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Its impact on Pakistan
economy
Foreign direct investment (FDI) plays an extraordinary and growing role in global business. It
has become a key component of national development strategies for almost all the countries
over the Globe
The most profound effect has been seen in developing countries, where yearly foreign direct
investment flows have increased from an average of less than $10 billion in the 1970’s to a
yearly average of less than $20 billion in the 1980’s, to explode in the 1990s from
$26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999
In recent years, given rapid growth and change in global investment patterns, the definition
has been broadened to include the acquisition of a lasting management interest in a
company or enterprise outside the investing firm’s home country. The foreign direct investor
may invest in by any of the following methods:
• An individual;
• A group of related individuals;
• An incorporated or unincorporated entity;
• A public company or private company;
• A group of related enterprises;
• A government body;
• An estate (law), trust or other societal organization
Importance of FDI
Home country:
The simple answer is that making a direct foreign investment allows companies to
accomplish several tasks:
Host countries:
It can contribute to the general development as well as to the poverty reduction objective in a
variety of ways. Major benefits to host countries are as follows:
• Service Sector
• Infrastructure Sector, and
• Social Sector
In order to achieve this objective, however, changing types of industrial policies have been
implemented in different times with a changing focus on either the private sector or the
public sector.
• Pakistan was basically an agricultural economy upon its independence in 1947.
• Its industrial capacity was negligible for processing locally produced agricultural raw
material.
• This made it imperative for succeeding governments to improve the country’s
manufacturing capacity
• Many Karachi based industrialists and traders brought substantial capital with them that
formed the basis for investment in wide range of industries esp. Textile.
1950s
• Faltering economy was converted into one that was beginning to grow & there was a little
show in terms of improved living standards by the end of 1950s.
• The private sector was the main vehicle for industrial investment during the 1950s and It
was gradually realized that agriculture should be given priority and provide the basis for
expansion of economy.
• For the further growth of industrial sector, the growth of agricultural sector was a
prerequisite.
• In 1958 martial law by Ayub Kahan ushered new phase of Pak’s economy.
1958-1969
• the 1960s and the involvement of the public sector was restricted to three out of 27
basic industries.5 It was also set that in the event of private capital not forthcoming for
the development of any particular industry of national importance, the public sector might
set up a limited number of standard units.
• Public sector participation in industry declined and it was led to private sector.
• By the late 1960s the economy was largely dominated by the private sector in
important areas like banking, insurance, certain basic industries, and international trade in
major commodities.6
• The services sector was reserved for local investors. Foreign investment was not
allowed in the field of banking, insurance, and commerce.
Importance of FDI
• Up to date Technology: Foreign direct investment (FDI) provides a major source of
capital which brings with it up-to-date technology. It would be difficult to generate this
capital through domestic savings, and even if it were not, it would still be difficult to
import the necessary technology from abroad,
• Job opportunities: Foreign direct investment helps in the creation of new jobs in a
particular country. It also helps in increasing the salaries of the workers. This enables
them to get access to a better lifestyle and more facilities in life
• Educational programmes: Foreign direct investment helps in the creation of new
jobs in a particular country. It also helps in increasing the salaries of the workers. This
enables them to get access to a better lifestyle and more facilities in life.innovation
• Trade: Foreign Direct Investments have opened a wide spectrum of opportunities in
the trading of goods and services in PAK both in terms of import and export production.
Products of superior quality are manufactured by various industries in PAK due to
greater amount of FDI inflows in the country.
FDI POLICY in Pakistan
Pakistan's Investment Policy has been formulated to create an investor-friendly environment,
with a focus on further opening up the economy and marketing the potential for direct foreign
investment. The essence of the policy is to strengthen Pakistan's competitiveness by
improving the policy regime, offering fiscal and tariff relief and providing comprehensive
facilitation services.
Previously, only the manufacturing sector was open to foreign investment. Now, the policy
regime is much more liberal with most other economic sectors open for foreign investment
and with significant efforts at mobilizing domestic financial resources towards long term
investment.
Investors are not required to obtain No Objection Certificate (NOC) from the Provincial
Governments for locating the project anywhere in the country except in the areas that are
notified as negative areas.
Foreign investors may hold 100% equity allowed on repatriation basis and the minimum
amount of foreign equity investment in the project shall be 0.15 million dollars.
Investment in Infrastructure Sector in Pakistan
Foreign Direct Investment in an infrastructure sector is allowed for infrastructure projects
which may include development of an Industrial Zone(s).
Foreign investors may hold 100% equity allowed on repatriation basis and the minimum
amount of foreign equity investment in the project shall be 0.30 million dollars.
Foreign investors may hold 100% equity allowed on repatriation basis and the minimum
amount of foreign equity investment in the project shall be 0.30 million dollars.
2. Financial Business: Financial sector: For a certain time period, the financial sector of
Pakistan had been attractive for foreign investors due to its high banking spread, market size,
and profitability level. However, in recent times, the failure of the Muslim Commercial Bank
(MCB) to takeover Royal Bank of Scotland (RBS) made foreign investors hesitate to invest
in Pakistan’s banking sector. According to the report, FDI in the financial sector fell to $86.4
million, as compared to $635 million in the same period of last year.
• The fiscal year 2002-03 witnessed tremendous inflow of FDI in textile sector in the
coursework of last one year has reached to US$4 billion which has led to improvement in
productivity, both in terms of quality & quantity, in yarn, fabrics, home textiles & clothes,
besides generating over 300,000 new jobs.
• Foreign direct investment (FDI) in Pakistan’s textile & clothing sector declined in the
coursework of the fiscal year 2008 ending June, partly due to political turmoil in the
country.
• The slump was blamed on increased costs of raw materials, shortage of energy, high
inflation, shortage of expert manpower, together with political turmoil over the past seven
months.
• The country attracted US$36.9m in textile & clothing FDI in the coursework of the year,
compared to US$18.1m in the coursework of the earlier year, according to the statistics
released by the State Bank of Pakistan (SBP).
4. Trade: The government have gradually liberalized its trade and investment regime by
providing generous trade and fiscal incentives to foreign investors through number of tax
concessions, credit facilities, and tariff reduction and have also eased foreign exchange
controls. But, due to rapid political changes and inconsistency in policies the level of FDI
remained low compared to other developing countries.
5. Construction:
• Construction sector has also been a major recipient of foreign investment during this
decade. Pakistan has started building new ports, highways, roads and bridges and oil-rich
Middle East investors have ventured into real estate development and construction of
housing units.
• But the average yearly inflow of FDI in construction, however, fell nine per cent to $87
million during FY08 to FY10 (till March) from $96 million in earlier three years.
“This has happened mainly because the real estate price bubble burst in Dubai and
elsewhere in the UAE,” explains an office-bearer of the Association of Builders and
Developers.
Traditionally, the FDI inflows have come from the US and the UK, Saudi Arabia and the
UAE, Norway, Switzerland and Germany and China, Japan and Hong Kong.
Slump in the macro-economy, decline in exports of cement, and the energy saga were the
main reasons for declining ratios of FDI in the cement and construction sector.
The Housing and Construction sector has also been declared as an Industry. It has also been
placed under priority industries of the investment policy.
Construction FDI in $ Million
2007-2008 89.0
2008-2009 93.4
Jul 09- Mar10 77.7
6. Power:
• But the pace of FDI inflows in power generation has not picked up as yet.
• The Asian Development Bank is also planning investment in this sector.
Power sector: The government is trying its level best to attract more inflows of FDI in the
power sector. Most recently, some private companies signed a memorandum of
understanding (MOU) for investing in the power sector. The delay in rental power projects
badly hit the confidence of foreign investors.
• The post-recession trend also shows a gradual shift in investment choices while financial
business, IT and telecom and oil and gas sectors continue to attract the bulk of FDI.
• Between FY08 and FY10 (till March) Pakistan received roughly $2.7 billion in financial
business, almost as much in IT and telecom and $1.9 billion in oil and gas exploration and
processing.
The foreign direct investment (FDI) in Pakistan’s telecom sector has fallen by more
than 50 per cent this year as compared to the corresponding period, according to the
Pakistan Telecommunication Authority’s annual report 2009-10. The report says there
has been subsequent decline in the FDI since cellular companies kicked off their
operation here in 2005.
Telecom sector attracted over $6.3 billion FDI in last 5 years which is an encouraging
response by the investor towards Pakistan telecom sector policies. UAE, Norway and USA
remained the major sources of FDI during last five years. Out of the total $6.3 billion FDI in
the sector, UAE invested in the PTA annual report another wave of FDI is expected after the
launch of 3G services by Pakistan.
Due to satisfaction of the investor Pakistan enable to have 19th position out of 175 countries
in securing investors
Comparative Analysis with India
Pakistan Telecom Authority Chairman Dr Mohammad Yasin said on Friday that Pakistan’s
telecommunication sector was growing faster, even more rapidly than that of India with over
63 per cent tele density, encouraging the foreign direct investment (FDI
“Look, India is lagging far behind Pakistan with 37 per cent tele-density as compared to 63.5
per cent in Pakistan. Our FDI policy is much more liberal than that of India to attract more
investment in Pakistan’s telecom sector,” he added.
The main reasons of decline in FDI were lack of foreign investors’ interest in the
telecommunication sector, low confidence in the country, limited prospects of market
expansion, and last but not the least, slowdown in the privatization drive.
10. TOURISM
• Tourism is another area which has been suffering from negligence since long. In order to
inject life in this sector, the government has declared it as an industry.
• In Pakistan tourism has a huge growth potential with high returns and revenue for the
investors. Hotels and other tourism projects hold great promise and rewards for the
investors:
Eras
The 1980s
After the dismal performance of the industrial sector following the 1972 nationalization, a
change occurred in September 1978 in the government’s approach toward the role of the
public and private sectors.
The role of the public sector was restricted to consolidating existing enterprises, and further
investment in this sector was strictly restricted.
In 1984 the industrial policy statement was published that not only accorded equal
importance to the public and private sectors but also encouraged the private sector to come
forward.
Specifically, FDI was discouraged by:
• Significant public ownership, strict industrial licensing, and price controls by the
GOP;
• The inefficient financial sector with mostly public ownership, directed credits, and
segmented markets
• A noncompetitive and distorting trade regime with import licensing, bans, and high
tariffs.
Pakistan began to implement a more liberal foreign investment policy as part of its overall
economic reform program toward the end of the 1980s. Accordingly, a new industrial policy
package was introduced in 1989 based on the recognition of the primacy of the private sector.
A Board of Investment (BOI), attached to the Prime Minister's Secretariat, was set up to help
generate opportunities for FDI and provide investment services. A “one-window facility”
was established to overcome difficulties in setting up new industries.
The 1990s
Originally, each foreign investment was subject to separate authorization, but this
requirement was eliminated in May 1991. In general, no special registration was required for
FDI, and the same rules and regulations were applied to FDI as to domestic investors.
All investors, whether domestic or foreign, were required to obtain a No Objection
Certificate (NOC) from the relevant provincial government for location of their projects.
Thus, the physical location of the investment was effectively controlled by the provincial
governments, which was considered a major bottleneck in speedy industrialization.
One of the most important measures taken recently by the government affecting FDI has been
the liberalization of the foreign exchange regime.
Residents and non-resident Pakistanis and foreigners are now allowed to bring in, possess,
and take out foreign currency, and to open accounts and hold certificates on foreign currency.
To further liberalize the foreign exchange regime, the Pakistani rupee has been made
convertible effective 1 July 1994. The ceiling earlier imposed on contracting foreign loans
has been abolished. Permission of the Federal Government or the SBP would not be required
regarding interest rate or payment period of foreign loans not guaranteed by the Government
of Pakistan.
A number of fiscal incentives include a three-year tax holiday to all industries throughout
Pakistan set up between 1 December 1990 and 30 June 1995. Investments in delineated rural
areas, industrial zones, and less developed areas enjoy five and eight years tax holiday
respectively, together with special custom duty and sales tax concessions. The import policy
has also been liberalized considerably, and the maximum tariff rate has been reduced from
225% in 1986/1987 to 45% in 1996/1997.
Special industrial zones (SIZs) have been set up to attract foreign investment in export-
oriented industries. Apart from foreign investors, Pakistanis working abroad are also eligible
to invest in SIZs. The government is responsible for providing the necessary infrastructure
and utility services in the SIZs.
In November 1997, the government issued the New Investment Policy which includes major
policy initiatives. In the past, foreign investment was restricted to the manufacturing sector.
Now foreign investment is allowed in sectors like agriculture and services, which constitute
above three fourths of gross national product. The main objective of the new policy is to
enhance the level of foreign investment in the fields of industrial base expansion,
infrastructure and software development, electronics, engineering, agro-food, value-added
textile, tourism, and construction industries.
1. BY DIRECTION
• Inward Investment: Inward investment means the investment when foreign capital is
invested in local resources. Inward investment is encouraged by tax breaks, subsidies,
grants etc. by the Govt.
• Outward Investment: Outward investment is the investment when local capital is
invested in foreign resources means investment in imports and exports from a foreign
commodity country. Outward Investment is discouraged by tax disincentive, subsidies for
local businesses and Government policies for the support of nationalization of the
industries.
2. BY TARGET
3. MOTIVE
FDI can also be categorized based on the motive behind the investment from the perspective
of the investing firm:
• Resource-Seeking: Investments which seek to acquire factors of production those are
more efficient than those obtainable in the home economy of the firm.
In some cases, these resources may not be available in the home economy at all (e.g.
cheap labor and natural resources).
• Cash brought in
• Capital equipment brought in
• Re-invested earnings
The structure of the sources of financing FDI in Pakistan has undergone a noticeable change.
Though all the components of FDI exhibit considerable fluctuations over time but the major
share of FDI in Pakistan is comprised of cash brought in (above 50% over the last 20 years).
Trends of Foreign Direct Investment in
Pakistan
Foreign Direct
Years Investment
2005 1524
2006 3521
2007 5139.6
2008 5152.8
2009 3179.9
2010 2150.8
The inflow of FDI in Pakistan over the last decade has remained very fluctuating as we can
see from the table the FDI increases from 322.5 Million $ to 5152.8 Million $ from FY2001
to FY2008 and than again decreases to 2150.8 Million $ in FY2010
Than afterwards the inflow of FDI in Pakistan shows a decreasing trend. The main reasons
for this decrease are weakening macro economic fundamentals e.g. power crises and poor law
and order situation in the country.
Determinants of FDI
Major factors of FDI are as follow:
1. Market size: One of the most important determinants of foreign direct investment is
the size as well as the growth prospects of the economy of the country where the foreign
direct investment is being made. It is normally assumed that if the country has a big market, it
can grow quickly from an economic point of view. Market size is generally measured by
Gross Domestic Product (GDP), GDP per capita income and size of the middle class
population.
2. Labor cost: This depends on the availability and cost of inputs, the efficiency at which
these are turned into outputs, and the costs of moving from production to marketing. It is
generally assumed that a foreign investment would invest in host country if costs (wages) of
producing in that country are lower that in the home country and if productivity is higher.
Low costs are so important that firms began investing in less developed countries simply to
take advantage of the cheaper labor. In order to maximize profits, production will be located
where costs are the lowest:
3. Human Capital: Higher level of human capital is a good indicator of the availability of
skilled workers, which can significantly boost the FDI. The increased role of host country
governments in upgrading human resources through educational and training programs is a
major motivator for firms.
However, Productivity levels in sub-Saharan Africa are generally lower than in low-income
Asian countries. The lack of engineers and technical staff in these countries is reported as
holding back potential foreign investment, especially in manufacturing; it lessens the
attractiveness of investing in productive sectors.
4. Political Stability : Political instability and the frequent occurrences of disorder ‘create an
unfavourable business climate which seriously erodes the risk-averse foreign investors'
confidence in the local investment climate and thereby repels FDI away.
Political instability, expressed in terms of crime level, riots, labor disputes and corruption, is
an important factor restraining substantial foreign investment.
5. Openness: The ratio of trade to GDP is often used as a measure of openness of a country
and is also often interpreted as a measure of trade restrictions. An open country gives
confidence to investors. Trade performance can be measured by export and import ratios.
The corporate tax rates (as measured by TAX) of the host country represent another factor
which foreign direct investors would consider and higher these tax levels of the host country
would be expected to deter potential FDI.
8. Presence of Natural Resources :Not only is the price and quality of natural resources
important, but the availability of local opportunities for upgrading the quality of resource
inputs and the processing and transportation of their outputs are also important. Natural
resources are exogenous economic factors that may help a country attract higher levels of
FDI that are independent of political institutions and government policies. We therefore
include the share of minerals and oil in total exports to capture the availability of natural
resource endowments.
• The FBR (Federal Board of Revenue) will not question as to the source of investment
• BOI’s (Board of Investment) approval is not required for foreign companies to open a
bank account.
The Foreign direct investment ( FDI) in Pakistan dropped by 39 per cent to 2.03 billion U.S.
dollars during the first 11 months of the current fiscal year ( July 2009 to June 2010) from
3.33 billion in the same period of last year, economists said Wednesday.
There was an outflow of 133.8 million of portfolio investment during these 11 months, which
was, however, much lower than the outflow of 1.103 billion in the same period last year, said
a report in the Daily Times.
Total foreign investment registered a fall of 14.8 per cent to 1. 876 billion from 2.227 billion
during the first 11 months, mostly concentrated in the services sector and little invested in the
manufacturing sector.
This trend is harmful for the country in the long run because these investments create few
jobs, but generate handsome profits in the country, which is then sent abroad, said an
economist.
In a breakdown, oil and gas exploration sector attracted 653.9 million FDI,
telecommunications 378.7 million, financial business 153.8 million, transport 115.5 million,
construction 95.5 million, food industry 71.9 million
The economist said that most of these sectors are not labor- intensive and, therefore, do not
contribute significantly to job creation efforts of the government. He said it was necessary for
the government to improve infrastructure and ensure elimination of energy shortages in order
to attract substantial foreign investment in the manufacturing sector.
The United States, with an investment of 521.8 million dollars, continued to be the largest
source of foreign investment for Pakistan.
Policy Recommendations
General Recommendations: First of all, Pakistan should make stronger efforts to attract as
much FDI as possible to the foreign exchange sectors in the short term. Taking into account
unfavorable balance of payments prospects, it should refrain from attracting any further
massive FDI in the no foreign-exchange-earning sectors for some years in the future. Political
stability and satisfactory law and order are likewise critical to attract FDI. The laws and
regulations should be simplified, updated, modernized, made more transparent, and their
discretionary application must be discouraged.
Specific Recommendations
• Credit Facilities Foreign firms operating in Pakistan are currently facing cash flow
problems as a result of many taxes and the Asian crisis. That these firms cannot borrow
more than their equity. There is a need to review this policy.
• Anti-monopoly Restrictions The existing monopoly control laws that benchmark the
concentration of economic power to an unrealistically low limit of Rs 300 million for
assets discourage capital formation.
The monopoly control authority must review the limit
• Labor Laws Overprotective labor laws do not encourage productivity and frighten
away much needed productive investment. There is a need to rationalize the labor laws
and multiple levies on employment that inhibit business expansion and job creation.
• Confidence-building Measure: The close partnership between the private and public
sector is essential to build confidence it is recommended that a forum be established
where the private and public sectors could sit together to discuss business promotion-
related issues.