FDI - A BROAD AGENDA AND CHALLENGE

According to the BOI, more than 600 foreign companies are successfully engaged in business activities in the country

RESEARCH DEPARTMENT
Mar 26 - Apr 01, 2007

For a country, the relationship of FDI and competitiveness is best transmitting through the impact of foreign direct investment on economic growth. The government during the last seven years, constancy, continuity and clarity of the policies due the accomplishment of the wide reforms program under takes the piercing rise of FDI in Pakistan. Structural reforms, high growth and macro economic stability are the reasons for such a sky-high rise in FDI. The continuity of FDI of such magnitude would be a golden chapter in the country's history. Nevertheless, mergers and acquisitions are significant form of FDI. Mergers are the most common way for multinationals to do Foreign Direct Investment.

The regulatory framework of a country frequently plays a pivotal role in deciding the success of such investments. Although promoting and arranging such investments are complicated, an effective regulatory environment and strong policy framework can make such investments successful.

According to the BOI, more than 600 foreign companies are successfully engaged in business activities in the country.

FDI inflows may be spurred by allowing foreign investors to participate in the privatization of public sector enterprises. In Pakistan, the process of privatizing state owned enterprises began in the late 1980s. In the beginning it played a very limited role but with the establishment of privatization commission in 1990s the FDI flows gathered momentum. So far the government has included seven major sectors in its privatization programmed are banking, financial, oil and gas, Power, Telecommunication, infrastructure, industry and transport sector.

FOREIGN DIRECT INVESTMENTS IN PAKISTAN

Pakistan is being chosen as a place for doing business as compared to other countries. According to the World Bank 2006 report Pakistan ranked 74 in the world for doing business and as of World investment report 2006 Pakistan comes under Matrix of inward FDI performance and potential with low FDI potential and Under-performers scenario.

The largest sources of foreign direct investment in Pakistan is financial business, which contribute 26.4% in first seven month of current fiscal year (June 06-Jan 07). The practice and occurrence of merging and acquisition of banking sector is being witnessed on rise benefiting the banking industry. Banking sector ranks high worldwide on account of its high profitability, but its current growth has short-run benefits for the country. Role of FDI in GDP growth is very high at 21 to 29 per cent in the past two years. Increased FDI inflows were partly determined by large acquisitions and consolidations, such as the largest acquisition of Union bank by Standard Charted Bank for $ 487 million (Standard Chartered Press Released 09-Aug-06). Standard Chartered has a 140 years history in this part of the world. Originally, the Chartered Bank became Standard Chartered after a merger of two British owned entities with large network in Asia and Africa in 1980s. And later, ANZ Grindlays was also taken over by SCB making it the largest foreign banking entity in Pakistan. Similarly the acquisition of PICIC by NIB an amount of $ 300 million, Dutch Bank and ABN Amro mutually acquired Prime bank by an amount of $ 227 million, which shows a massive interest of foreign banks in Pakistani banks.

The second largest sources of foreign direct investment in Pakistan are telecommunication sector, the growth of telecommunication in FDI is witnessed as 26.1% during first seven months of current fiscal year. In developed countries, the cellular access is at maximum and there are very little growth predict. Therefore most of the worldwide cellular companies now focus on developing countries. In Pakistan, more worldwide companies have shown interest in investment after successful operation of Egypt-based Mobilink, Norway-based Telenor and UAE-based Warid.

Telenor brought the single largest FDI (about 18 billion rupees) in 2005 and was planning to invest approx 60 billion rupees over the next 5 years (Telenor Press Released, 01-03-2006) followed by Warid with an investment of $140 million to $150 million in the first phase of its launch in 2004. China mobile has acquiring Paktel for $ 2.84 million dollar, and the companies are investing their profits as they see more growth in the telecom sector. So far, the mobile companies plan invest $ 2.4 million dollar in telecom infrastructure.

There is keen competition among developed and developing countries to attract foreign direct investment (FDI). Foreign investors have been allowed participation in local projects on 100% equity basis. In Pakistan, USA and UK have the major shares in country's FDI inflows i.e. 24.5% and 23.3% respectively in first seven months of current fiscal year 2006-2007. The other countries significantly contributed in FDI have been U.A.E (14.1%), Switzerland (6.2%) and Netherlands (3.0%).

IMPACT OF FOREIGN DIRECT INVESTMENT

FDI's impact depends on many conditions. FDI is the largest source of external finance for developing countries. FDI has the potential to generate employment, raise productivity, employment and skill levels, technology diffusion and knowledge transfer, linkages and spillover to domestic firms, enhance trade and exports and contribute to the long-term economic development of the world's developing countries. FDI not only increases domestic competition but also access to inputs, resulting in increased domestic productivity. Well-developed and implemented policies can help maximize its gains.

A number of studies have been undertaken to determine whether FDI impacts positively on economic growth. Two types of studies-macro and micro have been conducted to study the relationship between FDI and growth. Micro studies usually find no positive evidence that FDI makes a positive contribution to growth. Macro studies, conversely, often find FDI to positively affect economic growth under certain conditions.

FDI affects growth positively by decreasing the costs of research and development (R&D) through stimulating innovation. However, volatile FDI flows could deter innovation due to uncertainty of R&D costs.

REASONS TO INVEST IN PAKISTAN

Among many others five main reasons to invest in Pakistan.

1. Rich land and Natural capital

* Widespread agricultural land
* Crop production including wheat, cotton, rice, fruit, and vegetables.
* Mineral reserves including coal, crude oil, natural gas, copper, iron ore, gypsum etc.
* Fisheries and livestock production

2. Physically powerful human resources

* English speaking work force
* Cost-effective managers and technical workers.

3. Bulky and mounting Domestic Market

* 160 million consumers with growing
* A growing-middle class moving to sophisticated consumption habits

4. Well-Establishment infrastructure and authorized systems

* Comprehensive roads, rail and sea links
* Good quality telecommunications and IT services
* Modern company law
* Long-standing corporate culture

5. Tactical location as a regional core

* Principal gateway to the central Asia Republic
* Strong and long-standing links with the Middle East and South Asia
* Comprehensive duty-free facilities for investors

Altering FDI Trends Require Governments to Take on New Promotion Strategies

Recent trends in foreign direct investment have created a unique opportunity for developing countries to attract the international resources, technologies, and skills essential for economic growth.

Foreign direct investment has been flowing from more sources and into more sectors than ever before. Although foreign investment to developing countries has fallen by 26 percent since 1999, its growth over the past 13 years has been phenomenal, averaging more than 17 percent a year in dollar terms. And investment flows between developing countries have also risen dramatically, now accounting for 30 percent of foreign investment in these countries, up from just 17 percent in 1995. Foreign investment is now targeting domestic markets, such as banking, retail and construction, instead of focusing primarily on the more traditional and export-driven natural resource and manufacturing sectors.

Countries that fail to respond to these trends when developing policies to attract foreign investment could be left behind. What strategies should they pursue to capture these new foreign investment flows? Some argue that strategies should focus on promoting specific sectors rather than on improving a country's macroeconomic conditions. Others say it is important for countries to address microeconomic fundamentals, such as the reduction of burdensome land and tax regulations and other forms of red tape.

WHAT AND HOW?

What type of foreign direct investment should countries try to attract? Which sectors should they target for such investment? When should countries use incentives to attract foreign investment, and which types of incentives should be used? Which factors have led to the change in foreign investment flows? How important are investment promotion agencies in getting more and better foreign direct investment?

NEW COURSE OF ACTION TO ATTRACT FOREIGN DIRECT INVESTMENT

* The best way to attract and benefit from FDI is to improve the investment climate in the country at both the macro and micro level.

* In effect competition is the best way to ensure that the good practices brought by FDI diffuse rapidly among competitors, suppliers and consumers. Competition is also a good way to keep FDI companies on their toes and to force them to keep reinvesting.

* The micro conditions required for high investment and competition levels differ from one sector to the other (e.g. efficient customs and infrastructure for exporters, access to land and equal tax enforcement for retailers.

* All sectors are potentially important given increasing complexity and interlinkages of the globalizing economy (e.g. telecom for remote services, retail to put pressure on manufacturers and construction for tourism).

* Investment promotion agencies have narrowly focused on providing incentives to export manufacturers.

* A new kind of institutional set up is needed to push this agenda, some combination of investment promotion/facilitation, competition agency and supreme economic councils.

* Deep sector level analysis is critically needed to identify the key binding constraints sector by sector.

CONCLUSION

If we critically analyze the pattern of Foreign Direct Investment inflows over the last decade, we will find that Pakistan performed healthy in this field. In spite of, numerous motivation packages, FDI has risen from a vigorous amount of $1101.7 million in 1995-96 to $3521 million in 2005-06 showing a significant increase of 219.6% an amount of $2419.3 million. Apart from that Pakistan has poor physical and institutional infrastructure, unsatisfactory law and order situation, and last but not the least political instability. Finally Pakistan is a business society where private investors are accepted as participants in the process of economic expansion.