FOREIGN INVESTMENT DOUBLE WHAMMY: INSECURITY AND POLITICAL INSTABILITY

SHAMIM AHMED RIZVI
June 8 - 14, 2009

Presently the investment climate in Pakistan is not conducive to say the least. The country, which according to the world investment report topped the 16 Asian developing states in the year 2005 in attracting foreign investment and was considered the best destination for foreign investors, has witnessed a decline of over 43% in its normal inflow of foreign investment.

Domestic shocks such as worst law & order situation, negative economic indicators, power shortage, and high input cost of doing business has led to this sharp decline in 10 months (July-April) of the financial year 2008-09. During the last five years (2002-07), Pakistan was the most favorite country for foreign investors because it offered high profit margins. However, at present foreign investors are reluctant to invest in Pakistan due to discouraging economic indicators, low profit margin because of high input cost, and unsatisfactory law & order situation in the country.

Experts are of the opinion that military operations against the militants and rising tension in the northern areas have played an important role in dampening foreign investments. If this operation does not end in the next few weeks, it will put a negative impact on the country's economy in the end, they maintained.

Rapid globalization and an increase in the international trade have given a new dimension to the economic theories of growth and investment. In particular, foreign direct investment (FDI) and trade contribute towards advancing economic growth in developing countries. Foreign investment consists of two components: direct investment and portfolio investment. Of these, the former is more important for developing countries such as Pakistan, because the latter is inherently volatile and easily reversible. FDI is also crucial for Pakistan's economy, because it stimulates domestic investment and brings advanced technology to the country.

FDI has a positive impact on a country's gross domestic product (GDP) through increase in exports, building knowledge economy, and transfer of new technology. It also has a beneficial influence on employment, because generally a positive correlation exists between job creation and higher levels of FDI. Additionally, FDI can also contribute to debt servicing and repayment, fuel export markets and generate foreign exchange revenue.

In today's global economy, the enhanced importance of FDI can be gauged from the fact that their stocks now constitute over 20 percent of global GDP. Therefore, developing countries rightly deem it as a key source of capital, advanced technology, and managerial skills. In fact, countries at all stages of development are engaged in a race to attract this much-valued investment, by initiating liberal trade policies and making the required structural changes in their economies.

Linkages can also be formed between foreign companies and local small and medium enterprises (SMEs). The level of economic development that has been attained by a host country is very important during the formation phase of these linkages. The presence of a robust small-scale sector that produces high quality products will benefit both small-scale industry owners and MNCs, because reliable, good quality and cheap products ensure that foreign enterprises are not reluctant to source locally. Empirical studies have long supported the positive correlation that exists between FDI and income growth, factor productivity, technological diffusion, growth and employment.

More than 64,000 foreign affiliates of MNCs create 53 million jobs worldwide each year. FDI is the largest source of external finance for developing countries, and the inward stock of FDI in 2000 amounted to around one-third of their GDP, as compared with just 10 percent in 1980. World FDI inflows grew from an annual average of $159 billion from 1986 to 1991 to $865 billion in 1999. FDI inflows as a percentage of gross domestic capital formation in the world rose from 2.3 percent in 1980 to 11.1 percent in 1998. By 1997, multinational firms accounted for 25 percent of the world's GDP, while they conducted approximately 75 percent of civilian research and development, and 90 percent of trade in technology and technology-intensive products.

Several polices have been formulated in Pakistan and the necessary structural changes made in the country's economy to attract FDI. In this regard, three major government investment liberalization initiatives were undertaken in 1992, 1997, and 2000. Pakistan has taken major steps to liberalize its trade and investment in the context of commitments made with the World Trade Organization (WTO), International Monetary Fund (IMF), and World Bank over the past few years. This can be evidenced from the rate at which liberalization and the privatization of the economy is taking place.

Before 1990, FDI did not have much role to play in Pakistan's economy. This was mainly due to the regulatory policy framework in vogue at that time. However, as trade policies gradually became more liberalized over the years, the role of FDI in Pakistan's economy also started gaining importance. Increasing privatization was one factor that led to this phenomenon, while others included the deregulation and liberalization policies adopted towards the end of the 1980s. The country witnessed a steady increase in FDI after 1990, as more laissez-faire policies were put in place.

FDI inflows into Pakistan rose from $10.7 million in 1976-77 to $1.296 billion in 1995-96, thus growing at the annual compound growth rate of 25.7 percent. However, it declined to $950 million in 1996-97. After the beginning of the liberalisation programme in 1991-92, FDI inflows into Pakistan grew at the compound growth rate of 15.2 percent. Noteworthy in absolute terms, the increase appeared trivial when compared with the relatively more upwardly mobile economies of East and Southeast Asia. While FDI flows to all developing countries reached $150 billion in 1997, East and Southeast Asia received the bulk of this share. Overall, however, FDI inflows into Pakistan have shown an upwardly mobile trend, with the amount reaching $1.524 billion in 2005.

FDI inflows into Pakistan remain far from what they could be, despite numerous incentives offered to foreign investors, particularly after the liberalization programme initiated in 1991-92. These incentives include 100 percent foreign ownership of capital, foreign investors operating their companies without enlisting in the local stock exchanges, no limit for repatriation of profits and dividends abroad, allowing disinvestment of the originally invested capital at any time, and no prescribed limits for remittance of royalties and technical fees abroad by foreign investors.

Besides these incentives, Pakistan with a population of over 170 million offers a vast potential for the marketing of both consumer and durable goods. These factors should have attracted a sizeable amount of FDI in Pakistan; however, after looking at the amount of FDI inflows into Pakistan in recent years it appears that the incentives have resulted in limited success only. Therefore, the government needs to adopt corrective measures if it wants to succeed in its attempt to attract as much FDI as possible. Two vital concerns that must be addressed in this regard are political stability and satisfactory law and order situation.