We assign very low probability to Pakistan dropping to the "Black" list during the upcoming 16-21 February FATF meeting. This is because:
Pakistan is demonstrably making efforts to address the deficiencies previously identified by the FATF and its geopolitical relations are supportive (with China, and the US, for at least as long as long as the US seeks an orderly troop withdrawal from Afghanistan).
The "Black" list risk is material and worth mentioning only because in the very unlikely event of this happening, the damage to the (positive) investment case for international institutional investors would be enormous.
| Table 1: FATF designations prior to Feb 2020 meeting |
|---|
| "Black" list (jurisdictions with a FATF call for counter measures) |
| Iran |
| North Korea |
| "Grey" list (jurisdictions with deficiencies) |
| Bahamas |
| Botswana |
| Cambodia |
| Ghana |
| Iceland |
| Mongolia |
| Pakistan |
| Panama |
| Syria |
| Trinidad & Tobago |
| Yemen |
| Zimbabwe |
We remain positive on Pakistan equities
(1) Macroeconomic repair (twin deficit reduction, FX reserves rebuild, inflation control, all at an FX rate close to fair value) continues under the IMF’s supervision;
(2) Disruption from insecurity remains low (death rates related to terror are still far lower than the 2011 peak);
(3) The military deep-state and the civilian government remain broadly united (this was reinforced by the renewal of the Army chief’s term to the end of 2022);
(4) An infrastructure upgrade (electricity, roads, rail, ports) via the China Pakistan Economic Corridor is ongoing;
(5) Top-down valuation is still modest with trailing PB and PE 25% and 10% below the 5-year median, respectively.
Main investment risks
(1) A long wait for macroeconomic repair to transition to sustainable, high growth, e.g. stubborn inflation or sluggish export pick up, (although the strength of most listed corporate balance sheets means low growth should not be compounded by financial distress);
(2) Spike in tensions with India (although there are limits to how far this can progress given nuclear capability on both sides);
(3) Divergence in interests with the US once the Afghan withdrawal completes;
(4) Government liabilities associated with guarantees for utility projects (should the government fail to enforce better collection of utility bills and reduce network theft) and losses for state-owned enterprises (should vested interests and unionised and politicised labour stand in the way of privatisation and reform);
(5) Backsliding on FATF-related counter-terrorist financing and anti-money laundering reforms;
(6) Low average daily traded value (relative to mainstream emerging markets).
FATF: “Black” and “Grey” lists
The Financial Action Task Force is a multilateral body that considers counter-terror financing and anti-money laundering procedures globally.
“Black” list countries (currently Iran and North Korea) are those which are judged to have repeatedly failed to take remedial action and where the FATF recommends financial sanctions.
Designation on the “Grey” list means that deficiencies have been identified and remedial action is recommended and monitored. Pakistan is not unique in our coverage: Ghana, Iceland, and Zimbabwe, among others, are also currently on the “Grey” list.
“Grey” list status does not inhibit repatriation, remittance, trade, investment or aid flows, but progress on those deficient procedures needs to be demonstrated.
Note that many Frontier and small Emerging markets have been placed on the Grey List, at different times, since 2012 (e.g. Bangladesh, Ghana, Indonesia, Iraq, Kenya, Morocco, Nigeria, Pakistan, Philippines, Sri Lanka, Tanzania, Thailand, Turkey, Uganda, Vietnam and Zimbabwe are among the countries we track).
In its previous stints on the “Grey-Black” and “Grey” list (e.g. 2012-15), Pakistan saw growth in remittances, the grant of GSP Plus status in its trade with the EU and the signature of the three-year, US$6.6bn IMF agreement.
Related reading
Pakistan and the FATF
Pakistan: Low FATF risk, still positive on equities, 7 October 2019
Pakistan: FATF "Grey" list inclusion likely and immaterial, 28 February 2018
Pakistan geopolitics
Trump to meet Khan, Implications for India, Pakistan, 15 July 2019
India, Pakistan: Escalation, emotion and MAD, 17 February 2019
Pakistan: Cricket is a symbol of much-improved security, 11 December 2019
Pakistan: Army-judicial-civilian unity and China alignment, still positive, 27 November 2019
Pakistan equities
Pakistan: Cheap enough, 10 factors to make you brave enough, 8 July 2019