Bushra Yasmin, one of the authors featured in Economy, Welfare, and Reforms in Pakistan (OUP 2022), has sought to unpack foreign investment into Pakistan, a troubled domain in any economic discussion of the country.
There are several reasons, such as the threat of terrorism, macroeconomic instability, political volatility, energy shortages, etc, that have kept foreign investors from bringing money into Pakistan in the past. There is also the factor of ideology, poor education affecting quality of manpower, and political instability hounding the state in 2022.
Though the volume of the Foreign Direct Investment (FDI) in developing countries has tremendously increased over time, its distribution has remained widely dispersed among different regions of the world. Latin America and the Caribbean were among the largest recipients of FDI until the mid-1980s, but the trend turned in favor of Asian and Pacific countries in the late 1980s; these regions received 85 percent of the FDI flows to developing countries in the 1990s. Having a glance at recent global trends in FDI, this has been declining with a 13 percent global fall in the first two quarters of 2018 due to repatriated foreign earnings accumulated by the United States Multinational Enterprises, as reported in an UNCTAD report.
Unsteady trends in FDI
In particular, the FDI to developed regions declined by 27 percent while for developing countries it remained stable with an upsurge of about 2 percent in 2018. At the regional level, the FDI rose by 11 percent in Africa and up to 4 percent in the developing Asia while in Latin America and the Caribbean it declined to 6 percent. Overall, FDI flows to Asian developing countries—the world’s largest FDI recipient—increased by 3.9 percent in 2018 where South Asia received an increase of 3.5 percent.
Pakistan adopted a number of measures to attract FDI with the advent of deregulation, privatization, and liberalization policies at the end of 1980s, and the amount of foreign investment consequently increased from $10.7 million in 1976-1977 to $1,296 million in 1996-1997, growing at the compound rate of 25.7 percent. In the wake of liberalization programs, the country observed a phenomenal increase in foreign investment when FDI in the power sector grew by 146.5 percent in 1995-1996. Realizing the potential role of FDI accelerating economic growth, Pakistan pursued wide-ranging structural reforms that helped it in becoming an attractive destination for Multinational Enterprises.
Efforts and errors
After incentivizing investment, Pakistan received reasonable amount of FDI worth $5 billion in 2007-2008. In terms of its contribution in the GDP, the FDI was 3 percent of GDP in year 2007-2008, which could not be sustained due to the financial crunch, terrorism, energy crisis and ended up at 1 percent of the GDP by 2014-2015. Comparatively, the FDI increased sharply from $988 million in 2014-2015 to $2,305 million in 2015-2016 and further increased to $2,749 million, and $3,471 million in years 2016-2017 and 2017-2018, respectively.
Generally, growth-oriented initiatives, including higher development expenditures, low inflation, and CPEC-related investment supported this upsurge in inflows of direct investment. Of special relevance are the political instability, poor law and order, and inconsistent economic policies that marked the 1990s and early 2000s and were put down with rigorous efforts on the ease of doing business and related measures. The incentives, like 100 percent foreign ownership of foreign capital and no limit on remitting profits and dividends, supported the FDI inflows positively. However, a reduction of 51.7 percent was observed in 2019 due to weak international scenario.
Low in the region
Overall, the figures on foreign investment in Pakistan show a growth trajectory but lag behind the FDI scene in the rest of South Asia. (The inflow to India was $74.01 billion in calendar year 2021). China has remained a major FDI partner to Pakistan but its contribution declined from 60.5 to 31.2 percent in 2019 due to a sharp decline in the power sector’s investment after completion of early harvest projects. The other major partners are the U.K., Hong Kong and USA, which have contributed 12 percent, 10 percent, 5 percent, respectively. In the backdrop of the China-Pakistan Economic Corridor, the sectors which attracted more investment are construction, oil and gas exploration, and financial businesses as these are growing sectors under various CPEC projects and the Special Economic Zones (SEZs).
The manufacturing sector and large-scale physical infrastructure attracted major FDI that brought along a package of capital, technology, skills, and market access. With a special focus on the telecommunication and power sector, the CPEC project is being considered a game-changer for the economy of Pakistan. A long-term plan of $60 billion investment by China for years 2017-2030 is a huge opportunity for the economy to flourish. The largest investment under the project is in the energy sector worth $22.8 billion which includes 7 projects. The other focused sector is the highway which links China to the Arabian Sea and another $5.2 billion is proposed on highway development. Similarly, the railways project is worth $8.2 billion. The spurt in the growth rate of the economy is expected to be up to 2 percent point as potential economic impact of CPEC.
Obstruction of red tape
Initially, the highly regulated nature of Pakistan’s economy deterred the inflows of FDI. Specifically, FDI was discouraged due to significant ownership of the public sector, strict licensing for industrial investment, financial constraints, segmented financial markets, and non-competitive trade regime with import licensing, high tariffs and bans. However, Pakistan instigated a more liberal foreign investment policy under the Structural Adjustment Program at the end of the 1980s. The new industrial policy in 1989 emphasized on the inclusion of the private sector in the investment endeavors and accordingly a number of policy and regulatory measures were taken to improve the business environment in general and to attract the FDI in particular. A Board of Investment was set up to support attracting investment opportunities along with the provision of investment services. Particularly, a one-window facility was established for investors to overcome difficulties they face while setting up new industries.
After entering office, the Pakistan Tehreek-e-Insaf (PTI) government attempted to increase FDI, especially in Pakistan’s tourism and agriculture sectors. The PTI aimed to enhance FDI from $2.8 billion in FY2019-20 to $7.4 billion in FY2022-23 under its multi-year foreign direct investment strategy. However, despite the government’s efforts to increase FDI, a recent report by the State Bank of Pakistan stated that the country’s FDI decreased by nearly 30 percent from $1.85 billion to $1.3 billion in the first eight months of FY2020-21. After the initiation of CPEC in 2013, China’s share in Pakistan’s FDI significantly increased, replacing the United States and the United Kingdom. However, in the first six months of FY2021, the net FDI from China also declined to $358.9 million from $395.8 million. Pakistan’s placement in the FATF grey-list (Financial Task Force, an intergovernmental organization founded in 1989 on the initiative of the G7 to develop policies to combat money laundering) coupled with stringent tax and interest rate policies deteriorate its foreign investment climate. Without modifying domestic economic policies to prevent a further decrease in FDI, Pakistan is bound to face long-term financial crises.
Challenges to attracting FDI
Inconsistent economic growth rate and a balance of payments crisis, due to import-led growth, rising debt payments, and a poor taxation system, increase the country’s current account and fiscal deficits and lowers investor interest in Pakistan’s market. Domestic terrorism has also curtailed foreign investor confidence. Despite the fact that security conditions have improved in the last few years, Pakistan’s FDI has not experienced sufficient growth. The country’s terror financing and anti-money laundering laws are still not compliant with international standards. Pakistan has been on the FATF grey-list intermittently resulting in a $38 billion economic loss and impacting investor confidence in the country’s investment climate. Moreover, political instability and constant imbalance in civil-military relations further discourage foreign investors from investing in Pakistan. For instance, foreign investors often complain about the difficulty in obtaining security clearance from the Ministry of Interior and the inconsistencies in investment laws at federal, provincial, and local levels.
According to the U.S. government’s Investment Climate Statements of 2020, Pakistan’s tax policies are also inconsistent and change depending on which sector is given a priority under each government. As maintained by World Bank’s Doing Business 2020 report, Pakistan requests advance tax payments from countries and asks countries to pay 34 different taxes while other South Asian countries request an average of 26.8. Additionally, Pakistan does not provide any formal investment incentives, such as tax deferrals and subsidized loans, for investors which further discourages foreign companies from seeking investment opportunities in Pakistan. Stringent regulations, lengthy dispute resolution procedures, and red-tapism all contribute to an erosion of investor trust.
IMF and FDI
The severe austerity measures taken under the IMF bailout program have further deteriorated the business environment in the country. The slashing of interest rates to around seven percent from 12.25 percent in 2021 made foreign investment less attractive. As the interest rates fall, “hot money”—capital that investors move between financial markets to profit from highest short-term interest rates—leaves the country because foreign investors transfer their funds to economies with higher returns.
Although Pakistan has failed to sufficiently utilize its geostrategic location and trade routes, foreign investors, such as China and the United States, have profited from Pakistan’s unique geographical traits. However, such FDI often comes up with strings attached; Pakistan is expected to fulfill the geopolitical interests of its investors. For example, in return for billions in military aid, Pakistan pursued the United States’ geopolitical interests in the region in the mid-2000s.
FDI under money-laundering
In order to attract FDI, Pakistan will need to come out of the FATF grey-list by complying with international standards against money laundering and terror financing and working aggressively to fulfill the remaining action points assigned by the Task Force. Additionally, to build investor confidence, Pakistan needs to ensure there is a consistent tax policy, an efficient tax system, and a stable political environment. Tax policies, specifically, should be more consistent from one government to another. Instead of placing more pressure on the salaried class in the form of increased income and sales taxes, the wealthy need to be brought under the tax net. Additionally, the agricultural sector of Pakistan, the least taxed sector of the economy despite its significant contribution to the country’s economy, should be taxed proportionally.
Educating and training working-age populations to participate in the manufacturing sectors can also attract FDI. To do this, Pakistan will need to recalibrate its budgetary priorities—instead of funneling mass amounts of money to defense, education and research opportunities should be sufficiently funded and promoted to support FDI opportunities in the future. Pakistan also needs to diversify and expand its foreign investment partnerships beyond China, the United States, Saudi Arabia, the United Kingdom, and the United Arab Emirates, by actively engaging in diplomatic efforts that could open up new avenues for FDI. Pakistan could increase economic diplomacy efforts with East Asian and emerging African economies, and market itself as a potential economic hub in South Asia. Fortunately, Pakistan has already started actively engaging with Central Asian countries to enhance trade and connectivity in the region.
As Pakistan faces a balance of payments problem every few years, its exports and remittances have not failed to report a sufficient increase. COVID-19 has slowed down global economic growth, severely impacting even the largest economies of the world hence making it more difficult to attract foreign investment in the years to come. Although Pakistan has moved up 28 places on the World Bank’s Doing Business 2020 rankings—from 136 to 108 out of 190 countries—it still has several obstacles to overcome. To attract more investment, Pakistan will need to provide substantial incentives to foreign investors, enhance its economic diplomacy efforts, effectively promote its improved law and order situation, ensure consistency in tax and other investment-related policies, and generally ease its stringent investment conditions in order to attract foreign investment in the country. Pakistan’s new geo-economic focus can only be achieved once domestic barriers to FDI are removed.