INVESTMENT CLIMATE IN PAKISTAN
AROOJ ASGHAR (firstname.lastname@example.org)
Jan 4 - 10, 2010
Over the past decade Pakistan performed overall well on many macroeconomic indicators, became more integrated with the world economy, and achieved impressive social gains as compared to the previous decade. However, now the performance of other low-income countries suggests that Pakistan has fallen short of its growth potential.
While Pakistan has maintained fairly high per capita growth for the past decade, its growth has lagged far behind some other countries. Take China and India as an example, as a result of the more rapid growth in these countries a big gap has opened up in per capita income, though all three countries stared at similar income levels in the eighties or seventies.
FDI in Pakistan consists primarily of three elements namely cash brought in, capital equipment brought in, and re-invested earnings. On average, most of FDI in Pakistan originated from abroad is in the form of cash and capital equipments and remaining in the form of re-invested earnings.
The inflows of foreign direct investment (FDI) in Pakistan declined 52.2 per cent during the first four months of the current fiscal 2009-10. Pakistan received a total of 774.0 million dollars worth foreign direct investment during July-November FY10 against 1.620 billion dollars in the corresponding period of the last fiscal year amid slowdown in the global economic recovery and political and security concerns, according to SBP reports.
The SBP latest break-up of foreign investment showed that it dropped 25.6 per cent during July-November 2009-10.
Does that imply Pakistan's investment climate poses particular obstacles to economic growth and development? To answer the question, we need to understand the political and geographical situations of the country. Some of the main findings are:
• Infrastructure poses some of the most severe obstacles facing firms. Pakistan is far behind to its competitors' general measures of infrastructure, and the vast majority reports that problems in infrastructure seriously hamper its growth.
• Electricity till last year but energy problems from 2009 onward have become a plague, as the country has less generation capacity per capita than its neighbors experiencing power outages or surges nearly every day they operate. As a result, more than 50 percent have to live without electricity and rest has to rely on electric generators at a great expense. On average, these generators cost more than $1,000 to purchase and almost 50 percent more per kilowatt-hour to operate than the price of power from the public grid.
• Corruption is pervasive. Pakistan ranks worse on measures of corruption than its neighbors ñ presently hardly anyone can dispute that this is an issue and perceive it as a major or a very ominous obstacle.
• Many view regulation as a serious problem. Starting a business in Pakistan is fairly difficult. And once firms are running, they receive frequent visits from government agencies - as many as 10 (maybe this is an exaggeration yet it is an issue) a year on average.
• Finance appears to be a looming problem. While most business appears to have access to finance, it is mostly short-term. Moreover, the very large share of nonperforming loans portends underlying difficulties.
• Small- and medium-size firms are disproportionately affected by all these problems. The smaller the firm, the more of its resources it devotes to bribes and to dealing with government visits and inspections and the less likely it is to have access to formal finance.
These problems can pose great barriers to market entry and growth for small firms. Dealing with these problems is no simple matter. But their size and prevalence underscore the urgency of reform. Among the potentially most important reforms are unbundling electricity generation and transmission, encouraging private investment in the power sector, corporatizing the ports, increasing accountability in the civil service, and streamlining regulatory procedures while eliminating unnecessary ones.
It is estimated that improvement in critical investment climate can have a potential gain of 50 percent. Carrying out the needed reforms may be difficult, but the costs of overlook and delays are high.
The deteriorating law and order situation in the country due to militancy is impinging on the economic growth. The situation is moving from bad to worse with each passing year, as the FDI during the last fiscal year 2008-09 remained almost half as compared with the financial year 2007-08. Foreign investment registered a slight net inflow of $1.085 billion during July-November 2009-10 against $1.457 billion in the same period last year. However, portfolio investment at local bourses posted a moderate growth of 291.1 percent as it stood at $311.3 million in July-Nov FY10 against $162.9m in the same period FY09. The total foreign private investment inflow with privatization and without privatization proceeds declined to $1.092 billion during the reported five months of FY10 from $1.476 billion in the same course of FY09 by depicting 25.9 percent negative growth.
Foreign private investment received from developed countries increased 44.2pc as it stood at $846.5m during July-November FY10 against $586.9 million in the five months of last year. FDI from developed region dropped to 547.0 million dollars during July-November FY10 from 742.2 million dollars during the same period of FY09.
From Western Europe, the total foreign investment amounted to $311.9 million, showing 30.8 per cent increase in growth during the said period as against $238.4 million while FDI reduced to $215.1 million from $292.4 million in the July-November FY09. Portfolio investment was recorded at $96.9m during July-November FY10 as against $54.0 million in the same period of last fiscal. From USA, Pakistan received 467.8 million dollars worth over all foreign investment as against $247.4m. FDI, however, witnessed a decline to $262.7m from $345.4m.
It is said that foreign investors have not been coming to Pakistan for the last couple of years mainly due to the deteriorating security situation. There are currently worth $10b projects available for investment in Pakistan but the global economic meltdown and the internal situation, especially security situation, were creating impediments to attract investment. AES Corporation of USA has sold its entire operating investment (AES Lal Pir and AES PakGen power plants 362 & 365 MW) to Nishat Group this month which means that they have left Pakistan. AES is also developing a 1000MW coal fired power plant in Balochistan for which NEPRA has already given tariff but with this exit no one can say with certainty whether they will further invest in Pakistan or not. It is absolutely not a good sign for Pakistan's economy. It is important to mention that some of the local businessmen are also shifting their businesses to the neighboring countries like Bangladesh due to unfriendly business atmosphere in Pakistan. On the other side, Ministry of Investment, a few months back, unveiled five-year proposed investment policy aiming at attracting around $75 billion local and foreign investment.
The policy included FDI strategy to attract the investment by adopting three actions program. These included enhancing the international image of Pakistan as an investment location, promoting investment projects by international investment and providing services to potential and actual foreign investors in Pakistan. Meanwhile, economists and analysts say, for attracting foreign investors we must first restore confidence of our own business community, as in the current situation we are not only facing law and order problems but also the issues like power and gas shortages. These are the main hurdles in the way of economic prosperity.
A country's general structure of governance and the institutions that govern interactions between business and government determine the burden that firms face in complying with government regulations, the quality of government services, and the extent to which corruption is associated with the procurement of these services. A large regulatory burden is often associated with corruption, involving payments to inspectors who visit firms or to officials who grant permits.
Corruption deters foreign and domestic investors. Finding quantitative measures of the quality of government regulation and the cost imposed by corruption is generally difficult. But many researchers and practitioners have tried to produce aggregate statistics that can be used for comparisons across countries.
The availability of inputs is a crucial element of the investment climate. For human resources, this implies more than just an abundant supply of workers. It also implies workers with sufficient education and technological know-how.
Power tops the list of infrastructure concerns in Pakistan. But reforms in telecommunications, transport, and ports and customs will also be critical to ease the bottlenecks hampering private enterprise in Pakistan.
System losses have increased from 30 percent to 35 percent, and revenue collection has dropped. Moreover, the sector is bankrupt, forcing a big drain on scarce fiscal resources. A radical and systematic restructuring to eliminate inefficiencies would allow the sector to fulfill its role in the development.
Governance - especially regulation and corruption - is an important concern in Pakistan, viewed by many as a serious problem. There are no easy solutions. But a proper plan can recognize the imperative of strengthening governance and the need to intervene on several fronts:
• Encouraging freedom of information.
• Establishing and enforcing clear rules and regulations for public sector administration, supported by the separation of power among all the branches of the government.
• Promoting voice and participation of civil society to foster a more transparent government. Ministries for example should be required to publish annual reports with performance outcomes for discussion by relevant parliamentary committees. But broader public administration reform will be required to create a new governance framework.
There must be streamlining of regulations and elimination of unnecessary rules, acceleration in service delivery, and strict check on informal (bribe) payments. Procedures for the entry of new companies could be simplified, for example, by reducing unnecessary costs and delays.
Investments have nose-dived. Investment is an engine of growth and its movement depicts the investment climate of a country and hinge on macroeconomic and political stability, continuity and predictability of the economic policies, security for investment and investor, facilities to the businesses, and level of infrastructure development.
GDP, forex reserves, exchange rate, tax to GDP ratio have declined, whereas foreign remittances increased with multiple impacts on the macroeconomic situation of the country. On the trade front exports remained stagnant while imports also declined due to the regulatory measures of the government as the prices of fuel and food declined internationally. Due to inflation the State Bank raised the discount rate which slowed down the private borrowing and reduced private investment. The current account deficit, although reduced due to substantial support from IMF, still poses a threat to the macro economy.
Pakistan's macroeconomic situation has been far from satisfactory. It has been affected by surge in war against terrorism and the global financial crisis. Deterioration in the security and law and order situation in the country has adversely affected the economic and investment climate, and has resulted in shrinking of overseas demand and the investment inflow in the country.
Pakistan needs foreign assistance for its development projects as well as meeting the saving investment gap. One of the most important measures taken by the government affecting FDI has been the liberalization of the foreign exchange regime. Residents, non-resident Pakistanis have been allowed to freely conduct business in foreign currency, and also using foreign exchange. They are allowed to access the capital market.