Problems & prospects

May 10 - 16, 2004

The economy of Pakistan, like other developing economies, is characterized by capital deficiency, a narrow industrial base, low capital-labour ratio, large disguised unemployment, lack of technical and managerial skills, a culture of inefficiency and overwhelming reliance on export of primary goods. Foreign investment, particularly, foreign direct investment (FDI), can be an important instrument of overcoming these structural weaknesses necessary for transition towards development.

The role of foreign investment as an impetus to economic development depends in the main on two factors: the magnitude or level of investment and the direction of investment. Since the purpose of attracting foreign capital is to supplement the domestic resources, the level of foreign investment must be such that it fills the gap between domestic savings and the desired level of investment. The gap in case of developing economies is rather high. In case of Pakistan, for example, domestic savings constitute only 15-18 per cent of GDP.

In order to increase the level of foreign capital inflows, developing countries liberalise their trade and investment regime by relaxing governmental controls and offering a number of financial and trade incentives like tax concessions and tariff reductions. Though exceedingly important, the right level of foreign investment is not enough.

What also matters is the direction of investment, that is, in which sectors it is made. For this purpose, the host country has to pursue active liberalization policies. For instance, to overcome trade deficit, the host country may encourage greater investment in export-oriented sectors or require foreign enterprises to export a particular percentage of their locally made goods. To increase employment generation, special packages may be announced for investment in labour intensive industries. To ensure that FDI stimulates domestic economic activity, the host government may make it mandatory for the foreign investor to use a certain amount of locally made inputs in production of final goods. This is called local content requirement. For up-gradation of technical and managerial know-how, the recipient country may require the foreign enterprise to transfer technology to domestic industry or to employ a particular proportion of local talent in managerial and technical positions. To broaden the domestic industrial base and give a momentum to industrialisation, investment in only those sectors may be opened to foreigners which are vital to the development of other sectors.

One problem with such measures, however, is that they may become an impediment to FDI inflows. Secondly, under the Agreement on Trade Related Investment Measures (TRIMs) of the WTO, many of such measures are disallowed. A third problem is that when countries conclude international investment agreements, they insist that their enterprises investing abroad should be given greater freedom in terms of choice of industries and production and marketing operations.

Let's have a glance now at the level and direction of FDI in Pakistan. From 1992-2003, total FDI in Pakistan has been worth $6.4 billion. This makes average investment per year nearly $550 million. The volume of investment was highest during 1995-96, when FDI crossed $1 billion. The surge in investment was mainly due to agreements signed with independent power producers (IPPS). However, subsequently FDI registered a fall. It touched the low water mark in 2000-01 when it was only worth $322 million. The main reasons for the fall in investment were the discontinuity and unpredictability of policies particularly the government's row with the IPPs, Pakistan's decision to go nuclear and the subsequent restrictions which that decision invited, and the Kargil conflict with India. However, in 2001-2002, there was an increase in FDI as it touched $485 billion. During the last financial year, FDI further rose to $798 million. In the first eight months of the current fiscal year, FDI receipts stand at $385 million registering a fall by 39 per cent over the last fiscal year's corresponding period.

Interestingly, while global FDI inflows registered a fall in 2002 from $735 billion in 2001 to $651 billion, FDI in Pakistan and South Asia rose. In South Asia, FDI rose from $4.07 billion in 2001 to $4.5 billion in 2002. In 2001, India accounted for 83 per cent of FDI inflows into South Asia, however, in 2002 its share dropped to 76 per cent. In contrast, the share of Pakistan in South Asian FDI receipts almost doubled from 9.46 per cent in 2001 to 18 per cent in 2002.

As for the direction of investment, during last one decade, the largest amount of FDI has been made in the energy sector, which accounts for more than 42 per cent of total FDI. The share of manufacturing has been about 25 per cent followed by the services sector whose share is 21 per cent. During 2002-2003, however, the banking and finance sector overtook the energy sector as the largest FDI sector. It attracted investment worth $207 million — 25 per cent of total investment.

Having glanced at the level and direction of FDI in Pakistan, let's look at the country's foreign investment regime, which consists of three components: regulatory, economic and socio-political. Courtesy privatization and deregulation, Pakistan has a very liberal regulatory regime. The regulatory framework for foreign investment consists of three laws: Foreign Private Investment (Promotion & Protection) Act 1976; Furtherance and Protection of Economic Reforms Act 1992; and Foreign Currency Accounts (Protection) Ordinance 2001. Owing to increasing emphasis on the protection of intellectual property rights (IPRs), Pakistan has also updated its IPR laws to bring them in compliance with international requirements particularly those mandatory under the Agreement on Trade Related Intellectual Property Rights (TRIPs) of the WTO.

The salient features of Pakistan's regulatory regime are:

•There is freedom to bring, hold and take out foreign currency from Pakistan in any form.
•Fiscal incentives provided by the government cannot be altered to the disadvantage of the investor.
•The privatization of an enterprise is fully protected. It cannot be re-nationalised. Nor can the government take over any foreign enterprise.
•Original foreign investment as well as profits earned on it can be repatriated to the country of origin.
•Equal treatment is provided to a foreign investor and local investor in terms of import and export of goods. FDI is not subject to taxes in addition to those levied on domestic investment.
•Foreign currency accounts are fully protected and they cannot be freezed (courtesy the Foreign Currency Accounts Ordinance 2001).

As regards to investment policy, all economic sectors including the service sector are open to FDI. Foreign equity up to 100 per cent is allowed in all sectors save the agriculture sector where it is allowed up to 80 per cent. In manufacturing sector, there is no lower limit on the size of FDI. In services and other sectors it is $0.3 million. No government sanction is required for setting up an industry in terms of field of activity, location and size except in case of four sectors. To avoid double taxation on income earned by foreign investors, Pakistan has concluded agreements with 51 countries. The list includes most of the developed countries. Pakistan has also bilateral investment protection agreements with more than 40 countries.

Pakistan has also rationalized its tariff regime. Custom duty on import of most of the primary raw material is not more than 5 per cent, while that on imported machinery is between 0 and 10 per cent.

As for the IPRs framework, copyright law has been amended while laws regarding patents, industrial designs and trademarks have been re-enacted. The purpose of fresh legislation is to broaden the scope of IPRs, particularly to protect the works of foreign authors inventors and firms in the same manner in which the works of local authors or firms are protected.

Though IPR laws have been updated, their enforcement needs a lot to be desired.

This is particularly true in case of copyright enforcement as piracy, especially that of software, is rampant in the country.

Pakistan's economic indicators have also improved. Growth rate is 5-6 per cent. Rupee is stabilized and inflation is less than 4 per cent. Banking system has been revamped, interest rates have been cut and the level of liquidity improved. The working of the capital market has also vastly improved. Add to this Pakistan's improved relations with the USA in particular and the western world in general. This is important because an overwhelming majority of MNCs in the world are either American or European firms. In Pakistan itself, out of the 300 major foreign enterprises having their production facilities 145 are European and 70 American.

This is a rosy picture. But all is not rosy in Pakistan. The investment climate has its thorny side. Take political uncertainty first. Political instability has been endemic in Pakistan. During 1990s four governments and parliaments were dismissed and three general elections held. Towards the close of the decade, the civilian set-up was replaced with a military regime. Frequent changes in government have made continuity and predictability of policies difficult thus adding to the risk of doing business in Pakistan.

Law and order situation is another factor. During last one and half decade, the twin menaces of sectarianism and ethnicism have run rampant in Pakistan. They have told upon our economy and presented Pakistan as an intolerant, lawless society. In many cases, foreigners and facilities owned by foreign enterprises have been attacked.

The third factor is lack of human capital. Wages in Pakistan are low but productivity is also low. While making investment decisions, MNCs take into account both worker productivity and wages.

Infrastructure, including rail, road and telecommunication network, and price and availability of utilities is another area that needs a lot of improvement. Cost of water and power for business customers in Pakistan is higher than those in other neighboring countries like India and China. Infrastructure is also not up to the mark. Poor infrastructure and high cost of utilities increase the cost of doing business and make the country a less attractive market for FDI.

Last but not least is the cultural factor. An overwhelming majority of existing or potential MNCs in Pakistan are from the West. The people of the West have a different lifestyle from us and want to continue that while staying here. However certain self-righteous people want to impose their own values on foreigners and thus meddle into their personal private lives. Nothing irks these foreign investors and managers more than meddling into their personal lives.

In brief, Pakistan has a lot of potential to attract foreign investment. However, there are factors like political uncertainty, poor law and order, low labour productivity and cultural intolerance that have, and are likely to bottleneck the growth of foreign investment.