Beware of the slipping management control of strategic entities into the hands of foreign investors

Nov 28 - Dec 04, 2005

Pace of develop in any developing country is dependent on a number of factors, the most important being fresh investment in creation of new productive facilities and infrastructure projects. As opposed to decade of nineties, in the new millennium private sector is not only playing a major role but also investing its own funds. The proactive role being played by the local entrepreneurs has also resulted in substantial inflow of foreign direct investment (FDI). A remarkable feature is that the FDI is not concentrated in a few sectors alone.

Before reviewing the quantum of FDI and preferred sectors it is important to first of all examine the overall investment in the country. According to the latest Annual Report of State Bank of Pakistan (SBP) nominal investment grew strongly during 2004-05 remaining well above the 5-year average of 10.5%. This growth was driven by robust macroeconomic fundamentals, increased availability of credit and significant rise in FDI. Indeed, even the slowdown in investment growth relative to 2003-04, is probably attributable to a high-base effect, and a sharp rise in the investment deflator, as much as the gradual tightening of monetary policy.

However, the cause of concern is that despite the rise in nominal investment during the preceding three years, the investment to GDP ratio has remained stagnant in recent years, continuing to hover around 15.5% in the last three years. While the decline in public investment as a percentage of GDP is consistent with the increasing importance to the private sector, the absence of corresponding acceleration in private investment is disappointing. The growth in private gross fixed investment in 2004-05 was much lower than expectations and does not conform to the behaviour of other components that form the investment goods basket. This raises serious doubts about the derivation of investment series in the national accounts. Either the coverage is incomplete and all activities are not fully reflected or the methodology of compiling the annual expenditure estimates is deficient. The federal ministries of Finance and Planning should examine this inconsistency in depth.

Another point of concern is that although the investment to GDP ratio remained stagnant in recent years, the steady decline in the savings to GDP ratio drove the saving-investment gap into deficit during the last financial year. The gap is not large by historical standard, and by itself, would not be a source of concern. However, given that the gap has emerged from a fall in savings rather than a rise in investment, even this low deficit should be a major cause of concern. Interestingly, the saving-investment gap entirely stems from the fall in private savings relative to private investment, while public sector emerges as a net saver.

Having said that it is important that investment has been broad-based and diversified. Investment in agriculture sector witnessed double-digit growth during last financial year, for the first time since 1998-99 with both, the private and the public sectors contributing to this acceleration. With the increased availability of institutional credit for the agriculture helped pushed up private investment, a significant increase in public sector development program supported the growth momentum in public sector investment.

Investment in the manufacturing sector witnessed a robust growth of 23% compared to 13.1% increase in the preceding year. The growth was equally shared by both large sector and small scale sub-sectors. This reflects a number of factors, including 1) strong demand on the back of rising income as well as easy availability of consumer financing, 2) capacity constraints in some of the industries, 3) aggressive investment by the textile sector and 4) recovery by the construction sector. The resulting nexus of strong demand, rising capacity utilization and improved credit availability allowed in deed capacity expansions by many sectors.

Investment in the services sector witnessed a growth of 11% as compared to a much sharper rise of 37.7% in 2003-04. This slowdown is also evident in a decline in the investment to GDP ratio for the services sector. The point worth noting is that investment to GDP ratio in the commodity-producing sector is trending downwards, it is gradually rising in services sector.

The contribution of private sector investment in the transport and communication sub-sector has been on the rise due to rising economic activities, privatisation and emerging attractive opportunities in the communications sector correspondingly the share of public investment in the sector is declining. Liberalization of telecommunication sector resulted in significant growth in private investment of 42.2% over an equally strong increase of 39% in the preceding year. This rise can be attributed mainly to the entry of two new mobile telephony companies.

After dipping to 19% in 2003-04, the growth in FDI resumed its near term trend growth, rising by more than 60% during last financial year. While this compares favourably with the rise of only 6% in global FDI flows, it must be kept in mind that the high growth rate simply reflects a low base. In fact, despite this substantial rise, Pakistan's share in overall flow of global investment rose by 0.1 percentage points, to a little above 0.23%. Even within the developing countries Pakistan's share of FDI rose only marginally, to reach 0.6%,

The most heartening point is that in the recent years Pakistan's performance in attracting FDI has improved significantly, with the growth during the last three years averaging approximately 48%. This compares very well with many countries in the region. This is clearly a reflection of 1) successful liberal regime to attract the foreign investment, 2) improved macroeconomic fundamentals, 3) appropriate amendment in laws and regulations governing FDI and 4) effective implementation of reforms to improve governance level. This has also reflected by the Pakistan's improved competitiveness ranking from 91st in 2004 to 83rd in 2005. However, the country's ranking in terms of attracting FDI is still very low. Saying is that it is worth noting that the latest Doing Business Survey 2006, published by World Bank and International Finance Corporation has ranked Pakistan 60th out of 145 countries in the index of ease of doing business. The DFI inflow during last financial year has been relatively broad-based or almost all the sectors witnessing higher inflows. The most significant influx was due to privatization in telecommunication and banking sectors. Excluding these sectors the DFI inflow was rather small.

Another factor responsible for higher DFI inflow has been addition of new capacities due to capacity utilization touching the designed capacity. The inflows have been well diversified in terms of geographical distribution. Top three sources contributed slightly more than 57% of the total FDI during last financial year. Previously, the US alone had accounted for over two-thirds of the have been on the rise. Inflows from the UAE were highest during last financial year. This may be a positive sign but the decline in inflow from the US should be a cause of concern because it has biggest share in global FDI. In fact, more than 41% or US$ 255 billion of global FDI in 2005 was directed to developing economies. In terms of sectoral distribution, the UK-based FDI was largely in Oil and Gas exploration. The inflows from the US were mainly concentrated in mining and communications. The inflow from UAE was also concentrated in telecommunication sector.

According to the figures recently released by the central bank total foreign private investment during July-October period increased by 127% to US$ 682 million from US$300.3 million in corresponding period of last year. During this period FDI increased by 69% on YoY to US$ 465.7 million from US$ 275.3 million and portfolio investment by 765% to US$ 216.3 million, as it was US$ 25 million in corresponding period last year. A significant feature of the data was that besides FDI, YoY basis inflow of portfolio investment in the country was enormously increased. It has registered steep rise right from the beginning of the current financial year.

During 2004-05, total investment inflow had crossed US$ 1.67 billion mark as against US$ 921 million in 2003-04. However, for the current fiscal year the government expects further improvement in foreign investment, especially with the improvement in macroeconomic indicators and infrastructure. Comparing inflow of foreign private investment in October with the same month last year, the data shows that it increased by 111% to US$ 208.3 million, as against US$ 98.5 million during October 2004. Among this FDI increased by 45% to US$ 136.9 million and the portfolio investment jumped to US$ 71.4 million in October 2005 as compared to US$ 4.3 million in October 2004.

The break up of investment by countries shows that US was the biggest investor in Pakistan with US$ 117.7 million and portfolio investment US$ 138.7 million, totalling to US$ 256.3 million during July-October 2005 period. United Kingdom is next with total investment of US$ 95.5 million, including FDI of US$ 53.2 million and portfolio investment US$ 42.3 million. However, in terms of direct investment, UK was third following United Arab Emirates with US$ 67 million. A significant feature of the data is that US portfolio investment during the period showed a high growth, as in July-October it grew to US$ 138.7 million from US$ 12.5 million during corresponding period last year. Besides, this FDI also grew to US$ 117.7 million from US$ 79.5 million.


A closer look at the foreign investment being made in Pakistan also raises some common concern. While some of these may not be serious threats, these have to be explored and addressed prudently. Sale of national assets to foreign strategic investors, through privatization, also raises some eyebrows. The immediate critiscim is that the control of Pakistan's key sectors like banking, telecommunication, power generation and distribution has gone into the hands of foreign investors. On top of this concentration of control in three/four countries gives them power to dictate their own terms and conditions. One may say that the rules and regulations do not provide them such power now, but one just cannot ignore the potential threat.

The management control of two of the largest commercial banks of Pakistan is now in the hands of the foreign investors. Share Purchase Agreement for the transfer of KESC's management control has been signed. The efforts are going on to convince Etisalat to take control of PTCL on terms, which would be very different from the terms and conditions agreed at the time of bidding. Management control of two of the largest IPPs is already in the hands of foreign investors and more of the state owned GENCOS and DISCOS may go into the kitty of foreign investors, as a result of their privatization.


It is right that FDI inflow quantum has on the rise but it is also true that Pakistan has not been able to attract any significant investment in the textile sector. It is necessary to reiterate that developed countries are shifting their textile manufacturing facilities to less developed countries and/or outsourcing the jobs. However, local entrepreneurs have not succeeded in forming any joint venture or soliciting outsourcing contracts. One may say that some of the entrepreneurs have succeeded in striking the deals, but these are the result of individual efforts rather than the joint efforts of the government and the entrepreneurs.

Last but not the least Pakistan just cannot succeed in attracting FDI without the active participation of the local entrepreneurs. Foreign investors are always on the search for a credible local participant. There may not be dearth of such entrepreneurs but the role of match-maker has to be played by the government.