The Impact of Foreign Direct Investment On Pakistan Economy Final Project

The Impact of Foreign Direct Investment on Pakistan Economy ____________________________________________________________________________________________________________________ _
INSTITUTE OF BUSINESS AND TECHNOLOGY
Impact of Foreign Direct Investment on Pakistan Economy.

Prepared By XXXXX XXXXX BM-250XX Course Code : MKT-606
MBA (Banking and Finance) FACULTY OF MANAGEMENT AND SOCIAL SCIENCES
Institute of Business and Technology
SPRING - 2011 CONTENTS

Page No.
ACKNOWLEDGMENT... ABSTRACT. CHAPTER NO.1 INTRODUCTION

1.1 1.2 1.3 1.4 1.5 Introduction.... Purpose of Study................................................. Research Objectives. Hypothesis.. Research Methodology.
2 3
4 5 5 6 6
CHAPTER NO.2 LITERATURE REVIEW

2.1 2.2 Early Literature. FDI in the context of growth and trade. 7 7
CHAPTER NO. 3 FOREIGN DIRECT INVESTMENT

3.1 3.2 3.3 Definition of Foreign Direct Investment.. Components of Foreign Direct Investment Types of Foreign Direct Investment 12 13 13
CHAPTER NO. 4 FOREIGN DIRECT INVESTMENT IN PAKISTAN

4.1 4.2 4.3 4.4 4.5 Growth.. Sector Wise Investment. Source of Investment..... Problems.. Future Prospects. 14 15 16 17 19
CHAPTER 5 CONCLUSION & RECOMMENDATIONS

5.1 5.2 Conclusion... Recommendations..... 22 23
BIBLOGRAPY
27
2
ACKNOWLEDGMENT
I would like to acknowledge our instructor, Dr. Noor Ahmed Memon for his co-ordination and guidance. His research skills and knowledge marked a road map for our research project throughout the semester. I appreciated his willingness to help me and guide me in the research at any point in the semester. Moreover, I would like to acknowledge all the respondents who took the time to cater our informational needs. possible. Without their input, this research would not have been
3
INSTITUTE OF BUSINESS AND TECHNOLOGY

SUBMITTED BY: Rakhman Ali Memon
DISCIPLINE:
MBA (Finance)
TITLE OF PROJECT REPORT:
Impact of Foreign Direct Investment on Pakistan Economy.
MONTH OF SUBMISSION:
Spring, 2010
NAME OF PROJECT SUPERVISOR:
Dr. Noor Ahmed Memon
ABSTRACT
Foreign direct investment (FDI) is often seen as an important catalyst for economic growth in the developing countries. It affects the economic growth by stimulating domestic investment, increasing human capital formation and by facilitating the technology transfer in the host countries. The main purpose of the study is to investigate the impact of FDI on economic growth in Pakistan, for the period 1990-2006. The relationship between FDI and economic growth will be analyzed by using the production function based on the endogenous growth theory, other variables that affect economic growth such as Trade, domestic capital, labor and human capital will also be used. The expected results of the study are a positive and statistically significant relation between the real per-capita GDP and FDI. Policy recommendations could be suggested in the light of the results obtained, regarding the FDI in Pakistan.
4
1.
1.1
INTRODUCTION
Introduction
Foreign Direct Investment (FDI) has emerged as the most important source of
external resource flows to developing countries over the 1990s and has become a significant part of capital formation in the developing countries despite their share in global distribution of FDI continuing to remain small or even declining (Kumar and pardhan, 2001). The role of the foreign direct investment (FDI) has been widely recognized as a growth-enhancing factor in the developing countries (Arshad, 2008). The effects of FDI in the host economy are normally believed to be increase in the employment, increase in productivity, and increase in exports and, of course, increased pace of transfer of technology. The potential advantages of the FDI on the host economy are it facilitates the use and exploitation of local raw materials, it introduces modern techniques of management and marketing, it eases the access to new technologies, Foreign inflows could be used for financing current account deficits, finance flows in form of FDI do not generate repayment of principal and interests (as opposed to external debt), it increases the stock of human capital via on the job training. The local enterprises are able to learn by watching if the economic framework is appropriate (Bhagwati, 1994) it stimulates the investment in R&D (Calvo and Robles, 2003). The amount of foreign direct investment increased significantly for developing economies during 1985 to 2000. The share of developing countries in world FDI inflows and outflows has risen from 17.4% in 1985-90 to 26.1% during 1995-2000. For Pakistan the amount of FDI inflows increased from $ 0.24 billion in 1990 to $ 55 billion in 2007(WDI indicators 2008). The present paper tries to empirically estimate the effect of FDI on economic growth in Pakistan, using the conventional neo-classical production function where FDI is considered to be an additional input.
5
1.2
Purpose of Study
FDI has been one of the defining features of the world economy over the past
two decades. It has grown at an unprecedented pace for more than a decade. The past decade has witnessed an unparallel opening and modernism of the economies in all regions, encompassing deregulation, de-monopolization, privatization and private participation in the provision of infrastructure, a and the reduction and simplification of tariffs. An integral part of this process has been the liberalization of foreign investment regime. Although Pakistan has not received any considerable amount of FDI as yet, but has remained relatively greater over the past couple of decades as it adopted market oriented policies. The present study found that the growth impact of FDI tends to be greater under an export promotion (EP) trade regime compared to an importsubstitution (IS) regime by using data for Pakistan over the period 1970-2001. 1.3 Research Objectives FDI in Pakistan consists primarily of three elements, namely, cash brought in, capital equipment brought in, and re-invested earnings. The information provided in Table 3 shows that the structure of the sources of financing FDI in Pakistan has undergone a noticeable change. Though all the components of FDI exhibit considerable fluctuations over time, the item labeled capital equipment brought in has remained substantially low during 1983-1988. Though the major share of FDI in Pakistan comprised cash brought in (on average 55.7% over the last 15 years), its share declined slightly (on average 50.2% during 1991-1994) during the post-reform period. The share of capital equipment brought in remained low, on average, over the last 15 years but it has made considerable improvement during the postreform period. In particular, its share jumped to 55.7% in 1994 mainly due to the equipment brought in for Hubco Power Plant. Re-invested earnings contributed slightly less than one third to FDI over the last 15 years but its share has declined to 23% during the postreform period.
6
1.4
Hypothesis
There is a significant relationship of FDI on economy of Pakistan.
1.5
Research Methodology
The main purpose of the study is to assess/quantify the impact of FDI on
economic growth in Pakistan. The Time period for study is 1990-2006, based on the grounds that Pakistan started receiving significant amount of FDI inflows after the 1990s. Y=A ka Lb Where Y is the output, K is capital and L is labour and A is the technology or the efficiency of production. The model is based on the endogenous growth theory, as developed by (Balasubramanyam, Salisu, and Sapsford, 1996) and (Borensztein, Gregorio,& Lee 1998). The model is based on the assumption that FDI contributes to economic growth directly through new technologies and other inputs as well as indirectly through improving human capital, infrastructure, and institutions and the level of a countrys productivity depends on the FDI, trade, domestic investment. As the variable A captures the total factor productivity (TFP) effect on growth in output and it is assumed that the effect of FDI on growth operates through variable A, and the effect of FDI on A also depends on the human capital. The main purpose of the study is to assess/quantify the impact of FDI on economic growth, in order to achieve the desired objective, other independent variables which are assumed typically to influence the economic growth will be included in the model. It is expected that this inclusion will reduce or eliminate the specification error. The theoretical model that is used to investigate the interaction of FDI and Economic growth is based on the following production function.
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2. LITERATURE REVIEW
2.1
Early Literature
A number of studies have analyzed the relationship between FDI inflows and
economic growth, the issue is far from settled in view of the mixed findings reached. Most of these studies have typically adopted standard growth accounting framework for analyzing the effect of FDI inflows on growth of national income along with other factors of production. Within the framework of the neo-classical models (Solow, 1956) the impact of the FDI on the growth rate of output was constrained by the existence of diminishing returns in the physical capital. Therefore, FDI could only exert a level effect on the output per capita, but not a rate effect. In other words, it was unable to alter the growth rate of output in the long run. It is not surprising, thus, that FDI was not considered seriously as a drive engine of growth by mainstream economics. In the contrast, the New Theory of Economic Growth, however, concludes that FDI may affect not only the level of output per capita but also its rate of growth. This literature has developed various arguments that explain why FDI may potentially enhance the growth rate of per capita income in the host country, the identified channels to boost economic growth include increased capital accumulation in the recipient economy, improved efficiency of locally owned host country firms via contract and demonstration effects, and their exposure to fierce competition, technological change, and human capital augmentation and increased exports. However, the extent to which FDI contributes to growth depends on the economic and social condition or in short, the quality of environment of the recipient country (Buckley, Clegg, Wang, & Cross, 2002). This quality of environment relates to the rate of savings in the host country, the degree of openness and the level of technological development. Host countries with high rate of savings, open trade regime and high technological product would benefit from increase FDI to their economies.
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2.2
FDI in the context of growth and trade Many empirical works are available in the economic literature showing the causal
relationship between FDI and growth. At the firm level, several studies provided evidence of technological spillover and improved plant productivity. At the macro level, FDI inflows in developing countries tend to crowd in other investment and are associated with an overall increase in total investment. Most studies found that FDI inflows led to higher per capita GDP, increase economic growth rate and higher productivity growth (see e.g. De Mello 1997, Kumar and Siddharthan 1997, & Saggi 2000, for recent reviews of literature) FDI increases technical progress in the host country by means of a contagion effect, (Findlay, 1978) which eases the adoption of advanced managerial procedures by the local firms. Similarly (De Gregorio, 1992) analyzed a panel of 12 Latin American countries in the period 150-1985. His results suggest a positive and significant impact of FDI on economic growth. In addition the study shows that the productivity of FDI is higher than the productivity of domestic investment. While, (Fry, 1992) examined the role of FDI in promoting growth by using the framework of a macro-model for a pooled time series cross section data of 16 developing countries for 1966-88 period. The countries included in the sample are Argentina, Brazil, Chile, Egypt, India, Mexico, Nigeria, Pakistan, Sri Lanka, Turkey, Venezuela, and 5 Pacific basin countries viz. Indonesia, Korea, Malaysia, Philippines, Thailand. For his sample as a whole he did not find FDI to exert a significantly different effect from domestically financed investment on the rate of economic growth, as the coefficient of FDI after controlling for gross investment rate was not significantly different from zero in statistical terms. FDI had a significant negative effect on domestic investment suggesting that it crowds-out domestic investment. Hence FDI appears to have been immiserizing. However, this effect varies across countries and in the Pacific basin countries FDI seems to have crowded-in domestic investment. FDI inflows had a significant positive effect on the average growth rate of per capita income for a sample of 78 developing and 23
9
developed countries as found by (Blomstrm et.al, 1994). However, when the sample of developing countries was split between two groups based on level of per capita income, the effect of FDI on growth of lower income developing countries was not statistically significant although still with a positive sign. They argue that least developed countries learn very little from MNEs because domestic enterprises are too far behind in their technological levels to be either imitators or suppliers to MNEs. In this regard, another study was conducted by (Borensztein, et.al, 1995) he included 69 developing countries in his sample. The study found that the effect of FDI on host country growth is dependent on stock of human capital. They infer from it that flow of advanced technology brought along by FDI can increase the growth rate only by interacting with countrys absorptive capability. They also find FDI to be stimulating total fixed investment more than proportionately. In other words, FDI crowds-in domestic investment. However, the results are not robust across specifications. Export-oriented strategy and the effect of FDI on average growth rate for the period 1970-85 for the cross-section of 46 countries as well as the sub-sample of countries that are deemed to pursue export-oriented strategy was found to be positive (Balasubramanyam et.al, 1996) and significant but not significant and some times negative for the sub-set of countries pursuing inward-oriented strategy. Accordingly (Sanchez-Robles, 1998) explored empirically the correlation among public infrastructure and economic growth in Latin America in the period 1970-1985. She also found a positive and significant impact of FDI on the economic growth of the countries of this area. Another economist (De Mello 1999) also conducted time series as well as panel data estimation. He included a sample of 15 developed and 17 developing countries for the period 1970-90. The study found strong relationship between FDI, capital accumulation, output and productivity growth. The time series estimations suggest that effect of FDI on growth or on capital accumulation and total factor productivity (TFP) varies greatly across the countries. The panel data estimation indicates a positive impact of FDI on output growth for developed and developing country sub-samples. However, the effect of FDI on capital accumulation and TFP growth varies across developed (technological leaders) and developing countries (technological followers).
10
FDI has a positive effect on TFP growth in developed countries but a negative effect in developing countries but the pattern is reversed in case of effect on capital accumulation. De Mello infers from these findings that the extent to which FDI is growthenhancing depends on the degree of complementarity between FDI and domestic investment, in line with the eclectic approach given by (Dunning, 1981). The degree of substitutability between foreign and domestic capital stocks appears to be greater in technologically advanced countries than in developing countries. Developing countries may have difficulty in using and diffusing new technologies of MNEs. Findings of (Xu, 2000) for US FDI in 40 countries for the period 1966-94 also support the finding of De Mello that technology transfer from FDI contributes to productivity growth in developed countries but not in developing countries, which he attributes to lack of adequate human capital. (Agosin and Mayer, 2000) analyzed the effect of lagged values of FDI inflows on investment rates in host countries to examine whether FDI crowds-in or crowds-out domestic investment over the 1970-95 period. They conclude that FDI crowds-in domestic investment in Asian countries crowds-out in Latin American countries while in Africa their relationship is neutral (or one-to-one between FDI and total investment). Therefore, they conclude that effects of FDI have by no means always favourable and simplistic policies are unlikely to be optimal. These regional patterns tend to corroborate the findings of (Fry, 1992) who also reported East Asian countries to have a complementarity between FDI and total investment. In another study by (Pradhan, 2001) found a significant positive effect of lagged FDI inflows on growth rates only for Latin American countries. He used a panel data estimation covering 1975-95 period for 71 developing countries. The study sheds light that the effect of FDI was not significantly different from zero for the overall sample and for other regions. A number of early studies have generally reported an insignificant effect of FDI on growth in developing host countries. FDI may have negative effect on the growth prospect of the recipient economy if they give rise to a substantial reverse flows in the form of remittances of profits, particularly if resources are remitted through transfer pricing and dividends and/or if the transnational corporations (TNCs) obtain substantial or other concessions from the host country. For instance, Singh, (1988)
11
found FDI penetration variable to have a little or no consequences for economic or industrial growth in a sample of 73 developing countries. In the same way (Hien, 1992) reported an insignificant effect of FDI inflows on medium term economic growth of per capita income for a sample of 41developing countries. For studies conducted in Pakistan a study was conducted by (Shabir and Mahmood, 1992) analyzed the relationship between foreign private investment FPI and economic growth in Pakistan. The study used the data for 1959-60 to 1987-88; the study concluded that net foreign private investment (FPI) and disbursements of grants and external loans (DISB) had a positive impact on the rate of growth of real GNP. However they did not treat FDI as a separate variable. Similarly (Ahmed, Butt, and Alam, 2003) examined the causal relationship between FDI, exports and output by employing Granger non-causality procedure over the period 1972 to 2001 in Pakistan. They found significant effect from FDI to domestic output, in contrast to the above mentioned studies.
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3. FOREIGN DIRECT INVESTMENT

3.1
Definition of Foreign Direct Investment

Foreign direct investment (FDI) refers to long term participation by country A into
country
B.
It
usually
involves outward
participation are two foreign
in management, types of FDI: investment,
joint, transfer inward resulting
of in
technology and
"know-how".
There
foreign
direct investment and
direct
a net FDI inflow (positive or negative). Foreign direct investment (FDI) is a measure of foreign ownership of productive assets, such as factories, mines and land. Increasing foreign investment can be used as one measure of growing economic globalization. Figure below shows net inflows of foreign direct investment as a percentage of gross domestic product (GDP). The largest flows of foreign investment occur between the industrialized countries (America, Western and Japan). But flows to non-industrialized countries are increasing sharply. 3.2
Components of Foreign Direct Investment

low corporate tax and income tax rates tax holidays other types of tax concessions preferential tariffs special economic zones investment financial subsidies soft loan or loan guarantees free land or land subsidies relocation & expatriation subsidies job training & employment subsidies infrastructure subsidies R&D support
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3.3
derogation from regulations (usually for very large projects)
Types of Foreign Direct Investment

an individual; a group of related individuals; an incorporated or unincorporated entity; a public company or private company; a group of related enterprises; a government body; an estate (law), trust or other societal organization; or any combination of the above.
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4.
4.1
FOREIGN DIRECT INVESTMENT IN PAKISTAN
Growth
15
4.2
Sector Wise Investment
16
4.3
Source of Investment
17
4.4
Problems
The success of FDI policies can be judged by the size of the inflows of capital.
Pakistan has been making efforts to attract FDI and such efforts have been intensified with the advent of deregulation, privatization, and liberalization policies initiated at the end of the 1980s. Table 1 documents the size of the inflow of foreign investment in Pakistan during the last two decades. The amount of foreign investment rose from a tiny $10.7 million in 1976/1977 to $1296 million in 1995/1996, thus growing at the annual compound growth rate of 25.7 percent. However, it declined to $950 million in 1996/1997. With the beginning of the overall liberalization program (1991/1992 onwards) the inflow of foreign investment grew at the compound growth rate of 15.2 percent. Investment inflows in 1995/1996 increased by 93.3% mainly due to the inflow of investment in power sector. Although significant by absolute terms, the increase appears trivial when compared to the relatively more buoyant economies of East and Southeast Asia. While FDI flows to all developing countries reached $150 billion in 1997, East and Southeast Asia received the bulk of this share. Total foreign investment consists of direct and portfolio investment. Prior to 1991/ 1992, portfolio investment has not only been low but also exhibited a fluctuating trend. However, with the beginning of liberalization policies in 1991/1992, portfolio investment crossed the $1.0 billion mark in 1994/1995. This impressive increase does not reflect the true picture of the trends in portfolio investment witnessed during the postliberalization period. If the $862.2 million sale of Pakistan Telecommunications Corporation (PTC) vouchers, which was a one-time phenomenon, was excluded, the portfolio investment not only declined to $227.8 million in 1994/1995 but followed an average trend of $215.4 million during 1991/ 1992 to 1995/1996 as against an average flows of only $9.0 million prior to reform (1984/ 1985 to 1990/1991).
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Foreign participation appears to be the major factor responsible for the increase in portfolio investment in the 1990s. The decline in international interest rates was also important in portfolio allocations toward Pakistani assets. With globalization, numerous international portfolio funds were created that were invested in emerging capital markets seeking for better returns. Pakistan was among the first countries in emerging markets to take measures to open up its stock markets to foreign investors. However, in relation to the total flows directed to developing countries, interest in Pakistan has been very modest (Khan 1996). Portfolio inflows, because of their inherently volatile nature, have proved to be reversible more than other forms in developing countries. Their potential volatility is great in Pakistan as well since portfolio investment in Pakistan is directed mainly toward short-term and some medium-term public debt instruments and the stock exchanges. Despite yearly fluctuations, the amount of FDI rose from $70.3 million in 1984/1985 to $1090.7 million in 1995/1996, thus growing at the compound growth rate of 25.7 percent. However, it decreased to $682 million in 1996/1997. Since the beginning of the liberalization program (1991/1992), FDI has grown faster than in the preliberalization period (1984/1985-1990/1991). In particular, 1995/1996 registered a phenomenal growth of 146.5% mainly due to the inflow of FDI in the power sector. FDI, on average, accounted for nearly 80-85% of total inflows over the period 1984/1985 to 1996/1997. It reports the inflow of FDI by origin since 1981/1982. The US and UK have been the major sources of FDI in Pakistan, although the shares of both US and UK have fluctuated widely, falling as low as 8.8% for the US and 4.7% for the UK and rising as high as 63.7% and 35.2%, respectively. The share of the US has been, by far, the largest of all the countries, averaging 32.4% over the last 16 years followed by the UK (12.9%), UAE (11.6%), Japan (5.7%), and Germany (5.4%). During the post-reform era, the share of the US further rose to 42.0% followed by the UK (12.3%), Japan (6.4%), Germany (5.4%), and the UAE (4.7%). It may be noted that Japan, which has emerged
19
as a major investor globally (averaging $27.9 billion during 1990-1997), has annually invested only $32.3 million (or 0.1%) in Pakistan during the same period. 4.5
Future Prospects
FDI in Pakistan consists primarily of three elements, namely, cash brought in,
capital equipment brought in, and re-invested earnings. The information provided in Table 3 shows that the structure of the sources of financing FDI in Pakistan has undergone a noticeable change. Though all the components of FDI exhibit considerable fluctuations over time, the item labeled capital equipment brought in has remained substantially low during 1983-1988. Though the major share of FDI in Pakistan comprised cash brought in (on average 55.7% over the last 15 years), its share declined slightly (on average 50.2% during 1991-1994) during the post-reform period. The share of capital equipment brought in remained low, on average, over the last 15 years but it has made considerable improvement during the postreform period. In particular, its share jumped to 55.7% in 1994 mainly due to the equipment brought in for Hubco Power Plant. Re-invested earnings contributed slightly less than one third to FDI over the last 15 years but its share has declined to 23% during the postreform period. On average, during 1980-1994, 30% of FDI in Pakistan originated from reinvested earnings, whereas 70% (55.7% as cash and 14.2% as capital equipment) came from abroad. During the postreform a structural shift appears to have taken place as the share of re-invested earnings in total FDI declined to 23% while those coming from abroad rose to 77 percent. It is important to note that the share of re-invested earnings in FDI has been declining since 1990, falling from 31% in 1989 to 12% in 1994. There appears to be two reasons for such a rapid decline. Firstly, as a result of chronic inflation, the cost of production has gone up considerably and along with the plethora of taxes due to the fiscal consideration, the after tax profit of foreign firms has declined. Consequently, the reinvested earnings that originate as savings from the investment previously made have slowed down. Secondly, as a result of liberalization, the entry barriers of foreign firms were removed, which led to higher inflows of new
20
investment. Consequently, the relative share of re-invested earnings in total FDI declined considerably after 1990. Having examined the trends and structural pattern of FDI, it is worthwhile to review its overall sectoral distribution pattern. The analysis of sectoral distribution of FDI may reflect two things: on the one hand, it may reflect the preferential treatment given by the government to certain sectors while encouraging FDI, and on the other hand, it may also indicate the foreign investors own preferences. As revealed by the information presented in Tables 4 and 5, a noteworthy change can be easily observed in the sectoral composition of FDI flow into Pakistan over the last 15 years. On the broad sectoral basis, manufacturing industries, mining and quarrying, and commerce are seen to have traditionally dominated the preferences of the foreign investors during 1980-1994 accounting for over 83% of total inflow of FDI. However, like total FDI flows, sectoral shares also exhibit considerable year-to-year fluctuations. For example, the sectoral share of manufacturing industries, though highest, continued to fluctuate violently overtime, falling from 74.6% in 1982 to 26.0% in 1983 and once again rising to 54.7% in 1984. The share of manufacturing industries in overall FDI averaged only 11% during 1987-1993 but rose to 35% in 1994. The general decline in manufacturing share is largely substituted by the rise in the share of mining and quarrying, which stood next to manufacturing (28.1%) over the last 15 years. It appears that foreign investors preferred the petroleum sector (natural gas in particular) during the period. A significant change in the composition of FDI was also witnessed during the prereform and postreform periods. Manufacturing and mining and quarrying registered a sharp decline during the postreform period as against the prereform era. On the other hand, commerce, construction, and utilities experienced substantial increase in total FDI during the postreform period. It may be noted that the share of utilities in total FDI jumped from almost zero in 1993 to 31.7% in 1994. This massive increase was entirely due to the inflow of FDI in
21
the power sector with the Hubco Corporation alone accounting for Rs 7 billion out of Rs 7.6 billion in 1994. In the remaining economic sectors (i.e., agriculture, transport, storage and communication) the flow of FDI has been meager and erratic because of the limited opportunities open for foreign exploitation in these areas.
22
5. CONCLUSION & RECOMMENDATIONS

5.1
Conclusion
FDI has been one of the defining features of the world economy over the past
two decades. It has grown at an unprecedented pace for more than a decade. The past decade has witnessed an unparallel opening and modernism of the economies in all regions, encompassing deregulation, de-monopolization, privatization and private participation in the provision of infrastructure, a and the reduction and simplification of tariffs. An integral part of this process has been the liberalization of foreign investment regime. Although Pakistan has not received any considerable amount of FDI as yet, but has remained relatively greater over the past couple of decades as it adopted market oriented policies. The present study found that the growth impact of FDI tends to be greater under an export promotion (EP) trade regime compared to an importsubstitution (IS) regime by using data for Pakistan over the period 1970-2001. The effect of FDI in import substitution industries may be different from those of export oriented industries since former target mostly the limited domestic market, while the latter target the larger international market. Moreover, it is more likely to generate more employment and, therefore spillover due to the expected larger production capacity associated with larger market. FDI can stimulate human resources development through investment in education and training. This enhances the stock of human capital, and increases productivity of labor and other factors of production. In short, these finding suggest that Pakistans capacity to progress on economic development will depend on her performance in attracting FDI. Pakistans outward looking development strategy should include FDI as an essential part in addition to export promotion strategy.
23
5.2
Recommendations
General Recommendations First of all, Pakistan should make stronger efforts to attract as much FDI as possible to the foreign exchange sectors in the short term. Taking into account unfavorable balance of payments prospects, it should refrain from attracting any further massive FDI in the nonforeign-exchange-earning sectors for some years in the future. Political stability and satisfactory law and order are likewise critical to attract FDI. The international press and media coverage Pakistan has received in recent years is not at all conducive to attracting foreign investors. News items on Pakistan being one of the most corrupt countries in the world, its bomb detonations, and its use of child labor will hardly encourage foreign investors to undertake initiatives in Pakistan. The countrys political leadership must take practical steps to improve the law and order situation particularly in the major growth poles of the country including Karachi. Macroeconomic stability plays a key role in boosting economic growth (see Kim 1993) and restoring foreign investors confidence on the economy. In an environment of large fiscal deficit and precarious foreign exchange reserves position, foreign investors are unlikely to increase their participation. Pakistans fiscal situation and foreign exchange reserves position will remain under considerable strain for some time making the macroeconomic environment less conducive for foreign investors. Some drastic and farreaching measures are needed to reduce the fiscal deficit on the one hand and raise foreign exchange reserves on the other. Inconsistent economic policies discourage foreign investors in undertaking projects of medium to long-run duration. Several recent examples of inconsistent economic policies pursued by Pakistan have sent wrong signals to foreign investors. There is a strong perception among foreign investors that the probusiness policies and inducements used to attract prospective new investors are somehow lost in the reality they encounter when they actually begin to set up and operate their business
24
in Pakistan. Although the investment approval requirement has been removed, numerous permits and clearances from different government agencies at national, regional, and local levels are still applied to foreign investors, causing delays to complete the process. The authorities should streamline administrative procedures regarding approval and official clearances. Foreign investors in Pakistan have to cope with a complex legal situation. Law based on different legal systems are applied independently and it is often not obvious which one will take precedence. The legal situation is even further complicated by the fact that government agencies are empowered to introduce certain changes through administrative orders and SROs. The laws and regulations should be simplified, updated, modernized, made more transparent, and their discretionary application must be discouraged. Specific Recommendations Taxes Payment of taxes and contributions in Pakistan is complex and cumbersome. In addition to corporate income taxes, a large number of indirect taxes are levied at the federal, provincial, and local levels. Essentially, separate collection of taxes and contributions have forced enterprises to face unnecessary, cumbersome, and costly administrative procedures, and to deal with a large number of collecting agencies at all three levels of government. There is an urgent need to reduce the number of taxes and contributions; streamline tax regulations and administrative procedures; and most importantly reduce the contact of foreign firms with a large number of tax and contributions-collecting agencies. The existence of such a large number of taxes and collecting agencies may breed corruption, which adds to the cost of production. Import tariffs on plant and machinery have discouraged investment, more so in Pakistan where capital is scarce and cost of borrowing is high. Because of this high cost, manufacturers are discouraged to modernize and the quality of local industry products are restricted against international competition. There is a need to examine tariffs of plant and machinery with a view to substantially reducing them.
25
Credit Facilities Foreign firms operating in Pakistan are currently facing cash flow problems as a result of many taxes and the Asian crisis. That these firms cannot borrow more than their equity capital have further aggravated the cash flow problem. There is a need to review this policy.
Anti-monopoly Restrictions The existing monopoly control laws that benchmark the concentration of economic power to an unrealistically low limit of Rs 300 million for assets discourage capital formation. The monopoly control authority must review the limit in consultation with the Overseas Investors Chamber of Commerce and Industry in Pakistan.
Labor Laws Overprotective labor laws do not encourage productivity and frighten away much needed productive investment. There is a need to rationalize the labor laws and multiple levies on employment that inhibit business expansion and job creation.
Infrastructure The availability of better quality and more reliable services in all areas of infrastructure are key ingredients of a business environment conducive to foreign investment. In most infrastructure services, Pakistan is highly deficient as compared with many developing countries that have attracted higher levels of foreign investment.
26
If Pakistan wants to catch up gradually with the development of the economies of East and Southeast Asia, it will have to investment more in the areas of education and physical infrastructure. On the education front, the government should identify the nature of skills critical to sustained industrial growth, and formulate strategies, policies, and programs that could facilitate the enhancement of these skills. In telecoms, the government should expedite the privatization of PTC. In the railway and road sector, government must engage the private sector in leases, concessions, and buildoperate-transfer (BOT) type contracts. The high cargo handling costs at the Karachi port need to be controlled. Dredging of shipping channels to accommodate large vessels, lowering labor costs, upgrading port handling equipment, and improving documentary procedures need urgent attention.
Confidence-building Measure The close partnership between the private and public sector is essential to build confidence. In this respect, it is recommended that a forum be established where the private and public sectors could sit together to discuss business promotion-related issues. The forum must be composed of the prime minister, all the presidents of the national chambers, top businessmen/industrialists, top bankers, as well as heads of overseas chambers of commerce and relevant ministries' secretaries and ministers. The forum may meet regularly to review the economic situation of the country. The problem faced by the business community can be discussed and decisions could be taken immediately. This kind of partnership between the government and private sector will help restore market confidence.
27
BIBLOGRAPY
Articles 1) Foreign direct investment in Pakistan: Policy, issues and operational implications. By: Ashfaque H. Khan and Yun-Hwan Kim 2) Impact of Foreign direct investment on economic growth in Pakistan By:Nuzhat Falki
Websites www.adb.org/Documents/EDRC/Reports eprints.hec.gov.pk www.sbp.org.pk www.pakboi.gov.pk/forign-invest.htm
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The Impact of Foreign Direct Investment On Pakistan Economy Final Project

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The Impact of Foreign Direct Investment on Pakistan Economy ____________________________________________________________________________________________________________________ _

INSTITUTE OF BUSINESS AND TECHNOLOGY

Impact of Foreign Direct Investment on Pakistan Economy.

MBA (Banking and Finance) FACULTY OF MANAGEMENT AND SOCIAL SCIENCES

Institute of Business and Technology