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Impact of franchising and FDI on foreign exchange reserves of Pakistan

Import payments is an important component of trade balance in the compilation of Pakistan’s Balance of Payments estimates. The payments of services contain all payments through banking channels performed by the nonresidents for residents, which includes transportation, travel, communication, construction, insurance, financial, computer and information, royalties/franchising and license fees, other business services, personal, cultural and recreation and government services.

In 2001, remittance of royalty/franchise and technical fee or service charges was allowed by State Bank of Pakistan in the newly-opened sectors for Foreign Direct Investment (FDI) as per Government’s Investment Policy i.e. agriculture, social Infrastructure and service projects including international food chains subject to following guidelines:

i- The initial lump sum fee payable to the foreign investor/the party providing technical expertise and/or allowing use of their brand name, should not exceed US$ 500,000/- irrespective of number of outlets under franchise. This would be allowed from the interbank market.

ii- A maximum of 5% remittance of net sales excluding 15% sales tax) in the food sector may be allowed as Franchise Fee only for those items which are core items of the franchise and are the specialties of the trade name. The payment of such fees be allowed on monthly basis. No item will be eligible for twice payment of Royalty/Franchise Fee. In other words, the payment of Royalty Franchise Fee shall not be admissible for those items whose franchise is not held by the food chains and/or which are sold under some other brand name e.g. soft drinks etc.

iii- Percentage/amount of fees etc. for other non-manufacturing projects may also be up to the maximum of 5% of net sales (excluding 15% sales tax).

iv- Initial period for which fees to be allowed for projects in non-manufacturing sectors including international food chains should not exceed 5 years. Subsequent extension in time period will be considered and allowed by the Government/State Bank of Pakistan provided these projects also make investment in allied upstream projects.

v- The applications for remittances of such payments by the Commercial Banks as well as Non-Banking Financial Institutes (NBFIs) including leasing/modaraba companies and investment banks, to the foreign collaborators in respect of their branded financial products/services within the area of their authorized business, would be processed and approved by the State Bank of Pakistan, on a case to case basis, on submission of an attested copy of the agreement and other relevant information/documents.

vi- Continuing royalty payments, service/technical charges/commission or handling charges/any other directly related charges not exceeding 0.25% in aggregate of customers’ billing net of taxes/surcharges would be allowed which would either be recovered from the customers or met through the financial institution’s own resources. No foreign exchange would be provided/utilized for this purpose from the interbank market.

Franchising implies that a domestic firm allows its production, sales, marketing, and management strategies to be used in a foreign market in exchange for a periodic payment. Domestic firms engage in joint ventures with foreign firms. A joint venture is a business arrangement between two businesses to produce a particular good, where these firms share expenditures, revenues, and assets. Foreign firms establish new subsidiaries in other countries. The term foreign direct investment (FDI) refers to establishing a new production facility, distribution network, management, and so forth in a foreign country. Parent companies have to transfer funds denominated in foreign currency to the FDI-receiving country. Also, depending on the FDI-receiving country’s restrictions, parent companies may receive income/profits from their foreign operations denominated in foreign currency. All these activities imply exchange rate risk.

On a macroeconomic level, no two nations have the same level of resources due to which the earlier form of “barter” has transformed into “international trade”. Every nation has some specialized skill or some special “product” that it produces by virtue of its geographical location, which is desired by some other nation due to lack of the same in their country. By engaging in international trade, economies of both the nations flourish resulting in better lifestyles for their people. Based on the concept of “comparative advantage”, agrarian economies import machinery for mechanized farming from industrial economies which results in better production yields and by exporting the “finished product”, they earn valuable foreign exchange. This is how the world economies thrive. On a microeconomic level, in today’s competitive business world, no organization could consider itself complete in terms of resources and efficacy of management. It has been observed that a firm may have some advantage over another firm in the same market due to some production/technical expertise.

Most countries have liberalized their policies to attract investments from foreign multinational corporations (MNCs). On the expectation that foreign MNCs will raise employment, exports, or tax revenue, or that some of the knowledge brought by the foreign companies may spill over to the host country’s domestic firms, governments across the world have lowered various entry barriers and opened up new sectors to foreign investment. An increasing number of host governments also provide various forms of investment incentives to encourage foreign owned companies to invest in their jurisdiction. These include financial incentives such as tax holidays and lower taxes for foreign investors, financial incentives such as grants and preferential loans to MNCs, as well as measures like market preferences, infrastructure, and sometimes even monopoly rights.

The globalization and regionalization of the international economy have made FDI incentives more interesting and important for national governments however the internationalization of capital markets has limited the possibilities to use exchange rate policy as a tool to influence relative competitiveness. The need of the hour is that national decision-makers remain committed to promoting the competitiveness and welfare of their constituencies, and should put more emphasis on those policy instruments that remain at their disposal including FDI incentives without compromising on national foreign exchange reserves.

The writer is a Karachi-based freelance columnist and is a banker by profession. He could be reached on Twitter @ReluctantAhsan

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