The Financial Action Task Force recently "gray-listed" Pakistan for failing to better combat money laundering and terrorism financing; at the same time, the international organization suspended countermeasures on Iran while Tehran implements reforms. The task force's decision will exacerbate Pakistan's financial risks and increase Islamabad's reliance on China as a lender of last resort. Internal divisions over how far Iran should go to comply with the organization's guidelines will complicate Tehran's pursuit of financial breathing room as Iran faces strong U.S. sanctions.
The Financial Action Task Force (FATF) is a 37-member intergovernmental organization that focuses on setting global standards for combating money laundering and terrorist financing. Headquartered in Paris, it holds three plenary sessions a year – in February, June and October. During its latest meeting, which ran June 24-29, the FATF added Pakistan to its "gray list" while it continued to suspend countermeasures on Iran.
The Big Picture
Iran and Pakistan are embroiled in a tense phase of their respective relationships with the United States. The United States continues to view militant safe havens in Pakistan as a key obstacle to advancing peace talks in Afghanistan and is using pressure tactics – including through the Financial Action Task Force – to force a shift in Islamabad's behavior. Meanwhile, the United States is intent on using financial sanctions to pressure Iran. Tehran views the funding of militant groups abroad as a critical component of its defense strategy, while Washington perceives such action as funding for terrorism. But with the FATF continuing to suspend countermeasures on Iran, Tehran has more time to conduct financial transactions without as much scrutiny.
What's at Stake for Pakistan?
Economic Context. Pakistan unsuccessfully sought to avoid being placed on the FATF's watchlist of "jurisdictions of strategic deficiencies," the so-called gray list. The FATF encourages its members to apply countermeasures against gray-listed countries that can include heightened scrutiny for international banking transactions. For Pakistan, the new listing will increase its risk profile at a time when the country's macroeconomic woes necessitate external financing. Foreign exchange reserves have dwindled to $9.7 billion, covering just two months of imports, while the current account deficit will reach 4.6 percent of gross domestic product compared with an average of 1.5 percent from 2014 to 2016. The developments highlight why ratings agency Moody's downgraded its outlook for Pakistan from stable to negative.
Geopolitics. The United States is using the FATF as part of its broader strategy of forcing Pakistan to change its long-standing support for militant organizations and charities accused of funding militant groups. Without question, Pakistan has taken a series of steps to redress the FATF's concerns about terrorism financing and money laundering. In February, President Mamnoon Hussain signed an ordinance broadening the country's Anti-Terrorism Act of 1997 to include individuals and organizations subject to U.N. Security Council sanctions. As a result, officials can target the financing of four individuals and groups – Jamaat-ud-Dawa, Falah-e-Insaniat, Al Akhtar Trust and Al Rashid Trust. Then on June 20, the Securities and Exchange Commission of Pakistan combined its formerly separate regulations targeting money laundering and combating terrorist financing. But these steps weren't enough for the FATF.
Implications. Because the use of militant proxies is a key strategy of the Pakistani army's asymmetric warfare campaign to counter a militarily powerful India and shape a friendly post-conflict government in Afghanistan, Islamabad will refuse to fundamentally alter the policy, choosing to absorb the consequences instead. (Still, Pakistan has agreed to implement an action plan with the FATF to redress its deficiencies over the next 15 months). Pakistan's placement on the gray list will ultimately increase the country's reliance on China as a lender of last resort – Beijing loaned more than $5 billion to Islamabad during the fiscal year that ended in June – but it won't affect Pakistan's ongoing support for the Taliban and Haqqani network in Afghanistan.
What's at Stake for Iran?
Economic Context. The Iranian government, though divided on the issue, has been seeking to remove Tehran from the FATF's blacklist and to stave off financially damaging countermeasures by following an action plan dictated by the organization. In June 2016, Iran announced it would seek to overhaul standards to bolster counterterrorism financing and combat money laundering. Iran has made some progress, including establishing a cash declaration regime and drafting (though not passing) some legislation per the FATF's guidelines. During June's plenary meeting, the FATF continued to suspend countermeasures against Iran – an acknowledgement from the organization that Tehran is still working on its action plan. Not having to face countermeasures – at least until the FATF's October meeting – gives Iran the opportunity to implement some structural banking reforms that could move it toward meeting the FATF action plan. Facing strong U.S. sanctions, Iran's banking and financial sector is already under significant pressure, and Iran needs as much financial breathing room as it can get.
Geopolitics. Under President Hassan Rouhani, Iran's government has been trying to work on much-needed banking and financial sector reforms for the past few years. But the question of how fully it must submit to the FATF guidelines has stirred a significant debate among different political factions in Iran, putting some financial reforms into the political crosshairs. Hard-line and religious factions with closer ties to the military disapprove of the extent to which Rouhani's more moderate government has tried to align with international expectations surrounding the FATF, viewing it as a foreign means of controlling Iran's behavior. The trickiest part for such factions is that complying fully with the FATF action plan could hamper Iran's ability to fund militant proxy groups like Hamas and Hezbollah – a critical component of Iran's defense strategy. The United States, too, is more intent than ever to sanction and contain Iranian activity that it views as destabilizing, including the funding of terrorist groups.
Implications. Iran has acquired some breathing room from the FATF until October, which means Iran can continue to conduct some global financial transactions without the pressure of countermeasures. But the most difficult part of Iran's path forward in working on its FATF-recommended action plan is complying with the organization on criminalizing terrorist financing. Iran needs to amend its own counterterrorism-financing law using text that aligns with the FATF's standards. In recent months, the Iranian parliament has delayed a bill on counterterrorism financing. It's a sign of how deeply politicized the issue has become – and a harbinger of failure in Iran's effort to fully align its government with the FATF's expectations.
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