Potential blacklisting by FATF may freeze capital inflows, lower investment in Pakistan: IMF

"The IMF programme continues to face significant risks, both from domestic and external factors."

ISLAMABAD (Dunya News) – The International Monetary Fund (IMF) – in its staff-level report released on Monday over the First Review of Pakistan’s Extended Fund Facility – stated that “Pakistan’s program is on track and has started to bear fruit” but alarmed about risks which remain elevated, and identified “strong ownership and steadfast reform implementation” as “critical to entrench macroeconomic stability and support robust and balanced growth.”

However, the global moneylender expressed concerns that “Pakistan remains at risk of being placed on the Paris-based Financial Action Task Force (FATF) blacklist that could have implications for capital inflows to the country.”

“A potential blacklisting by FATF could result in a freeze of capital flows and lower investment to Pakistan,” it stated. 

Addressing Remaining AML/CFT Deficiencies

“Despite the significant progress already achieved to date, in consultation with staff, the end-October 2019 SB related to actions on AML/CFT to help exit the FATF “gray list” had to be reset to end-June 2020 because of implementation constraints (MEFP 12). The high-level, inter-agency National Coordination Committee, dedicated to the purpose will continue to work closely with the FATF secretariat to complete the action plan, drawing on technical assistance from a number of capacity development providers, including the IMF. As a part of this process, the authorities intend to make significant and sustained progress across the full range of actions by the next plenary session of FATF (in February 2020) and continue to improve AML/CFT measures for the FATF Immediate Outcome 9 and Immediate Outcome 10 (a new SB set for endMarch 2020) towards a substantial level of effectiveness, in line with FATF assessment methodology. The Pakistani authorities would continue to welcome Fund staff to assess progress on the full range of measures included in the FATF action plan for the next review,” the report pointed out.

“Pakistan continues to be included in FATF’s list of jurisdictions with serious AML/CFT deficiencies. The authorities have been addressing the AML/CFT action plan agreed with FATF through an inter-agency and high-level working group. The Asia Pacific Group on Money Laundering also discussed Pakistan’s Mutual Evaluation Report, noting that existing efforts were inconsistent with the level of risks and greater effectiveness needs to be demonstrated. With assistance from capacity development providers (including the IMF), the authorities are committed to completing the actions in the structural benchmark by end-June 2020 (end-October 2019 SB; reset to end-June 2020), with an improvement towards a substantial level of effectiveness to be achieved by end-March 2020 and consistent with FATF Immediate Outcome 9 on terrorism financing investigations and Immediate Outcome 10 on targeted financial sanctions,” the report mentioned.

The report admits that the quality of fiscal adjustments under the IMF programme was not high in the first quarter (July-September).

The IMF programme continues to face significant risks, both from domestic and external factors, the report added.

Potential external risks include blacklisting by FATF that could result in a freeze of capital flows to Pakistan, slow progress in refinancing/re-profiling loans from major bilateral creditors, and increasing headwinds from a weaker global economic backdrop.

The IMF report added that Pakistan continues to be included in the FATF’s list of jurisdictions with serious AML/CFT deficiencies.

The Asia Pacific Group on money laundering also discussed Pakistan’s Mutual Evaluation Report, noting that existing efforts were inconsistent with the level of risks and greater effectiveness needs to be demonstrated.

Due to a delay in completing the 27-point Action Plan, the IMF has also accordingly adjusted a programme condition to complete the work from October 2019 to June 2020.

But Pakistan has to show a substantial level of effectiveness to the IMF by end-March 2020 that should be consistent with FATF Immediate Outcome 9 on terrorism financing investigations and Immediate Outcome 10 on targeted financial sanctions, according to the IMF.

While discussing the domestic risk, the report noted that pushback on policy initiatives was expected from the vested interest groups and the lack of majority by the ruling party in the upper house may also affect the approval of new legislation.

The resistance to reform from vested interest groups could undermine the programme’s fiscal consolidation strategy and put debt sustainability at risk.

“[The] failure to meet programme objectives could jeopardise the availability of external financing,” cautioned the IMF.

The IMF staff flagged the risks stemming from the composition of fiscal adjustment and cautioned that fiscal consolidation must be achieved on the back of high-quality measures to ensure the sustainability of the adjustment.

Energy Sector Reforms

The report, also disclosed significant increase in electricity prices from next month, in addition to re-introduction of debt servicing surcharge in power bills on account of circular debt-related fresh borrowings.

“Pakistan’s entrenched energy sector problems are sources of fiscal drain and quasifiscal risks, are contributing to widespread inefficiencies across the energy sector, and are hampering the sector’s development. The power sector’s stock of arrears — "circular debt"— had ballooned to 4 percent of GDP by end-September 2019, of which more than a quarter was accrued in Q1 FY2020. The authorities have begun taking steps — as part of a comprehensive plan prepared in consultation with IFIs, including the IMF— to address the root causes of these arrears (MEFP 14-16) and positive results are already noted. Through sustained implementation, the authorities 5 aim to reduce the accumulation of new arrears from PRs 450-500 billion in FY2019 to PRs 50-75 billion by FY2023 and eliminate all new arrears by end-2023. The plan will be monitored closely by the Ministry of Energy and the first report on plan implementation will be published by end-January 2020. Reforms in the gas sector are also progressing well; the July 2019 tariff adjustment eliminated the flow of gas sector arrears and tariffs will be further adjusted by end-December,” it highlighted.

“The plan, prepared in consultation with international partners and IMF staff, aims to reduce the annual flow of circular debt from the current level to around PRs 50-75 billion by FY 2023 through improving collection and reducing losses, streamlining tariff updates, and rationalizing subsidies. Monitoring of the plan will take place through implementation reports published by the Ministry of Energy. Key measures of the plan include: (i) timely updating tariffs, including the Q2 FY 2020 adjustment for capacity payments to take place by end-January (new end-January 2020 SB); (ii) streamlining of tariff procedures and reintroducing surcharges via amendments to the NEPRA Act to be submitted to Parliament by end-December (modified end-December 2019 SB); (iii) improving efficiency and collection; and (iv) rightsizing of subsidies,” it pointed out.

Stronger efforts needed to improve viability of power sector, tackle rising arrears

At end-September, the stock of power sector arrears stood at PRs 1,690 billion8 (about 4 percent of GDP), of which PRs 465 billion were accumulated in FY 2019. The main contributors to these new arrears were technical and distribution losses, delays in updating tariffs, and provision of unbudgeted subsidies.

The authorities have taken steps to address some of the sources of arrears, including by: (i) investing in infrastructure to reduce technical losses; (ii) launching an antitheft drive and stepping up enforcement to increase collections; (iii) adjusting tariffs gradually (quarterly) to cost recovery levels, including on September 30 (end-September 2019 SB) by around 5 percent, largely to recover arrears accumulated over FY 2019, and on November 29, 2019 (prior action) by around 2 percent on account of Q1 FY 2020 capacity payments; and (iv) budgeting or eliminating all power sector subsidies.9 These efforts are already showing some results, with accumulation of new arrears falling from about PRs 38 billion/month in FY 2019 to around PRs 10 billion/month in the first three months of FY 2020. The authorities remain committed to bring the flow of power sector arrears to zero by end-2023.

The IMF on Thursday approved the second tranche of $452.4 million for Pakistan under the $6 billion Extended Fund Facility (EFF), declaring that Pakistan’s reform programme is "on track and has started to bear fruit".

In July, the IMF package aimed to support and revive Pakistan’s ailing economy through periodic release of funds over a 39-month period, conditional on the government meeting the Fund’s policy guidelines.

Following the release of the latest tranche, the total amount of money so far granted by the IMF under the current programme will rise to $1,440m.