Foreign Direct Investment

Foreign Direct Investment (FDI) is capital provided by a foreign direct investor, either directly or through other related enterprises, where the foreign investor is directly involved in the management of the enterprise. Development of a new business or acquisition of at least 10% interest in a domestic company or a tangible assets, (purchase of bond & stock). Foreign direct investment is the transfer by a multinational firm of capital, managerial, and technical assets from its home country to a host country. FDI has three components: equity capital, reinvested earnings and intra-company loans. FDI flows are recorded on a net basis (capital account credits less debits between direct investors and their foreign affiliates) in a particular year. Outflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a company resident in the economy (foreign direct investor) to an enterprise resident in another country (FDI enterprise). Inflows of FDI in the reporting economy comprise capital provided (either directly or through other related enterprises) by a foreign direct investor to an enterprise resident in the economy (called FDI enterprise). Foreign direct investment (FDI) includes significant investments by foreign companies, such as construction of production facilities or ownership stakes taken in U.S. companies. FDI not only creates new jobs, it can also lead to an infusion of innovative technologies, management strategies, and workforce practices. The ultimate flow of foreign involvement is direct ownership of foreign- based assembly or manufacturing facilities. The foreign company can buy part or full interest in a local company or build its own facilities. If the foreign market appears large enough, foreign promotion facilities offer distinct advantages. First, the firm secures cost economies in the form of cheaper labor or raw material, foreign government incentives, and freight savings. Second, the firm strengthens its image in the host country because it creates jobs. Third, the firm develops the recent relationship with the government, customers, local suppliers, and distributors, enabling it to adapt its product better to the local environment. Forth, the firm retains full retain over its investment and therefore can develop manufacturing and marketing policies that serve its long-term international objectives. Fifth, the firm assures itself access to the market in case the host country starts insisting that locally purchased goods have domestic content.

Types of Foreign direct investment

Multinational Corporation A country that maintains significant operation in multiple countries but manages them from the base in the home country.3 The MNCs are playing an important role in economic development of developing countries. First, the investment made by MNCs help in filling the saving investment gap. Secondly, it fills the foreign exchange or trade gap. Thirdly, the govt. of the developing countries is able to fill up the reserves gap by taxing the profits of MNCs. Fourthly, MNCs fill the gaps in management entrepreneurship, technology and skills in the developing countries.

Transnational Corporation A country that maintains the significant operation in more than one country but decentralize management to the local country. Strategic alliance An approach to going global that involves partnerships between an organization and a foreign company in which both share knowledge & resources in developing new products or building production facilities. It is an agreement typically between a large company with established products & channel of distribution and an emerging technology company with a promising research and development program in areas of interest to the larger company. In exchange for its financial support, the larger established company obtains a stake in the technology being developed by the emerging company. Today, strategic alliance is common place in the biotechnology, information technology & the software industries.6 Companies are also discovering that they need strategic patterns if they hope to be effective. Even giant companies like AT&T, IBM, Phillips, Siemens etc often can not achieve leadership, either nationally or globally, without forming strategic alliances with domestic or multinational companies that complement or leverage their capabilities and resources. Well-managed alliances allow companies to obtain a greater sales impact at less cost. To keep their strategic alliances thriving, corporation has begun to develop organizational structure to support them and have come to view the ability to form and manage partnership as core skills in and of themselves. Joint venture An approach going global that is a specific type of strategic alliance in which the partners agree to form an independent organization for some business purpose. They can be of two types: A contractual joint venture between firms is usually for a specific project, such as manufacturing a component or other product for a fixed period of time. An equity joint venture is when firms hold an equity stake in the setting up of a joint subsidiary, again to produce a good or a service, for example Toyota and General Motors formed the subsidiary NUMMI to manufacture cars in the United States. Foreign investors may join with local investors to create a joint venture in which they share ownership and control. For instance: Coca-cola and Nestle joined forces to develop the international market for ready to drink tea & coffee, which currently sell in significant amount only in Japan.

Forming a joint venture may be necessary or desirable for economic & political reasons. The foreign form might lack the financial, physical and managerial resources to under take the venture alone. Or the foreign govt. might require joint ownership as a condition for entry. Even corporate giants need joint ventures to crack the toughest markets. Foreign subsidiary An approach going global that involves a direct investment in a foreign country by setting up a separate & independent production facility or office. Licensing An approach to going global by manufacturing organizations that involves giving other organizations the right to use your brand name, technology or product specifications.10 When a firm (the licensor) has legal control over intellectual property rights and the setting-up of a local operation in another country seems too expensive, they can give a license to another company. This method is often used when there is a need for the rapid manufacturing of a product, to exploit an opportunity when there is insufficient time to put in the own production capacity. There are different types of licensing: a) ASSIGNMENT - to hand over completely a patent etc to licensee b) SOLE LICENCE - to one company and no licenses to any other firms c) EXCLUSIVE - not for use with licensors other products d) KNOW-HOW LICENSING - of confidential knowledge The licensee (the firm obtaining the license) usually demands exclusive rights in the country or countries and may have the right to subcontract to other parties. Exclusive licensing may contravene EU competition laws, but there are exemptions, for example if the good or service has less than 5% market share and the turnover of the parties is less than 200m Ecus. Japanese firms licensed much especially in the immediate post-war period. In 1945 Japan produced mainly low priced toys, textiles & basic engineering goods. The Government (by the actions of their Ministry of Finance and Ministry of International Trade and Industry) redirected resources to high volume, capital-intensive industries in order to stimulate productivity and economic growth. They used licenses to acquire the technology that was needed to develop medium and high technology industries, for example the transistor from the USA. They then applied the technology to produce a range of products, many of which came to dominate world markets by capturing large market shares. In 1976 Japanese firms

had gained 90% of the OECD exports of motorbikes, 70% of TVs and radios, 43% of ships, 23% of watches and 20% of cars. Franchising An approach to going global by service organizations that involves giving other organizations the right to use your brand name, technology or product specifications.11 Franchising is a form of licensing. The franchisee adopts the parent companys entire business format; the name, trademark, methods, management services, training, technical advice and stock control systems. You can probably think of a number of firms, particularly in the retail and food sectors that use the franchise system. The franchisor, such as the American McDonalds fast food firm, keeps firm control over the franchisees in order to maintain the quality of the product. They supply good quality raw materials and set standards (verified by random checks) that have to be maintained if the franchise is to continue. The franchisor receives royalties, a lump sum fee and the profit on the materials that are supplied to the franchisee. MacDonald's have established a high reputation and the franchise system have enabled them to spread rapidly throughout the world. Franchisee's now pay large sums to acquire the right for this business, especially in the world's major cities such as Hong Kong. INTRODUCTION* The role of foreign direct investment (FDI) has been widely recognized as a growthenhancing factor in developing countries. There are a variety of channels through which FDI can promote economic growth, in the host country. Most of the developing countries rely primarily on FDI as a source of external finance because FDI stimulates economic growth more than other sources of capital inflows. FDI is likely to be an engine of host countrys economic growth, because (i) inward FDI may enhance capital formation and employment generation, (ii) FDI may promote manufacturing exports, (iii) FDI may bring resources into host country such as, management know-how, access of skilled labour to international production networks, and established brand names, and (iv) FDI may result in technology transfers FDI in Pakistan is being widely considered as an important vehicle for economic growth. Pakistan has introduced a wide range of incentives, congenial for local and foreign investors and has increasingly tended to turn to FDI as source of capital, technology, managerial skills and market access needed for sustained economic development. The country provides a one-window facility for setting up business, and foreign investment is fully protected by law, including avoidance of double taxation. The outward orientation in policies designed by the government to attract more FDI has been accompanied by the adoption of policies relating to privatization and deregulation of economic activity and greater reliance on market forces in the country.

Pakistans recent reforms offer unprecedented and conducive business environment to all multinational corporations (MNCs). Pakistan is know one of those countries in the region whose reforms and economic achievements during the last few years have steered the country to a business-friendly environment, creating a win-win situation for both investors and consumers. Investment in electronics and other high-tech industries is widely seen as special desirable in developing countries like Pakistan, providing employment opportunities, and boosting exports by increasing production and help in modernizing the economy. THEORIES OF FOREIGN DIRECT INVESTMENT Theories play an important role in shaping legal attitudes both nationally and internationally. Theories of FDI assert that the basis for such investment lies in the transaction costs of transferring technical and other knowledge. Three important theories of FDI are discussed below. Neoclassical Economic Theory of FDI Neoclassical economic theory propounds that FDI contributes positively to the economic development of the host country and increases the level of social wellbeing [Bergten, et al. (1978)]. The reason behind this argument is that the foreign investors are usually bringing capital in to the host country, thereby influencing the quality and quantity of capital formation in the host country. The inflow of capital and reinvestment of profits increases the total savings of the country. Government revenue increases via tax and other payments [Seid (2002)]. Moreover, the infusion of foreign capital in the host country reduces the balance of payments pressures of the host country. The other argument favouring the neoclassical theory is that FDI replaces the inferior production technology in developing countries by a superior one from advanced industrialised countries through the transfer of technology, managerial and marketing skills, market information, organisational experience, and the training of workers [Kojima (1978)]. The MNCs through their foreign affiliates can serve as primary channel for the transfer of technology from developed to developing countries. The welfare gain of adopting new technologies for developing countries depends on the extent to which these innovations are diffused locally. The proponents of neoclassical theory further argue that FDI raises competition in an industry with a likely improvement in productivity [Kojima (1978); Bureau of Industry Economics (1995)]. Rise in competition can lead to reallocation of resources to more productive activities, efficient utilization of capital and removal of poor management practices. FDI can also widen the market for host producers by linking the industry of host country more closely to the world markets, which leads to even greater competition and opportunity to technology transfer [Bureau of Industry Economics (1995)]. It is also argued that FDI generates employment, influences incomes distribution and generates foreign exchange, thereby easing balance of payments constraints of the host

country [Reuber, et al. (1973); Sornarajah (1994); Bergten, et al. (1978)]. Furthermore, infrastructure facilities would be built and upgraded by foreign investors. The facilities would be the general benefit of the economy [Sornarajah (1994)]. The Guidelines on the Treatment of Foreign Direct Investment incorporates the neoclassical theory when it recognises: that a greater flow of direct investment brings substantial benefits to bear on the world economy and on the economies of the developing countries in particular, in terms of improving the long-term efficiency of the host country through greater competition, transfer of capital, technology and managerial skills and enhancement of market access and in terms of the expansion of international trade. Kennedy (1992) has noted that host countries became more confident in their abilities to gain greater economic benefits from FDI without resorting to nationalization, as the administrative, technical and managerial capabilities of the host countries increased. Dependency Theory of FDI Dependency school theory argues that foreign investment from developed countries is harmful to the long-term economic growth of developing nations. It asserts that First World nations became wealthy by extracting labour and other resources from the Third World nations. It further argued that developing countries are inadequately compensated for their natural resources and are thereby sentenced to conditions of continuing poverty. This kind of capitalism based on the global division of labour causes distortion, hinders growth, and increases income inequality in developing countries. Hence, Third World nations must develop independently without depending on foreign capital and goods. The influence of the dependency theory peaked in the 1970s; many authors advocated that dependency theory provided some useful qualitative methods to restrict foreign capital. Various countries adopted dependency theory perspectives in the 1970s, including East Asian and Latin American countries. A number of these countries adopted import substitution strategy and demonstrated a hostile attitude toward foreign investment. These policies had harmful effects on these economies [Hein (1992)]. During 1970s and 1980s East Asian countries also shifted their attention from dependency theory to more liberal policies to attract foreign investment. 2.3. Industrialization Theory on FDI Caves (1971) and 1974) and Kindle Berger (1984) extended the industrial organization theory of FDI by emphasizing the behavior of the firms that deviate from perfect competition as the determinants of FDI. They are of the view that in comparison to the domestic firms, MNCs face a number of problems such as geographical distances in managing enterprises, linguistic, and cultural barriers. When a firm undertakes FDI in a foreign country, it must posses some special ownership advantages over domestic competitors. Such advantages include marketing and management skills, brand names, patent-protected superior technology, and cheaper source of financing, preferential access to markets and economies of scale [Haque (1992). Unlike portfolio investment, FDI entails a cross border transfer of a variety of resources including,

process and product technology, managerial skills, marketing and distribution know how, and human capital. AN OVERVIEW OF FDI INFLOWS IN PAKISTAN 1970-2006 The higher level of saving and investment is necessary to increase the rate of capital formation. However, in developing countries the level of domestic savings falls below the desired level because of low per capita income. In the case of Pakistan, domestic savings account for less than 20 percent of the GDP. This gap between domestic savings and desired level of investment can be filled by the transfer of resources from outside. FDI is one of the most important sources. To increase the level of foreign capital inflows, liberalization of trade and investment regime by relaxing controls and offering financial and trade incentives like tax concessions and tariff reductions should be needed. Furthermore, host country should pursue active liberalization policies to overcome trade deficit, and encourage investment in export-led sectors. To ensure that FDI stimulates domestic economic activity, the host country should make it mandatory for the foreign investor to use a certain amount of locally made inputs in the production of final goods. The domestic policies opted by the host countries have an important influence on the decisions of foreign investment. To attract FDI, the host country should adopt concrete and investor friendly policies, strong infrastructure are the pre-conditions to restore the confidence of foreign investors. After following somewhat restrictive economic policies, the government of Pakistan initiatedmarket-based reforms in the 1990s. These reforms included gradual liberalization of trade and investment regime by providing various trade and fiscal incentives to foreign investors through tax concessions, credit facilities, tariff reduction and easing foreign exchange controls [Khan (1997)]. In the early 1990s, the government undertook a number of policy and regulatory measures14 to improve the business environment in order to attract foreign investment [Anwar (2002)]. In order to encourage FDI, restrictions on capital inflows and outflows were gradually lifted. Foreign investors were allowed to hold 100 percent of the equity of industrial project a repatriable basis without any prior approval. Furthermore, investment shares issued to non-residents could be exported, and remittance of dividends and disinvestments proceeds was permissible without any prior permission of State Bank of Pakistan (SBP). In 1994, restrictions on some capital transactions were partially relaxed, and foreign borrowing and certain outward investments were allowed to some extent. Full convertibility of the Pak-rupee was established on current international transactions. The establishment of an interbank foreign exchange market also marked an important step towards decentralizing the management of foreign exchange and allowing market forces to play a greater role in exchange rate determination. Pakistans foreign investment regime mainly consists of three components. (i) regulatory, (ii) economic, and (iii) socio-political. Regarding privatization and deregulation, Pakistan has opted very liberal regulatory regime. The regulatory framework for foreign investment consists of three laws facilitating and protecting foreign investors; (i) Foreign Private Investment (Promotion and Protection) Act 1976, (ii) Furtherance and Protection of Economic Reforms Act 1992, and (iii) Foreign

Currency Accounts (Protection) Ordinance 2001. In addition Bilateral Agreements include: investment protection with 43 countries and avoidance of double taxation with 51 countries. To protect the intellectual property rights (IPRs), Pakistan has also updated IPR laws to bring them in compliance with international requirements particularly, those mandatory under the Agreement on Trade Related Intellectual Property Rights (TRIPS) of the WTO. The salient features of the Pakistans regulatory regime are: Freedom to bring, hold and take out foreign currency from Pakistan in any form. Privatization of an enterprise is fully protected. Neither it can be renationalized, nor can the government take over any foreign enterprise. Original FDI as well as profits earned can be repatriated to the country of origin. Equal treatment is provided to the foreign investor and local investor in terms of import and export of goods. FDI is not subject to taxes in addition to those levied on domestic investment. Foreign currency accounts are fully protected and they cannot be frozen. All the economic sectors including services sector are open to FDI, foreign equity up to 100 percent is allowed in all sectors. However, foreign equity up to 80 percent is allowed in agriculture sector. There is no lower limit on the size of FDI in manufacturing sector. However, in services, infrastructure and social sectors the minimum amount of foreign equity investment is $0.3 million. No government sanction is required to set up any industry, in terms of field of activity, location, and size, except arms and ammunitions, high explosives, radioactive substances, security printing, currency and mint and alcoholic beverages. No double taxation on income earned by foreign investors. Pakistan has also rationalised its tariff regime. Custom duty on import of most of the primary raw material is not more than 5 percent, while on the imported machinery is between 0 and 10 percent. Copyright law has been amended while laws regarding patents; industrial designs and trademarks have been re-enacted. There is no requirement for obtaining no objection certificate (NOC) from provincial governments for locating the project anywhere in the country except in areas that are notified as negative areas. But due to the inconsistency of government policies, the level of FDI remained low as compared to other developing countries. Pakistan has received comparatively higher amount of FDI over the past two decades due to its market-oriented investment policies and enabling environment for investment. FDI inflows to Pakistan can be explained in terms of its size and percentage of gross domestic product (GDP). Due to inconsistent policies, the flow of FDI was insignificant until 1991. However, the flow of FDI steadily increased in the postliberalisation period. Actual inflows of FDI to Pakistan have increased from $119.6 million in the 1975-79 to $3299.8 millions in the 199599 (Table 1 and Figure 2). The FDI inflow increased from $469.9 million in 1999-2000 to $798 million 2002-03 showing 65 percent increase and stood $3521 million in 2005-06.

Since 2004, there has been a significant increase in the net inflows of capital. Capital inflows included mainly one-off inflows such as, $354 million through privatization and $600 million through sovereign debt issued internationally and an increase in confessional longterm loans from the World Bank and Asian Development Bank. FDI reached to $1.5 billion in 2005, 61 percent higher than in 2004. New FDI is concentrated in a few sectors such as telecommunications, finance and Oil and Gas exploration. However, this increase becomes insignificant when we compare with the South Asian countries. The net private inflows to these countries were about $106 billion in 1996 [Burki and Savitsky (2000)]. The reasons for low level of FDI inflows include the lack of political stability, slow bureaucratic process, inadequate infrastructure facilities, macroeconomic imbalances, inconsistent economic policies of successive governments, delays in the privatisation of state-owned enterprises,

past disputes between foreign investors and the government, piracy of intellectual property, and arbitrary and non-transparent applications of government regulations. Dimensions of FDI in Pakistan The dimensions of the FDI flows into Pakistan can be explained in terms of its growth and size, sources and sectoral compositions. The growth of FDI in Pakistan was not significant until 1990 due to the regulatory policy framework. However, under the more liberal policy regime, it has played a more significant role in the development of Pakistans economy as shown in Table 2. It shows that over the postliberalization era, there is a steady build up in the actual FDI inflows which have steadily increased from US$ 216.2 million in 1990 to US$ 1524 million in 2005, thus growing at the annual compound rate of 21.47 percent. The decline to US$322.5 million in 2000-01 can be attributed to many factors including the US sanctions imposed in the aftermath of the nuclear tests, the East Asian financial crisis and political instability. However, the flow of FDI picked up after 2001-02 due to the revival of closer US-Pak ties and the liberalized foreign investment environment and FDI grew at 212 percent since 2000. In the year 2004-05 FDI was $1524 million. During the fiscal year 2005-06 Pakistan received $3521 million as FDI. Since 2003, Pakistan has registered an increasing trend of FDI inflows and the FDI-GDP ratio (Figure 3). Table 3 depicts the inflows of FDI by origin in Pakistan since 1989-90. The US, UK and UAE remain the major source of FDI inflows in Pakistan despite considerable fluctuations in their shares. The share of FDI from UAE fluctuated between 1.20 percent in 2000 to 24.1 percent in 2005-06, that of UK from 6.5 percent in 2002-03 to 36 percent and USA 21.4 percent to 67.3 percent. Figure 4 indicates that over 80 percent of the FDI shares to Pakistan collectively originated from US, UK, UAE, Germany, France, Italy, Japan, and Netherlands since 1990. The top two investors during the year 2005-06 in Pakistan are UAE, which accounted for nearly 42.5 percent, and the US 14.7 percent. Saudi Arabia, UK, Switzerland and Norway accounted for 7.9, 6.9, 4.8 and 7.2 percent of FDI flows to Pakistan, while all other sources amounted to 18 percent (Table 3a). The inflows of FDI over the last four years were relatively broad-based, with almost all sectors witnessing an increasing trend (Table 4).

Table 4 and Figure 5 indicate that the services sector attracted the major chunk of FDIs (Figure 6). The significant increase of FDI in services sector has enhanced its contribution towards GDP by 66 percent. Within services sector, Telecom sector remained the most dominant as depicted by an absolute increase of around $1937.7 billion. During 2005-06 the contribution of Telecom in total FDI exceeded 55 percent. Power generation is the second major area of interest followed by the communication sector in attracting FDI. This industry has immense potential for investment and the government is trying to attract more investment in this industry. The investment which dipped to negative $14 million in 2003-04 is now increasing and touched to $320.6 million in 200506.17 Other important sector is the Oil and Gas exploration. Pakistan has the fifth largest reservoir of coal (184 billion tons) in the Thar but only 4.5-5.0 million tons is mined annually, representing significant upside potential of the industry. The flow of FDI in this sector is continuously increasing and reached to $312.7 million in 2005-06. Besides telecommunication and power sectors, financial services have also attracted considerable FDI. More than 800 percent growth of FDI in the financial sector over the last four years is due to the financial sector reforms. Liberalization and privatisation of the financial sector appears to be the main factor responsible for a massive inflow of foreign capital. FDI inflows in this sector have increased up to $329.2 million at the end of 2005-06 as compared to $269.4 million in 2004-05.

Trade group attracted $118 million, construction $89.5 million and others $413.3 millions. Pakistan has a lot of potential to attract foreign investment. Though, the rising trend of FDI reflects the success of the policy. However, FDI is considerably hindered due to institutional weaknesses, corruption, ineffective legal institutions, political uncertainty, poor law and order situation and low labor productivity.

Review of Last 10 Years

Impact of Foreign Direct Investment (FDI) on the sectors (agriculture, industry and service) growth pattern of Pakistani economy over the last 10 years 2000-2009. Total FDI for the first 3 quarters of 2007 stands at USD 3.86 billion; 72% higher than the corresponding period of the previous year. One interesting point is that over the period 2000 to 2009, the country enjoyed a positive net FDI inflow except, when foreign investors have taken out more money than they have pumped into the country through repatriation of profit/dividend, capital and repayment of loans with foreign banks and other sources. Pakistan has witnessed a steady growth in FDI during past few yeas. This growth in FDImay be attributed mainly to political stability and macroeconomic reforms by the government (Khan, 2005). The most attractive sectors for foreign investors have been oil and gas exploration, telecommunication and financial services (BOI, 2006). The deregulation policy regarding telecom sector attracted huge foreign investment accounting for 55% of total FDI in the year 2005-2006. But then due to political instability and socioeconomic factors, Pakistanhas seen a decrease in the following years till present. Until the1980s, most developing countries viewed FDI with great weariness. In recent years, however FDI restrictions have been significantly reduced. Most countries offer incentives to attract FDI, such as tax concessions, tax holidays, accelerated depreciation on plants and machinery, export subsidies and import entitlements etc. As a developing country Pakistanneeds FDI for its ongoing development process. Since independence, Pakistan is trying to be a suitable location for FDI. However, as the recipients of FDI, Pakistans position, in comparison with other counties of the world, is weak. Pakistan has performed better in last few years and received more than double

inward FDI flows in 2005 as compared to 2000, however, this performance is much lower than the other developing and developed countries of the world.

Table 1: Sector Wise FDI Inflows (Million $) Sector 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2007-08 2008-09 01 02 03 04 05 06 07 08 (July(July- April) April) Oil & Gas 80.7 268.2 186.8 202.4 193.8 312.7 545.1 634.8 509.4 612.1 Financial (34.9) 3.6 207.4 242.1 269.4 329.2 930.3 1,607.6 997.1 680.9 Business Textiles 4.6 18.5 26.1 35.4 39.3 47.0 59.4 30.1 25.1 28.4 Trade 13.2 34.2 39.1 35.6 52.1 118.0 172.1 175.5 139.6 147.7 Construction 12.5 12.8 17.6 32.0 42.7 89.5 157.1 88.5 77.2 76.8 Power 39.9 36.4 32.8 (14.2) 73.4 320.6 193.4 70.3 52.2 80.2 Chemical 20.3 10.6 86.1 15.3 51.0 62.9 46.1 78.0 66.5 58.0 Transport 45.2 21.4 87.4 8.8 10.6 18.4 30.2 73.0 6.0 0.5 Communication NA 12.8 24.3 221.9 517.6 1,937.7 1,898.7 1,625.3 1,164.9 828.5 (IT&Telecom) Others 140.9 66.2 90.4 170.1 274.0 285.0 1,107.2 769.7 681.1 692.3 Total 322.4 484.7 798.0 949.4 1,523.9 3,521.0 5,139.6 5,152.8 3,719.1 3,205.4 Privatisation 127.4 176.0 198.8 363.0 1,540.3 266.4 133.2 133.2 Proceeds FDI Excluding 322.4 357.3 622.0 750.6 1160.9 1980.7 4873.2 5,019.6 3,585.9 3,205.4 Pvt. Proceeds 13.8% decrease in FDI Including Pvt. Proceeds as compared to July-April FY 08 10.6% decrease in FDI Excluding Pvt. Proceeds as compared to July-April FY 08
Source: BOI, Pakistan Magnitude of FDI: Till almost a decade ago, the Foreign Direct Investment (FDI) inflows in Pakistan stood fairly below the desired level. In 1995-96, the economy though registered FDI inflows worth USD 1.1 billion mainly on account of agreements with Independent Power Producers (IPPs), the inflows fell sharply in the following year as the successive government renounced agreements with IPPs. This gave rise to a row between the government and IPPs, which adversely affected foreign investors confidence in Pakistan. Moreover the countrys decision to go nuclear in 1998 prompted several foreign countries to impose economic restrictions which exerted further downward pressure on FDI inflows. It was only during the last six financial years that the FDI levels improved significantly owing to the dynamic economic and investment policies executed by the government that included

opening the economy through privatization and deregulation and establishment of a liberal FDIregulatory regime. This regulatory framework for foreign investment constitutes three laws: Foreign Private Investment (Promotion & Protection) Act 1976; Furtherance and Protection of Economic Reforms Act 1992; and Foreign Currency Accounts (Protection) Ordinance 2001. Taken together, these laws protect FDI in the following manner:
1. There is freedom to bring, hold and take out foreign currency from Pakistan in any form. 2. Fiscal incentives provided by the government cannot be altered to the disadvantage of the investor. 3. The privatization of an enterprise is fully protected. 4. No foreign enterprise can be taken over by the government. 5. Original foreign investment as well as profits earned on it can be repatriated to the country of origin. 6. Equal treatment is provided to a foreign investor and local investor in terms of import and export of goods. 7. FDI is not subject to taxes in addition to those levied on domestic investment. 8. Foreign currency accounts are fully protected and they cannot be frozen. (Courtesy the Foreign Currency Accounts Ordinance 2001).

Foreign investors are permitted to hold 100% of the equity in not only industrial projects but also in the Service, Infrastructure and Social Sectors (subject to certain conditions) on repatriable basis. Moreover, no government sanction is required for setting up an industry in terms of field of activity, location and size except in case of four sectors relating to national security. Under the deregulation policy, government controls on business activity are being relaxed even further. To avoid double taxation on income earned by foreign investors,Pakistan has already concluded agreements with 51 countries that include nearly all the developed economies. As a result of these proactive policies, the FDI increased by more that 900% in the past six years. It crossed the USD 1 billion mark in FY 04 and is set to cross the USD 4 billion mark in the current fiscal year. Total FDI inflows for the first nine months of the current fiscal year stand at USD 3.86 billion which is 72% higher than the amount of USD 2.24 billion for the corresponding period of the last fiscal year. Nearly half of these FDI inflows were a result of proceeds from the sale of state enterprises while the financial services sector, telecommunications and the energy sector remained the primary recipients of the bulk of FDI. Figure 1: Foreign Direct Investment (FY01-FY06)

Source: BOI, Pakistan Although the ranking of Pakistan on FDI performance ranking index in year 1990 was 78 for the inward FDI performance (Table 2), yet, this ranking is continuously declining, as growth in FDI inflows is low. India, during 2000, with 119 ranking in the performance index, however, showed a steady growth in FDI inward flows from US $ 1705 millions in 2000 to US $ 6958 millions in 2006 (Table 3). The growing technological capabilities of Indian firms, particularly in information technology services and pharmaceuticals, are driving the FDIgrowth. Access to marketing, distribution networks, foreign technology and strategic assets such as brand names, are the main motivators. TABLE 2

Inward FDI Performance Index Rankings, 1990-2005 Countries Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka

1990 109 101 100 78 72

2000 2004 2005 110 119 131 118 108 119 112 136 109 96 116 119 135 102 106

Source: UNCTAD, World Investment Report 2006 TABLE 3

FDI Flows for Selected Countries and Regions in Millions of 1990US $ Countries 2000

2002 2003 2004 2005

Bangladesh Bhutan India Maldives Nepal Pakistan Sri Lanka China South Asia
Source: UNCTAD, World Investment Report 2006

190 2 1705 9 11 463 159 30104 2533

328 350 460 692 1 1 1 5627 4585 5474 6598 12 14 15 14 6 15 5 823 534 1118 2183 197 229 233 272 52743 53505 60830 72408 8982 5729 7301 9765

FDI inflow: sectoral composition (agriculture, industry and service) Attraction of FDI is becoming increasingly a global phenomenon often based on the implicit assumption that greater inflows of FDI bring unambiguous benefits to the economy. Like any other flow of capital, FDI represents a source of capital and therefore is believed to contribute positively to Gross Domestic Product, Gross Fixed Capital Formation, and balance of payments. In addition to this, FDI has the potential to generate employment, raise productivity, transfer foreign skills and technology, and subsequently contribute to the long-term economic development of the worlds developing countries. FDI can also contribute toward debt servicing repayments while also stimulating export markets and producing foreign exchange revenue. Subsidiaries of multinational enterprises, which bring the vast portion of FDI, are estimated to produce around a third of total global exports. However the impact of FDI is dependant on what form it takes. This includes the type of FDI, sector, scale, duration and location of business and secondary impacts on the economy. Therefore a refocusing of perspective, from merely enhancing the availability of FDI, to the better application of FDI for sustainable objectives is crucial to reap the real benefits of FDI. Economic literature has outlined a range of positive and negative aspects of FDI as a source of development for developing economies which we will highlight in this section. FDI, where it generates and expands businesses, helps stimulate employment, raise wages and replace declining market sectors. However, the benefits may only be felt by a small portion of the population, example where employment and training is given to more educated, typically wealthy elites or there is an urban emphasis. As a result wage differentials between income groups will be exacerbated. Cultural and social impacts may also occur when investment is particularly directed at non traditional goods. Huge foreign currency inflows resulting from increased FDI under a flexible exchange rateregime where exchange rate is determined by market forces essentially result in appreciation of the local currency. For example in case of Pakistan, excess dollar inflows will increase the supply of dollar in the market, exerting a

downward/upward pressure on the dollar/rupee. This shall reduce the burden of foreign debt and is therefore beneficial in debt repayments. TABLE 4

Sector-Wise FDI in Pakistan Sector 2005 %age 2004 %age 2003 %age 2002 %age IT & Telecom 1937.7 55 518 34 222 23.4 208 18 Financial Business 329.2 9.3 269 17.7 242 25.5 208 26 Oil and Gas 312.7 8.9 218 14.3 273 28.8 187 23.41 Trade 118 3.4 52.1 3.4 35.6 3.7 39.1 4.9 Power 320.6 9.1 73.3 4.8 35.4 3.7 32.8 4.11 Construction 89.5 2.5 51 3.3 32 3.4 32.8 4.11 Others 413.3 11.1 343 22.5 109 11.5 158 19.47 Total 3,521.0 100 1524 100 949 100 798 100
Source: UNCTAD, World Investment Report 2006 FDI inflow by source country The emergence of new sources of FDI may be of particular relevance to low-income host countries like Pakistan. Indeed, the role of developing and transition economies as sources ofFDI is increasing with the passage of time. Transnational Corporations (TNCs) from developing and transition economies have become important investors in many LDCs.Pakistan also depends on these countries across the globe for FDI. Among the sources, 21 countries belong to the developing and transition economies. Table 4 illustrates the total FDIinflow in Pakistan over the last 9 years from 2000 to 2009 from different countries across the world. Table 4 depicts that more than 50 percent annual FDI has been received from only 8 countries.

Table 7: Country Wise FDI Inflows (Million $) Country 2000- 2001- 2002- 2003- 2004- 2005- 2006- 2007- 2007-08 2008-09 01 02 03 04 05 06 07 08 (Jul(JulApril) April) USA 92.7 326.4 211.5 238.4 325.9 516.7 913.1 1,309.3 1,161.4 745.2 UK 90.5 30.3 219.4 64.6 181.5 244.0 860.1 460.2 304.8 220.2 U.A.E 5.2 21.5 119.7 134.6 367.5 1,424.5 661.5 588.6 535.3 170.2 Japan 9.1 6.4 14.1 15.1 45.2 57.0 64.4 131.2 100.3 65.2 Hong Kong 3.6 2.8 5.6 6.3 32.3 24.0 32.6 339.8 121.3 124.4 Switzerland 3.6 7.4 3.1 205.3 137.5 170.6 174.7 169.3 141.4 210.4 Saudi Arabia 56.6 1.3 43.5 7.2 18.4 277.8 103.5 46.2 37.0 (55.6) Germany 15.5 11.2 3.7 7.0 13.1 28.6 78.9 69.6 61.7 60.4 Korea(South) 3.7 0.4 0.2 1.0 1.4 1.6 1.5 1.2 0.8 0.9

Norway China Others Total Privatisation Proceeds FDIExcluding Pvt. Proceeds

41.9 0.3 76.6 322.4 -

0.1 3.0 173.9 484.7 127.4

0.3 14.3 108.6 798.0 176.0

146.6 0.4 369.3 949.0 198.8

31.4 1.7 521.9 1523.9 363.0

252.6 25.1 275.0 154.8 91.9 712.0 13.7 13.2 (69.7) 1,512.2 1,748.7 1,087.1 1,641.9 3521.0 5139.6 5,152.8 3,719.1 3,205.4 1540.3 266.4 133.2 133.2 0.0

322.4 357.3 622.0 750.2 1,160.9 1,980.7 4,873.2 5,019.6 3,585.9 3,205.4

13.8% decrease in FDI Including Pvt. Proceeds as compared to July-April FY 08 10.6% decrease in FDI Excluding Pvt. Proceeds as compared to July-April FY 08
FDI related inward and outward remittances FDI brings much-needed foreign funds for current investment, but it also creates long-term obligations in the form of future repatriation of profit earned by the foreign investor. Another bothersome aspect is the round tripping of capital that finds original investment (including intra-company debt and interest) and domestic capital reinvested as FDI, because of discriminatory taxation policy that favors FDI over domestic investment. Table 6 shows the possible repatriation of foreign exchange in the form of dividend/profit, capital repatriation, private debt repayment and family maintenance during 1995 to 2005. Table 7 shows that over the number of years Pakistan enjoyed a higher rate of FDI inflow with a lower outflow of profit and loan repayment. Table 8

Net Effects and Policy Recommendations Foreign companies are often reluctant to arrange funds domestically or float shares in the domestic capital market. These practices do not alleviate the capital market of its weaknesses. One reason is perhaps the concern that if the stock prices of these foreign companies remain low in Pakistan that may ultimately hamper their business in other locations. Of course, listing in the stock exchanges is not mandatory for foreign companies as yet. Moreover, due to some restrictions on sanctioning funds (e.g., single borrower exposure limit) by domestic banks and financial institutions, foreign companies have not been looking for domestic finance in most cases. In spite of negative flows generated in some years, overall FDI helps output growth, particularly in service and industrial sectors of the economy. However, one should weigh up both the positive and negative implications of individual FDI proposals before any decision. It would appear that the specific policy directives might be revisited so as to reduce dependence on foreign bank borrowing, and instead encourage foreign and domestic investors alike to raise more capital from the domestic equity market. If some industry segments, e.g., telecom phone companies find the local market too limited, funds may be raised by floating shares simultaneously in both domestic and regional markets (e.g., Dubai, Hong Kong, Malaysia, Singapore, etc.).

As mentioned in the beginning, the FDI inflows in Pakistan, strongly influenced by rapid liberalization of financial markets and privatization of economic activity, have registered significant growth in the past few years. The FDI inflows for Jul- Mar 2007 period stand at USD 3.9 billion and are expected to go beyond the USD 6 billion mark by the end of the year. After exploring the pros and cons of FDI in the light of empirical evidence present in economic literature, it is clear that FDI is after all not a miracle drug for all developing economies as it was thought of in the 1990s. This raises some serious questions regarding the rapidly risingFDI inflows in Pakistan. What is interesting or rather fortunate to note is that currently Pakistan is bent more towards reaping the favorable side of the FDI inflows. Though increased foreign inflows in the recent months have expanded the reserve money growth, the benefits of these inflows cannot be ignored. Pakistan has received little export oriented FDI, limiting the role of FDI as a tool of export promotion. Besides these sectors, in other sectors, many foreign companies including Nestle, Unilever and Procter & Gamble are expanding their infrastructure in the country.

Factors Influencing the Flow of FDI in Pakistan

The inflow of FDI in Pakistan remains far from encouraging despite numerous incentives offered to foreign investors, particularly after the liberalization program initiated since 1991/1992. Incentives like 100% foreign ownership of capital, foreign investors operating their companies without enlisting in the local stock exchanges, no limit for remittance of profits and dividends abroad, allowing disinvestment of the originally invested capital at any time, and no prescribed limits for remittance of royalties and technical fees abroad by foreign investors are highly competitive with incentives offered by many other developing countries to the prospective foreign investors. Besides these incentives, Pakistan with a population of about 130 million offers a vast potential for the marketing of both consumer and durable goods. Various incentives apart, these two factors should alone have attracted a respectable amount of FDI in Pakistan. However, by looking at the amount of FDI in Pakistan in recent years, it appears that the incentives and other factors have resulted in limited success. Why was Pakistan not able to attract FDI like the PRC; Hong Kong, China; Malaysia; and Thailand despite offering competitive incentives, favorable geographical location, and a relatively large population? This section attempts to provide answers to this query. A summary of host country determinants of FDI in general is given shortly. In view of these determinants, the fundamental requirement that governs foreign investment in Pakistan revolves around ten main factors, which could be called the ten checkpoints. These are political stability; law and order; economic strength; government economic policies; government bureaucracy; local business environment; infrastructure; quality of labor force; quality of life; and welcoming attitude. Political Stability: This factor is essential to attract foreign direct investment because it creates confidence for foreign investors (see MIGA 1994). Political turmoil could wipe out overnight even the most

lucrative investments and endanger the lives of personnel. Many investors have paid a heavy price for overlooking or ignoring this factor in other parts of the world. Lack of political stability has been the hallmark of Pakistan during the last fourteen years (1988-2002). Three elected governments were dismissed on various charges while four caretaker regimes each remained in power for only 90 days over the last fourteen years. Such a frequent change in government accompanied by abrupt changes in policies and programs are hardly congenial for foreign investors. Law and Order: An unsatisfactory law and order situation keeps prospective foreign investors on the sidelines. Safety of capital and the security for the personnel engaged in the projects are essential ingredients that govern foreign investment. Investors priority is the safety of their lives and that o their employees and the security of the project assets. They and their families wish to live in peace and carry out their usual chores without having to look over their shoulders all the time. Incase they feel threatened, in any way, they will relocate to other countries.1Unfortunately, Pakistans law and order situation has remained far from satisfactory in the major growth poles of the country. Karachi, the largest industrial and commercial center and the only commercial port of the country, has been disturbed in varying degrees since 1989. In recent years the law and order situation has also deteriorated in the Punjab province. Notwithstanding attractive incentives offered to foreign investors, this factor has discouraged them to set up their businesses in Pakistan. In a survey, the International Asset Management Company (IAMC), an affiliate of the British-based Morgan Stanley Asset Management, found that the business environment in Pakistan has deteriorated considerably. The IAMC surveyed 115 leading listed and unlisted companies including multinationals operating in Karachi. The sector covered for the survey-included automobiles, banks, chemicals, insurance, energy, textile and apparel, financial services and electrical goods. Some 74% of investors answered that they had no investment plan for 1996/1997; while in 1995/1996 some 56% of those had not invested in Pakistan. The key reason for the negative sentiment of businessmen was the deteriorating law and order situation in Karachi. Three out of four businessmen interviewed blamed political instability as the major constraint facing business today and over 59% of the 115 respondents were not pleased with government policies. Economic Strength: Investors would not want to invest in a country where the economic fundamentals are so weak that it is unpredictable what the government would do next to prop up a sagging economy. In countries of high economic strength, the investor is assured of a growing of high economic strength, economy, and of increased opportunities for business, as more government development projects and private sector investments put purchasing power in the hands of the people. Increased purchasing power means increased positive multiplier effects on the economy and a source for stability. Furthermore, foreign investors are unlikely to increase their participation in economies that are expected to remain affected by foreign exchange scarcities for several years into the future (UNCTAD 1985).

As compared with the decade of the 1980s, Pakistans macroeconomic imbalances worsened in the 1990s, along with the slowdown of economic activity. Annual average GDP growth slowed from 6.4% in the 1980s, to 3-4% in the 1990s. In particular, large-scale manufacturing has slowed down to 2-3% as against almost 8.0% during the 1980s. The large fiscal deficit has emerged as a major source of macroeconomic imbalances in Pakistan. Slippages on both the revenue and expenditure sides contributed to mounting financial imbalances. The rate of inflation has averaged 11% during the 1990s as against an average rate of 7.3% in the 1980s. Pakistan external sector also remained under pressure during the 1990s as compared with the 1980s. The current account deficit averaged 4.4% of GDP as against 3.9% during the 1980s. Pakistan foreign exchange reserves have also fluctuated in an unpredictable manner in the 1990s. Thus, attractive incentives not withstanding, the large macroeconomic imbalances and slowing down of economic activity must have discouraged FDI in Pakistan Government Economic Policies: Pakistans track record in maintaining consistent economic policies has been poor. The abrupt changes in policies with a change in government as well as a change in policy within the tenure of a government have been quite common. Pressures to raise revenues (for fiscal consideration), and other conflicting objectives have generally led to inconsistencies in investment and industrialization policies, and an ad hoc and changing incentive system. Revenue measures are not in harmony with the industrial policies. This makes planning difficult, adds uncertainty and enhances risk. In todays competitive world, investors before making investment in a country, take into account continuity and consistency of its policies. Foreign investors inhibited if they perceive that government authorities are unreasonably delaying things or are delaying matters for insignificant reasons. Quick and judicious decisions by the govt. shall rehabilitate the confidence of the foreign investors. In a seminar held in Pakistan a few months ago, certain international investors asks for improving a number of administrative and policy related irritants, as the country with its strategic location can become an attractive destination for the international investors. Reportedly there are four assemblers of Chinese motorcycles in Pakistan who are unable to market their products as the govt. has put restrictions on registration of such motorcycles. The government is urged for an early resolution of this issue, as well as other similar issue.1 Another example concerns the concessions given to the petroleum and power sectors in terms of duty-free imports of machinery. Resource crunch forced the government to withdraw this concession by imposing a 10% regulatory duty in October 1995. It took several months to get the petroleum sector concession restored but the regulatory duty was re imposed in the 1996/1997 federal budget. The serious disagreement in 1998 between the GOP and IPPs on the purchase of electricity by the WAPDA aggravated investors' confidence. The investment approval requirement has been removed but other regulations instituting the need for other administrative approvals, however, are still in place. Numerous permits and clearances from different government agencies at national, regional and local levels still apply to investors.

Incentives/concessions to foreign investment apart, private investors continue to face a plethora of federal, provincial, and local taxes and regulations. Federal levies include custom duties, sales tax, with holding tax at import stage, and excise duty. At the provincial level there are stamp duties, professional taxes, boiler inspection fees, and weight and measures fees. In addition, local government taxes are levied, including a local metropolitan tax, and the Octopi. At the federal and provincial levels, labor taxes have to be paid separately in compliance with labor laws, such as the contributions to the Workers Welfare Fund, Social Security, worker's children's education, and workers participation in profit and group insurance. In particular, a 5% withholding tax at the import stage as well as restrictions that these firms cannot borrow more than their equity capital has caused serious cash flow problems. Foreign investors in Pakistan also have to cope with a complex legal situation. Law based on different legal systems is applied independently. Uncertainty is exacerbated by the practice of issuing Special Regulatory Orders (SROs) that can amend or alter existing laws. Over time many SROs have been issued under a particular law, changing its scope and intent. Government Bureaucracy: This could perhaps be the biggest "burden" in any investment environment. It does not matter how efficient the government thinks its investment policy is; what is critical is the perception of businessmen, especially those already in the country. Do businessmen feel that they have the support of government officials in their efforts to set up and operate efficient business units, or do they feel that they have to fight the government to get projects off the ground? The general perception of businessmen in Pakistan is that there exists a large gap between the policies and their implementation. The implementation of policies has been slow and the bureaucracy has not responded to the initiatives with conviction. Such perception about the slow implementation of policies is not at all conducive o attracting FDI. Local Business Environment: This covers many factors, including the availability of local lawyers, secretarial services, accountants, architects and building contractors, local consultants, etc. all required both before and during the life of a project. Also, there is the question of the availability of ancillary and supporting industries, their quality, and their cost. Another question would be the availability of suitable joint venture partners, and whether there are lists of potential partners that the investors can choose from. All these conditions are not satisfactory in Pakistan. Infrastructure: The availability, reliability, and cost of infrastructure facilities (power, telecommunications, and water supplies) are important ingredients for a business environment conducive to foreign investment. Pakistan compares unfavorably in infrastructure facilities with other developing countries that have attracted higher levels of foreign investment. Pakistan has only 18% of paved roads in good condition as against 50% in Thailand, 31% in Philippines, and 30% in Indonesia. Pakistans extensive but poorly managed railway system does not make good for this disadvantage. Telecommunication is another bottleneck: there are only

10 telephones per 1,000 persons in Pakistan compared with 31 and 112 in Thailand and Malaysia, respectively. Pakistans amount of electricity produced per capita is higher than Indonesia's (435 kWh as against 233 kWh), but is only a fourth of Malaysia's and one half of Thailand. In most cases the urban infrastructure is grossly inadequate. Only 50% of population has access to safe drinking water as against 81, 72, and 78% for Philippines, Thailand, and Malaysia, respectively. Karachi Port is six times more expensive than Dubai port (Jebal Ali), three times more expensive than Colombo port, and twice as expensive as Bombay port. While other ports offer goods container terminal facilities, Karachi port cannot even offer priority berthing for container vessels. There are frequent delays and cancellations of berthing and sailing due to obsolete tugs and pilot boats at Karachi port. Moreover, due to the lack of maintenance the berths are unsafe. Karachi port cannot even provide proper container handling equipment and there is a shortage of space and bad planning, resulting in high cost to the consignees. Large vessels cannot come to the port because of the lack of dredging of shipping channels. Moreover, congestion in the hazardous cargo results in containers being detained longer in the barge. All these have made Karachi port much more expensive than ports of neighboring countries. Such infrastructure deficiencies have discouraged the flow of FDI in Pakistan. Labor Force: A technically trained, educated, and disciplined labor force along with a country's labor laws are critical factors in attracting foreign investors. Pakistan has an acute short age of technically trained and educated labor, especially in middle managerial positions and in engineering, which may have discouraged foreign investors. In particular, Pakistan is at a more serious, disadvantaged position in terms of education and health compared with other developing countries that have attracted FDI at much higher levels. Pakistan adult illiteracy rate is 62% as against 17% for Malaysia, 16% for Indonesia, 5% for Philippines, and 6% for Thailand. Only 80% of primary school age boys are enrolled in school (49% for girls); the lowest rate for the four reference countries is 93% for Malaysia. Pakistans expenditure on education accounts for only 1.1% of total expenditure as against 10% for Indonesia, 15.9% for Philippines, 21.1% for Thailand, and 20.3% for Malaysia (World Bank 1997). It also has by far the worst indicators of public health among the five countries. With the general level of education and health care being low, foreign investors may not find the workforce they need. Besides poor education and health indicators, Pakistans labor laws are complicated and overprotective, discouraging job creation, inhibiting business expansion, and frightening away much needed productive investment. Such labor laws have created unnecessary labor disputes posing problems for management and causing productivity losses, which have also discouraged foreign investment. Quality of Life: Quality of life along with cultural and social taboos is critical to attract foreign investors. These factors are less conducive to foreign investors in Pakistan who are accustomed to liberal lifestyles. This is in fact, one of the largest hidden handicaps Pakistan possesses against NIEs and ASEAN countries (Shirouzu 1993). Foreign investors find better conditions in Indonesia and Malaysia (both Muslim countries) in the ASEAN region in terms of social life and quality of life.

Welcoming Attitude: Have immigration and customs officials at the airports and other entry points been fully briefed about the critical role they play in investment promotion efforts? Their attitudes play an important role in foreign investors' decision making. Although the high government officials and business leaders express their enthusiasm in inviting foreign investment, the lack of a cordial environment to accommodate foreigners and foreign investment prevails in Pakistan. The ancillary government agencies and officials seem to have an indifferent and unsympathetic attitude toward foreign investors. The ten checkpoints discussed above constitute an investment environment and can be classified into four factors, namely, cost, convenience, capability, and concessions. All these factors do not appear to be as favorable as in East and Southeast Asian economies.

Impact of nuclear explosion, Kargil and terrorist attack on world trade center
The two episodes, that is, nuclear explosions in 1998 and the Kargil conflict in1999 had also negative effect on FDI because both the episode conveyed negative perception about Pakistan the Western countries, investors and IFIs. It is to be appreciated that USA, UK, Holland, Germany; UAE & Japan were in 1998 the top six countries, which made reasonable FDI in country. Since then their involvement has been on the decrease because of inter state relations, basically due to change perception s of foreign policy objectives. Almost each & every sector in Pakistan is affected due to the terrorist attack on world trade centre in New York. Before 11 September, industrial production was already falling and there had been a substantial downward movement in equity prices as well as a decrease in foreign direct investment (FDI). Pakistan's critical textile industry has been adversely affected since September 2001, and agricultural production was already suffering from a severe drought in 2001. There is the drastic reduction in investment of industrial & manufacturing sector. Foreign investors hesitate to invest especially in those countries, which are suffering from political instability, and any other factors explain above.

Policies for attracting FDI

Previously only the manufacturing sector was open to foreign investment. Now, the Policy Regime is much more liberal with most other economic sectors open for foreign involvement and with significant efforts at mobilizing domestic financial resources towards long term investment. 1. Manufacturing/Industrial Sector Foreign Investors are permitted to hold 100% of the equity of industrial projects without any permission of the Government. No Government sanction is required for setting up any industry, in terms of field of activity, location, and size, except for the following:

 Arms and Ammunitions. High Explosives. Radioactive Substances Security Printing, Currency and Mint. No new unit for the manufacture of alcoholic beverages or liquors will be allowed. 2. Non - Manufacturing/Industrial Sector Foreign investment on reportable basis is now allowed in the Service, Infrastructure, Social and Agriculture Sectors subject to the conditions indicated against each. They will have to simply register their company with Security Exchange Commission of Pakistan under the Companies Ordinance, 1984 and to inform the State Bank of Pakistan provided the relevant conditionality is fulfilled. i. Services Sector Activities FDI in Service Sector is allowed in any activity subject to condition that services which require prior permission/NOC or license from the concerned agencies will continue to get the same treatment until and unless de-regulated by such agencies and will be subject to provisions of respective sectors policies. Conditions The amount of foreign equity investment in the company/project shall be at least US$ 0.3 Million. Foreign investors are allowed to hold 100% of the equity subject to the condition that the repatriation of profits will be restricted to a maximum of 60% of total equity or profits and that a minimum of 40% of the equity is held by Pakistani investors (including sale of shares in stock exchange) within five years. ii. Infrastructure Sector Activities Infrastructure Projects, including the development of Industrial Zones. Conditions The amount of foreign equity investment in the company/project shall be at least US$ 0.3 million. 100% foreign equity is allowed on reportable basis

iii. Social Sector Activities Education, Technical / Vocational Training, Human Resource Development (HRD), Hospitals, Medical and Diagnostic Services. Conditions The amount of foreign equity investment in the company/project shall be at least US$ 0.3 million. 100% foreign equity is allowed

SUGGESTIONS
Continuity of policies Once a CEO of MNC who had been working since decades in Pakistan. He said at a forum Give me worse policies, even than I am ready to work here but please dont change them overnight. The biggest hindrance, investors face in Pakistan when they invest here is discontinuity of policies. The priorities and preferences of one government are 180 degree opposite to the policies of previous government. And with respect to four different governments in 1990`s, policies also changed. So the need of hour is to make sure that policies made by some government should be acceptable and applicable for next government. The requirement is to make policies, past laws and then implement them in their true spirit so that they may be durable and the goal of reasonable FDI can be achieved. Absence of Democracy Another obstacle, which stops the investors, to come to Pakistan and invest here is absence of true and sustainable democracy. Military interventions to government affairs with regular intervals are a reality, which has made a bad image of Pakistan in the minds of foreign investors. It is well said, During military governments, even country makes progress economically but travels downward morally. And this is the degree of morality of a country, which can only attract the foreign investors, and there is also a need to avoid some civilian dictatorial rulers who are capable of amending the constitution with in hours. So, to attract the foreign investors there is need for implementation of democratic principals in a true spirit. Law and Order situation The security of investors own life and his money is most important and investors give highest consideration to this factor. One of the factor because of which, Pakistan has lost much of its FDI is poor law and order situation. The countrys economic capital KARACHI had suffered worse communal riots two times in 1990s because of which many foreign investors left the country reluctantly. The military operations in result of these riots fueled to fire. In post September 11 scenario when Pakistan decided to be a part of alliance against

terrorism, the attacks on minority centers and on foreigners worsen the situation. So, need of hour is to put law and order situation under control and its better way is to create better coordination between law enforcing agencies. Free Market economy A demand by foreign investors is to decrease the government role in market, because they are always afraid of nationalizing their entities or freezing their accounts. So even not fully a free market system is possible in Pakistan, there is need to decrease the government role to a minimum level. So that investors may invest and work here comfortably. Infrastructure There is not sufficient infrastructure in Pakistan to work with, easily and comfortably. Funds are allocated in budget for this purpose but not used properly and a big problem for investors to work in far off places where labor is available at very lower rate. So there is a need for proper infrastructure attracts the foreign investors and best way is to use the allocated resources properly. Role of BOI (board of investment) BOI is a government institution, officially responsible for taking measures to attract and accommodate the foreign investment in Pakistan. But we have seen that at many stages the work of BOI is intervened by CBR (Central Board of Revenue), SBP (State Bank of Pakistan) and many other financial agencies, which badly affects the performance of BOI, which ultimately affects the investment in country. So there is a need for some law to make this important institution independent and to provide it a good management, so that it can achieve its goal effectively and efficiently. These are the major prerequisites to attract the foreign investors. If these suggestions are met, Pakistan may be an attractive and considerately country for investors. Factors Influencing the Flow of FDI in Pakistan In view of these determinants, the main factors that influence investment in Pakistan may be labeled as law and order, political stability, economic strength, government economic policies, bureaucracy, infrastructure, quality of labor force, welcoming attitude, etc. (also see Shirouzu, 1993; Khan 11 and Kim, 1999). The major barriers in the way of both domestic and foreign investment are described below turn by turn. Law and Order: An inadequate law and order situation keeps prospective investors on the sidelines. Pakistans law and order situation has remained far from satisfactory in the major growth poles of the country (e.g. Karachi). In recent years the law and order situation has deteriorated all over the country. Political Stability: It is an important factor to attract investment as it builds confidence of investors. Lack of political stability remained an important feature of Pakistans politics

during the last two decades (1988-2008). Such frequent changes in government along with immediate changes in policies are hardly cordial for investors. Economic Strength: In countries of high economic strength, the investor is assured of increased opportunities for business, as more government development projects and private sector investments put purchasing power in the hands of the people. Increased purchasing power means increased positive multiplier effects on the economy and a source for stability. Macroeconomic indicators show that Pakistan is loosing its macroeconomic strength, which is likely to adversely affect investment. Government Bureaucracy: This is perhaps the biggest hurdle regarding investment in Pakistan. Corruption at all levels in the bureaucracy is widespread, and is taken into account by investors considering business in Pakistan. The administrative harass factor remains high in Pakistan. Local Business Environment: This covers many factors, including the availability of local lawyers, secretarial services, accountants, architects and building contractors, local consultants, ancillary and supporting industries, their quality, and their cost. It also includes the availability of suitable joint venture partners. All these conditions are not satisfactory in Pakistan. Transparency of Regulatory System: Starting from a position of extreme overregulation, the trend has been a gradual decrease of governmental obstruction of private business. Many regulatory changes, however, have not yet been politically possible to be implemented in Pakistan. Protection of Property Rights: Protection of property rights is critical to encourage investment. The government of Pakistan is progressing slowly in bringing its intellectual property rights laws into compliance with the World Trade Organizations Trade Related Aspects of Intellectual Property Rights (TRIPS) Agreement. Infrastructure: The availability, reliability, and cost of infrastructure facilities (power, telecommunications, and water supplies) are important ingredients for a business environment conducive to investment. Pakistan compares unfavorably in infrastructure facilities with other developing countries that have attracted higher levels of foreign investment. High Business Cost: In Pakistan cost of doing business is very high as compared to world standard. Labor Force: A technically trained, educated, and healthy labor force along with a countrys labor laws are critical factors in attracting investment. Pakistan has an acute shortage of technically trained and educated labor, which may have discouraged investors. Pakistans labor laws are complicated and overprotective, which discourages job creation, inhibits business expansion, and frightens away much needed productive investment. Such labor laws have discouraged investment in the country.

 Quality of Life: Quality of life along with cultural and social norms is critical to attract investors. These factors are less conducive to investors in Pakistan who are accustomed to liberal lifestyles. Judicial System: A fundamental impediment to investment in Pakistan is a weak and slow legal system in which the enforceability of contracts is uncertain. Welcoming Attitude: Although the high government officials and business leaders express their enthusiasm in inviting investment, the ancillary government agencies and officials seem to have an indifferent and unsympathetic attitude toward investors. Child Labor: Use of child labor is also a bottleneck in the way of foreign investment in Pakistan. Tax Structure: According to Administrative Barrier Report of World Bank, payment of taxes and contributions in Pakistan is a complex and cumbersome process. In addition to corporate income taxes, a large number of direct and 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. The existence of such a large number of taxes and collecting agencies breed corruption, which adds to the cost of production and discourage investment in the country. The checkpoints discussed above constitute an investment environment and can be classified into four factors, namely, cost, convenience, capability, and concessions. All these factors do not appear to be so favorable in Pakistan as in East and Southeast Asian countries. 6. POLICY RECOMMENDATIONS Pakistan has to make stronger efforts to attract as much domestic and foreign investment in the foreign exchange sectors at least in the short term to improve its balance of payments position. To encourage domestic and foreign investment, Pakistan has to remove the bottlenecks outlined in the previous section. Government of Pakistan should take the following steps on priority basis to enhance both domestic and foreign investment in the country: Law and Order: Satisfactory law and order situation is critical to attract investment in Pakistan. The countrys political leadership must take practical steps to improve law and order situation particularly in the major growth poles of the country including Karachi. Political Stability: Satisfactory political stability is also critical to attract investment. Macroeconomic Stability: Pakistans fiscal and balance of payment situations and foreign exchange reserves position is 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 to raise trade surplus and foreign exchange reserves on the other.

 Removal of Bureaucratic Hurdles: 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 investors, causing delays to complete the process. The authorities should streamline administrative procedures regarding approval and official clearances. The laws and regulations should be simplified, updated, modernized, and transparent, and their discretionary application must be discouraged. Fiscal Incentives: Fiscal incentives should be given liberally by the government to investors. Import of plant and machinery for new industries may be allowed duty free in case such machinery is not manufactured in Pakistan. Tax relief in the form of accelerated depreciation allowance may also be available to priority industries, besides the availability of similar relief to existing industries undertaking balancing, modernization and expansion in production facilities. Credit Facilities: Foreign firms operating in Pakistan are currently facing cash flow problems. That these firms cannot borrow more than their equity capital has further aggravated the cash flow problem. There is a need to review credit facilities given to investors. Transfer of Technology: There should be no restriction on payment of royalty and/or technical service fees for the manufacturing sector. There should be Intellectual and Industrial Property Rights in conformity of WTO Agreements. 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: In most infrastructure services, Pakistan is highly deficient as compared with many developing countries that have attracted higher levels of foreign investment. 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. Confidence-building Measure: The close relationship between private and public sector is essential to build confidence. It is suggested that a forum may be established where the private and public sectors could sit together to discuss business promotion-related issues. This kind of partnership between the government and private sector will help restore investors confidence. Identification of Potential Investors and Sectors: To promote investment government should identify potential countries. Government should move from traditional investors (USA, UK, Japan, Saudi Arabia, UAE, Libya, Lebanon) to new directions (China, Malaysia, Korea). Government should also identify new sectors for investment (mining and

quarrying, tourism, construction, etc.) rather than focusing on traditional sectors (financial business, textiles, oil and gas, etc.) Improvement in Tax Structure: There is an urgent need to reduce the number of taxes and contributions, to streamline tax regulations and administrative procedures, and most importantly to reduce the contact of firms with a large number of tax and contributionscollecting agencies. There is also a need to examine tariffs of plant and machinery with a view to substantially reducing them.

Conclusion
The FDI can undoubtedly play an important role in the economic development of Pakistan in terms of capital formation, output growth, technological progress, exports and employment. Nevertheless, concerns remain about the possible negative effects of FDI, including the question of market power, technological dependence, capital flight and profit outflow. The limited evidence gathered above tends to support some of these apprehensions. On a positive note, service sector growth appears well correlated with FDI flow to this sector. Further, this has a linkage effect to the rest of the economy. Observing the current impacts of FDI on the economy, particularly in terms of efficiency spillovers generated by multinational corporations, it is reasonable to take FDI in Pakistan as an important vehicle for economic growth. The government has successfully introduced a wide range of incentives, congenial for local and foreign investors and has increasingly tended to turn to FDI as a source of capital, technology, managerial skills and market access needed for sustained economic development. The outward orientation in policies designed by the government to attract more FDI has been accompanied by the adoption of policies relating to privatization and deregulation of economic activity, offering unprecedented and conducive business environment to all multinational corporations. Hence Pakistan is now stands out as one of those economies in the region whose reforms and economic achievements during the last few years have steered the country to a business-friendly environment, creating a win-win situation for both investors and consumers. We hope this paper can encourage future studies on this subject.