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Foreign direct investment and its impact on Pakistan economy

Economic growth is the aspect to a nation’s progress and prosperity. Foreign direct investment (FDI) is generally considered as a key driver of global economic integration. Investment provides base to the economic development to the developing countries. Standard economic theory points to a direct, causal relationship between economic growth and FDI that can run in either direction.

On the one hand, FDI flows can be induced by host country economic growth if the host country offers a sizeable consumer market, in which case FDI serves as a substitute for commodity trade or if growth leads to greater economies of scale and cost efficiency in the host country. On the other hand, FDI itself may contribute to host country economic growth, by augmenting the country’s capital stock, introducing complementary inputs, inducing technology transfer and skill acquisition, or increasing competition in the local industry. Of course, FDI may also inhibit competition and thus hamper growth, especially if the host country government affords extra protection to foreign investors in the process of attracting their capital.

Foreign direct investment as growth accelerating component has received a great attention in developed countries even in developing countries during recent years. It has a matter of great concern for economists how FDI effects economic growth of the host countries economy. In closed economy there is no access to foreign investments and savings this type of economy is solely based on domestic savings and investment resources either from domestic savings and domestic resources. But in open economy the investment comes from both sources either from domestic savings or foreign capital inflows like FDI. The FDI enables the host country to achieve investment level beyond its capacity to improve GDP and economic growth.

In Pakistan the saving rate is very low as compared to other developing countries. The most important factor affecting saving rate is foreign capital inflow. Because the major portion of the foreign capital inflow to Pakistan was utilized in consumption purpose so the inflow of foreign capital into Pakistan’s economy has reduced the saving rate in private and public sector. The saving rate can be increased by liberating the foreign trade and payment sector. Because of shortage of capital in the developing countries, there is need of capital for their development process, and the marginal productivity of capital is higher in these countries. Mostly investors in the developed countries seek high returns for their capital. Hence there is a common benefit in the international movement of capital.

Liberalization of the economies in many developing countries has led to a severe competition for inward FDI in these countries. As far as Pakistan is concerned during early 1980s, the government in Pakistan has initiated market-based economic reform policies. These reforms began to take hold in 1988. In the 1990s, the government further liberalized the policy and opened the sectors of agriculture, telecommunications, energy and insurance to FDI. But, due to political instability FDI remained low. The political stability, peaceful law and order situation, level of technical labor force and mineral resources and liberal policies of the government attracts foreign investors in Pakistan. FDI can also be considered as one of the main transmission vehicles of advanced technology from leaders to developing countries. FDI have a positive impact on the productive efficiency of domestic enterprises. Local firms have an opportunity to improve their efficiency by learning and interacting with foreign firms. FDI increases technical progress in the host country by means of a contagion effect, which eases the adoption of advanced managerial procedures by the local firms. But in order to get the benefit of FDI the Pakistan government should try hard to achieve a sound degree of political and economic stability, together with a liberalized environment.

Export is a main determinant of overall economic growth. Export sector may generate positive externalities on non-export sectors through more efficient management styles and improved production techniques. Indeed the export expansion will increase productivity by offering potential for scale economies. Exports are likely to alleviate foreign exchange constraints and so can provide greater access to international market. FDI can contribute in growth in both direct and indirect ways.

Foreign investments have significant positive effect on productivity of domestic firms. Foreign technical collaborations increase productivity in part through its effect on the FDI inflows. Developing countries witnessed a surge in FDI inflows post 1990s. In many developing countries the rate of growth of FDI inflows exceeds the growth rates of foreign trade. At macro level, the role of FDI has become crucial because it provides new capital, additional investments in human as well as physical capital, which can be beneficial for developing countries which are capital scarce. The inflow of new knowledge like: greater production methods; new technologies; organizational and managerial techniques; management and marketing skills and activities may benefit domestic firms through imitation, increased competition, mobility of human capital from foreign firms to domestic firms, thereby leading to increase in overall productivity levels. The most of the developing countries are keen to attract FDI not only because of the flow effects of ideas and innovations.

Foreign investment can help mitigate problems encountered in external debt management. In this case FDI enables countries to manage their problems arising out of escalating external debt by providing an alternative source of long-term finance. Secondly FDI has the potential of meeting the domestic resource gaps of developing countries thereby enhancing their growth prospects. It is based on the argument that the long-term view of benefits arising out of FDI is based on the perception that such inflows of capital act as ‘engines of growth’ in developing countries.

The importance of the foreign direct investment for the financial development of the developing countries as if the country has much financial resources the development process would be as fast as the finance is required for the developmental projects. But the contribution of financial development can be dependent on the political situation of the recipient nation. If the country is politically stable it can attract more and more foreign investment and the higher political stability aids financial institutions to reap the benefits of FDI efficiently. Financial Development is an integral component of the growth process of an economy. For the financial development through FDI it is important to measure the market size, efficiency of financial intermediaries and markets. Political stability is important in a sense that it helps build institutions that provide protection for the rights of the investors that is important enough to attract and retain new foreign investment and alternatively it would aid the financial sector.

 

Pakistan, being a developing country, has not been traditionally a large recipient of FDI. In the 1980s the average annual inflows of FDI were around $ 42 million for Pakistan. If FDI is taken in relation to total gross domestic investments, it constitutes 1.4 percent of it. Foreign direct investment brings into the recipient economy resources which can play an important role in the modernization of the national economy. FDI is now considered to be an instrument through which economies are being integrated at the level of production into the globalizing world economy by bringing a package of assets including capital, technology, managerial capacities and skills and access to foreign markets.

Pakistan’s foreign direct investment (FDI) dropped 52% to $1.37 billion in first 10 months (Jul-Apr) of the current fiscal year. The country recorded a net outflow of $22.6 million in the same period under the head of foreign investment compared to a net inflow of $5.16 billion in the same period of last year. Not too far back, in 2006-7, Pakistan’s economy with a growth rate of 7 percent and FDI over $ 9 billion was rated among the three best in the region — Pakistan, Vietnam and India.

Data published by the State Bank of Pakistan revealed that FDI halved to $1.737 billion from $3.471 same period last year. These desolating figures come at a time when the government is struggling to contain significant economic challenges on the back of large fiscal and financial needs and weak and unbalanced growth.

Inflows from China, leading investor in the country, during FY19 fell to $540 million compared to $2 billion during FY18 as the CPEC enters into the second phase. On the other hand, data showed that US, with inflows of $155 million during FY18, reported outflows of $575 million during FY19 as relations between Islamabad and Washington have worsened in the last year.

Inflows from UK during the period under review remained almost unchanged at $230m compared to $212m in FY18 whereas other significant inflows came in from Japan at $118m, Norway $115m, UAE $101.8m and Turkey $73.7m. Sector-wise, investments were led by the construction sector which attracted $421m, followed by $308.8m in the oil and gas sector, $286.5m in financial business and $134.5m in the chemicals; up from $48.9 in the same period last year.

It’s very difficult to attract those investors who left the country on one pre-text or other. No serious efforts has been made to bring back those early birds. The Federal Board of Investment (BoI), responsible to mobilize and regulate FDI, is no longer a one window operation and has more or less lost its relevance for the purpose it was formed for. It’s now more of a regulator to issue NOCs.

The good news is that the fundamentals of FDI are strong in Pakistan. It has one of the world’s largest growing middle classes with ambition and talent. The country is also one of the world’s largest consumer market with great purchasing power — which can be verified from the mushrooming of retail outlets flooded with local and expensive imported products. It is this combination which propelled the unprecedented and sustainable economic growth of India, China, Vietnam and others in the region.

Pakistan with better fundamentals is left out as we failed to put our act together. We need to put in a lot of efforts to make this happen through reforms and restructuring to make the country investor friendly, which we are not when benchmarked to other countries in the region.

The rate of return and incentives offered to investor in Pakistan are attractive. The 200 multinational companies, operative under the ambit of Overseas Investors Chamber of Commerce and Industry record invariably a double-digit profitability.

The issue is the security and sustainability for the investor, notably to the potential investor with no exposure to Pakistan. It is this fear which needs to be addressed. Much of this has to do with country perception then realities on ground. We need to work on building a soft image of the country which needs to sink into the hearts and minds of foreign community. India has set up its cultural centers in all major business hubs where Indians exhibit their country’s image through art and culture to wider segments of society. Unfortunately, however, Pakistan has none.

Our foreign missions need to move from passive to active mode for better business and people outreach. India has the presence of its business chambers at all important business hubs, notably, in Brussels, in the vicinity of the EU office. Pakistan has none. While Pakistan may have a probability of achieving some mega FDI from China or Saudi Arabia or elsewhere but this is an unpredictable model to adopt for boosting FDI.

Pakistan needs a critical FDI mass as a base for its sustainability and growth in FDI. Under the circumstances, it can be very fast achieved by mobilizing the SMEs, particularly those in Europe, which are hungry to venture into new markets because of a significant slowdown in Europe and deterrents placed by the USA. Also, the best chance to fill in the numerous Special Economic Zones is through SMEs – foreign, local and joint ventures. To attract FDI to Pakistan is not any easy task but it is a possible one. Lots and lots of efforts have to be employed in the reorganization and restructuring of our entities, processes and systems and a workable strategy to outreach the prospective investors.

The incumbent government has done well in its foreign policy and outreach, easing out the visa facilities and opening up tourism. Much, much more, however, needs to be done to achieve our goal as a sustainable investor friendly country.

The author, Mr. Nazir Ahmed Shaikh, is a freelance columnist. He is an academician by profession and writes on diversified topics. Currently he is associated with SZABIST as Registrar and could be reached at  registrar@szabist.edu.pk.

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