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Cover Story

Investors keenly await the economic revival package

Dec 06 - 12, 1999

"Capital is made at home", wrote the influential Columbia University economist Ragner Nurkse in 1953. His point is still true today. Most productive projects and enterprises in a country are financed locally and generate revenue in local currency. Domestic capital formation is the driving force behind any country's development. At the same time, foreign investment has a critical role to play. Its presence often brings with it foreign technical know-how, competitive pricing, higher standards of disclosure and improved performance. All of these promote the efficiency in local markets.

Many developing countries benefit from outside assistance in undertaking three major tasks: building financial infrastructure, improving the ability of small savers and investors to access financial services, and attracting international capital. Attracting international capital helps to close the gap between local savings and investment needs.

Foreign investment is responsive to information. Early efforts to promote foreign portfolio investment focused on providing information about market, regulations and financial returns to a wide international audience eventually pays-off in formation of the early country funds. These are the first to track and benchmark emerging securities markets.

Foreign portfolio investment usually has an importance for market development far beyond the actual dollars invested. The presence of professional foreign institutional investors usually lead to healthy changes in market regulation, better disclosure and more market services such as custody, transfer agents and registry.

Money flows to markets with the best regulatory environments or to markets that are seen to have exceptional return potential. Foreign portfolio investment has grown many fold in the last decade but a substantial chunk still goes to about a dozen mostly middle-income, high population countries, and is still a relatively small portion of GDP in most. The challenge ahead lies in improving the domestic infrastructure and regulatory environment to attract the international capital needed to fund productive business to improve market structure.

Pakistan opened up its market much earlier as compared to India and there was large influx but gradually the interest fizzled out due to a number of external and internal factors. Many external factors were beyond Pakistan's control but the constant shift in priorities was a major deterrent. These included political instability and economic uncertainties due to inconsistent policies.

The two sectors namely energy and pharmaceuticals were the major attraction for the foreign investors. However, inability of the economic managers to resolve IPPs issue and abide by the pricing formula for pharmaceutical emerged to be the strongest irritants. Since Pakistan was on marginal list, with the culmination of Asian currency crisis the off-loading of portfolio investment intensified. Freezing of foreign currency accounts and stringent forex management policies, after the imposition of economic sanctions, prompted the foreign investors to further down grade Pakistan on the investment priority list.

While a few projects still managed to attract quality investors, the overall interest of foreign investors remained low due to the shyness of local investors. Local investors were not ready to undertake any project having large equity base, long gestation period and not offering minimum rate of return on equity. This low interest is evident from the number of fresh listing at local stock exchanges. However, when TFC issues were offered not only that they were oversubscribed but sponsors also decided to retain the oversubscribed amount. It was mainly due to the fact that TFCs offered guaranteed return and have a short tenure of about five years.

Portfolio investment, a sub-group of foreign direct investment, was also low despite the fact that most of the scrips were traded at substantial discount. The reasons for staying away from Pakistan included, small equity base of most of the listed companies, limited number of attractive scrips and poor dividend policy. On top of this lack of disclosure and poor regulatory framework hardly allowed the portfolio managers to exercise many options.

The working environment and risks are not unique to Pakistan but the real irritant are inconsistent policies, poor implementation of these policies and the attitude of the past government towards overseas investors. Commercial disputes were not handled in commercial manner. It may take some time to restore the confidence of both local and foreign investors. However, the gap can be bridged by perusing speedy and transparent privatization and curtailing forex controls.

Last but not the least, innovators await the economic revival package of the current regime. The positive factors include restructuring of Pakistan's external debts. Since this has been brokered by the IMF, continuation of ESAF programme may help in curtailing forex controls. At the same time one should not ignore hike in POL prices and electricity tariff as make shift arrangements.