic AML/CFT deficiencies for which they have developed an action plan with the FATF”. The name of the blacklist is “jurisdictions with strategic anti-money laundering and countering the financing of terrorism (AML/CFT) deficiencies for which a call for action applies”. You can see why people prefer grey list and not the blacklist.

What does all of that jargon mean in layman’s terms? It is easiest to illustrate this with an example.

Let us say that you are Gul Ahmed Textiles. You own a factory that makes readymade garments, in which you have invested millions of dollars, and you rely on export orders from the United States and the European Union for your business. When you meet an American buyer from let’s say Macy’s at Heimtextil (a trade show in Europe), they do not know you and you do not know them, but there is a potentially profitable relationship to be had, if only the trust barrier could be resolved.

That is where the global banking system comes in. Gul Ahmed will go to a bank in Karachi and say they want a letter of credit to be able to export their goods to the United States. Gul Ahmed’s bank – let’s say Faysal Bank – will then contact their corresponding bank in New York, say, JPMorgan Chase. JPMorgan Chase will then connect with the Macys’ bank in Chicago (US Bank, for example) and serve as an intermediary to ensure that the transaction takes place.

Faysal Bank will procure evidence from Gul Ahmed that they have put the goods on a ship in Karachi, bound for the port of New York and New Jersey. The US Bank, meanwhile, will hold money in escrow from Macy’s and will inform JPMorgan Chase that it has done so. JPMorgan will then inform Faysal Bank that the money is in the bank and ready to be wired to Gul Ahmed as soon as the ship safely reaches New Jersey.

This is of course a highly simplified version of what happens, but in a nutshell, that process is the lifeblood of global commerce.

In between, however, there are several steps that take place. Before deciding that it will be the corresponding bank for Faysal Bank in the United States, for example, JPMorgan Chase will have to undertake due diligence on just how trustworthy an institution Faysal Bank is. Among the factors they will look at are the AML and CFT compliance procedures that are in place at the bank.

Now, obviously, if every corresponding bank had to physically inspect and examine every other corresponding bank’s branches and audit them for AML and CFT procedures, nobody would ever have enough time to do business with anybody else, so in reality, they rely on measures of risk from third parties, one of the most important and trusted of which is the FATF.

The consequences of the lists:

So if the FATF says “banks in these countries do not have good AML/CFT controls”, that puts banks of other countries in a bind. Their reaction to how to proceed next is dependent on what the FATF says next. If the FATF says “they do not have adequate controls but are trying to put them in place” (the grey list), banks in other countries have a little more leeway.

“If a country is on the grey list, that just means more scrutiny on every single transaction that takes place between banks in that country and the United States, for example,” said one former corporate banker who worked as the lead corresponding banker for South Asian banks at HSBC in New York, and declined to be identified.

That extra legwork that the bankers at JPMorgan would have to do for every transaction, however, may mean one of two things: either JPMorgan will charge Faysal Bank more for each transaction, or they will stop doing business with Faysal Bank altogether.

In the first case, that cost will have to be borne by someone, and Faysal Bank will no doubt pass it on to Gul Ahmed, which will raise Gul Ahmed’s cost of doing business at a time when Pakistani exporters are already complaining that they face higher costs compared to competitors in Bangladesh and Vietnam.

A worse thing that JPMorgan could decide to do is to say that having to bear the burden of the extra cost of doing due diligence on every single transaction from Faysal Bank is simply not worth it (New York salaries do not come cheap, after all) and cancel the correspondent banking relationship with Faysal Bank altogether.

Now, of course, one bank cancelling their corresponding relationship with Faysal Bank is not the end of the world and there are plenty of other banks they could turn to. But how much do you think the other banks will charge Faysal for their services, knowing that JPMorgan fired Faysal as a client.

“Generally speaking, a lot of US banks decide that it is simply not worth the hassle to have those kinds of relationships, especially from countries with smaller economies and transaction sizes,” said the former HSBC banker.

If, however, the FATF says that “banks in these countries do not have adequate controls in place and they are not even trying to do anything about it”, a country gets placed on the blacklist and that causes all sorts of trouble.

“I have no idea what happens to those countries, because I have never seen a transaction from them,” said the former HSBC banker.

There are even mechanisms in place to trace the origins of transactions so that you cannot simply evade the rules by going through a third country, though as the fines on HSBC and Standard Chartered Bank in New York in 2012 illustrated, there are clearly ways to get around those, especially if the banks get sloppy. However, those fines also motivated previously lax banks to tighten their AML/CFT monitoring.

One particularly unnerving impact of being on the blacklist: it gets harder for expatriates to remit money, and individuals of Pakistani origin in other countries, who send money to their families back home, may face more personal scrutiny for having a regular stream of transactions with a country on the blacklist. Some of them may decide to reduce the frequency with which they send money, or start sending it through illicit channels, both of which would have a negative impact on the country’s remittance numbers.

So, what happens now?

Contrary to Planning Minister Ahsan Iqbal’s tweet, Pakistan has never actually been on the blacklist, though it has been on and off the grey list since at least 2008, and most recently came off the grey list in February 2015. This fact has led many Pakistani commentators to say out loud some version of an argument best articulated by former federal finance secretary Waqar Masood, in an opinion column in Business Recorder: “This is not the best thing that has happened to Pakistan, but this is also not a calamity fallen on the country.”

Essentially, the argument goes, if we have faced it before without the country’s economy collapsing, we can face it again. In one of his astonishingly few public statements on the matter, Miftah Ismail, advisor to the prime minister on finance and de facto finance minister, said in an interview with Capital TV: “The greylisting carries with it no sanctions, so it will not make a difference… in the day-to-day life of a Pakistani industrialist or shopkeeper, there will be no difference.”

Ismail, who himself owns a company that exports goods (Ismail Industries, a confectionary manufacturer), did acknowledge that there is a reputational risk associated with a grey listing. “If we go out into the capital markets to raise [sovereign] bonds, we obviously do not want to be grey listed,” he said in the same interview. “It is an embarrassment that we will have to face and a question we will have to answer from investors.”

Miftah Ismail’s confidence in stating that this decision will have no impact comes from his assertion that there is absolutely no possibility of Pakistan ever being placed on the blacklist. While that level of confidence might perhaps not be warranted, he is certainly correct in his assertion that most serious consequences of getting on the FATF’s bad side start at the blacklist level, not at the grey list level and that the probability of Pakistan being placed on the blacklist is relatively low.

The problem with this argument, however, is that it is too narrowly focused on the specific consequences of the FATF grey list itself, and – to the horror of Pakistanis who have been paying attention – not remotely concerned with the machtpolitik machinations behind it.

The complete blindsiding of the Foreign Office:

It is by now cliché to say that Pakistan’s foreign policy is overly obsessed with India. Yet it is nonetheless important to point out the specific ways in which that hurts Pakistan. Even now, for instance, one of the few public statements by Foreign Minister Khawaja Muhammad Asif about the FATF debacle was to blame Indian diplomacy at the FATF meeting in Paris for having been responsible for Pakistan’s placement on the grey list.

The problem with the stalker-like obsession with India, however, is that the Pakistani foreign policy establishment – both civilian and military – miss when key variables from other parts of the world change around them. They have no way of understanding, let alone appropriately reacting, to changes around the world.

Yes, it is true that India made it a point to lobby for Pakistan’s placement on the grey list, but India has lobbied many times before. A good strategic thinker would ask: what changed? A Pakistani military officer or diplomat would simply assert: “India finally succeeded.”

What changed is that the United States now defines its strategic interests in South Asia differently than it has since 2001, a change that has been accelerated by the advent of a new administration in Washington. What changed is China finally getting more assertive about including Pakistan’s alleged  jihadi proxies among the list of terrorists it would like to wipe off the face of the earth. Islamabad may believe in “good Taliban, bad Taliban” but Beijing never has, and – under President Xi Jinping – is not willing to ignore it anymore.

In the case of the United States, it has been clear since the US began its drawdown of troops in 2014 that the focus of US policy in the Afghanistan-Pakistan region was inverting. In 2001, the policy started off as the United States thinking of Afghanistan as the strategic threat and Pakistan as the strategic ally. By the second term of US President Barack Obama, however, it was the opposite: Afghanistan started becoming more of a strategic partner, if not outright ally, and one that enabled the US to monitor the strategic threat emanating from Pakistan.

This change is being accelerated by the Trump Administration, which has a more overtly hostile attitude towards Pakistan, and one that is less likely to be tempered by the US State Department, which has been hollowed out, and many of the policy experts who could have pushed a dissenting view have been pushed out. There have always been anti-Pakistan hawks in the US national security establishment, and their voices grew louder after May 2, 2011 – when Osama bin Laden was found hiding in Abbottabad. Now, however, they are completely ascendant and the pro-Pakistan doves that the Pakistani national security establishment is used to dealing with are gone, never to be replaced again.

In the case of China, one needs to go all the way back to April 2000 to understand Beijing’s attitude towards Pakistan. In that month, the anti-Taliban Northern Alliance had caught some Taliban fighters and gleefully paraded them in front of the cameras of the international media. Among those were several foreign fighters, including some men from the East Turkestan Islamic Movement (ETIM), a rebel group seeking the secession of China’s Muslim-majority western province of Xinjiang.

In that moment, China very politely issued what was effectively a veiled threat to Pakistan: rein in your proxies’ support of the Taliban, or else face the consequences. It was left implied that the military option was not being ruled out. Indeed, soon afterwards (June 2001), China announced the creation of the Shanghai Cooperation Organisation, which was meant to be a collaboration between China, Russia and the Central Asian republics against terrorists who had found refuge in the then-Taliban controlled Afghanistan. Pakistan’s applications for membership were pointedly refused for decades, and India’s application for observer status was accepted long before Pakistan’s.

Islamabad took away from this the lesson that, China cannot be directly threatened and in turn could even rely on Chinese support to prevent United Nations sanctions against them. This may have been true in earlier eras, but even under former President Jiang Zemin, it was clear that China wanted Pakistan to actively help them crush the militant movement in Xinjiang.

Indeed, former President Pervez Musharraf was asked by China to give a speech in Urumqi, the capital of Xinjiang, to the Muslim community there, the theme of which was to discourage an armed uprising against Beijing. Musharraf gave the speech in Turkish, a language he is fluent in, and one that bears linguistic similarities to, and is intelligible to the native speakers of, Uighur, the language spoken by Muslims in Xinjiang.

What does all of this have to do with the FATF, you might ask.

Everything.

The coming trouble with the IMF:

Bear in mind that the reason Pakistan was placed on the grey list due to its failure to take sufficient steps to curb terrorist financing, not specifically anti-money laundering. No international criminal gangs use Pakistani banks to launder their money, certainly not the kind that the rest of the world would care about. But funds for terrorism do flow through Pakistani banks.

Here is why this is relevant: the United States is sufficiently willing to use international pressure on Pakistan against terrorism financing that it was willing to call a vote a second time after Foreign Minister Khawaja Asif prematurely tweeted out that Pakistan had dodged a bullet at the FATF after the first vote. It strong-armed Saudi Arabia and, crucially, convinced China to back down from supporting Pakistan.

What makes Islamabad think that Washington will not be willing to use the IMF – an organisation literally headquartered in Washington DC, less than half a mile from the White House – to do its bidding to also turn up the pressure on Pakistan? And if China was willing to go along with a US vote against Pakistan at the FATF, why would it resist US efforts at the IMF, where it has less influence?

Here is the reality nobody in Islamabad wants to hear: the United States has completely run out of patience with Pakistan and is slowly bringing out all its tools to start piling on the pressure on the latter until it cooperates. This is not the United States doing what India wants it to do. This is America paying back the country where the murderer of 3,000 Americans was living – the perpetrator of the worst foreign attack on American soil – for a full decade in a house that cost over $1 million. Are we seriously deluded enough to think that the United States does not have enough reasons to hate Pakistan on its own that it needs India’s cajoling to get it to act against us?

And now that Pakistan is moving ever more firmly into China’s sphere of influence, Beijing must be thinking to itself: “must we tolerate the kind of two-faced behaviour that Islamabad has shown the Americans? Absolutely not!”

China did not abstain from the vote because the Americans persuaded it to, or, as the Chinese embassy stated, because it would have been diplomatically unwise to go against a winning motion. They abstained because they want to punish Pakistan, and they didn’t want their fingerprints all over it. China and America are teaming up on Pakistan and playing good-cop, bad-cop.

It is the worst kept secret in Islamabad that the government of Pakistan is already in talks with the IMF for another bailout later this year, most likely after the elections. Let us not forget that the last two bailouts – in 2008 and 2013 – were approved on very soft terms by the IMF board because the White House pressured them to go easy on Pakistan.

How inclined does anyone think President Trump – or US Secretary of State Rex Tillerson – are to help Pakistan out with the IMF? And in the absence of that help, what kind of terms will the IMF be willing to extract?

Here is the worst-case scenario: the civil servants from the finance ministry go into IMF meetings thinking they know exactly what to expect. The IMF likes to play tough, but ultimately concedes to targets that Pakistan says it can achieve, which tend to not be very difficult targets at all. And even when the government misses them, US influence typically means that the IMF is often willing to let those failed targets slide. But Pakistani bureaucrats do not see the US pulling the strings in the background. They think it is their own brilliance and negotiating skills that won them the day.

That illusion may well come crashing down very soon. And when that happens, Pakistan will find itself needing a lot of cash very fast. And lest anyone in Islamabad think China-Pakistan Economic Corridor (CPEC) money will come to the rescue, Beijing made it abundantly clear in both 2008 and 2013 that it is in no mood to help Pakistan out of the mess created by its own inability to pay for its own bills. CPEC money will fund the infrastructure projects that China wants, and nothing else.

We have to face the reality that, by accepting CPEC, Pakistan has mortgaged its economic independence and future over to China, and Beijing is a much harsher master than Washington, and our old overlords in the United States are in no mood to bail us out of our mistakes.

The government may yet manage to pull through with an IMF package that works for them later this year. But the Ponzi scheme that is the government of Pakistan is rapidly running out of tricks to keep itself afloat. Heaven help us when that time inevitably comes. Lord knows we have made enough enemies who will gleefully laugh at us and kick us on the way down.

 

10 COMMENTS

  1. Brilliant article presenting eye opening realities that very few people in Pakistan know or are willing to even hear.

    The situation calls for a complete change in internal and foreign policies however rest assured all this will be ignored and the only priority would be politics, and cries of victimization.

  2. Excellent article…. Makes us Pakistanis realize the harsh realities that we don’t want to face stubbornly.
    The only question arises ‘What are these officials doing for our country and what we as Pakistanis are doing…??’

  3. Scaremongering is the objective of this article. We Pakistanis only want to downplay Pakistan wherever we are able to. FATF is a political organisation and is used politically to pressurise countries in submitting to the whims of powerful countries. Pakistan will do what it takes to manage this situation. We just have to go on with our lives and stop being so concerned about it as we are also needed by these powerful nations in their effort to stop terrorism and stability in the region. We have our own interests to protect against opposing objectives of our enemies. In the end things always work out and have worked out. The media should not create unecesaary fear and chaos to achieve their own sinister objectives. When the government of the day is confident to.sort this issue satisfactorily we should also believe our government officials instead of countering with our own set of arguments against everything that the government does or says.

  4. International politics & affairs must be dealt with extreme caution. It requires an experienced, well educated team to understand full spectrum of challenges confronting Pakistan ??. There is a feeling, all is not going well. There is no time to be complacent or naive. Pakistan must think three steps ahead, otherwise we will rue this day.

  5. Several points. 1) Role of China is very suspicious, in the 1st vote, 2nd vote and statements to Pakistan afterwards. They obviously take most people for fools 2) If Pakistan is innocent, it should refuse to take any action. China, Turkey and Saudis should be giving it support 3) If Pakistan thinks FAFT process was political, then it will be tough to change minds. These guys will make sure Pakistan remains in FAFT for a long time. Reality is that Pakistan has been allowed to morph into its alter-ego, which is extremely ugly and rejected everyone barring a few. Article says as much. FAFT is only to placate US and NATO. Other countries should not be satisfied.

  6. Overall the article gives good insight into how the international trade works and theoretically what ‘can’ happen if Pakistan goes into blacklist, however on the other hand the writer seems clearly more impressed and supports the notion of American/Western media about Pakistan’s ‘double face’ in dealing with the counter terrorism agenda. Who defines terrorism and what is terrorism?? Simply put, the one who is powerful in this world defines this… not you me or our government.. and they define and twist it according to their preferences. So dear avoid to harp their tune or tone as it changes with the wind. Indeed Pakistan has made some blunders but squarely blaming Pakistan for all the ills without holistically taking into the complex circumstances surrounding within Pakistan and this region shows you are reading their side of the media stories far too much.

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