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Falling FDI inflows

Foreign Direct Investment (FDI) inflows into Pakistan have been drying up over the past few years. After hitting an all-time peak of $5.4 billion in 2007-08, net FDI sank to a low of $824 million in FY12, before recovering moderately. The net inflow for July-August in the current year, however, presents yet another dismal picture. Net FDI has collapsed to a paltry $87m, from $138m in the same period in 2013.

The sharp decline in FDI comes at a time of global recovery in outward FDI from developed economies. According to UNCTAD, total outward FDI in 2013 amounted to $1.45 trillion globally; the share of developing countries was 54pc, or a total inflow of $778bn. Of this, Pakistan managed to attract 0.17pc — far below its weight in terms of GDP within this cohort.

More troubling than the fall in incoming FDI is the pick-up in outflow of FDI from the country. In fact, the decline in overall FDI in the recent past has been caused as much by higher outflows as by sharply lower inflows. The worrying conclusion: not only is Pakistan failing to attract new FDI from the world, but it is failing to retain part of its existing FDI stock of around $29bn.

Pakistan offers market size but little else to a world-savvy investor. Attracting the right kind of foreign direct investment has a number of advantages for the host country. Typically, FDI is associated with the following ‘virtues’: technology transfer; productivity gains; foreign market access; higher wages and better labour conditions. Even if none of these advantages accrue fully, the bare minimum advantage accorded by FDI to its host country is that it places it on the radar for other foreign investors (the so-called fire-fly effect).

In this context, Pakistan’s virtual exclusion from global FDI flows is troubling — but hardly surprising. The sharp deterioration in the internal security situation around 2007 onwards coincided with rising political uncertainty in the country. At the same time, the global financial crisis had impacted FDI flows worldwide.

When global FDI flows did rebound, Pakistan’s attraction as an investment destination had already been blighted by the incompetent handling of the economy under the PPP government between 2008 and 2013. A full-blown energy crisis had been compounded by media reports of mega corruption, both of which were regularly transmitted and telegraphed around the world casting the country in poor light.

To be sure these were not the only reasons for foreign investors to be recalcitrant about putting their money in Pakistan. Studies on the motivation for making an investment decision in a particular country by a foreign investor point to the fact that FDI is associated with either of two main reasons for choosing a location: market size and/or a productive and relatively cheap labour force. To complement these two basic factors are assessments about the country’s investment regime and the general business environment, and the economic as well as political risks associated with the investment.

Pakistan offers market size but little else to a world-savvy investor. Policy and political instability is high, lack of a serious commitment to economic reform means a macroeconomic crisis is never far away, the labour force is largely semi-educated and unskilled, technological innovation is rare, and the tax regime is complicated and chaotic.

To make a bad situation even worse, the country has engaged in frequent high-level disputes with large and small foreign investors over the past two decades. Nawaz Sharif as prime minister in the late 1990s skewered the Independent Power Producers set up under the 1994 power policy. Little thought was given to the fact that these IPPs represented not just some of the biggest international companies in the field, but the power investments represented a consortia of global financial, insurance, operations and maintenance and civil works companies. Most of the investments were underwritten or financed partly by the World Bank and International Finance Corporation and some of the world’s leading export credit agencies, such as the US Ex-Im Bank — making multilateral agencies and sovereign countries party to our political fight.

More recently, Pakistan is engaged in another dispute with one of the world’s largest mining companies over the Reko Diq concession in Balochistan. In 2012, Pakistan technically defaulted to the IPPs when sovereign guarantees were called, while the handling of the power sector since then means that the circular debt issue is never far from the minds of investors.

Finally, both the government and Federal Board of Revenue continue to do their bit to turn away FDI. By its failure to reform the taxation system and increase the tax net, the government has allowed FBR to resort to ‘predatory taxation’. This involves making excessive tax demands on large companies — usually multinationals in the oil and gas, financial or telecommunications sector — to meet quarterly tax collection targets.

The rising and unfair tax burden on the corporate sector is not a trivial issue. According to World Bank data, Pakistan ranks 21st in the world in terms of number of tax payments required to be made by a large firm. Investor surveys rank ‘tax administration’ as amongst the top constraints to business in the country.

In overall terms, the investment environment has steadily worsened over the past few years — not just for foreign investors but for domestic ones as well. While the success of the recent military operation against terrorist havens on the western border has led to an improvement in the situation — as well as in perceptions of the same — much more work needs to be done.

In addition to improving the energy situation, the government has to bring normalcy to Karachi in terms of law and order. Finally, FBR’s harassment of large businesses to offset the government’s unwillingness and inability to tax the powerful and connected has to be stopped. Only with a comprehensive approach can the country’s investment fortunes be turned around.

The writer is a former economic adviser to government, and currently heads a macroeconomic consultancy based in Islamabad. Published in Dawn, October 17th, 2014

Sakib Sherani, "Falling FDI inflows," Dawn. 2014-10-17.
Keywords: Economics , Economic issues , Economic needs , Economic policy , Economic relations , Foreign investment , Economic development , Security issues , Political stability , Military operation , Power policy-1994 , Economic reforms , World Bank , Foreign investors , Corruption , Oil , Gas , PM Nawaz Sharif , Pakistan , United States , Balochistan , FDI , GDP , FBR