ISLAMABAD -- Pakistan is set to become increasingly reliant on Chinese loans and investment now that the Financial Action Task Force, an inter-governmental anti-money laundering watchdog, has initiated a process to place the country back on a counter-terrorist financing watchlist, political and financial analysts say.
The U.S.-backed move follows President Donald Trump's decision in August 2017 to ramp up pressure on Pakistan for failing to shut down militant groups banned by the United Nations Security Council.
Pakistan in February belatedly sought to avert being placed on the watchlist by seizing properties owned by the Jamaat-ud-Dawah, the charitable front of the Lashkar-e-Taiba terrorist group responsible for a three-day attack in Mumbai. Over three days in 2008, 166 people were killed in the offensive.
Counter-terrorist financing is the Financial Action Task Force's top priority. The FATF comprises 35 member states and two regional organisations representing most international financial centres.
Pakistan must now work with the FATF to develop a plan to overcome shortcomings in its counter-terrorist financing regulations. If a plan is approved by FATF members at their next scheduled meeting in June, Pakistan would be placed on the organisation's gray list.
Pakistan's gray-listing would not impact the estimated $60 billion China-Pakistan Economic Corridor, the single largest infrastructure investment program under President Xi Jinping's Belt and Road Initiative. The corridor, sometimes referred to as CPEC, is being financed by Chinese state-owned banks.
However, the gray-listing would affect Pakistan's standing in international financial markets and its ability to obtain financing from Bretton Woods institutions, analysts said.
"The FATF decision would have an impact on Pakistan's financial position, making it more difficult to raise capital on international markets, and making outsiders even more wary of foreign direct investment," said Joshua White, senior adviser on South Asia to the Pentagon and the White House during Barack Obama's presidency. "And it would, as a result, put continued pressure on Pakistan's foreign reserves."
In a series of tweets, White further said the FATF decision "would also send a clear signal that the U.S. may be willing to use its influence with the International Monetary Fund, World Bank, et al to ensure that any future funds from those institutions receive stricter scrutiny and come with tighter financial conditions."
Pakistan was previously placed on the gray list in 2012-2015 but was removed in 2016 after legislating drastic reforms to its anti-money laundering and counter-terrorist financing regulations.
Syria and Yemen are among the nine countries currently on the FATF's gray list. Iran and North Korea are the only two blacklisted countries.
This is merely the beginning of a painful medium-term transition, either toward becoming an economically resilient nation or, probably, solely reliant on Chinese bailoutsA.A.H. Soomro, senior adviser for Tundra Fonder
With U.S. diplomatic pressure unlikely to relent, the FATF gray-listing will likely push Pakistan toward China, rather than the IMF, in the event that it needs balance of payments support to plug its rapidly growing current account deficit and bolster its flagging foreign exchange reserves, fund managers say.
"This is merely the beginning of a painful medium-term transition, either toward becoming an economically resilient nation or, probably, solely reliant on Chinese bailouts, owing to CPEC's significance as the showcase program of the One Belt, One Road Initiative," said A.A.H. Soomro, senior adviser for Tundra Fonder, a Stockholm-based emerging markets fund manager.
China emerged as Pakistan's biggest lender in the fiscal year through June, accounting for about a quarter of its international borrowing. The trend has continued into the current financial year, with China being the second-largest source of financing for Pakistan, after international bond markets.
Yousuf Nazar, an economic consultant and former Citigroup executive, said the placing of Pakistan on the FATF watchlist would have "slow but far-reaching repercussions" for its banks, which have struggled to comply with U.S. anti-money laundering and counter-terrorist financing regulations.
The New York State Department of Financial Services in September forced Pakistan's biggest commercial lender, Habib Bank Ltd., to shut down its only branch in the U.S. and fined it $225 million for "grave" compliance errors.
It found HBL had improperly used a "good guy" list of customers who supposedly presented a low risk of illicit transactions to permit at least $250 million in transactions without any screening. They included more than 150 transactions involving individuals and entities subjected to U.S. sanctions, including the head of a Pakistani terrorist group and a Chinese arms dealer.
"After Habib Bank's New York branch was closed, a major European bank stopped extending correspondent banking facilities to Pakistani banks," Nazar said. "International banks have mostly exited our market."
The independent Basel Institute of Governance ranked Pakistan's economy the 46th-most susceptible to money laundering and terrorist financing out of the 146 countries it assessed in 2017.