INVESTMENT CLIMATE IN PAKISTAN
Inconsistency, adhocism, poor implementation, etc, continue to be the biggest irritants
By SHABBIR H. KAZMI
Sep 15 - 21, 2003
A broad-based economic recovery, further strengthening of macroeconomic stability and a near elimination of external account vulnerability has been the major success for Pakistan. However, the country still faces many challenges that include raising investment to sustain higher economic growth, reducing poverty, improving social indicators on sustained basis and improving the financial health of public sector enterprises.
These successes include: a sharp pick-up in growth, aided by stellar growth in manufacturing and a robust recovery in agriculture; double-digit growth in per capita income, low inflation, highly conducive interest rates environment, fiscal deficit reduction and foreign trade, registering impressive growth. Pakistan achieved surplus current account and foreign exchange reserves touched new highs. Credit rating of the country also improved.
Pakistan's overall economic performance has been relatively much stronger when compared with the economies of other developing countries within and outside the region. Pakistan posted a relatively stronger growth, exceeding the average growth of 4.6% of developing countries. The growth is not only impressive but is board-based as well as testifies to the sharp pick up in industrial activity. This is the second highest growth achieved during the last thirteen years. Another major success has been the sharp increase in real GNP growth.
(GDP Growth over last year in percentage)
Source: Economic Survey 2002-03
Pakistan faced severe fiscal imbalance and attained rise in public debt. These imbalances have had far reaching impact on country's investment and growth. As a results of recent efforts, fiscal imbalances have been narrowed. Fiscal deficit has been reduced due to improvement in revenue and curtailment of expenditure. Reductions in fiscal deficit and interest cost to finance deficits along with prudential debt management have resulted in substantial decline in domestic debt.
Pakistan seems to have recovered from its difficult past. Now it has to build on the current gains and use the strong foundation laid through the implementation of wide ranging structural reforms for sustained strong growth. Notwithstanding major progress made in many areas and key economic fundamentals improving in difficult external environment, Pakistan still faces some challenges, which need to be tackled on priority basis. The most important challenge being, boosting investment to sustain higher economic growth for reducing poverty.
Investment is one of the most important determinants of long-term economic growth. The stable macroeconomic environment influences investment. The stable macroeconomic environment is believed to be conducive for investment and therefore, to growth. However, the fresh investment has not picked up to the desired level. Analysts say, "Despite reduction in interest rates and growing demand new production facilities are not being created. However, most of the investment over the last couple of years has been for balancing, modernization and replacement (BMR)."
The immediate question that comes to mind is why the quantum of fresh investment is so low? The slow pace of fresh investment does not perturb many analysts. They say, "During the 1990s there was a sudden and substantial increase in installed capacities of various sectors, i.e. cement, sugar, automobile, etc. However, the demand did not pick up and most of these sectors still suffer from low capacity utilization. Therefore, unless capacity utilization crosses optimum level investment for creation of new capacities in these sectors is expected to remain low.
However, others say, "A serious concern is that some of the sectors need immediate and substantial investment but investors are shy to make long-term commitment. Since the local investors are shy the country should not expect major influx of foreign direct investment." Some analysts say, "Investment has no nationality. It goes to only those destinations that offer attractive return. Therefore, unless the policy planners stop discriminating between local and foreign investors the country may not succeed in attracting investors."
Total foreign direct investment (FDI) flows have experienced massive contraction globally since 2000 declining from almost US$ 1.2 trillion to US$ 500 billion in 2002. Both developed and developing countries have been affected by the reduction in FDI flows with the exception of China and Central/Eastern European countries where they have continued to rise. In such a difficult external environment, Pakistan succeeded to attract almost US$ 700 million FDI during July-April 2002-03 as against US$ 308 million in the corresponding period of last year. Oil and gas, financial sector (including privatization proceeds of United Bank), chemicals and transport together accounted for nearly three-fourth of FDI. Almost 30% of FDI have come from the UK followed by USA (25%) and UAE (16.3%).
The critics also do not support the GoP's policy of inviting non-resident Pakistanis to invest in Pakistan. As stated the non-resident Pakistanis have a right to choose the destination for their investment. They should not be black mailed emotionally. Pakistan's economic managers must create an environment whereby the country becomes a preferred choice.
Privatization programme being followed by the GoP has the potential to attract both local and foreign investors. The size of public sector industries has shrank from twelve holding corporations with 116 manufacturing units before the start of privatization in 1990-91 to seven corporations with 27 units. The key transaction yet to be concluded are — Karachi Electric Supply Corporation (KESC), Habib Bank (HBL), Allied Bank of Pakistan (ABL), Pakistan State Oil Company (PSO), Oil and Gas Development Company (OGDC) and Sui twins. The other entities on the privatization list are Pakistan Telecommunication Company (PTCL), corporatize entities of Power Wing of WAPDA and cement and fertilizer manufacturing units.
The GoP has already initiated the process for listing of a number of state-owned enterprises at local stock exchanges and sale of part of government holding through offer of shares to general public. After the successful sale of shares of National Bank of Pakistan (NBP) Privatization Commission intends to sell further shares of NBP, Sui Southern Gas Company (SSGC) and Pakistan International Airlines (PIA). This is the most appropriate time to divest GoP holding because of prevailing bullish sentiments in the equities market.
The critics of present economic managers say, "It is heartening to note that efforts have been made to improve the working environment. However, the common complaints, i.e. inconsistency, adhocism, poor implementation, etc, continue to be the biggest irritants. Some how the other we have not come out of colonialism myth, dividing people into two groups, the rulers and those being ruled. Most of the policies are being prepared without proper consultation with all the stakeholders. When the business community pinpoints anomalies a number of meetings are held. However, either most of these meeting remain inconclusive or even when certain amendments are agreed the required notifications are not issued for months."
For example it has been a tradition that Ministry of Finance asks chambers, trade bodies and associations to submit their budget proposals. However, it is on record that these suggestions are hardly considered. Some analysts say, "We understand that the GoP was under excessive pressure from multilateral lenders to follow their guidelines for preparing budget and often could not accept the legitimate demands of trade and industry. However, the practice must change now."
It may be of some interest to note the common complaint of Ministry of Finance. The complaint is, "Most of the proposals are either received so late that it is impossible to incorporate them in the budget or often the demand are made in isolation, without evaluating their impact on other sectors/sub-sectors." Though, the Ministry may not accept it but the fact is that there are some pressure groups in the country that often succeed in bringing certain amendments in the GoP policies that adversely affect the operations of other sectors/sub-sectors. The poor state of Pakistan's economy can be best described as 'The sad saga of toothless regulators and remorseless rent seekers'.
Some analysts say, "Lack of vision, protectionism, promotion of investment through SROs and concessional financing and area and industry specific incentives have been the major reasons for poor economic development of the country. The thrust of GoP's policy has been shifting from agriculture to industry or import substitution to export led growth. The absence of long-term commitment did not allow the country to achieve either of the objectives.
Though, it is often said that the largest number of companies were listed at local stock exchanges in 1990s and banks also disbursed very large quantum of funds, 1990s can only be termed 'lost decade', at the best. Most of the funds were disbursed to rent seekers only because of the SROs, a large number of units established during that era were not economically viable and companies were listed at stock exchanges with the sole objective of ripping off the small investors. The results of the banks, particularly the nationalized commercial banks and state-owned DFIs, are still carrying a heavy load of non-performing loans.
Protection of infant industries may be a must. However, one often fails to understand that most of the industries in the country continue to demand protection under infant status even though these have been in operation for decades. The two industries enjoying the maximum protection, for the longest period, in the country are textile and automobile. Textile sector enjoyed supply of cotton at subsidized rates for nearly four decades and virtually complete ban on import of textile products into the country. However, protection only proliferated inefficiency and mismanagement.
One of the reasons for higher prices of locally assembled automobiles is failure of the GoP to ensure implementation of deletion programme. Non-compliance of this programme did allow establishment and development of 'vendor' industries. The common complaint of local assemblers has been that the components and accessories produced in Pakistan do not comply with the quality standards. However, it sounds strange that over the decades they have not be able to help the local vendors. The general perception is that they were never serious in developing the local suppliers, they always wanted to import semi-knocked down (SKD) kits.
It has been a common complaint that locally assembled cars are expensive and delivery period is too long. Despite improvement in rupee yen parity, reduction in interest rates and improvement in capacity utilization prices of locally assembled cars have come down proportionately. This is only because Ministry of Production has not been able to implement its own decisions.
It is interesting to note that while the government functionaries are not able to implement their own decisions regarding automobile industry, they are asking manufacturers of cement and urea to reduce price — penalty for being efficient. It is true that the government has reduced CED on cement by 25% but the industry has been able to cut its cost mainly by switching from furnace oil to coal. While the industry was suffering due to higher fuel cost the government did not reduced CED for the benefit of consumers. However, since the industry has achieved a milestone, the government is putting pressure on the manufacturers to reduce the price.
However, policy planners do not understand that in case cement price is reduced the biggest losers would be the state-owned cement plants. Most of the cement plants that have been converted from furnace oil to coal belong to private sector. Almost all the state-owned plants are still running on furnace oil. Any reduction in cement price can only add to their losses and dampen prospects for their privatization.
As regards urea price, the policy being pursued by the government is a paradox. The price of feedstock was raised in July 2003 and the increase must reflect in retail price of urea but manufacturers were forbidden to adjust price. The premise was 'the urea manufacturers are making too much profit and do not pass on the benefit to farmers'. However, it is a total contradiction of the policy the GoP has been following as regards to Pakistan State Oil Company (PSO). The consumers of POL products are being ripped off to ensure that the company continues to pay around 100% dividend. In the case of PSO the biggest beneficiary has been the government. Isn't this hypocrisy?
Yet another failure of Ministry of Production is failure to resolve the problems faced by sugar industry. No one can deny the fact that sugar industry is the driving engine of rural economy. The key problems of sugar industry are inadequate supply of sugarcane, its price and absence of clear-cut sugar policy. While the government continues to enhance support price of sugarcane it does not allow the millers to increase sale price of sugar accordingly. Farmers prefer to maintain limited supply in the hope of solicit price above the fixed price. Higher support price and inadequate supply of sugarcane does not allow the mills to achieve higher capacity utilization. In the absence of sugar export policy even if sugarcane is available mills are reluctant to attain higher production, due to fear of over supply in the domestic market.
Reducing country's vulnerability requires sound macroeconomic policies, first and foremost sound fiscal policy. A culture of living within means and incurring debt (under reasonable terms) only for production purpose. Though, considerable improvement has been achieved in fiscal balance, continued vigilance is required to remain fiscally responsible.
In Pakistan, the successive governments remained fiscally irresponsible for a long period. A rule-based fiscal policy is absolutely necessary for achieving long-run fiscal sustainability. The government has already announced a policy, enshrined in a Fiscal Responsibility Law. Announcement of a policy or promulgation of a law is not sufficient. The government must follow the policy in letter and spirit and avoid popular policies to achieved sustained growth.
The sustained high growth of large scale manufacturing over the last three years simply reflects the relatively higher capacity utilization rates at the backdrop of improved macroeconomic environment. Until and unless the excess capacity is utilized to a larger extent, investment rate may not accelerate in the short-term. A stable macroeconomic environment is still a pre-requisite even to encourage higher utilization of capacity in the manufacturing sector.
Reducing poverty and improving social indicators are the other challenges. Poverty should not be viewed in terms of low income alone. Lack of access to education, health, clean drinking water and proper sanitation are also the various dimensions of poverty and need to be addressed rigorously.
Sound macroeconomic policies are not an end in themselves they simply indicate government's commitment. While Pakistan has achieved a broad-based economic recovery but maintaining the growth rate is a must. Recent estimates may suggest a marginal decline in poverty but poverty alleviation cannot be achieved without investing more and more in creating new manufacturing facilities and infrastructure projects.
Macroeconomic stability and the blanket investment policy cannot help in convincing the investors to make long-term commitments in Pakistan. The GoP must come up with sector-specific policies, remove the existing irritants and restore confidence of local investors. Unless local investors are willing to make long-term commitment, Pakistan should not expect any large-scale foreign direct investment.
Last but not the least, the country still suffer from negative perception. The key factors adding to this negative perception are law and order situation and the ongoing political confrontation. Despite the US terming Pakistan its best friend, it does approve travel of US citizens to Pakistan.