Foreign Direct Investment (FDI) and Trade Liberalization Policies in Pakistan

What is FDI?

Foreign direct investment (FDI) means an individual, a group of individuals, an incorporated or un-incorporated entity or a public or private company investing its money in other country.[i] Increasing FDI is usually used as one of the indicators of growing economy as Pakistan had received more than five billion dollars in 2007[ii] and was aspiring to becoming an Asian Tiger. Foreign direct investment (FDI) usually involves participation in management, joint-ventures, transfer of technology and expertise.

Competing Narratives:

Liberal school of thought considers FDI beneficial for developing countries.[iii] This presumption is based on the idea that FDI may generate positive spillovers for the rest of the economy. They have opinion that FDI will also benefit the host country by sharing technology of developed countries. Moreover, the host country will receive benefits such as technology transfer, raising foreign funds and creating employment. On the contrary, protectionist school of thought believes that opening up trade with foreign investors will hurt local businesses and jobs.[iv] Therefore government should protect local market by imposing import tariffs and quotas.

Indicators of FDI in Pakistan:

Market Size:

Market Size has always remained a source of attraction for investors. According to World Bank report Pakistan’s economy is the 23rd largest in the world in terms of GDP growth.[v] Pakistan has a very vibrant market and a large consumer base of more than 180 million people. Pakistan is the 26th largest economy in the world in terms of purchasing power parity.[vi] These statistics are helpful in attracting foreign investors in the country.

Skill Level:

The adult population (15-59) is considered as the wealth of a nation in terms of human resource. Moreover, investors are attracted to those countries where they find cheap labour. In Pakistan, adult population has increased from 104 million in 2011 to 110 million in 2013.[vii] Pakistan has the 9th largest labour force in the world which has comparatively lower wages in South Asia.[viii] According to the labour force survey 2010-11, the total labour force in the country was 57.24 million.[ix]

Availability of Infrastructure:

Poor infrastructure causes increase in transaction cost and limits access to both local and global markets which ultimately discourages FDI in developing countries. Pakistan over the years has developed better infrastructure as compared to other developing countries in the world which is a source of attraction for FDI in the country.

Political Stability:  

Political stability is a prerequisite for attracting foreign investors. According to World Bank survey 2014, countries which are politically stable, got 67 percent more foreign investment than the politically unstable countries.[x] Pakistan is considered as a semi-stable country in this regard. The recent sit-ins had negative impact on FDI in the country. The details of the FDI inflows during the sit-ins are shown in figure 1.

FDI from July to October 2014 (Million Dollars)

July-2014 August-2014 September-2014 October-2014
Inflow Outflow Net FDI Inflow Outflow Net FDI Inflow Outflow Net FDI Inflow Outflow Net FDI
113.6 95.2 18.4 92.0 33.9 58.1 108.8 31.9 76.9 938.8 690.0 248.8

 

Source: SBP, Net Inflow of Foreign Public & Private Investment (Archive)

 

Brief History of Trade Liberalization Policies in Pakistan:

Pakistan has gradually liberalized its economic policies in order to attract FDI. This gradual liberalization has provided ample time to the local industry to become competitive. From 1947 to 1958 Pakistan maintained strict control on FDI, even it was not allowed in banking, insurance and commerce.[xi] However, former president Ayub Khan changed the liberalization policies. The Government dismantled import controls of 1950s through issuing licenses on importable items.[xii] Automatic licensing schemes were introduced in 1961allowing the automatic renewal of import licenses. Most importantly, a free list was introduced in 1962 which was considered most market friendly step towards trade liberalization.[xiii] The FDI policy liberalized and foreign banks were allowed to open branches in Pakistan.

However, from 1971 to 1977 government changed its policies from liberalization of economy to nationalization programme.[xiv] To make his nationalization programme successful, Zulfiqar Ali Bhutto had introduced concessions on import of machineries. Moreover, he liberalized the import licensing system. In order to provide legal cover and protection of the sovereign, an act was passed in 1976 which helped in increasing the FDI in the country.[xv] By and large, that era was based on protectionist policies in Pakistan. Since 1977, successive Governments in Pakistan realized the necessity of changing their economic policy to compete globally. In the early years of 1980s, government adopted market based economic policy. The maximum tariff rate was reduced from 225 percent to 125 percent, excluding automobiles which continued to carry tariff upto 250 percent. FDI inflows increased with particular emphasis in Oil and Gas sectors.[xvi]

The governments from 1988 to 1999 undertook trade liberalization under a series of Structural Adjustment Programs (SAPs).[xvii] The governments of 1990s became very generous to FDI by providing fair trade policy, fiscal incentives and tariff facilities to foreign investors to make Pakistan the most attractive investment place in the region. Since the mid-1990s, FDI inflow increased significantly in Pakistan in some sectors such as agriculture, telecommunications and energy. Maximum tariff was reduced from 125 percent to 80 percent. Para-tariffs known as ‘flood relief surcharge’ and ‘Iqra Surcharge’ were abolished.[xviii] Moreover, Pakistanis were allowed to open foreign currency deposit accounts. Legal frameworks were strengthened to protect the FDI. A board of investment was also established to attract investment. The investment policy of 1997 relaxed visa policy for businessmen which further enhanced the opportunities of foreign investment in the country.[xix]

The most successful era of economic policies is considered from 2000 to 2007.[xx] During that period, former president Pervaiz Musharraf introduced Economic Regulations Program (ERP). Pakistan’s principle trade policy objectives became rapid reduction in anti-export and import biases by opening economy to international trade and foreign direct investment. The government removed import quotas, import surcharges and regulatory duties. Maximum tariff rate was reduced from 80 percent to 25 percent. In 2005, Pakistan removed tariffs on cement, sugar, livestock and some vegetables. Currently, there are no licensing requirements and public sector monopolies in imports. Tariffs which were considered as a source of revenue for government were replaced by tax administration reforms. Moreover the government made progress in regional and bilateral trade liberalization. Government had signed bilateral agreements on promotion and protection of investment with 46 countries.[xxi] Moreover, regional trade agreement, i.e., South Asian Free Trade Agreement (SAFTA) was signed in 2004 to promote regional trade.

 

Investment Policy 2013[xxii]:

The investment policy 2013 introduced various new incentives in order to attract foreign investors. The idea was to take the FDI stock to 20% of the GDP by attracting US$ 2 billion in 2013, $ 2.5 billion in 2014, $ 2.75 in 2015, $ 3.25 in 2016 and $ 4 billion in 2017 through reducing the cost of doing business. However, in fiscal year 2013-2014 government could not achieve its target.[xxiii] Now the government is very optimistic to achieve its target in fiscal year 2014-15 through privatization policy.

Incentives for Foreign Investors:

Pakistan over the last few years has developed itself as a potential market for foreign investors with its liberal investment policy 2013, cheap labour, tax incentives and good return on investment of about 30 percent which is far better as compared to other South Asian countries.[xxiv] The investment policy 2013 has provided various incentives to foreign investors such as tax concessions and exemptions to various businesses. The Federal Board of Revenue (FBR) does not question about the source of investment; however, the FBR only inquires whether the investor has paid requisite income tax on that specific investment. Moreover, there is no requirement for a No Objection Certificate (NOC) from the provincial government. According to investment policy 2013, Board of Investment (BOI) approval is not required for foreign companies to open a bank account.[xxv]

Why Should Foreigners Invest in Pakistan?

Pakistan is strategically located to become Asia’s premier trade, energy and transport corridor. Its strategic location reduces the transportation cost which attracts foreign investors. This strategic advantage makes Pakistan a marketplace teeming with opportunities. Moreover, Pakistan has favourable economic policies. Foreigners have free access to Pakistani capital markets and there are no restrictions on the repatriation of principal amount of investment, dividends and profits.

 

Pakistan-India Trade Openness: Cost and Benefit Analysis

There are two narratives about Pakistan-India trade openness. The economists, who believe that expansion in Pakistan-India trade would be win-win situation,[xxvi] argue that expansion in trade between two countries would benefit middle class. They claim that expansion in trade will lead to specialization in various sectors in the country. Moreover, it would provide both countries a cushion against still persisting ill effects of global financial crisis. On the contrary, economists who are against expansion in trade with India warn of trade deficit which would hamper Pakistan’s economic sector.[xxvii] Moreover, strained political relations have negative impact on trade sector. They believe that Pakistan’s industry needs some time to become competitive; therefore government should support local industry through subsidies and import quotas.

Recommendations:

  • According to World Bank, Pakistan needs to remove the barriers which are supporting automotive industry and preventing import of cars and their spare parts.
  • Stable macroeconomic policies, discontinuation of previous economic policies with change of the governments is one of the factors that result in low FDI.
  • When 92 percent of businesses are managed by the private sector they should have a say in framing economic policies too.
  • Investment in physical and human capital is required for the growth of economy. Skilled labour is one of the major factors in developing a nation, which makes human capital as important as physical.
  • Gulf countries are budget surplus. There is huge potential in attracting FDI from Gulf countries. Government needs to focus on this region in order to attract FDI, particularly in agriculture sector.
  • Better quality of infrastructure and conducive business environment will attract investors. Government has planned to establish land port authorities, however this process should be accelerated.
  • WTO has pointed out that Pakistan’s heavy dependence on particular export items such as cotton can make it vulnerable to external distortions and restrictions. Pakistan’s exports market is dependent on European Union, US and Japan. Therefore, it is a dire need that government should diversify export industry.
  • Since 2007, more than 50 percent FDI has been attracted only in two sectors, i.e., Oil & Gas and Telecommunication. Though government had introduced energy emergency but it failed to attract FDI as much as it was required in the country. There is a need that government should also make other sectors more attractive and diversify FDI inflows.
  • There is a need to reduce tariff percentage. However this reduction should be gradual and industries which are not competitive should be exempted from this tariff reduction.
  • Law and order situation also carries negative impact on FDI. Though government had introduced national internal security policy last year in order to improve security situation in the country, however it did not improve much.

Conclusion:

Currently Pakistan is facing hard times. Internally, it is fighting brutal war against terrorism and externally, its economy is resisting against lingering ill effects of global financial crisis for last six years. Yet, the statistics of Pakistan’s GDP, GNP and FDI of past few years suggest that its economy is resilient and there are hopes that after this hard time, Pakistan will be able to realize the dream of becoming an Asian tiger in near future.

 

 

 

 

 

 

Bibliography:

 

[i] Investment Division, Directorate for Financial and Enterprise Affairs Organisation for Economic Co-operation and Development, Glossaries and Definitions, http://www.oecd.org/investment/investmentfordevelopment/2487495.pdf [Accessed December 21, 2014]

[ii] Statistics and DWH Department, State Bank of Pakistan, Hand Book of Pakistan Economy, June 2011. http://www.sbp.org.pk/departments/stats/PakEconomy_HandBook/Chap-7.12.pdf [Accessed December 14, 2014]

[iii] Manuel R. Agosin and Ricardo Mayer, Foreign Investment In Developing Countries: Does it Crowd in Domestic Investment?, UNCTAD, Number 146, February 2000. http://unctad.org/en/Docs/dp_146.en.pdf [Accessed December 16, 2014]

[iv] Anup Shah, “Criticisms of Current Forms of Free Trade”, Global Issues, March 31, 2006. http://www.globalissues.org/article/40/criticisms-of-current-forms-of-free-trade [Accessed December 16, 2014]

[v] See: World Bank 2014 Report. http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG [Accessed December 22, 2014]

[vi] Ibid.

[vii] National Vocational & Technical Training Commission (NVTTC).

[viii] Ibid.

[ix] See details Labour Force Survey 2011.

[x] See: World Bank 2014 Report. http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG [Accessed December 22, 2014]

[xi] Muhammad Shoaib and Jayatilleke S Bandara, “Trade Liberalization and Regional Disparities in Pakistan”, Routledge: New York, 2009. pp. 16

[xii] Ibid, pp. 18

[xiii] Ibid, pp. 19

[xiv] Ibid, pp. 22

[xv] See: Foreign Direct Investment (FDI) Promotion and Protection Act 1976. http://punjablaws.punjab.gov.pk/public/dr/FOREIGN%20PRIVATE%20INVESTMENT%201976.doc.pdf [Accessed December 26, 2014]

[xvi] Muhammad Shoaib and Jayatilleke S Bandara, “Trade Liberalization and Regional Disparities in Pakistan”, Routledge: New York, 2009. pp. 24

[xvii] Ibid, pp. 26

[xviii] Ibid, pp. 27

[xix] See: Investment Policy 1997. http://www.sbp.org.pk/epd/1997/c31.htm [Accessed 28, 2014]

[xx] Muhammad Shoaib and Jayatilleke S Bandara, “Trade Liberalization and Regional Disparities in Pakistan”, Routledge: New York, 2009. pp. 32

[xxi] Ibid, pp. 34

[xxii] See: Trade Policy 2013 and Investment Strategy 2013-17. http://boi.gov.pk/UploadedDocs/Downloads/InvestmentStrategy.pdf [Accessed 28, 2014]

[xxiii] Statistics and DWH Department, State Bank of Pakistan, 2014. http://www.sbp.org.pk/departments/stats/PakEconomy_HandBook/Chap-7.12.pdf [Accessed December 28, 2014]

[xxiv] See: Trade Policy 2013 and Investment Strategy 2013-17. http://boi.gov.pk/UploadedDocs/Downloads/InvestmentStrategy.pdf [Accessed 28, 2014]

[xxv] Ibid.

[xxvi] Ishrat Hussain, “Prospects and Challenges for Increasing India-Pakistan Trade”, Atlantic Council, November 2011. pp. 07

[xxvii] Michael Kugelman and Robert M. Hathaway, “Pakistan-India Trade: What needs to be done? & What does it matter?”, Wilson Centre, Washington 2013. pp. 75-97

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About the Author

Mr. Khurram Abbas is Assistant Research Officer (ARO) at Islamabad Policy Research Institute. He holds MPhil degree in International Relations from National Defence University (NDU), Islamabad. He is doing his PhD in Peace and Conflict Studies (PCS) from Centre for International Peace and Stability (CIPS), NUST, Islamabad and his thesis is “Role of Social Media in Radicalization Process: Analysis of Muslim World with Particular Reference to Pakistan". His area of interest includes, Perception Management, Role of Social Media, De-Radicalization Strategies, Counter Violent Extremism, Religious Extremism in South Asian region with particular emphasis on India, Afghanistan and Pakistan. Mr. Abbas regularly participates in National and International Conferences. He undertakes extensive research and regularly contributes in academic research journals and national/international dailies. Email: khurram306pcips@nipcons.nust.edu.pk

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