PRIVATE FOREIGN INVESTMENT
BY S. M. Mazhar Hasan
Jun 05 - Jun 11, 2000
This paper examines the trends in the flow of private foreign investment in Pakistan during 1990s. The importance of such a study lies in the fact that for capital deficit developing countries, foreign investment is an alternative course to speed up industrialization without creating debt problems. It also answers the question why the country lagged behind other countries in the region in attracting sufficient amount of foreign investment despite a host of favourable measures adopted in this relation. The leading constraints have been outlined and it has been shown that along with other measures, the credibility gap has to be filled in to attract foreign investment.
Commercial loans from abroad involve government guarantee and their repayment is not dependent on the success of the project. In sharp contrast to this, foreign investment does not create fixed obligations in foreign exchange and profits are directly related to the success of the project. Moreover, it adds to the limited productive resources of a country in the form of capital, technology, trained labour and entrepreneurship. It also enhances the accessibility of host countries to the global market. Indirectly, it helps in meeting the current account deficits and building of foreign exchange reserves. As foreign investors have a vast level playing field, they are more selective and careful in their investment decisions and ensure efficient utilization of resources. A reversal of investment (outflow) exerts adverse effects on the balance of payments and on the local currency as has been witnessed in the East Asian economic crisis of 1997-98. Countries like Pakistan remained unaffected by the crisis mainly due to their low exposure to foreign investment.
Trends in inflow of foreign private investment in Pakistan:
Pakistan has traditionally been a debt receiving country. Foreign investment has played a comparatively smaller role in the overall economic development of the country. With the rising debt burden and stringent conditionalities attached to loans, foreign investment has emerged as an alternative viable option. Average net inflow per year was about $16 million during 1970s, $103 million during 1980s and $766 million during 1990s. Thus contrary to common belief, there has been perceptible improvement in foreign investment inflows during the current decade. However, looking at the picture on annual basis, it is observed that net inflow of foreign private investment in Pakistan amounted to $212 million during 1989-90, which increased to $554 million in 1991-92. It fell to $443 million in the succeeding month but increased continuously during the next three years to reach at a record level of $1532 million in 1994-95. The net inflow showed a downward trend, thereafter, to reach at a low level of $403 million in l998-99. If we take the two components of foreign investment viz. direct and portfolio separately, it is observed that they depicted different behaviours over the years. While direct investment showed almost a steady growth over the years except in 1998-99, portfolio investment showed wide fluctuations. Direct invesment was at its peak at $1.1 billion during 1995-96 due mainly to large investment in the power sector. The power generating companies, were allowed to be treated at par with manufacturing concerns for the purpose of issue, transfer and export of shares. Portfolio investment, which was negative to the extent of $5 million in 1989-90, turned positive in 1991-92 and reached to $289 million during 1993-94. It reached an all time high of $1.09 billion during 1994-95 mainly due to massive inflow on account of sale proceeds of PTC vouchers worth $862.2 million. It fell, amid fluctuations, to $27 million during 1998-99 after the economic sanctions against the country following the nuclear test of May, 1998. This is indicative of the volatile and sensitive nature of such type of investment. Its disastrous impact was reflected in heavy fall in the stock market indicators of the country. The SBP General Index of Share Prices (1990-91=100) fell to 98.8 during l997-98 from 143 a year earlier and the market capitalization of shares declined to Rs. 259.4 billion from Rs. 469.2 billion over the same period.
Country- wise analysis of foreign investment:
A country-wise analysis of foreign investment in Pakistan shows that the US has been the largest investor in Pakistan during the decade Appendix-l. It accounted for 43.5 per cent of the total net inflow during 1998-99 followed by Japan (14.2 per cent), UK (12.7 par cent) and UAE (8.0 per cent). Together they contributed 78.4 per cent to total inflow during 1998-99 compared with 66.0 per cent during 1989-90.
In the total inflow, portfolio investment was negative to the extent of 2.2 per cent in 1989-90 which rose to an all time high of 71.1 per cent in 1994-95 but dropped to 6.8 per cent in 1998-99. The leading counties in case of portfolio investment during the decade have been the US, UK and UAE. Hong Kong also remained active in some years.
Pakistan's comparative share in total private investment:
It will be interesting to see how did net inflow of private foreign investment behave in some leading developing countries of Asia during the current decade.
Private Foreign Investment(Net)
In Some Developing Countries of Asia
Thus, in terms of volume, Pakistan exceeded only Bangladesh in attracting private foreign investment both in 1990 and l997. Of the total inflow of $172.9 billion during 1997, China claimed 30%, Thailand 4.9%, India 3.4%, Malaysia 2.8%, Turkey 1.8% and Pakistan and Bangladesh each 0.07%.
It may be noted that 1997 was the year in which the currency crisis started in East Asian countries with its contagion effects all over the world. The full effects of the crisis were reflected in the succeeding years.
Policies to attract foreign investment:
A poor share of Pakistan in the net inflow of direct private foreign investment to developing countries is surprising despite very friendly investment policies adopted during 1990s. The main thrust of investment policy during the decade has been creation of conducive environment with the focus on further opening of the economy to attract foreign investment. Foreign investment has been allowed on repatriable basis in agriculture, services, infrastructure and social sectors. Foreign investors can invest in industrial projects on the basis of 100 per cent equity without any permission of the government. No government sanction is required for setting up industries in any place (except the negative areas), field or size except arms and ammunition, high explosives, radioactive substances, security printing and alcohol manufacturing except industrial alcohol.
Manufacturing sector has been prioritized in four categories: a) Value added or export industries, b) Hi-tech industries, c) priority industries, and d) Agro-based industries. Machinery and plants not manufactured locally could be imported for category (a) and (b) free of any duty. Foreign private loans could be contracted to finance cost of imported plant and machinery for agriculture, infrastructure and social services.
A scheme of National Industrial Zones engulfing Industrial Estates, Free Industrial Zones, Free Trade Zones and Export Oriented Units within the area of its boundary was announced to be launched at few selected prime sites. All industrial units could be set up at these zones except specified units and competitive industries such as cotton ginning units, sugar, flour mills, steel re-rolling, beverages etc. Local DFIs/banks have been allowed to finance projects in the zone. There is no restriction on payment of royalty and technical services fee for manufacturing sector. However, such agreements will have to be registered with the State Bank of Pakistan and will be taxed at the rate of 15%.
Despite the favourable policy environment, the ratio of Gross Fixed Investment to GNP in the economy stagnated around 17% during 1990-1996 and showed continuous decline during the succeeding three years. It stood at its lowest level during the decade at 13.4 per cent in 1998-99. Due to privatization, public sector investment has been declining but private investment has failed to offset this decline.
Impediments to inflow of foreign investment:
According to studies on capital inflow issues, flows have been driven by domestic factors prominent being strong fundamentals i.e. high investment- GDP ratio, low inflation and exchange rate stability. Countries with strong fundamentals received the largest inflows. These basic fundamentals were weak in case of Pakistan. Inflation, measured in terms of Combined Consumer Price Index remained at the average of 10.1 per cent during l992-99. The rupee, which stood at Rs. 21.92 to a dollar in 1989-90, depreciated to Rs. 51.70 at end- June 1999. Fixed investment remained stagnant during 1991-96 and, in fact has been falling thereafter as mentioned in the preceding section.
Investment has been captive of a host of other factors also. These included frequent change in Government, reversal of policies, withdrawing of already announced concessions/exemptions bad law and order situation; aging infrastructure, higher interest rates and higher utility charges and corruption. But foremost critical factor hindering inflow in foreign investment in recent years has been the credibility gap resulting from row with independent power projects. Although agreement in this relation has been reached with most of them, the stalemate continues with some of them, including the largest of these units viz. the Hub Power Project. Moreover, the freezing of the foreign currency accounts and non- adherence to the terms and conditions of such accounts scared the foreign investors. The crisis was further deepened by the exchange control restrictions following economic sanctions in the wake of nuclear test, worsening trade balance and downgrading by international credit rating agencies.
1. Foreign investment responded favourably to the investment friendly policies in the country specially in the first half of the decade. A downturn look place since 1995-96. However, it performed poorly when compared with other countries in the region.
2. Domestic investment remained stagnant and has actually been falling since 1996-97. To induce foreign investment local investment needs to be revived.
3. The credibility gap has to be filled in by restoring investors confidence through long-term economic policies.
4. The privatization process needs to be revived.
5. Going deeper into the circumstances before and after May, l998, it is observed that the country was already under a debt trap. Increasing current account deficit and the budgetary gap have put the country into a vicious circle rising borrowing, larger debt servicing, wider fiscal deficit and again more borrowing. Borrowings in their wake bring conditionalities from the lending agencies culminating into exchange rate depreciation, higher utility charges, costly imports and rising production cost nullifying any major breakthrough in exports. All these go to erode investors confidence. So the final solution lies in eliminating this vicious circle through short and long term measures to fill the two gaps. This calls for expanding the tax base, mobilizing more revenues and containing expenditure. At the same time, it calls for export expansion through value addition and quality improvement and contraction in imports. Sound and stable policies will help in reviving local investment and attracting foreign investment as well.