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In the future, Pakistan will need to broaden the scope for FDI

By Abdul Waheed
Jun 19 - 25, 2000

The capital inflows that finance a country's deficit can take several forms. Different types of capital inflows are;

  1. Bond Finance (selling bond to private foreign citizens)

  2. Bank loans (borrowing directly from commercial banks in the developed countries)

  3. Foreign Direct Investment (a firm largely owned by foreign residents acquires or expands subsidiary firm or factory located domestically)

  4. Official Lending (borrow from international agencies like International Monetary Fund or World Bank and from the governments of other countries).

The four types of finance just described can be classified into two categories: debt and equity finance. Bond, bank and official finance are debt finance. The debtor must repay the face value of the loan, plus interest, regardless of its own economic circumstances. Direct investment, on the other hand, is a form of equity finance. Foreign owners of a direct investment have a claim to a share of its net return, not a claim to a fixed stream of money payments. Adverse economic events in the host country thus results in an automatic fall in the earnings of direct investments and in the dividends paid to foreigners.

A large body of literature exists on the subject of foreign direct investment covering different viewpoints. A review of the existing literature indicates that four major theoretical approaches can be identified on the subject of foreign direct investment. In the neoclassical approach foreign direct investment is seen as being good for economic development and growth. This argued that transfer of this kind of investment to developing countries would be prerequisite to the achievement of a sustainable growth strategy. This approach emphasized that foreign direct investment bring to the host country a package of 'cheap capital, advance technology, superior management ability, and superior knowledge of foreign markets for both final products, and capital goods, intermediate inputs, and raw materials. On these grounds proponents of foreign direct investment have strongly arched developing countries to avoid restrictive policies which might impede or deter foreign investors'.

In contrast with the neoclassical approach, the dependence schools emphasis the risks and negative effects of foreign direct investment on growth and development. They argued that the way in which the developing countries are joined to the international economic system is the most critical source of their economic difficulties. They pointed out that the cost of an externally oriented development includes income concentration, an emphasis on luxury consumer durable, foreign indebtedness and unemployment. They also pointed out that the benefit of foreign capital in promoting industrialization occur at the expense of 'the autonomy of the national economic system and of policy decision for development.' Some dependencia writers have arched developing countries to 'delink' [at least temporary] from the international economy.

Proponents of the bargaining approach argue that the distribution of gains from foreign direct investment emerge from bargaining and negotiation between foreign interests and developing countries. Foreign investment should therefore be permitted, even encourages, although these analysis don't believe that developing countries will inevitably gain from foreign direct investment. The critical element in this approach is the emphasis place on the development of national institution and capacities to enhance the share of developing countries' benefits in their relationship with foreign investors.

Structuralists challenge the bargaining school's relative optimism about the long term negotiating prospects of developing countries, suggesting that developing countries are more likely to suffer a long term decrease in their power, especially over high tech foreign manufacturing companies. In stressing the distortive the developmental effects of foreign direct investment, structuralists arguments are more in line with the dependencias, but they don't subscript neither to delinking nor to constructing "paths to socialism" as alternative strategies.

In recent years many developing countries have increasingly resorted to Foreign Direct Investment (FDI) as source of the capital, technology, managerial skills and market access needed for sustained economic growth and development. The growing balance-of-payment (BOP) difficulties and decline in concessional foreign aid since the end of the cold war have forced developing countries to deregulate and liberalized economic activity. As a result of this change total foreign direct investment (FDI) flows in the world in 1997 reached to US $400.5 billion against US $203.8 billion in 1990. The developed world stake in global inflows decline from 88 per cent in 1980 to 60 per cent in 1997. While developing countries have increased their share of global inflows of foreign direct investment by increasing its share from 12 per cent in 1980 to 37 per cent of total global FDI inflows in 1997. The Asian continent has become the largest FDI recipient region among developing world in last few years as FDI inflows progressed by annual average of 27 per cent during 1990-96 which accounts for 58.4 per cent of total developing countries FDI inflows and 22 per cent of world FDI inflows. The financial turmoil of 1997 in South East Asia had already eroded credibility of the countries in the region but economic sanctions imposed by some developed countries proved last straw on the camel's back. The FDI inflows to Pakistan declined to US $ 296.1 million during July-March 1998-99 as against US $ 436.1 million in the same period in last year which reveal decline of 32.1 per cent. As far as sectoral distribution of foreign direct investment is concerned, power sector continue to dominate for some years and got lion's share (39.1 per cent) of FDI by attracting US $ 115.8 million out of total volume of US $ 296.1 million in the period July-March 1998-99 which is lower than previous year's US $ 148.6 million out of US $ 436.1 million during July-March 1997-98. The other considerable recipient of the stake include important sectors like mining and quarrying (15.7 per cent), chemicals and pharmaceutical (13.6 per cent) and petrochemicals & petroleum refining (9.6 per cent).

An overview of the history reveals that in Pakistan foreign direct investment has taken various forms like subsidiaries branches and joint ventures. To quote a few examples, Shell started operations in the area in 1903. Imperial Chemical Industries (ICI) established soda ash manufacturing unit in 1942. ANZ Grindlays Bank and Standard Chartered Bank were working in these areas before independence. Pakistan's industry is mainly agro-based. Exxon (now Engro with full Pakistan's equity) came first in this field in 1960, establishing the urea factory. Hercules of USA was next with a joint venture. With mechanization in agriculture, farm industry developed and Massey Ferguson, Fiat and Belarus established joint ventures. In the infrastructure development as well, the French firm Sogea has been active in the construction of Karachi airport terminal, which has the latest facilities.

As markets developed in Pakistan, the inflow of foreign investment has increased. In earlier years, the scarcity of manufactured items, which required simple and basic technologies like tea blending, tobacco processing and paint manufacturing made investment attractive for foreign investors. As a result industries like tobacco, pharmaceutical, petroleum and vegetable ghee attracted large amounts of direct foreign investment. In the recent years, however, foreign investment has been shifted towards sector such as energy, oil and gas, fertilizers, pharmaceuticals and light engineering industry. The US, German, British and other pharmaceuticals came in the second wave. Many European, Korean and Middle-East companies are active in construction, communications and other fields. Japanese are mainly in the automotive industry like Toyota, Nissan, Suzuki, Hino, Honda. Currently about 250 foreign companies are operating in the country. According to a large number of analysts, no foreign company, which entered Pakistan, has ever left the country, rather they have been expanding their operations through expansion and diversification.

Pakistan was among the first few countries in the region to open up the market in early nineties. Now the foreign investors can virtually invest in any sector except a few. Opening up of market and initiation of process of privatization made Pakistan a center of attraction. Since 1994-95 FDI has registered a constant downward trend. But even during this period foreign investment has continued to come in projects like ICI Pakistan's PTA plant, Engro, Pak tank and Engro Asahi polymer to name a few.

In the future, Pakistan will need to broaden the scope for FDI by giving greater attention and emphasis to the following areas. First foreign investment should also be encouraged in the services sector such as banking, insurance, shipping, aviation, and consulting services. Second, Pakistan should open up onshore exploration of oil and gas for FDI. Given more conductive policies, procedures and infrastructure, Pakistan will be able to attract larger amounts of FDI, particularly in high-technology industries. As long as the foreign investors are not assured of a reliable and efficient system for acquiring foreign exchange to import raw materials and spare parts and to remit profits, they will continue to be reluctant to invest. The absence of such a system also prevents the development of effective backward and forward linkages. Other issues that need to be addressed are availability of imported inputs at international prices; transport and communication links and availability of water and energy in many locations. Of course, most of the above-mentioned issues are equally applicable to domestic investments in Pakistan.

(The author is lecturer at the Department of Economics, University of Karachi.)