Pakistan: Painful Path to Recovery

I am pleased to share with my readers a report by IMS Research. You may not agree with all the points, but it makes a good basis for an ‘Academic Discussion’. Pakistan needs a ‘home grown plan’ to overcome its inadequacies.

According to the brokerage house, FY23 Federal Budget saw the government attempt to widen the tax net, but the brunt eventually fell on the existing narrow tax base in the shape of higher corporate and personal taxes.

The benchmark index of Pakistan Stock Exchange (PSX) shed 3.6% (6.6% in US$), with turnover thinning out even further.

Foreign institutions and local insurance companies remained aggressive sellers. Pakistan is inching closer to the IMF program, but investor confidence remains low due to a sticky current account deficit, and ugly inflation prints around the corner.

That said, we believe risks are largely in the price, with default likely be avoided as the IMF agreement draws near. 

Inching closer to the IMF program

Pakistan has significantly reduced energy subsidies and sharply raised direct taxes. The 7th and 8th IMF reviews are reportedly being combined and Pakistan could see US$2 billion program resumption.

The FY23 Budget attempted to widen the tax net on real estate and retailers, but ultimately could not avoid further burdening the narrow tax base.

Most large corporates will now face additional 10% tax in in 2022, which reduces to a permanent +4% in subsequent years.

Improved fiscal discipline reduces the load on the monetary side but the State Bank of Pakistan (SBP) could yet raise rates on July 07, 2022 monetary policy, with the next inflation print expected north of 18% and international oil prices failing to come off. We expect an increase of 100bps, which will take the Policy Rate to 14.75%. This may be the last rate hike of the cycle though.    

Improving relations with others

Chinese commercial banks have recently disbursed loans of US$2.3 billion, negotiations are underway with Saudi Arabia to enhance the deferred oil payment facility, and UAE is reportedly interested in acquiring stakes in state-owned entities listed at the PSX.

Progress includes the appointment of a new US Ambassador to Pakistan for the first time since 2018, the visit of the German Foreign Minister, and a positive outcome in the recent FATF plenary with exit from the grey list looking likely subject to on-site verification.

A European Union mission also reached Pakistan to assess GSP+ compliance, and the broader improvement in relations with the West should help Pakistan’s case in our view.

The brokerage house assigns little probability to Pakistan procuring oil from Russia, even though local refineries have been asked to assess suitability, with political considerations likely to win out over economic ones.

Key risks

The government is digging in, going by its increasing willingness to take tough decisions and secure the IMF program. While coalition partners such as MQM have expressed discontent at the results of local body elections in Sindh, and PML-N rule is vulnerable in Punjab, it is difficult to envisage the coalition fracturing at this stage.

Imran Khan is a lot quieter but remains a uniting factor for the ruling parties, no matter their disparate nature.

For the economy, stabilization measures are underway and Moody’s decision to downgrade Pakistan’s outlook to Negative has not been matched by the other major credit rating agencies.

Corporate profits will hurt in the near-term, owing to the 10% super tax for 2022, but the impact on recurring profitability is modest. On market cap to GDP, Pakistan is cheaper than its Covid low and nearly as cheap as its trough during the global financial crisis.

 

Is FATAF being used by global powers to pressurize Pakistan?

The Financial Action Task Force (FATF) announced on Friday that Pakistan had largely complied with 26 of the 27 items on the action plan agreed to in June 2018, but the country will continue to remain on the ‘increased monitoring list’ even after it addresses the sole remaining item.

The global financial watchdog slapped a new list of six action items on Pakistan which it said were identified by its regional partner, the Asia Pacific Group (APG), in 2019.

FATA President Dr. Marcus Pleyer said that for Pakistan to be delisted, it will have to largely address all items on the new action plan in addition to the only remaining item on the original plan.

The FATF decision to keep Pakistan on its grey list, in spite of this country’s substantial progress on the original action plan, has disappointed many. The over whelming perception is that FATF is being used by global powers as a political tool to put pressure on countries like Pakistan.

There are examples where the global watchdog delisted other jurisdictions under its enhanced monitoring even though they had done far less than Islamabad to tighten their controls over flows of illicit money.

The FATF President has said clearly that the country will remain on the list as long as it does not address the single remaining action (related to the investigation and prosecution of senior leaders and commanders of UN-designated terror groups) as well as the items on a parallel action plan handed out by the watchdog’s regional partner, the Asia Pacific Group, in 2019.

A number of senior journalists, politicians and activists expressed surprise on the FATF decision and also raised doubts on the integrity of the financial watchdog.

Senior journalist Mubashir Zaidi questioned what the point of keeping Pakistan on the ‘grey list’ was when it had already implemented 26 of the 27 action plan items given by the FATF.

Jamaat-i-Islami Central Vice President Mian Aslam sniffed a global conspiracy behind the FATF decision and asked the Pakistan to not surrender its freedom.

Analyst Jan Achakzai also condemned the decision of the FATF, calling the body a “tool weaponized against Pakistan”.

Senior journalist Zarrar Khuhro also cast doubt on the FATF’s integrity, saying it was "a tool of geopolitical pressure".

The official Twitter account of former President Pervez Musharraf said FATF was being used to blackmail Pakistan.

Another user said the FATF’s credibility was on the line for ignoring Pakistan’s commitment and compliance with the task force targets.

Pakistan has been on the FATF’s grey list for deficiencies in its counter-terror financing and anti-money laundering regimes since June 2018.

Until the last assessment, Pakistan was found deficient in acting against organizations allegedly linked to terror groups listed by the UN Security Council, prosecuting and convicting banned individuals and tackling smuggling of narcotics and precious stones.

Pakistan’s placement in grey list by FATF is nothing but arm twisting

Reportedly Pakistan’s name has been added to the Financial Action Task Force (FATF) "Grey-list". The overwhelming reaction to this move is being termed "arm-twisting" to add to the woes of the country already suffering from serious balance of payment crisis. A point worth exploring is that there is no official FATF terminology segregating countries into grey or black lists, Pakistan has never been identified as a potential risk to the international financial system, even after 9/11 and often being accused of supporting the various militant groups.

I am being inclined to refer to a report by Pakistan’s leading brokerage house, AKD Securities. The brokerage house has taken a cues from the    2008-14 period (public identification/monitoring status), a termed the report a non-event in terms of crucial flashpoints on the macro-front, namely: 1) Foreign ownership of equities, 2) economic assistance, 3) workers’ remittances and 3) foreign exchange reserves. Reflective of the same, the benchmark index has recovered strongly in the recent past. Post clarity regarding the FATF decision (expected by Saturday 30th June). Investor’s risk-reward profile would soon align with more dominant economic (interest rate hikes, further devaluation prospects) and ongoing electioneering.

In the backdrop of the 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.  The perception in Pakistan is that such news reports have been more disparaging with a tinge of exaggeration (particularly in regional and local outlets) which are not only baseless and not rooted in published reports of 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 February 2018 meeting show 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 seriously as it has since then taking action against non-complaints, introduce various legislations, reforms and protocols to strengthen its AML/CFT framework.

One of the immediate response is that 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), brokerage house finds domestic regulations (post 2015) stringent enough to counter long-term structural deficiencies (grey financial flows, hawala/hundi, low financial inclusion and sub-par lending practices). The 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 measures (amnesty schemes, increasing declarations of foreign assets, raising the tax net).

Despite Pakistan’s placement in "Grey-list", foreign participation is largely expected to remain 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. In absolute Pak Rupee /US$ terms, foreign ownership increased considerably during this period.

Economic Assistance is likely to continue keeping in view the past practices. Over the years, disbursements by bilateral/multilateral agencies have averaged US$1.3 billion to US$2.3 billion annually (excluding the 3-year SDR4.4bn/US$6.2bn IMF program approved in September 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 mobilization through floating foreign bonds, commercial borrowing and the IMF) improved substantially during the 2008-2014 period.          .

Worker's Remittances continue to play an important role in containing current account deficit, despite ever increasing imports and paltry exports. Stringent KYC/AML/CFT protocols have certainly increased the cost of transactions, inward remittances increased substantially over the years, indicating that inclusion in the FATF grey list may not have a material impact on the cost of inward remittances.

Pakistan’s foreign exchange reserves increased to US$18.6 billion at the end of FY15 from US$11.3 billion in FY08. This also indicates that the Government of Pakistan (GoP) 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$6.2 billion.   

Risk of Pakistan facing economic sanctions would include a reconsideration of all business relationships with Pakistan by global financial institutions and any attempt to put Pakistan along with North Korea and Iran is totally absurd. 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 September'18) gives weight to GoP's "big-ticket".

Having a strong faith in the robustness of Pakistan’s financial system and the ongoing efforts to improve it the country’s placement in "Grey-list" is nothing but "arm-twisting". It is more than obvious that the US policies towards Afghanistan, Syria, Iran, China, EU countries and NAFTA members are aimed at establishing its hegemony around the world.