Foreign direct investment: where do we stand
By Zafar-ul-Hassan Almas

Economists and governments these days, agree on the crucial importance of foreign direct investment (FDI), both as an important source for bridging saving-investment gap as well as financing current account deficit through non-debt creating inflows. In countries like Pakistan, it is seen both as the global market’s “seal of approval” on a country’s economic policies and prospects, and as a force for far-reaching change in the economic fundamentals. This consensus seems surprising when you remember political sensitivities attached to the FDI in many developing countries. The point about FDI is that it is far more than merely “capital inflow”: it is a uniquely potent bundle of capital, contacts, skills and managerial and technological knowledge.

Although, economic theory and empirical evidence support the notion that FDI has a beneficial impact on developing host countries. However, some recent empirical work also caution several potential risks, including its possible reversal through financial transactions; it can be excessive owing to adverse selection and fire sales; its benefits can be limited by leverage; and a high share of FDI in a country's total capital inflows may reflect its institutions' weakness rather than their strength. Proponents of FDI often assert that it creates jobs and improves the quality of goods and services produced in the economy. However, there are instances where FDI does not foster growth and stability. On the contrary, it follows both. Foreign investors are attracted to success stories. They are drawn to countries already growing, politically stable, and with a sizable purchasing power. Pakistan is a classical example where foreign investors followed the success story during the past few years.

Foreign-owned projects are normally capital-intensive and labour-efficient and thus are not creating enough jobs. “It also depends on the job creating ability of particular sectors where foreign investors are more interested.” In Pakistan, foreign investors are rushing to only four sectors where more than our 80 per cent of the FDI is concentrated. These sectors are telecommunication, financial businesses, power and oil & gas. The job creating ability of all these sectors is limited. Pakistan has attracted FDI in these sectors too by going out of the way while giving unprecedented price guarantees, repatriation of profits and dividends and, dubious terms and conditions.

Foreign investors normally invest in machinery and intellectual property and not in wages. Skilled workers get paid well above the local norms, and that exacerbates skill gap which already exists, with all its severity, in Pakistan. The natives rarely benefit and when they do find employment, it is for a short-term and they are meagrely paid. Mergers and Acquisition constitute 60-70 per cent of all FDI in the developing countries but currently, not prominent in Pakistan. The privatisation proceeds is an important source of FDI proceeds in Pakistan and privatisation is notorious for inexorably generating job losses.

The future outlook for FDI and its repercussions on the economy are a matter of great academic interest; however, forecasting it is far from easy. The reason for future outlook being difficult to forecast is that the determinants are complicated and not quantifiable; this is not specific to Pakistan but forecasting FDI for even developed countries is very difficult if not impossible. Sometime ago, the Economist Intelligence Unit, a sister company of The Economist, tried to explore this uncharted territory for a forecast for FDI for not fewer than 60 countries, these countries accounted for virtually all of the world’s actual and projected flows but results were not impressive. It provides a forecast for FDI for not fewer than 60 countries and these countries accounted for virtually all of the world’s actual and projected flows of FDI.

The main determinant of FDI was the business environment as explained by Economist Intelligence Unit (EIU) and this is a broad term that includes 70 separate indicators. Some of these indicators are so vague and unquantifiable like political structure, stability, sustainability etc. These indicators have to be gauged through surveys that ask investors questions such as, “Is the quality of the bureaucracy and its ability to carry out government policy very high, high, moderate, low or very low?” Questions like that hardly give freedom to the researcher to predict how political and other conditions will change. So we can not forecast at all how foreign investors would respond to socio-political developments in the region in general and Pakistan in particular. Pakistan is playing a dangerous game of too much reliance on FDI to finance current account deficit. No sane economist will rely on sustainability of these flows.

The burgeoning current account deficit driven by stagnation in exports and rising import needs thus, ask a big question of financing beyond the so-called non-debt creating inflows (mainly driven by FDI inflows). Some signs of complacency on the part of economic managers have led to a burgeoning current account deficit which is causing enormous rise in external debt in spite of tremendous rise in non-debt creating inflows. During the last seven years, Pakistan has witnessed inflow of $13.7 billion worth of FDI against only $4.4 billion in the 1990s. This amount also included an amount of $2.7 billion of privatisation proceeds. Almost 75 per cent of FDI inflows or $9.4 billion is in four areas; namely, communication, financial businesses, oil & gas exploration, and power sector.

This pattern of FDI inflows is not beneficial to the economy because the four sectors are least labour intensive and their future balances of payment (BoP) implications are adverse. If we look into the pattern of outflow of remittance of profits and dividends for the last two years, they are rising at a tremendous pace and in future they are likely to go even further. The FDI inflows in the production sector are badly needed but at the moment they are negligible. The premature liberalisation of the financial sector has provided great leverage to the foreign investors in the financial sector and they are endangering the existing domestic financial sector. Banking sector is playing with spread and service charges. Financial sector offers the most attractive terms to the foreign investors in the region. Foreign investors are also lured by weaker vigilance and regulatory framework along with inflated profits. 

Studies show that in some developing countries and even in Pakistan during the 1990s, profits repatriated by multinationals have exceeded total FDI inflows in a particular year. This untoward outcome is exacerbated by principal and interest repayments where investments are financed with debt and by the outflow of royalties, dividends, and fees. This is not to mention the ****sucking sound**** produced by quasi-legal and outright illegal practices such as transfer pricing and other mutations of creative accounting.

All sorts of foreign investment are fragile and unreliable. Foreign investors of all stripes jump off the ship with the first sign of contagion, unrest, and declining fortunes. Studies have demonstrated that the multinationals are always in a hurry to repatriate earnings and repay inter-firm loans with the early harbingers of trouble. FDI is, therefore, partly pro-cyclical. Pakistan in the past has witnessed outflows of FDI. Foreign investment in the financial businesses is especially very fragile and easy to wither away.

Pakistan has to review its investment policy and domestic investors are to be provided level playing field. Concerted effort is needed to look into balance of payment implications of current patterns of FDI and risk assessment associated with foreign investment.

FDI INFLOWS IN PAKISTAN

(US $ Million)

          Total FDI          Privatization

                    Proceeds

2000-01          322.4          -

2001-02          764.5          117.0

2002-03          989.2          188.0

2003-04          1225.2          199.0

2004-05          1743.1          363.0

2005-06          3521.0          1540.3

2006-07          5124.9          266.4

Grand Total          13690.3        2673.7

FDI in the

1990s (1990-1999)  4445.1

Source: SBP