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Foreign Direct Investment

Foreign direct investment (FDI) includes significant investments by foreign companies,such as construction of production facilities or ownership stakes taken in U.S. companies.

FDI not only creates new jobs, it can also lead to an infusion of innovative technologies,management strategies, and workforce practices. The ultimate flow of foreign involvementis direct ownership of foreign- based assembly or manufacturing facilities. The foreigncompany can buy part or full interest in a local company or build its own facilities. If theforeign market appears large enough, foreign promotion facilities offer distinct advantages.First, the firm secures cost economies in the form of cheaper labor or raw material, foreigngovernment incentives, and freight savings. Second, the firm strengthens its image in thehost country because it creates jobs. Third, the firm develops the recent relationship withthe government, customers, local suppliers, and distributors, enabling it to adapt its product

better to the local environment. Forth, the firm retains full retain over its investment andtherefore can develop manufacturing and marketing policies that serve its long-terminternational objectives. Fifth, the firm assures itself access to the market in case the hostcountry starts insisting that locally purchased goods have domestic content.

Foreign Direct Investment (FDI) is capital provided by a foreign direct investor, eitherdirectly or through other related enterprises, where the foreign investor is directly involvedin the management of the enterprise. Development of a new business or acquisition of atleast 10% interest in a domestic company or a tangible assets, (purchase of bond & stock).Foreign direct investment is the transfer by a multinational firm of capital, managerial, and

technical assets from its home country to a host country.

FDI has three components: equity capital, reinvested earnings and intra-company loans.FDI flows are recorded on a net basis (capital account credits less debits between directinvestors and their foreign affiliates) in a particular year. Outflows of FDI in the reportingeconomy comprise capital provided (either directly or through other related enterprises) bya company resident in the economy (foreign direct investor) to an enterprise resident inanother country (FDI enterprise). Inflows of FDI in the reporting economy comprise capitalprovided (either directly or through other related enterprises) by a foreign direct investor toan enterprise resident in the economy (called FDI enterprise).

Types of Foreign direct investment

Multinational Corporation

A country that maintains significant operation in multiple countries but manages them fromthe base in the home country.3

The MNCs are playing an important role in economic development of developing countries.First, the investment made by MNCs help in filling the saving investment gap. Secondly, it


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fills the foreign exchange or trade gap. Thirdly, the govt. of the developing countries is ableto fill up the reserves gap by taxing the profits of MNCs. Fourthly, MNCs fill the gaps inmanagement entrepreneurship, technology and skills in the developing countries.

Transnational Corporation

A country that maintains the significant operation in more than one country butdecentralize management to the local country.

Strategic alliance

An approach to going global that involves partnerships between an organization and aforeign company in which both share knowledge & resources in developing new products or

building production facilities.

It is an agreement typically between a large company with established products & channel ofdistribution and an emerging technology company with a promising research and

development program in areas of interest to the larger company. In exchange for itsfinancial support, the larger established company obtains a stake in the technology beingdeveloped by the emerging company. Today, strategic alliance is common place in the

biotechnology, information technology & the software industries.6

Companies are also discovering that they need strategic patterns if they hope to beeffective. Even giant companies like AT&T, IBM, Phillips, Siemens etc often can not achieveleadership, either nationally or globally, without forming strategic alliances with domesticor multinational companies that complement or leverage their capabilities and resources.

Well-managed alliances allow companies to obtain a greater sales impact at less cost. Tokeep their strategic alliances thriving, corporation has begun to develop organizationalstructure to support them and have come to view the ability to form and managepartnership as core skills in and of themselves.

Joint venture

An approach going global that is a specific type of strategic alliance in which the partnersagree to form an independent organization for some business purpose.

They can be of two types:

Acontractual joint venture between firms is usually for a specific project, such asmanufacturing a component or other product for a fixed period of time.

An equityjoint venture is when firms hold an equity stake in the setting up of a jointsubsidiary, again to produce a good or a service, for example Toyota and General Motorsformed the subsidiary NUMMI to manufacture cars in the United States.

Foreign investors may join with local investors to create a joint venture in which they shareownership and control. For instance:


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Coca-cola and Nestle joined forces to develop the international market for ready to drinktea & coffee, which currently sell in significant amount only in Japan.

Forming a joint venture may be necessary or desirable for economic & political reasons. Theforeign form might lack the financial, physical and managerial resources to under take the

venture alone. Or the foreign govt. might require joint ownership as a condition for entry.Even corporate giants need joint ventures to crack the toughest markets.

Foreign subsidiary

An approach going global that involves a direct investment in a foreign country by setting upa separate & independent production facility or office.

Licensing

An approach to going global by manufacturing organizations that involves giving otherorganizations the right to use your brand name, technology or product specifications.10

When a firm (the licensor) has legal control over intellectual property rights and thesetting-up of a local operation in another country seems too expensive, they can give alicense to another company.

This method is often used when there is a need for the rapid manufacturing of a product, toexploit an opportunity when there is insufficient time to put in the own production capacity.

There are different types of licensing:

a) ASSIGNMENT - to hand over completely a patent etc to licensee

b) SOLE LICENCE - to one company and no licenses to any other firms

c) EXCLUSIVE - not for use with licensors other products

d) KNOW-HOW LICENSING - of confidential knowledge

The licensee (the firm obtaining the license) usually demands exclusive rights in thecountry or countries and may have the right to subcontract to other parties.

Exclusive licensing may contravene EU competition laws, but there are exemptions, forexample if the good or service has less than 5% market share and the turnover of the parties

is less than 200m Ecus.

Japanese firms licensed much especially in the immediate post-war period. In 1945 Japanproduced mainly low priced toys, textiles & basic engineering goods. The Government (bythe actions of their Ministry of Finance and Ministry of International Trade and Industry)redirected resources to high volume, capital-intensive industries in order to stimulateproductivity and economic growth. They used licenses to acquire the technology that wasneeded to develop medium and high technology industries, for example the transistor from


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the USA. They then applied the technology to produce a range of products, many of whichcame to dominate world markets by capturing large market shares. In 1976 Japanese firmshad gained 90% of the OECD exports of motorbikes, 70% of TVs and radios, 43% of ships,23% of watches and 20% of cars.

Franchising

An approach to going global by service organizations that involves giving otherorganizations the right to use your brand name, technology or product specifications.11

Franchising is a form of licensing. The franchisee adopts the parent companys entirebusiness format; the name, trademark, methods, management services, training, technicaladvice and stock control systems. You can probably think of a number of firms, particularlyin the retail and food sectors that use the franchise system.

The franchisor, such as the American McDonalds fast food firm, keeps firm control overthe franchisees in order to maintain the quality of the product. They supply good quality raw

materials and set standards (verified by random checks) that have to be maintained if thefranchise is to continue. The franchisor receives royalties, a lump sum fee and the profit onthe materials that are supplied to the franchisee.

MacDonald's have established a high reputation and the franchise system have enabledthem to spread rapidly throughout the world. Franchisee's now pay large sums to acquirethe right for this business, especially in the world's major cities such as Hong Kong.

INTRODUCTION*

The role of foreign direct investment (FDI) has been widely recognized as a growth-enhancing factor in developing countries. There are a variety of channels through which FDIcan promote economic growth, in the host country.

Most of the developing countries rely primarily on FDI as a source of external financebecause FDI stimulates economic growth more than other sources of capital inflows.

FDI is likely to be an engine of host countrys economic growth, because (i) inward FDI mayenhance capital formation and employment generation, (ii) FDI may promotemanufacturing exports, (iii) FDI may bring resources into host country such as,management know-how, access of skilled labour to international production networks, andestablished brand names, and (iv) FDI may result in technology transfers

FDI in Pakistan is being widely considered as an important vehicle for economic growth.Pakistan has introduced a wide range of incentives, congenial for local and foreign investorsand has increasingly tended to turn to FDI as source of capital, technology, managerial skillsand market access needed for sustained economic development. The country provides aone-window facility for setting up business, and foreign investment is fully protected by law,including avoidance of double taxation. The outward orientation in policies designed by thegovernment to attract more FDI has been accompanied by the adoption of policies relating


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to privatization and deregulation of economic activity and greater reliance on market forcesin the country.

Pakistans recent reforms offer unprecedented and conducive business environment to allmultinational corporations (MNCs). Pakistan is know one of those countries in the region

whose reforms and economic achievements during the last few years have steered thecountry to a business-friendly environment, creating a win-win situation for both investorsand consumers.

Investment in electronics and other high-tech industries is widely seen as special desirablein developing countries like Pakistan, providing employment opportunities, and boostingexports by increasing production and help in modernizing the economy.

THEORIES OF FOREIGN DIRECT INVESTMENT

Theories play an important role in shaping legal attitudes both nationally andinternationally. Theories of FDI assert that the basis for such investment lies in the

transaction costs of transferring technical and other knowledge. Three important theories ofFDI are discussed below.

Neoclassical Economic Theory of FDI

Neoclassical economic theory propounds that FDI contributes positively to the economicdevelopment of the host country and increases the level of social wellbeing [Bergten, et al.(1978)]. The reason behind this argument is that the foreign investors are usually bringingcapital in to the host country, thereby influencing the quality and quantity of capitalformation in the host country. The inflow of capital and reinvestment of profits increasesthe total savings of the country. Government revenue increases via tax and other payments[Seid (2002)]. Moreover, the infusion of foreign capital in the host country reduces the

balance of payments pressures of the host country.

The other argument favouring the neoclassical theory is that FDI replaces the inferiorproduction technology in developing countries by a superior one from advancedindustrialised countries through the transfer of technology, managerial and marketingskills, market information, organisational experience, and the training of workers [Kojima(1978)].

The MNCs through their foreign affiliates can serve as primary channel for the transfer oftechnology from developed to developing countries. The welfare gain of adopting newtechnologies for developing countries depends on the extent to which these innovations are

diffused locally.

The proponents of neoclassical theory further argue that FDI raises competition in anindustry with a likely improvement in productivity [Kojima (1978); Bureau of IndustryEconomics (1995)]. Rise in competition can lead to reallocation of resources to moreproductive activities, efficient utilization of capital and removal of poor managementpractices. FDI can also widen the market for host producers by linking the industry of hostcountry more closely to the world markets, which leads to even greater competition andopportunity to technology transfer [Bureau of Industry Economics (1995)].


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It is also argued that FDI generates employment, influences incomes distribution andgenerates foreign exchange, thereby easing balance of payments constraints of the hostcountry [Reuber, et al. (1973); Sornarajah (1994); Bergten, et al. (1978)]. Furthermore,infrastructure facilities would be built and upgraded by foreign investors. The facilities

would be the general benefit of the economy [Sornarajah (1994)].

The Guidelines on the Treatment of Foreign Direct Investment incorporates the neoclassicaltheory when it recognises: that a greater flow of direct investment brings substantial

benefits to bear on the world economy and on the economies of the developing countries inparticular, in terms of improving the long-term efficiency of the host country throughgreater competition, transfer of capital, technology and managerial skills and enhancementof market access and in terms of the expansion of international trade.

Kennedy (1992) has noted that host countries became more confident in their abilities togain greater economic benefits from FDI without resorting to nationalization, as theadministrative, technical and managerial capabilities of the host countries increased.

Dependency Theory of FDI

Dependency school theory argues that foreign investment from developed countries isharmful to the long-term economic growth of developing nations. It asserts that First Worldnations became wealthy by extracting labour and other resources from the Third Worldnations. It further argued that developing countries are inadequately compensated for theirnatural resources and are thereby sentenced to conditions of continuing poverty. This kindof capitalism based on the global division of labour causes distortion, hinders growth, andincreases income inequality in developing countries. Hence, Third World nations mustdevelop independently without depending on foreign capital and goods.

The influence of the dependency theory peaked in the 1970s; many authors advocated that

dependency theory provided some useful qualitative methods to restrict foreign capital.Various countries adopted dependency theory perspectives in the 1970s, including EastAsian and Latin American countries. A number of these countries adopted importsubstitution strategy and demonstrated a hostile attitude toward foreign investment. Thesepolicies had harmful effects on these economies [Hein (1992)]. During 1970s and 1980s East

Asian countries also shifted their attention from dependency theory to more liberal policiesto attract foreign investment.

2.3. Industrialization Theory on FDI

Caves (1971) and 1974) and Kindle Berger (1984) extended the industrial organization

theory of FDI by emphasizing the behavior of the firms that deviate from perfectcompetition as the determinants of FDI. They are of the view that in comparison to thedomestic firms, MNCs face a number of problems such as geographical distances inmanaging enterprises, linguistic, and cultural barriers.

When a firm undertakes FDI in a foreign country, it must posses some special ownershipadvantages over domestic competitors. Such advantages include marketing andmanagement skills, brand names, patent-protected superior technology, and cheaper sourceof financing, preferential access to markets and economies of scale [Haque (1992). Unlike


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portfolio investment, FDI entails a cross border transfer of a variety of resources including,process and product technology, managerial skills, marketing and distribution know how,and human capital.

AN OVERVIEW OF FDI INFLOWS IN PAKISTAN 1970-2006

The higher level of saving and investment is necessary to increase the rate of capitalformation. However, in developing countries the level of domestic savings falls below thedesired level because of low per capita income. In the case of Pakistan, domestic savingsaccount for less than 20 percent of the GDP.

This gap between domestic savings and desired level of investment can be filled by thetransfer of resources from outside. FDI is one of the most important sources. To increasethe level of foreign capital inflows, liberalization of trade and investment regime by relaxingcontrols and offering financial and trade incentives like tax concessions and tariff reductionsshould be needed. Furthermore, host country should pursue active liberalization policies toovercome trade deficit, and encourage investment in export-led sectors. To ensure that FDI

stimulates domestic economic activity, the host country should make it mandatory for theforeign investor to use a certain amount of locally made inputs in the production of finalgoods. The domestic policies opted by the host countries have an important influence on thedecisions of foreign investment. To attract FDI, the host country should adopt concrete andinvestor friendly policies, strong infrastructure are the pre-conditions to restore theconfidence of foreign investors.

After following somewhat restrictive economic policies, the government of Pakistaninitiatedmarket-based reforms in the 1990s. These reforms included gradual liberalizationof trade and investment regime by providing various trade and fiscal incentives to foreigninvestors through tax concessions, credit facilities, tariff reduction and easing foreignexchange controls [Khan (1997)]. In the early 1990s, the government undertook a number of

policy and regulatory measures14 to improve the business environment in order to attractforeign investment [Anwar (2002)]. In order to encourage FDI, restrictions on capitalinflows and outflows were gradually lifted. Foreign investors were allowed to hold 100percent of the equity of industrial project a repatriable basis without any prior approval.Furthermore, investment shares issued to non-residents could be exported, and remittanceof dividends and disinvestments proceeds was permissible without any prior permission ofState Bank of Pakistan (SBP). In 1994, restrictions on some capital transactions werepartially relaxed, and foreign borrowing and certain outward investments were allowed tosome extent. Full convertibility of the Pak-rupee was established on current internationaltransactions. The establishment of an interbank foreign exchange market also marked animportant step towards decentralizing the management of foreign exchange and allowingmarket forces to play a greater role in exchange rate determination.

Pakistans foreign investment regime mainly consists of three components. (i) regulatory,(ii) economic, and (iii) socio-political. Regarding privatization and deregulation, Pakistanhas opted very liberal regulatory regime.

The regulatory framework for foreign investment consists of three laws facilitating andprotecting foreign investors; (i) Foreign Private Investment (Promotion and Protection) Act1976, (ii) Furtherance and Protection of Economic Reforms Act 1992, and (iii) Foreign


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Currency Accounts (Protection) Ordinance 2001. In addition Bilateral Agreements include:investment protection with 43 countries and avoidance of double taxation with 51 countries.

To protect the intellectual property rights (IPRs), Pakistan has also updated IPR laws tobring them in compliance with international requirements particularly, those mandatoryunder the Agreement on Trade Related Intellectual Property Rights (TRIPS) of the WTO.The salient features of the Pakistans regulatory regime are: Freedom to bring, hold and takeout foreign currency from Pakistan in any form. Privatization of an enterprise is fullyprotected. Neither it can be renationalized, nor can the government take over any foreignenterprise. Original FDI as well as profits earned can be repatriated to the country of origin.

Equal treatment is provided to the foreign investor and local investor in terms of import andexport of goods. FDI is not subject to taxes in addition to those levied on domesticinvestment.

Foreign currency accounts are fully protected and they cannot be frozen.

All the economic sectors including services sector are open to FDI, foreign equity up to 100percent is allowed in all sectors. However, foreign equity up to 80 percent is allowed inagriculture sector.

There is no lower limit on the size of FDI in manufacturing sector. However, in services,infrastructure and social sectors the minimum amount of foreign equity investment is $0.3million. No government sanction is required to set up any industry, in terms of field ofactivity, location, and size, except arms and ammunitions, high explosives, radioactivesubstances, security printing, currency and mint and alcoholic beverages.

No double taxation on income earned by foreign investors.

Pakistan has also rationalised its tariff regime. Custom duty on import of most of theprimary raw material is not more than 5 percent, while on the imported machinery is

between 0 and 10 percent. Copyright law has been amended while laws regarding patents;industrial designs and trademarks have been re-enacted. There is no requirement forobtaining no objection certificate (NOC) from provincial governments for locating theproject anywhere in the country except in areas that are notified as negative areas. But dueto the inconsistency of government policies, the level of FDI remained low as compared toother developing countries. Pakistan has received comparatively higher amount of FDI overthe past two decades due to its market-oriented investment policies and enablingenvironment for investment. FDI inflows to Pakistan can be explained in terms of its sizeand percentage of gross domestic product (GDP). Due to inconsistent policies, the flow of

FDI was insignificant until 1991. However, the flow of FDI steadily increased in the post-liberalisation period. Actual inflows of FDI to

Pakistan have increased from $119.6 million in the 1975-79 to $3299.8 millions in the 1995-99 (Table 1 and Figure 2). The FDI inflow increased from $469.9 million in 1999-2000 to$798 million 2002-03 showing 65 percent increase and stood $3521 million in 2005-06.


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Since 2004, there has been a significant increase in the net inflows of capital. Capital inflowsincluded mainly one-off inflows such as, $354 million through privatization and $600million through sovereign debt issued internationally and an increase in confessional long-

term loans from the World Bank and Asian Development Bank. FDI reached to $1.5 billionin 2005, 61 percent higher than in 2004. New FDI is concentrated in a few sectors such astelecommunications, finance and Oil and Gas exploration. However, this increase becomesinsignificant when we compare with the South Asian countries. The net private inflows tothese countries were about $106 billion in 1996 [Burki and Savitsky (2000)]. The reasonsfor low level of FDI inflows include the lack of political stability, slow bureaucratic process,inadequate infrastructure facilities, macroeconomic imbalances, inconsistent economicpolicies of successive governments, delays in the privatisation of state-owned enterprises,


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past disputes between foreign investors and the government, piracy of intellectual property,and arbitrary and non-transparent applications of government regulations.

Dimensions of FDI in Pakistan

The dimensions of the FDI flows into Pakistan can be explained in terms of its growth andsize, sources and sectoral compositions. The growth of FDI in Pakistan was not significantuntil 1990 due to the regulatory policy framework.

However, under the more liberal policy regime, it has played a more significant role in thedevelopment of Pakistans economy as shown in Table 2. It shows that over the post-liberalization era, there is a steady build up in the actual FDI inflows which have steadilyincreased from US$ 216.2 million in 1990 to US$ 1524 million in 2005, thus growing at theannual compound rate of 21.47 percent. The decline to US$322.5 million in 2000-01 can beattributed to many factors including the US sanctions imposed in the aftermath of thenuclear tests, the East Asian financial crisis and political instability.

However, the flow of FDI picked up after 2001-02 due to the revival of closer US-Pak tiesand the liberalized foreign investment environment and FDI grew at 212 percent since2000. In the year 2004-05 FDI was $1524 million. During the fiscal year 2005-06 Pakistanreceived $3521 million as FDI. Since 2003, Pakistan has registered an increasing trend ofFDI inflows and the FDI-GDP ratio (Figure 3). Table 3 depicts the inflows of FDI by originin Pakistan since 1989-90.

The US, UK and UAE remain the major source of FDI inflows in Pakistan despiteconsiderable fluctuations in their shares. The share of FDI from UAE fluctuated between1.20 percent in 2000 to 24.1 percent in 2005-06, that of UK from 6.5 percent in 2002-03 to36 percent and USA 21.4 percent to 67.3 percent. Figure 4 indicates that over 80 percent ofthe FDI shares to Pakistan collectively originated from US, UK, UAE, Germany, France,

Italy, Japan, and Netherlands since 1990. The top two investors during the year 2005-06 inPakistan are UAE, which accounted for nearly 42.5 percent, and the US 14.7 percent. Saudi

Arabia, UK, Switzerland and Norway accounted for 7.9, 6.9, 4.8 and 7.2 percent of FDI flowsto Pakistan, while all other sources amounted to 18 percent (Table 3a). The inflows of FDIover the last four years were relatively broad-based, with almost all sectors witnessing anincreasing trend (Table 4).


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Table 4 and Figure 5 indicate that the services sector attracted the major chunk of FDIs(Figure 6). The significant increase of FDI in services sector has enhanced its contribution

towards GDP by 66 percent. Within services sector, Telecom sector remained the mostdominant as depicted by an absolute increase of around $1937.7 billion. During 2005-06the contribution of Telecom in total FDI exceeded 55 percent.

Power generation is the second major area of interest followed by the communication sectorin attracting FDI. This industry has immense potential for investment and the governmentis trying to attract more investment in this industry. The investment which dipped tonegative $14 million in 2003-04 is now increasing and touched to $320.6 million in 2005-06.17 Other important sector is the Oil and Gas exploration. Pakistan has the fifth largestreservoir of coal (184 billion tons) in the Thar but only 4.5-5.0 million tons is minedannually, representing significant upside potential of the industry. The flow of FDI in thissector is continuously increasing and reached to $312.7 million in 2005-06.

Besides telecommunication and power sectors, financial services have also attractedconsiderable FDI. More than 800 percent growth of FDI in the financial sector over the lastfour years is due to the financial sector reforms.

Liberalization and privatisation of the financial sector appears to be the main factorresponsible for a massive inflow of foreign capital. FDI inflows in this sector have increasedup to $329.2 million at the end of 2005-06 as compared to $269.4 million in 2004-05.


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Trade group attracted $118 million, construction $89.5 million and others $413.3 millions.

Pakistan has a lot of potential to attract foreign investment. Though, the rising trend of FDI

reflects the success of the policy. However, FDI is considerably hindered due to institutionalweaknesses, corruption, ineffective legal institutions, political uncertainty, poor law andorder situation and low labor productivity.

Review of Last 10 Years

Impact of Foreign Direct Investment (FDI) on the sectors (agriculture, industry andservice) growth pattern of Pakistani economy over the last 10 years 2000-2009.Total FDI for the first 3 quarters of 2007 stands at USD 3.86 billion; 72% higher than thecorresponding period of the previous year. One interesting point is that over the period2000 to 2009, the country enjoyed a positive net FDI inflow except, when foreign investors

have taken out more money than they have pumped into the country through repatriation ofprofit/dividend, capital and repayment of loans with foreign banks and other sources.

Pakistan has witnessed a steady growth in FDI during past few yeas. This growthin FDImay be attributed mainly to political stability and macroeconomic reforms by thegovernment (Khan, 2005). The most attractive sectors for foreign investors have been oiland gas exploration, telecommunication and financial services (BOI, 2006). Thederegulation policy regarding telecom sector attracted huge foreign investment accountingfor 55% of total FDI in the year 2005-2006. But then due to political instability and socio-economic factors, Pakistanhas seen a decrease in the following years till present.

Until the1980s, most developing countries viewed FDI with great weariness. In recent

years, however FDI restrictions have been significantly reduced. Most countries offerincentives to attract FDI, such as tax concessions, tax holidays, accelerated depreciation onplants and machinery, export subsidies and import entitlements etc. As a developingcountryPakistanneeds FDI for its ongoing development process. Sinceindependence, Pakistan is trying to be a suitable location for FDI. However, as therecipients ofFDI, Pakistans position, in comparison with other counties of the world, is

weak. Pakistan has performed better in last few years and received more than double


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inward FDI flows in 2005 as compared to 2000, however, this performance is much lowerthan the other developing and developed countries of the world.

Table 1: Sector Wise FDI Inflows (Million $)

Sector 2000-

01

2001-

02

2002-

03

2003-

04

2004-

05

2005-

06

2006-

07

2007-

08

2007-08

(July-

April)

2008-09

(July-

April)

Oil & Gas 80.7 268.2 186.8 202.4 193.8 312.7 545.1 634.8 509.4 612.1

Financial

Business

(34.9) 3.6 207.4 242.1 269.4 329.2 930.3 1,607.6 997.1 680.9

Textiles 4.6 18.5 26.1 35.4 39.3 47.0 59.4 30.1 25.1 28.4

Trade 13.2 34.2 39.1 35.6 52.1 118.0 172.1 175.5 139.6 147.7

Construction 12.5 12.8 17.6 32.0 42.7 89.5 157.1 88.5 77.2 76.8

Power 39.9 36.4 32.8 (14.2) 73.4 320.6 193.4 70.3 52.2 80.2

Chemical 20.3 10.6 86.1 15.3 51.0 62.9 46.1 78.0 66.5 58.0

Transport 45.2 21.4 87.4 8.8 10.6 18.4 30.2 73.0 6.0 0.5

Communication

(IT&Telecom)

NA 12.8 24.3 221.9 517.6 1,937.7 1,898.7 1,625.3 1,164.9 828.5

Others 140.9 66.2 90.4 170.1 274.0 285.0 1,107.2 769.7 681.1 692.3

Total 322.4 484.7 798.0 949.4 1,523.9 3,521.0 5,139.6 5,152.8 3,719.1 3,205.4

Privatisation

Proceeds

- 127.4 176.0 198.8 363.0 1,540.3 266.4 133.2 133.2

FDI Excluding

Pvt. Proceeds

322.4 357.3 622.0 750.6 1160.9 1980.7 4873.2 5,019.6 3,585.9 3,205.4

13.8% decrease in FDI Including Pvt. Proceeds as compared to July-April FY 0810.6% decrease in FDI Excluding Pvt. Proceeds as compared to July-April FY 08

Source: BOI, Pakistan

Magnitude of FDI:

Till almost a decade ago, the Foreign Direct Investment (FDI) inflows in Pakistan stoodfairly below the desired level. In 1995-96, the economy though registered FDI inflows worthUSD 1.1 billion mainly on account of agreements with Independent Power Producers (IPPs),

the inflows fell sharply in the following year as the successive government renouncedagreements with IPPs. This gave rise to a row between the government and IPPs, whichadversely affected foreign investors confidence in Pakistan.

Moreover the countrys decision to go nuclear in 1998 prompted several foreign countries toimpose economic restrictions which exerted further downward pressure on FDI inflows. It

was only during the last six financial years that the FDI levels improved significantly owingto the dynamic economic and investment policies executed by the government that includedopening the economy through privatization and deregulation and establishment of a


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liberal FDIregulatory regime. This regulatory framework for foreign investment constitutesthree laws: Foreign Private Investment (Promotion & Protection) Act 1976; Furtherance andProtection of Economic Reforms Act 1992; and Foreign Currency Accounts (Protection)Ordinance 2001. Taken together, these laws protect FDI in the following manner:

1. There is freedom to bring, hold and take out foreign currencyfrom Pakistan in any form.

2. Fiscal incentives provided by the government cannot be altered to thedisadvantage of the investor.

3. The privatization of an enterprise is fully protected.

4. No foreign enterprise can be taken over by the government.

5. Original foreign investment as well as profits earned on it can be repatriatedto the country of origin.

6. Equal treatment is provided to a foreign investor and local investor in termsof import and export of goods.

7. FDI is not subject to taxes in addition to those levied on domestic investment.

8. Foreign currency accounts are fully protected and they cannot be frozen.(Courtesy the Foreign Currency Accounts Ordinance 2001).

Foreign investors are permitted to hold 100% of the equity in not only industrial projectsbut also in the Service, Infrastructure and Social Sectors (subject to certain conditions) onrepatriable basis. Moreover, no government sanction is required for setting up an industryin terms of field of activity, location and size except in case of four sectors relating tonational security. Under the deregulation policy, government controls on business activityare being relaxed even further. To avoid double taxation on income earned by foreigninvestors,Pakistan has already concluded agreements with 51 countries that include nearlyall the developed economies. As a result of these proactive policies, the FDI increased by

more that 900% in the past six years. It crossed the USD 1 billion mark in FY 04 and is set tocross the USD 4 billion mark in the current fiscal year. Total FDI inflows for the first ninemonths of the current fiscal year stand at USD 3.86 billion which is 72% higher than theamount of USD 2.24 billion for the corresponding period of the last fiscal year. Nearly halfof these FDI inflows were a result of proceeds from the sale of state enterprises while thefinancial services sector, telecommunications and the energy sector remained the primaryrecipients of the bulk ofFDI.

Figure 1: Foreign Direct Investment (FY01-FY06)


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Source: BOI, Pakistan

Although the ranking ofPakistan on FDI performance ranking index in year 1990 was 78for the inward FDI performance (Table 2), yet, this ranking is continuously declining, asgrowth in FDI inflows is low. India, during 2000, with 119ranking in the performanceindex, however, showed a steady growth in FDI inward flows from US $ 1705 millions in2000 to US $ 6958 millions in 2006 (Table 3). The growing technological capabilities ofIndian firms, particularly in information technology services and pharmaceuticals, aredriving the FDIgrowth. Access to marketing, distribution networks, foreign technology andstrategic assets such as brand names, are the main motivators.

TABLE 2

Inward FDI Performance Index Rankings,1990-2005 Countries

1990 200020042005

Bangladesh 109 110 119 116

Bhutan

India 101 119 112 119

Maldives

Nepal 100 131 136 135

Pakistan 78 118 109 102

Sri Lanka 72 108 96 106

Source: UNCTAD, World Investment Report2006

TABLE 3

FDI Flows for Selected Countries and Regions in Millions of 1990- 2002 2003 2004 2005


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US $ Countries 2000

Bangladesh 190 328 350 460 692

Bhutan 2 1 1 1

India 1705 5627 4585 5474 6598

Maldives 9 12 14 15 14Nepal 11 6 15 5

Pakistan 463 823 534 1118 2183

Sri Lanka 159 197 229 233 272

China 30104 52743535056083072408

South Asia 2533 8982 5729 7301 9765


FDI inflow: sectoral composition (agriculture, industry and service)

Attraction ofFDI is becoming increasingly a global phenomenon often based on the implicitassumption that greater inflows ofFDI bring unambiguous benefits to the economy. Likeany other flow of capital, FDI represents a source of capital and therefore is believed tocontribute positively to Gross Domestic Product, Gross Fixed Capital Formation, and

balance of payments. In addition to this, FDI has the potential to generate employment,raise productivity, transfer foreign skills and technology, and subsequently contribute to thelong-term economic development of the worlds developing countries.

FDI can also contribute toward debt servicing repayments while also stimulating exportmarkets and producing foreign exchange revenue. Subsidiaries of multinationalenterprises, which bring the vast portion ofFDI, are estimated to produce around a third oftotal global exports.

However the impact ofFDI is dependant on what form it takes. This includes the typeofFDI, sector, scale, duration and location of business and secondary impacts on theeconomy. Therefore a refocusing of perspective, from merely enhancing the availabilityofFDI, to the better application ofFDI for sustainable objectives is crucial to reap the real

benefits ofFDI. Economic literature has outlined a range of positive and negative aspectsofFDI as a source of development for developing economies which we will highlight in thissection.

FDI, where it generates and expands businesses, helps stimulate employment, raise wages

and replace declining market sectors. However, the benefits may only be felt by a smallportion of the population, example where employment and training is given to moreeducated, typically wealthy elites or there is an urban emphasis.

As a result wage differentials between income groups will be exacerbated. Cultural andsocial impacts may also occur when investment is particularly directed at non traditionalgoods. Huge foreign currency inflows resulting from increased FDI under aflexible exchangerateregime where exchangerate is determined by market forces


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essentially result in appreciation of the local currency. For example in case ofPakistan,excess dollar inflows will increase the supply of dollar in the market, exerting adownward/upward pressure on the dollar/rupee. This shall reduce the burden of foreigndebt and is therefore beneficial in debt repayments.

TABLE 4

Sector-Wise FDI in Pakistan Sector2005 %age2004%age2003%age2002%age

IT & Telecom 1937.7 55 518 34 222 23.4 208 18

Financial Business 329.2 9.3 269 17.7 242 25.5 208 26

Oil and Gas 312.7 8.9 218 14.3 273 28.8 187 23.41

Trade 118 3.4 52.1 3.4 35.6 3.7 39.1 4.9

Power 320.6 9.1 73.3 4.8 35.4 3.7 32.8 4.11

Construction 89.5 2.5 51 3.3 32 3.4 32.8 4.11

Others 413.3 11.1 343 22.5 109 11.5 158 19.47

Total 3,521.0100 1524100 949 100 798 100


FDI inflow by source country

The emergence of new sources ofFDI may be of particular relevance to low-income hostcountries like Pakistan. Indeed, the role of developing and transition economies as sourcesofFDI is increasing with the passage of time. Transnational Corporations (TNCs) fromdeveloping and transition economies have become important investors in manyLDCs.Pakistan also depends on these countries across the globe for FDI. Among the

sources, 21 countries belong to the developing and transition economies. Table 4 illustratesthe total FDIinflow in Pakistan over the last 9 years from 2000 to 2009 from differentcountries across the world. Table 4 depicts that more than 50 percent annual FDI has beenreceived from only 8 countries.

Table 7: Country Wise FDI Inflows (Million $)

Country 2000-

01

2001-

02

2002-

03

2003-

04

2004-

05

2005-

06

2006-

07

2007-

08

2007-08

(Jul-

April)

2008-09

(Jul-

April)

USA 92.7 326.4 211.5 238.4 325.9 516.7 913.1 1,309.3 1,161.4 745.2

UK 90.5 30.3 219.4 64.6 181.5 244.0 860.1 460.2 304.8 220.2

U.A.E 5.2 21.5 119.7 134.6 367.5 1,424.5 661.5 588.6 535.3 170.2

Japan 9.1 6.4 14.1 15.1 45.2 57.0 64.4 131.2 100.3 65.2

Hong Kong 3.6 2.8 5.6 6.3 32.3 24.0 32.6 339.8 121.3 124.4

Switzerland 3.6 7.4 3.1 205.3 137.5 170.6 174.7 169.3 141.4 210.4

Saudi Arabia 56.6 1.3 43.5 7.2 18.4 277.8 103.5 46.2 37.0 (55.6)


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Germany 15.5 11.2 3.7 7.0 13.1 28.6 78.9 69.6 61.7 60.4

Korea(South) 3.7 0.4 0.2 1.0 1.4 1.6 1.5 1.2 0.8 0.9

Norway 41.9 0.1 0.3 146.6 31.4 252.6 25.1 275.0 154.8 91.9

China 0.3 3.0 14.3 0.4 1.7 712.0 13.7 13.2 (69.7)

Others 76.6 173.9 108.6 369.3 521.9 1,512.2 1,748.7 1,087.1 1,641.9Total 322.4 484.7 798.0 949.0 1523.9 3521.0 5139.6 5,152.8 3,719.1 3,205.4

Privatisation

Proceeds

- 127.4 176.0 198.8 363.0 1540.3 266.4 133.2 133.2 0.0

FDIExcluding

Pvt. Proceeds

322.4 357.3 622.0 750.2 1,160.9 1,980.7 4,873.2 5,019.6 3,585.9 3,205.4

13.8% decrease in FDI Including Pvt. Proceeds as compared to July-April FY 0810.6% decrease in FDI Excluding Pvt. Proceeds as compared to July-April FY 08

FDI related inward and outward remittances

FDI brings much-needed foreign funds for current investment, but it also creates long-termobligations in the form of future repatriation of profit earned by the foreign investor.

Another bothersome aspect is the round tripping of capital that finds original investment(including intra-company debt and interest) and domestic capital reinvested as FDI,

because of discriminatory taxation policy that favors FDI over domestic investment. Table 6shows the possible repatriation of foreign exchange in the form of dividend/profit, capitalrepatriation, private debt repayment and family maintenance during 1995 to 2005.

Table 7 shows that over the number of years Pakistan enjoyed a higher rate ofFDI inflowwith a lower outflow of profit and loan repayment.

Table 8


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Net Effects and Policy Recommendations

Foreign companies are often reluctant to arrange funds domestically or float shares in thedomestic capital market. These practices do not alleviate the capital market of its

weaknesses. One reason is perhaps the concern that if the stock prices of these foreigncompanies remain low in Pakistan that may ultimately hamper their business in otherlocations. Of course, listing in the stock exchanges is not mandatory for foreign companiesas yet. Moreover, due to some restrictions on sanctioning funds (e.g., single borrowerexposure limit) by domestic banks and financial institutions, foreign companies have not

been looking for domestic finance in most cases. In spite of negative flows generated insome years, overall FDI helps output growth, particularly in service and industrial sectorsof the economy. However, one should weigh up both the positive and negative implicationsof individual FDI proposals before any decision. It would appear that the specific policydirectives might be revisited so as to reduce dependence on foreign bank borrowing, andinstead encourage foreign and domestic investors alike to raise more capital from thedomestic equity market. If some industry segments, e.g., telecom phone companies find thelocal market too limited, funds may be raised by floating shares simultaneously in bothdomestic and regional markets (e.g., Dubai, Hong Kong, Malaysia, Singapore, etc.).


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As mentioned in the beginning, the FDI inflows in Pakistan, strongly influenced by rapidliberalization of financial markets and privatization of economic activity, have registeredsignificant growth in the past few years. The FDI inflows for Jul- Mar 2007 period stand atUSD 3.9 billion and are expected to go beyond the USD 6 billion mark by the end of the

year. After exploring the pros and cons ofFDI in the light of empirical evidence present ineconomic literature, it is clear that FDI is after all not a miracle drug for all developingeconomies as it was thought of in the 1990s. This raises some serious questions regardingthe rapidly risingFDI inflows in Pakistan.

What is interesting or rather fortunate to note is that currentlyPakistan is bent moretowards reaping the favorable side of the FDI inflows. Though increased foreign inflows inthe recent months have expanded the reserve money growth, the benefits of these inflowscannot be ignored.

Pakistan has received little export oriented FDI, limiting the role ofFDI as a tool of exportpromotion. Besides these sectors, in other sectors, many foreign companies includingNestle, Unilever and Procter & Gamble are expanding their infrastructure in the country.

Factors Influencing the Flow of FDI in Pakistan

The inflow of FDI in Pakistan remains far from encouraging despite numerous incentivesoffered to foreign investors, particularly after the liberalization program initiated since1991/1992. Incentives like 100% foreign ownership of capital, foreign investors operatingtheir companies without enlisting in the local stock exchanges, no limit for remittance ofprofits and dividends abroad, allowing disinvestment of the originally invested capital atany time, and no prescribed limits for remittance of royalties and technical fees abroad byforeign investors are highly competitive with incentives offered by many other developingcountries to the prospective foreign investors.

Besides these incentives, Pakistan with a population of about 130 million offers a vastpotential for the marketing of both consumer and durable goods. Various incentives apart,these two factors should alone have attracted a respectable amount of FDI in Pakistan.However, by looking at the amount of FDI in Pakistan in recent years, it appears that theincentives and other factors have resulted in limited success. Why was Pakistan not able toattract FDI like the PRC; Hong Kong, China; Malaysia; and Thailand despite offeringcompetitive incentives, favorable geographical location, and a relatively large population?This section attempts to provide answers to this query. A summary of host countrydeterminants of FDI in general is given shortly. In view of these determinants, thefundamental requirement that governs foreign investment in Pakistan revolves around tenmain factors, which could be called the ten checkpoints. These are political stability; law and

order; economic strength; government economic policies; government bureaucracy; localbusiness environment; infrastructure; quality of labor force; quality of life; and welcomingattitude.

Political Stability:

This factor is essential to attract foreign direct investment because it creates confidence forforeign investors (see MIGA 1994). Political turmoil could wipe out overnight even the most


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lucrative investments and endanger the lives of personnel. Many investors have paid a heavyprice for overlooking or ignoring this factor in other parts of the world. Lack of politicalstability has been the hallmark of Pakistan during the last fourteen years (1988-2002).Three elected governments were dismissed on various charges while four caretaker regimeseach remained in power for only 90 days over the last fourteen years. Such a frequentchange in government accompanied by abrupt changes in policies and programs are hardlycongenial for foreign investors.

Law and Order:

An unsatisfactory law and order situation keeps prospective foreign investors on thesidelines. Safety of capital and the security for the personnel engaged in the projects areessential ingredients that govern foreign investment. Investors priority is the safety of theirlives and that o their employees and the security of the project assets. They and theirfamilies wish to live in peace and carry out their usual chores without having to look overtheir shoulders all the time. Incase they feel threatened, in any way, they will relocate toother countries.1Unfortunately, Pakistans law and order situation has remained far from

satisfactory in the major growth poles of the country. Karachi, the largest industrial andcommercial center and the only commercial port of the country, has been disturbed invarying degrees since 1989.

In recent years the law and order situation has also deteriorated in the Punjab province.Notwithstanding attractive incentives offered to foreign investors, this factor hasdiscouraged them to set up their businesses in Pakistan. In a survey, the International AssetManagement Company (IAMC), an affiliate of the British-based Morgan Stanley AssetManagement, found that the business environment in Pakistan has deterioratedconsiderably. The IAMC surveyed 115 leading listed and unlisted companies includingmultinationals operating in Karachi. The sector covered for the survey-includedautomobiles, banks, chemicals, insurance, energy, textile and apparel, financial services and

electrical goods. Some 74% of investors answered that they had no investment plan for1996/1997; while in 1995/1996 some 56% of those had not invested in Pakistan. The keyreason for the negative sentiment of businessmen was the deteriorating law and ordersituation in Karachi. Three out of four businessmen interviewed blamed political instabilityas the major constraint facing business today and over 59% of the 115 respondents were notpleased with government policies.

Economic Strength: -

Investors would not want to invest in a country where the economic fundamentals are soweak that it is unpredictable what the government would do next to prop up a sagging

economy. In countries of high economic strength, the investor is assured of a growing ofhigh economic strength, economy, and of increased opportunities for business, as moregovernment development projects and private sector investments put purchasing power inthe hands of the people. Increased purchasing power means increased positive multipliereffects on the economy and a source for stability. Furthermore, foreign investors areunlikely to increase their participation in economies that are expected to remain affected byforeign exchange scarcities for several years into the future (UNCTAD 1985).


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As compared with the decade of the 1980s, Pakistans macroeconomic imbalances worsenedin the 1990s, along with the slowdown of economic activity. Annual average GDP growthslowed from 6.4% in the 1980s, to 3-4% in the 1990s. In particular, large-scalemanufacturing has slowed down to 2-3% as against almost 8.0% during the 1980s.

The large fiscal deficit has emerged as a major source of macroeconomic imbalances inPakistan. Slippages on both the revenue and expenditure sides contributed to mountingfinancial imbalances. The rate of inflation has averaged 11% during the 1990s as against anaverage rate of 7.3% in the 1980s. Pakistan external sector also remained under pressureduring the 1990s as compared with the 1980s. The current account deficit averaged 4.4% ofGDP as against 3.9% during the 1980s. Pakistan foreign exchange reserves have alsofluctuated in an unpredictable manner in the 1990s. Thus, attractive incentives not

withstanding, the large macroeconomic imbalances and slowing down of economic activitymust have discouraged FDI in Pakistan

Government Economic Policies:

Pakistans track record in maintaining consistent economic policies has been poor. Theabrupt changes in policies with a change in government as well as a change in policy withinthe tenure of a government have been quite common. Pressures to raise revenues (for fiscalconsideration), and other conflicting objectives have generally led to inconsistencies ininvestment and industrialization policies, and an ad hoc and changing incentive system.Revenue measures are not in harmony with the industrial policies.

This makes planning difficult, adds uncertainty and enhances risk. In todays competitiveworld, investors before making investment in a country, take into account continuity andconsistency of its policies. Foreign investors inhibited if they perceive that governmentauthorities are unreasonably delaying things or are delaying matters for insignificantreasons. Quick and judicious decisions by the govt. shall rehabilitate the confidence of the

foreign investors. In a seminar held in Pakistan a few months ago, certain internationalinvestors asks for improving a number of administrative and policy related irritants, as thecountry with its strategic location can become an attractive destination for the internationalinvestors. Reportedly there are four assemblers of Chinese motorcycles in Pakistan who areunable to market their products as the govt. has put restrictions on registration of suchmotorcycles. The government is urged for an early resolution of this issue, as well as othersimilar issue.1

Another example concerns the concessions given to the petroleum and power sectors interms of duty-free imports of machinery. Resource crunch forced the government to

withdraw this concession by imposing a 10% regulatory duty in October 1995. It took several

months to get the petroleum sector concession restored but the regulatory duty was reimposed in the 1996/1997 federal budget. The serious disagreement in 1998 between theGOP and IPPs on the purchase of electricity by the WAPDA aggravated investors'confidence.

The investment approval requirement has been removed but other regulations institutingthe need for other administrative approvals, however, are still in place. Numerous permitsand clearances from different government agencies at national, regional and local levels stillapply to investors.


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Incentives/concessions to foreign investment apart, private investors continue to face aplethora of federal, provincial, and local taxes and regulations. Federal levies includecustom duties, sales tax, with holding tax at import stage, and excise duty. At the provinciallevel there are stamp duties, professional taxes, boiler inspection fees, and weight andmeasures fees. In addition, local government taxes are levied, including a local metropolitantax, and the Octopi. At the federal and provincial levels, labor taxes have to be paidseparately in compliance with labor laws, such as the contributions to the Workers WelfareFund, Social Security, worker's children's education, and workers participation in profit andgroup insurance. In particular, a 5% withholding tax at the import stage as well asrestrictions that these firms cannot borrow more than their equity capital has caused seriouscash flow problems.

Foreign investors in Pakistan also have to cope with a complex legal situation. Law based ondifferent legal systems is applied independently. Uncertainty is exacerbated by the practiceof issuing Special Regulatory Orders (SROs) that can amend or alter existing laws. Overtime many SROs have been issued under a particular law, changing its scope and intent.

Government Bureaucracy:

This could perhaps be the biggest "burden" in any investment environment. It does notmatter how efficient the government thinks its investment policy is; what is critical is theperception of businessmen, especially those already in the country. Do businessmen feelthat they have the support of government officials in their efforts to set up and operateefficient business units, or do they feel that they have to fight the government to get projectsoff the ground? The general perception of businessmen in Pakistan is that there exists alarge gap between the policies and their implementation. The implementation of policieshas been slow and the bureaucracy has not responded to the initiatives with conviction.Such perception about the slow implementation of policies is not at all conducive oattracting FDI.

Local Business Environment:

This covers many factors, including the availability of local lawyers, secretarial services,accountants, architects and building contractors, local consultants, etc. all required both

before and during the life of a project. Also, there is the question of the availability ofancillary and supporting industries, their quality, and their cost. Another question would bethe availability of suitable joint venture partners, and whether there are lists of potentialpartners that the investors can choose from. All these conditions are not satisfactory inPakistan.

Infrastructure:

The availability, reliability, and cost of infrastructure facilities (power, telecommunications,and water supplies) are important ingredients for a business environment conducive toforeign investment. Pakistan compares unfavorably in infrastructure facilities with otherdeveloping countries that have attracted higher levels of foreign investment. Pakistan hasonly 18% of paved roads in good condition as against 50% in Thailand, 31% in Philippines,and 30% in Indonesia. Pakistans extensive but poorly managed railway system does notmake good for this disadvantage. Telecommunication is another bottleneck: there are only


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10 telephones per 1,000 persons in Pakistan compared with 31 and 112 in Thailand andMalaysia, respectively. Pakistans amount of electricity produced per capita is higher thanIndonesia's (435 kWh as against 233 kWh), but is only a fourth of Malaysia's and one half ofThailand. In most cases the urban infrastructure is grossly inadequate. Only 50% ofpopulation has access to safe drinking water as against 81, 72, and 78% for Philippines,Thailand, and Malaysia, respectively.

Karachi Port is six times more expensive than Dubai port (Jebal Ali), three times moreexpensive than Colombo port, and twice as expensive as Bombay port. While other portsoffer goods container terminal facilities, Karachi port cannot even offer priority berthing forcontainer vessels. There are frequent delays and cancellations of berthing and sailing due toobsolete tugs and pilot boats at Karachi port. Moreover, due to the lack of maintenance the

berths are unsafe. Karachi port cannot even provide proper container handling equipmentand there is a shortage of space and bad planning, resulting in high cost to the consignees.Large vessels cannot come to the port because of the lack of dredging of shipping channels.Moreover, congestion in the hazardous cargo results in containers being detained longer inthe barge. All these have made Karachi port much more expensive than ports of neighboring

countries. Such infrastructure deficiencies have discouraged the flow of FDI in Pakistan.

Labor Force:

A technically trained, educated, and disciplined labor force along with a country's labor lawsare critical factors in attracting foreign investors. Pakistan has an acute short age oftechnically trained and educated labor, especially in middle managerial positions and inengineering, which may have discouraged foreign investors. In particular, Pakistan is at amore serious, disadvantaged position in terms of education and health compared with otherdeveloping countries that have attracted FDI at much higher levels. Pakistan adult illiteracyrate is 62% as against 17% for Malaysia, 16% for Indonesia, 5% for Philippines, and 6% forThailand. Only 80% of primary school age boys are enrolled in school (49% for girls); the

lowest rate for the four reference countries is 93% for Malaysia. Pakistans expenditure oneducation accounts for only 1.1% of total expenditure as against 10% for Indonesia, 15.9%for Philippines, 21.1% for Thailand, and 20.3% for Malaysia (World Bank 1997). It also has

by far the worst indicators of public health among the five countries. With the general levelof education and health care being low, foreign investors may not find the workforce theyneed. Besides poor education and health indicators, Pakistans labor laws are complicatedand overprotective, discouraging job creation, inhibiting business expansion, andfrightening away much needed productive investment. Such labor laws have createdunnecessary labor disputes posing problems for management and causing productivitylosses, which have also discouraged foreign investment.

Quality of Life:

Quality of life along with cultural and social taboos is critical to attract foreign investors.These factors are less conducive to foreign investors in Pakistan who are accustomed toliberal lifestyles. This is in fact, one of the largest hidden handicaps Pakistan possessesagainst NIEs and ASEAN countries (Shirouzu 1993). Foreign investors find betterconditions in Indonesia and Malaysia (both Muslim countries) in the ASEAN region interms of social life and quality of life.


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Welcoming Attitude:

Have immigration and customs officials at the airports and other entry points been fullybriefed about the critical role they play in investment promotion efforts? Their attitudesplay an important role in foreign investors' decision making. Although the high governmentofficials and business leaders express their enthusiasm in inviting foreign investment, thelack of a cordial environment to accommodate foreigners and foreign investment prevails inPakistan. The ancillary government agencies and officials seem to have an indifferent andunsympathetic attitude toward foreign investors.

The ten checkpoints discussed above constitute an investment environment and can beclassified into four factors, namely, cost, convenience, capability, and concessions. All thesefactors do not appear to be as favorable as in East and Southeast Asian economies.

Impact of nuclear explosion, Kargil and terrorist attack on worldtrade center

The two episodes, that is, nuclear explosions in 1998 and the Kargil conflict in1999 had alsonegative effect on FDI because both the episode conveyed negative perception aboutPakistan the Western countries, investors and IFIs. It is to be appreciated that USA, UK,Holland, Germany; UAE & Japan were in 1998 the top six countries, which made reasonableFDI in country. Since then their involvement has been on the decrease because of inter staterelations, basically due to change perception s of foreign policy objectives. Almost each &every sector in Pakistan is affected due to the terrorist attack on world trade centre in New

York. Before 11 September, industrial production was already falling and there had been asubstantial downward movement in equity prices as well as a decrease in foreign directinvestment (FDI). Pakistan's critical textile industry has been adversely affected sinceSeptember 2001, and agricultural production was already suffering from a severe drought in

2001. There is the drastic reduction in investment of industrial & manufacturing sector.Foreign investors hesitate to invest especially in those countries, which are suffering frompolitical instability, and any other factors explain above.

Policies for attracting FDI

Previously only the manufacturing sector was open to foreign investment. Now, the PolicyRegime is much more liberal with most other economic sectors open for foreigninvolvement and with significant efforts at mobilizing domestic financial resources towardslong term investment.

1. Manufacturing/Industrial Sector

Foreign Investors are permitted to hold 100% of the equity of industrial projects withoutany permission of the Government.

No Government sanction is required for setting up any industry, in terms of field of activity,location, and size, except for the following:


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Arms and Ammunitions.

High Explosives.

Radioactive Substances

Security Printing, Currency and Mint.

No new unit for the manufacture of alcoholic beverages or liquors will be allowed.

2. Non - Manufacturing/Industrial Sector

Foreign investment on reportable basis is now allowed in the Service, Infrastructure, Socialand Agriculture Sectors subject to the conditions indicated against each. They will have tosimply register their company with Security Exchange Commission of Pakistan under theCompanies Ordinance, 1984 and to inform the State Bank of Pakistan provided the relevantconditionality is fulfilled.

i. Services Sector

Activities

FDI in Service Sector is allowed in any activity subject to condition that services whichrequire prior permission/NOC or license from the concerned agencies will continue to getthe same treatment until and unless de-regulated by such agencies and will be subject toprovisions of respective sectors policies.

Conditions

The amount of foreign equity investment in the company/project shall be at least US$ 0.3Million. Foreign investors are allowed to hold 100% of the equity subject to the conditionthat the repatriation of profits will be restricted to a maximum of 60% of total equity orprofits and that a minimum of 40% of the equity is held by Pakistani investors (includingsale of shares in stock exchange) within five years.

ii. Infrastructure Sector

Activities

Infrastructure Projects, including the development ofIndustrial Zones.

Conditions

The amount of foreign equity investment in the company/project shall be at least US$ 0.3million.

100% foreign equity is allowed on reportable basis
http://www.pakboi.gov.pk/html/industrial_zones1.htmlhttp://www.pakboi.gov.pk/html/industrial_zones1.html


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iii. Social Sector

Activities

Education, Technical / Vocational Training, Human Resource Development (HRD),Hospitals, Medical and Diagnostic Services.

Conditions

The amount of foreign equity investment in the company/project shall be at least US$ 0.3million.

100% foreign equity is allowed

SUGGESTIONS

Continuity of policies

Once a CEO of MNC who had been working since decades in Pakistan. He said at a forumGive me worse policies, even than I am ready to work here but please dont change themovernight. The biggest hindrance, investors face in Pakistan when they invest here isdiscontinuity of policies. The priorities and preferences of one government are 180 degreeopposite to the policies of previous government. And with respect to four differentgovernments in 1990`s, policies also changed. So the need of hour is to make sure thatpolicies made by some government should be acceptable and applicable for nextgovernment. The requirement is to make policies, past laws and then implement them intheir true spirit so that they may be durable and the goal of reasonable FDI can be achieved.

Absence of Democracy

Another obstacle, which stops the investors, to come to Pakistan and invest here is absenceof true and sustainable democracy. Military interventions to government affairs with regularintervals are a reality, which has made a bad image of Pakistan in the minds of foreigninvestors. It is well said, During military governments, even country makes progresseconomically but travels downward morally. And this is the degree of morality of a country,

which can only attract the foreign investors, and there is also a need to avoid some civiliandictatorial rulers who are capable of amending the constitution with in hours. So, to attractthe foreign investors there is need for implementation of democratic principals in a truespirit.

Law and Order situation

The security of investors own life and his money is most important and investors givehighest consideration to this factor. One of the factor because of which, Pakistan has lostmuch of its FDI is poor law and order situation. The countrys economic capital KARACHIhad suffered worse communal riots two times in 1990s because of which many foreigninvestors left the country reluctantly. The military operations in result of these riots fueledto fire. In post September 11 scenario when Pakistan decided to be a part of alliance against


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terrorism, the attacks on minority centers and on foreigners worsen the situation. So, needof hour is to put law and order situation under control and its better way is to create bettercoordination between law enforcing agencies.

Free Market economy

A demand by foreign investors is to decrease the government role in market, because theyare always afraid of nationalizing their entities or freezing their accounts. So even not fully afree market system is possible in Pakistan, there is need to decrease the government role toa minimum level. So that investors may invest and work here comfortably.

Infrastructure

There is not sufficient infrastructure in Pakistan to work with, easily and comfortably.Funds are allocated in budget for this purpose but not used properly and a big problem forinvestors to work in far off places where labor is available at very lower rate. So there is aneed for proper infrastructure attracts the foreign investors and best way is to use the

allocated resources properly.

Role of BOI (board of investment)

BOI is a government institution, officially responsible for taking measures to attract andaccommodate the foreign investment in Pakistan. But we have seen that at many stages the

work of BOI is intervened by CBR (Central Board of Revenue), SBP (State Bank of Pakistan)and many other financial agencies, which badly affects the performance of BOI, whichultimately affects the investment in country. So there is a need for some law to make thisimportant institution independent and to provide it a good management, so that it canachieve its goal effectively and efficiently.

These are the major prerequisites to attract the foreign investors. If these suggestions aremet, Pakistan may be an attractive and considerately country for investors.

Factors Influencing the Flow of FDI in Pakistan

In view of these determinants, the main factors that influence investment in Pakistan maybe labeled as law and order, political stability, economic strength, government economicpolicies, bureaucracy, infrastructure, quality of labor force, welcoming attitude, etc. (also seeShirouzu, 1993; Khan 11 and Kim, 1999). The major barriers in the way of both domesticand foreign investment are described below turn by turn.

Law and Order:An inadequate law and order situation keeps prospective investors onthe sidelines. Pakistans law and order situation has remained far from satisfactory in themajor growth poles of the country (e.g. Karachi). In recent years the law and order situationhas deteriorated all over the country.

Political Stability: It is an important factor to attract investment as it builds confidenceof investors. Lack of political stability remained an important feature of Pakistans politics


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during the last two decades (1988-2008). Such frequent changes in government along withimmediate changes in policies are hardly cordial for investors.

Economic Strength: In countries of high economic strength, the investor is assured ofincreased opportunities for business, as more government development projects and private

sector investments put purchasing power in the hands of the people. Increased purchasingpower means increased positive multiplier effects on the economy and a source for stability.Macroeconomic indicators show that Pakistan is loosing its macroeconomic strength, whichis likely to adversely affect investment.

Government Bureaucracy: This is perhaps the biggest hurdle regarding investment inPakistan.

Corruption at all levels in the bureaucracy is widespread, and is taken into account byinvestors considering business in Pakistan. The administrative harass factor remains high inPakistan.

Local Business Environment: This covers many factors, including the availability oflocal lawyers, secretarial services, accountants, architects and building contractors, localconsultants, ancillary and supporting industries, their quality, and their cost. It alsoincludes the availability of suitable joint venture partners. All these conditions are notsatisfactory in Pakistan.

Improvement in Tax Structure: There is an urgent need to reduce the number oftaxes and contributions, to streamline tax regulations and administrative procedures, andmost importantly to reduce the contact of firms with a large number of tax andcontributionscollecting agencies. There is also a need to examine tariffs of plant andmachinery with a view to substantially reducing them.

Conclusion

The FDI can undoubtedly play an important role in the economic developmentofPakistan in terms of capital formation, output growth, technological progress, exportsand employment. Nevertheless, concerns remain about the possible negative effects ofFDI,including the question of market power, technological dependence, capital flight and profitoutflow. The limited evidence gathered above tends to support some of theseapprehensions. On a positive note, service sector growth appears well correlated

with FDI flow to this sector. Further, this has a linkage effect to the rest of the economy.

Observing the current impacts ofFDI on the economy, particularly in terms of efficiencyspillovers generated by multinational corporations, it is reasonable totake FDI in Pakistan as an important vehicle for economic growth. The government hassuccessfully introduced a wide range of incentives, congenial for local and foreign investorsand has increasingly tended to turn to FDI as a source of capital, technology, managerialskills and market access needed for sustained economic development.

The outward orientation in policies designed by the government to attract more FDI hasbeen accompanied by the adoption of policies relating to privatization and deregulation of


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economic activity, offering unprecedented and conducive business environment to allmultinational corporations. Hence Pakistan is now stands out as one of those economies inthe region whose reforms and economic achievements during the last few years have steeredthe country to a business-friendly environment, creating a win-win situation for bothinvestors and consumers. We hope this paper can encourage future studies on this subject.

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