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Discouraging FDI

Foreign Direct Investment (FDI) is vital for the health of any economy. For Pakistan’s developing economy, considered by foreign investors as a high risk one, FDI is critical due to its relatively lower domestic investment and resources and a higher reliance on foreign investment to spur domestic productivity and growth. Annual FDI inflows into Pakistan in the last 10 years have reduced from a peak of USD $5.4 billion in 2007-08 to USD $1.4 billion in 2011-12. Total FDI inflows into Pakistan in the preceding 10 years have been only USD $25.66 billion.

There are three primary reasons for the steady decline of FDI into Pakistan: (i) the energy shortfall; (ii) the poor security situation; and (iii) the global recession. Therefore, any foreign investor, who decides to invest in Pakistan in spite of these adverse and trying conditions, should be given a red carpet treatment, saluted and awarded a medal, and their foreign investment into Pakistan should be fast-tracked.

As if the energy shortfall and poor security situation were not enough to dissuade foreign investors from investing in Pakistan, the government is embarking on misconceived and ill-advised policies that are further discouraging, if not scaring away, those few foreign companies that are still interested in investing in Pakistan, despite the odds. Instead of being welcomed with a red-carpet, foreign investors are being met with red-tape and suspicion.

In July 2011, Pakistan’s Ministry of Interior (MOI) issued a directive, U.O. No 5/37/2011-S-II dated 19 July 2011, which stipulates that all foreign investors must undergo security clearance prior to any of the following:

(i) Incorporation of a company in Pakistan with foreign shareholders/directors;

(ii) Issuance or transfer of shares to new foreign shareholders in a company incorporated in Pakistan;

(iii) Election/re-election of foreign directors or appointment of a foreign chief executive in a company incorporated in Pakistan; and;

(iv) Registration of a foreign company’s branch office in Pakistan.

All the above actions are necessary preludes to FDI. Therefore, if foreign investors are unable to get past the above, FDI will either be delayed or lost permanently.

Prior to this directive, the requirement of obtaining security clearance was restricted to only three types of entities: (i) security service companies; (ii) companies with Indian nationals as shareholders or directors and (iii) non-governmental organisations (NGOs) having foreign funding or involving foreigners.

A major problem is that security clearance is conducted by eight different agencies, including the Inter-Services Intelligence (ISI) and Intelligence Bureau (IB). From the perspective of a foreign investor, it is uncomfortable, if not daunting, to be investigated by intelligence agencies. This is not the right way to welcome foreign investors into Pakistan. It is counterproductive and may scare away foreign investors. One does not invest in a foreign country to be investigated.

The events that led to the issuance of this MOI security clearance directive are seemingly the Raymond Davis incident in January 2011 and the Abbottabad incident in May 2011 and the resulting revelation that the US Central Intelligence Agency (CIA) was allegedly using private enterprises, including front companies, as a cover for covert and clandestine operations in Pakistan. It is a classic example of getting the diagnosis right but the prognosis wrong. No patriotic person wishes to see foreign spies and Blackwater types roaming freely in their country and committing espionage and terrorism. However, there are ways to deal with such problems and there are ways not to deal with such problems. If you want to kill weed in a lawn, you use a weed-killer that kills only the weed and not poison that kills everything, including healthy grass. If you want to kill a fly, you use a flyswatter, not a sledgehammer.

The MOI directive was issued to the Securities and Exchange Commission of Pakistan (SECP), which is the regulator of the corporate sector in Pakistan. The SECP began immediate implementation of the same without questioning its legality. The SECP has overlooked the fact that the MOI directive has no legal basis because the same has been issued by the MOI and does not arise from any statutory instrument and the MOI does not have statutory jurisdiction over matters pertaining to the corporate sector in Pakistan that fall under ambit of the SECP. For example, companies in Pakistan are incorporated and function under the Companies Ordinance, 1984 and the rules and regulations made thereunder. By issuing the security clearance directive, the MOI has practically amended the procedure under which companies are incorporated and function, which is illegal and without lawful authority. By doing so, the MOI has encroached on the SECP’s domain because, under the law, it is the SECP, not the MOI, which determines who may or may not incorporate a company in Pakistan and how directors are to be elected or re-elected.

I have had the opportunity of being engaged by the World Bank/International Finance Commission as a consultant on numerous occasions for the Pakistan part of their Doing Business and Investing Across Borders reports, which respectively provide indicators of the cost of doing business by identifying specific regulations that enhance or constrain business investment, productivity, and growth and provide objective measures of business regulations and their enforcement and benchmark the ease of establishing and operating foreign-owned companies in countries across the world by evaluating their investment policy framework and its implementation in practice. In both reports, Pakistan was ranked above India and other regional countries when it came to ease with which a foreign investor could set up a business. That is, until the MOI security clearance directive.

Subjecting foreign investors to security clearance would have been somewhat tolerable if government machinery was competent, efficient and sincere enough to process security clearance cases expeditiously and transparently. Unfortunately, however, this is not the case and processing of security clearance cases has been delayed due to bureaucratic red-tape and even, as some quarters have alleged, graft.

The result of the MOI security clearance directive, apart from pushing Pakistan down acclaimed business and investment rankings, has wreaked havoc on FDI in Pakistan, especially with regard to foreign investment in small and medium enterprises (SMEs), which constitute the bulk of the approximately 63,000 companies in Pakistan (as of December 2012). The immediate impact, hitherto only known to the foreign investors themselves and their lawyers and chartered accountants engaged by them in Pakistan at the pre-investment stage, has been devastating. Prior to the MOI security clearance directive, the incorporation of a private limited company with foreign shareholding used to take, on average, seven days (the fastest incorporation experienced by me in over 12 years of law practice was only two days (from the date of filing) by the SECP’s Company Registration Office in Lahore). Now, after the security clearance directive, it is taking at least three months to incorporate a company with foreign shareholding, while the average period is closer to six months. Indeed, there are security clearance cases that have been pending for over almost a year with the MOI. Not so long ago, company set-up procedures in Pakistan used to be the fastest not only in South Asia, but also compared to the Middle East and Central Asia. Pakistan has now slipped to the bottom of the investment indicators vis-à-vis company incorporation. Since local company incorporation is a prerequisite to most business activity involving foreign investment in Pakistan, the adverse impact of this security clearance requirement has rippled across all investment sectors.

The government should, in Pakistan’s economic interests, either (a) recall the MOI security clearance directive or (b) allow provisional approvals to all matters involving foreign investors pending their security clearance so that, in the interim, foreign investors can get on with the business of investing in Pakistan. Such provisional approvals should be allowed to continue indefinitely until such time that the security clearance process is completed. If it transpires that the MOI has no objection to a particular foreign investor, then final approval may be given. If, on the other hand, a foreign investor, for some reason, is considered a security risk on the basis of some intelligence finding, then the provisional approval may be cancelled. This way, the majority of foreign investors, who are legitimate and do not pose any security risk, would not suffer needless delays while awaiting the outcome of their security clearances. Such a measure would also restore Pakistan’s investment reputation and investment-friendly rankings, at least to levels that existed prior to the issuance of the MOI security clearance directive.

The decline in FDI arising from the security clearance requirement for foreign investors is a needless, self-inflicted wound that is harming Pakistan’s developing economy and one which it can ill afford.

Rai Muhammad Saleh Azam, "Discouraging FDI," Business recorder. 2012-01-02.
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