IMPORTANCE OF FDA IN PAKISTAN ECONOMY
Aug 13 - 19, 2007
Global liquidity has benefited almost all the economies of the world. It has played a key role in bringing a new life to the developing economies that were dead just few years back. Petro dollars earned by oil exporting countries due to rise in international oil prices from $20 per barrel in 2002 to $72 per barrel now has been a catalyst to this liquidity. Moreover, growth in developed economies that was brought by increase in their local consumption led to the creation of exportable surplus in developing economies resulting in the earning of higher exportable surpluses. Due to Lower yields on treasury securities and higher fluctuations in leading currencies, it had become very important to find avenues to invest surplus dollars and hence foreign direct investment that was already existent but at a lower scale became the driving force to boost the world GDP at record pace and increase contribution of developing economies in it.
Pakistan is no exception to this global phenomenon. If one looks at the remarkable growth than economy has witnessed in last five years then one does not need to be an Einstein to understand the immense importance that FDA has in Pakistan's economy. Pakistan is very prominent on the world map as a nation where low savings is a cultural problem and hence ambitious GDP growth targets can not be achieved by merely relying on local savings which currently stands at 14% and is declining with each passing year as base effect is increasing due to escalating size of GDP.
When we talk about foreign direct investment we are actually talking about the role of private sector in the economy. Pakistan has a very interesting record in policy making for the private sector. There was an era when Government policies supported the private sector up to an extent that it witnessed exponential growth, however this growth was ruined by subsequent Governments that almost washed the trust and role of private sector in Pakistan.
The private sector started contributing in industrial development in 1950s and there was a need to build their trust and give them support through an efficient banking system which was in reality absent at that time. However ambitions were high and hence private sector somehow managed to come up and build a support for itself to develop further. It was Government policies that could take private sector in either direction but fortunately these policies supported this upward momentum. As a result the economy was largely dominated by private sector in 1960s. It was the time when an integrated development was required where economy could base itself on certain strong pillars. The fortune and good government policies still favored the economy and an integrated development was witnessed not only on industrial side but also in the financial industry specially banking. Private sector was now in a position to take off with support of an efficient banking industry. However, Government took a policy decision by not allowing foreign investment in the banking sector. The private sector had grown to an extent that economy could maintain its growth momentum without any foreign direct investment. However, foreign investors had an eye on Pakistani economy and the growth momentum was not only praised internationally but policies were also adopted by some of the regional countries.
The decade of 70s started with high hopes of economic growth and its trickle down to the masses. The consistency of policies had enabled private sector to grow by leaps and bounds so that they were not only able to spread out their investment locally but was expected to grow soon to an extent that can invest abroad. The economy was in a position to open up itself. Foreign investors were eyeing relaxation in the policies regarding foreign investment in certain sectors.
Then came a policy decision of nationalizing the privatized companies that took economy 20 years back. It shattered the confidence of private sector and from a destination with top priority Pakistan was no where on the radar of foreign investors anymore. Nationalized entities could not continue their operations in the same way as before and economy saw worst recession. The chances of economic recovery in next many years were in doldrums.
The decade of 80s went with so many uncertainties. No one was willing to invest in Pakistan. Though, some industrialization started taking place but that was again with borrowed money as private sector was not willing to invest their own money in the economy due to expectations of any such policy decision in future.
In 1984, guidelines were developed for foreign investment in the country. These guidelines discriminated foreign and local investment as each foreign investment was subject to separate authorization. It took seven years to eliminate this requirement in 1991. Foreign investment was subject to Government approval but this requirement was also removed. At the time when neighbors like china and India had put strict controls on foreign investment, Pakistani Government allowed 100% participation of foreign investment in different sectors. In addition to this, foreign investors were allowed to purchase equity in already existent industrial sector on repatriable basis. In 1995, it was for the first time that foreign inflows in Pakistan crossed $1bn to $1.25bn. However, its number was very volatile in subsequent years.
Pakistan is among the countries that took a policy decision of following guidelines of Washington consensus much before other economies. India and Chinese models reveal that they had prioritized the things before opening up their economy for foreign investment. They developed their human resource by focusing more on the education and technical training. Higher number of working age population is an asset whose productivity can be increased through proper education and that is what our neighbors practically did. Another important area is infrastructure. Both, china and India heavily invested in improving their infrastructure in form of roads, electricity and etc. it was then that they opened up their economies for foreign investment but with so many restrictions on profit outflows so that it should not prove a burden in future.
In Pakistan, virtually no planning was done before opening up the economy. Human resource was not developed and Government kept on showing its stubbornness by not allocating a reasonably good sum on both basic and technical education. Infrastructure was poor and it is in last five years that government has realized importance of infrastructure development by allocating huge sums in form of PSDP. However, power still remains the biggest problem. No development on dams and improper strategy for utilization of huge coal reserves makes it more doubtful that Pakistan is in a position that it should have opened up its economy so soon.
The loopholes in the policies become more evident when one looks at the segmentation of FDA in Pakistan. If the government had focused on the infrastructure and technical development of human resource then this break up of the FDA could show a different picture that could act as a long term support and source of inflows for the economy.
The higher numbers in FDA are governed by telecommunication and banking sector. However, the inflow that economy has seen in this sector is nullified due to equal rise in imports of mobile sets that is in access of $1bn. If proper planning was done then huge foreign exchange could be saved. However, the Government has now realized the importance by making a ten points agenda to attract foreign investment in this area. There is a strong perception in the industry that Pakistan has missed the boat and there is no use of such steps. According to Nadeem Safdar, country head Motorola ์there is not much possibility that these measures will bring any investment in this area
Internationally, foreign participation in the banking sector has brought efficiencies to the system and same can be expected in Pakistan. However, point of discussion is the effectiveness of this FDA to Pakistan's economy and its impact in the future. Economic managers have portrayed FDA as a key indicator of the good economic performance. According to them, these inflows are an obvious indicator that foreigners have a very long term positive outlook about Pakistan's economy. There is a big question mark on the positive stance and outlook of Pakistan's economy as viewed by foreigners. The return on equity in the Pakistan's banking sector exceeds 30% which translates into a time span of less than four years to get their investment back and then reap profits. 4 years is not a long term outlook in any sense of investment so economic managers should cautiously use word long term while quoting FDA numbers.
Another key contributor is foreign portfolio investment. Where, returns are very lucrative, keeping in view the 100% profit outflow in the absence of capital gain tax Huge sums of foreign portfolio investment attracted by all the regional economies have benefited exchequer due to imposition of capital gain tax but local government's own policies have deprived itself from this bounty.
People who are even at the very beginning stages of economic studies are aware about the concepts of import substitution and exportable surplus. Economies like Pakistan, that has higher demand due to local consumption, need to develop industrial base so that they can have import substitution. In Pakistan, extent of liberalization has overshadowed all the positive developments and hence no import substitution took place. It was further fueled by higher inflation which made locally produced products more expansive than the imported ones. Exportable surplus is something that is next to possible now in the present situation of high cost of doing business and lack of foreign interest in this area.
No economy has ever achieved a sustainable growth based on only foreign savings. India has 33% savings and china has 45% that translates into an investment to GDP ratio which is genuinely dependent on local savings. Pakistan has 14% savings rate and for an investment to GDP ratio of 21 and for 7% comes from foreign savings. This 7% is a long term liability that will impact foreign exchange in form of profit outflows in future. Strategies should be developed to incentivise foreign investment so that it can be channelized in productive areas. This will not only create exportable surplus, import substitution but will also lead to a sound economic growth on strong footings.