Foreign direct investment (FDI) is now perceived in many developing countries as a key source of much needed capital, foreign advanced technology, and managerial skills. Realizing its importance to economic development, these developing countries have taken wide-ranging steps to liberalize their inward FDI regime and have succeeded in attracting substantial amount of FDI.
Foreign direct investment refers to direct investment equity flows in the reporting economy. It is the sum of equity capital, reinvestment of earnings and other capital. Direct investment is a category of cross-border investment associated with a resident in one economy having control or a significant degree of influence on the management of an enterprise that is resident in another economy.
The positive developmental role of FDI in general is well documented. FDI produces a positive effect on economic growth in host countries. One convincing argument for that is that FDI consists of a package of capital, technology management, and market access. FDI tends to be directed at those manufacturing sectors and key infrastructures that enjoy actual and potential comparative advantage. In those sectors with comparative advantage, FDI would create economies of scale and linkage effects and raise productivity. For FDI, repayment is required only if investors make profit and when they make profit, they tend to reinvest their profit rather than remit abroad. Another benefit of FDI is a confidence building effect. While the local economic environment determines the overall degree of investment confidence in a country, inflows of FDI could reinforce the confidence, contributing to the creation of a virtuous cycle that affects not only local and foreign investment but also foreign trade and production. This phenomenon well matches the directions of historical flows of FDI in the Asian and Pacific region. Initially, FDI had surged into the newly industrialized economies (NIEs) (Hong Kong, China; Korea; Singapore; and Taipei, China) and thereafter moved to ASEAN countries. Recently, it has been changing its direction to People’s Republic of China (PRC), India, and Vietnam. This changing stream of FDI flows suggests that the degree of confidence building, inflows of FDI, and the pace of economic growth seem to have a positive interrelation in the Asian and Pacific region.
Need for mobilization of foreign resources
Given its fragile balance of payments position and urgent need to boost industrial production, Pakistan needs to significantly increase its mobilization of foreign resources. However, long-term official assistance will become increasingly scarce, while promoting large portfolio investments is not a proper policy option due to Pakistan’s underdeveloped and narrow capital market. Significant increases in commercial borrowings are also not desirable. It is therefore crucial to accord high priority to foreign direct investment (FDI). Previous inflows of FDI in Pakistan were meager, accounting for only 0.2% of the world total and less than one percent of the Asian sub- total each year in the 1990s. Among the major impediments are urban violence, inconsistent economic policies, and government bureaucracy. Remedial policy actions are essential.
Another major problem is the concentration of FDI on the power sector, a domestic-oriented sector, which results in large foreign exchange costs and remittances. This has serious balance of payments implications. Lessons learned from the Pakistan experience are: developing economies should attach short-term priority to attracting FDI to the foreign exchange earning sector, or, at least, both the foreign exchange earning sector and other sectors simultaneously. Multilateral development organizations, including the Asian Development Bank, should also take this into account in their private sector operations, particularly the build-own-transfer type, to develop economic infrastructures in developing economies.
Pakistan has recorded a notable growth in fresh foreign direct investment in projects related to oil and gas exploration, power production and mobile phone services in recent months. Pakistan’s Foreign Direct Investment (FDI) increased by US$ 112.3 million in Aug 2020, compared with an increase of US$ 114.3 million in the previous month. The FDI data reached an all-time high of US$1.3 billion in June 2008 and a record low of US$-367.5 million in Oct 2018.
In the latest reports of Pakistan, Current Account recorded a deficit of US$282.0 million in June 2020. Pakistan’s Direct Investment Abroad fell by US$18.0 million in June 2020. Its Foreign Portfolio Investment fell by US$749.0 million in June 2020. The country’s Nominal GDP was reported at US$264.1 billion in June 2020.
Significantly, Pakistan was ranked 108th out of 190 countries in the World Bank’s Doing Business Report 2020 where it was also acknowledged as one of the countries with the most notable economic improvement. While China dominates foreign investment due to China Pakistan Economic Corridor (CPEC) projects, other countries such as Netherlands, Norway, Turkey, Hong Kong and Italy have shown interest in the oil, gas, energy, financial business and telecommunication sectors of Pakistan. In the fiscal year July- February 2020, the oil and gas industry alone attracted US$177 million whereas financial business, power and communication sectors received US$194.7 million, US$ 575.6 million and US$471.8 million respectively.
The largest foreign investor in Pakistan
China remained the largest foreign investor in Pakistan. It invested a net $532.8 million in first seven months of FY20 compared to $282.6 million in the same period of last year. It was followed by Norway which invested a net $288.5 million in the period under review compared to outflow of $3.9 million in the corresponding period of last year. Malta poured $129.6 million compared to outflow of $81.6 million last year, according to the SBP.
The growth in investment, however, remains low compared to the existing potential as investors anxiously wait for consistency in economic policies before initiating new projects in the country.
According to UNCTAD’s 2020 World Investment Report, FDI inflows to Pakistan increased from US$1.7 billion in 2018 to US$2.2 billion in 2019. At the same time, the total stock of FDI stood at US$34.8 billion at the end of 2019. As per SBP Report, FDI inflows in the first half of the 2019-20 fiscal year (July-December 2019) rose by 68.3% on the year to US$ 1.34 billion, against US$ 796.8 million in the same period last year. Inflows were also at a 30-month high of US$487 million in December 2019, mostly boosted by high Chinese investment. Flows were higher at the end of the year as the Pakistani government put an end to its year-long policy of letting the rupee depreciate against the US dollar and the political uncertainty has dwindled in the aftermath of general elections in July 2018. The financial sector is the primary recipient of FDI in Pakistan, followed by the chemicals industry and construction. In regards to countries, China is by far the biggest investor in Pakistan; however, recently, the United Kingdom, South Korea and Japan have stepped up their investments.
The potential attractiveness of Pakistan for investment remains lower than neighboring India, but equal to Sri Lanka and Bangladesh. Pakistan’s attractiveness improves, albeit very slowly, against a backdrop of a challenging security environment, electricity shortages, and a burdensome investment climate also hinder investments. Pakistan was ranked 108th out of 190 countries in World Bank’s 2020 Doing Business Report, up by 28 positions from a year earlier. This was mainly a result of significant improvement in getting electricity and handling of construction permits. The recent outbreak of coronavirus (COVID-2019) would result in a decline in FDI in Pakistan, like other countries. Pakistan has a relatively friendly legal environment for FDI which, coupled with an improvement in law and order, has made the country a suitable candidate for international investors in the industrial and manufacturing sector; however, corruption remains a major hurdle to foreign investment. Nonetheless, a legal regime to govern, regulate and protect foreign investors in Pakistan exists in the form of the Protection of Economic Reforms Act 1992 and the Foreign Private Investment (Promotion and Protection) Act 1976 (FPIA). Under these laws the Government of Pakistan provides protection of fiscal incentives for setting up industries and offers a shield to the foreign investors against the government from acquiring their investments. The investors are free to bring, hold or take out foreign exchange within or out of Pakistan in any form and are given immunity from inquiry from the Income Tax Department. The earnest efforts of Pakistan are evidenced from the fact that the banks are ordered to maintain complete secrecy in respect of foreign currency accounts whereas, the State Bank of Pakistan shall not impose any restrictions on deposits or withdrawals. In tandem with these incentives, the Government of Pakistan is obligated to accord equal treatment to the foreign private investments. Furthermore, the rupee devaluation was one of the biggest concerns of foreign direct investors. Now when Pakistan has addressed the concern, it has regained foreign investors’ trust on the country.
The above-stated figures reflect the government’s endeavors to pursue FDI attraction policy with the guarantee of equal treatment between foreign and local investors and a whole series of tax incentives. The country has financial and logistical support from the United States and the International Monetary Fund (IMF). What’s more is that, Pakistan offers a number of tax incentives for the establishment of industrial units in certain specific sectors; energy, ports, highways, electronics and software. Pakistan has also set up special export-oriented zones called export-processing zones, in order to encourage foreign investment. Over and above that, profit or capital remittance shifts are made without any stipulations by routing the same from scheduled commercial banks in Pakistan without repeated approval from the SBP. According to the SBP data, foreign investment in government securities such as market treasury bills and Pakistan Investment Bonds have reached $1.839 billion, compared with $0.1 million a year ago.
It is to be appreciated that, Pakistan has signed Double Taxation Treaties with 52 countries which enables foreign investors to claim tax credit in their home-country in respect of corporate taxes paid in Pakistan. We cannot ignore the fact that, to promote infrastructure financing in Pakistan, the SBP has issued Prudential Regulations for Infrastructure Project Financing with the aim of assisting banks and Development Finance Institutions (DFIs) to develop expertise for financing of infrastructure projects, essentially by evaluating the intrinsic cash flow generating ability of these projects. Besides conventional infrastructure financing, banks/DFIs are also encouraged to adopt Islamic mode of banking to develop infrastructure products as it is very conducive to infrastructure financing. Appreciably, Pakistan encourages the inevitable investment disputes to be amicably settled through internationally recognized principles of Arbitration/Alternate Dispute Resolution mechanisms which are acceptable to all the parties. To defend investment claims and restore the investors’ confidence the Government of Pakistan has enacted The International Investment Disputes Act on 2011.
Pakistan is a signatory to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards, 1958 whereby, foreign arbitral agreements and awards are now enforceable except for rejecting the same on the grounds set forth in the Convention.
Despite the afore-stated efforts of the Government of Pakistan, we cannot ignore the fact that the recent outbreak of COVID-19 has led to significant economic deficits with a shrink in the FDI worldwide. According to Asian Development Outlook (ADO) 2020 the economic growth in Pakistan is expected to reduce to 2.6% whereas, inflation is projected to accelerate to 11.5% in FY2020.
The UN Report on 1st April 2020, warned that, “the adverse effects of prolonged economic restrictions in developed economies will soon spill over to developing countries via trade and investment channels”. The IMF has announced that the world has entered into a recession as bad as or worse than in 2009. Meaning thereby, that Pakistan shall expect less FDI in the FY2020 due to this sharp decline in global economy with an estimated economic loss of PKR1.3 trillion. COVID-19 shall prove to be catastrophic for Pakistan due to high capital outflows, lost export earnings and currency depreciations.
Pakistan’s growth in FDI was primarily due to the fact that the outflows of FDI were less than the inflow. According to UNCTAD, the outflows of capital in the developing countries shall see a rise which will ultimately result in a backwards shift in FDI with respect to Pakistan. On account of this, there will surely be an overall ripple effect causing disruptions in our foreign market. Quite notably, the preventive measures undertaken by Pakistan are further strengthened by the provision of a US$200 million package by the World Bank with the aim of assisting Pakistan in instating effective and timely action against COVID-19. By the same token, the Pandemic Response Effectiveness Project shall assist the poor and vulnerable sections of Pakistan to cope during the pandemic.
The potential for achieving socio-economic stability and continuing to attract FDIs in spite of COVID-19 remains favorable for Pakistan. As rightly pointed out in a UN report that “the first pandemic in history that could be controlled. The bottom line is, we are not at the mercy of the virus”.