Foreign Direct Investment Prospects for Pakistan Khalil Hamdani Visiting Professor Pakistan Institute of Development Economics 7 April 2009

FDI flows to Pakistan 1959 first Bilateral Investment Treaty in world (Germany) Privatization Fully open investment regime Import liberalization Foreign exchange guarantees Board of Investment Export Processing Zones Authority Early investors were ICI, Glaxo, Phizer Foreign Investment Act

Pakistan’s economic growth cycle Close correlation between investment and GDP. Growth in investment leads growth in trend GDP. For most years the trend growth rate in GDP has been above 5 per cent. However, investment growth has been significantly less. The investment growth cycle was driven by private sector in the early years, then by the public sector investments in the 1970s, which slowed in the 1980s. Structural adjustment and policy liberalization in 1990s, brought a shift back to the private sector. Privatization in 1990s onwards, began to attract FDI. Source: State Bank of Pakistan Annual Report 2007-2008.

World FDI inflow Billions $ Source: UNCTAD, World Investment Report .

Pakistan in top 10 FDI destinations in Asia FDI inflows, Billions $ Source: UNCTAD, World Investment Report 2008.

FDI inflow and GDP % Millions $ Source: State Bank of Pakistan. See Table 2 in M.R. Khan, “Foreign Direct Investment and Economic Growth: The Role of Domestic Financial Sector”, PIDE Working Papers 2007:18.

FDI inflow and capital formation Note: percent age of gross fixed capital formation. Source: UNCTAD, World Investment Report 2008.

FDI stock and GDP Millions $ % Note: FDI stock as percent age of gross domestic output. Source: UNCTAD, World Investment Report 2008.

Foreign presence Number of foreign affiliates

FDI inflow by type Millions $ In 2006, the privatization of PTL attracted FDI from UAE in an acquisition valued at $2.6 billion , the fourth largest South-South M&A in 2006. Source: Board of Investment.

FDI inflow by industry The composition of FDI has changed over time. In early years, dominant sectors were manufacturing (30%), mining (28%) and trade (24%), comprising on average 82 percent of FDI in 1980-94. Now, financial business services, telecommunications and oil & gas exploration account for 71 percent of FDI. Source: State Bank of Pakistan Annual Report 2007-2008.

FDI and technology The overall manufacturing sector grew on average by 10.61% in real terms during 1998-2007. The textile sectors are the lowest growing sectors in terms of nominal and real growth rate. Manufacturing industries experienced an overall positive TFP growth of 0.9% during 1998-2007. The worst performer in terms of total factor productivity growth is the textile sector which includes spinning, composite and weaving. Total factor productivity of the textile sector decreased on average by -0.80%, -0.20% and -1.2% in the composite, spinning and weaving sectors respectively. It suggests that manufacturing sub sectors are lacking in terms of technological adoption. Note: 2005 data. Source: UNIDO, Industrial Development Report 2009.

Technology 30% is Medium & High-tech 70% of MVA is low tech production Note: 2005 data. Source: UNIDO, Industrial Development Report 2009.

A smaller manufacturing base with much less technology content 17% 30% 22% GDP GDP Note: 2005 data. Source: UNIDO, Industrial Development Report 2009.

FDI inflow by country Traditional sources still dominate even with inflows from region. Note: three-year moving average. Source: State Bank of Pakistan Annual Report 2007-2008.

World FDI inflows are falling Billions $ Source: UNCTAD, World Investment Report .

FDI prospects trend Note: Data for fiscal year (July-June). FY2010 is provisional.

FDI strategy Address investor confidence Target Asian investors Target existing investors Sustain public investment

1. Investor confidence Policy framework attractive to FDI Cost of doing business high but competitive in the region Domestic private sector uncertain More than 3/4th of the respondents (out of 110 firms) are willing to invest in next two years. However, investor concerns: law & order, political uncertainty, energy deficiency, high cost of operations and infrastructure bottlenecks.” Overseas Investors’ Chamber of Commerce & Industry (OICCI). Business Perception Survey 2008.

Business regulation: best in region Sri Lanka ranks 102. Source: World Bank/IFC, Doing Business 2009: Country Profile for Pakistan.

2. Target Asian investors FY 2008 FY 2009 Note: First eight months of fiscal year. Source: State Bank of Pakistan, The State of Pakistan's Economy - First Quarterly Report 2008-2009.

Target Asian investors Region Of the 7 top TNCs from South: 6 Asian; 1 Mexican Of the top 100: 78 Asian; 11 African; 11 Latin American Of Fortune Global 500: 55 Asian; 10 Latin American Industry Electrical/electronic equip./ computers: 17 Diversified: 13 Petroleum: 10 Food & beverages: 8 Transportation & storage: 7 Telecommunications: 6 Source: UNCTAD.

Target Asian investors Resource sector resilient to global trend Oil & Gas exploration, coal, alternative energy Market-seeking investment resilient to global trend Manufacturing, services Industrial zones compensate for high operating costs China Privatization (but avoid fire sales) Export-oriented FDI in medium-term Regional market Attract technology transfer PIDE research shows that firms in manufacturing have improved efficiency but have been slow to adopt new technologies. Need to link up with global value chains. Abdul Raheman, Talat Afza, Abdul Qayyum, and Mahmood Ahmed Bodla, “Estimating Total Factor Productivity and its Components: Evidence from Major Manufacturing Industries of Pakistan”, 2008.

Global Value Chain: textiles and garments Synthetic Fibers Finishing Garment production Raw Cotton Textile Yarn FDI Joint Venture potential now<2% Need to upgrade technology 16.0% 54.5% 11.3% 11.3% 6.9% Value Added Need to upgrade skills Source: Gherzi

3. Target existing investors Encourage reinvestment (horizontal, vertical) Encourage corporate social responsibility (training, linkages) Support services for domestic enterprises SME finance. 75% SMEs in Gujranwala have never applied for bank loans. Tackle bottlenecks (power outages) 62% of Gujranwala manufacturing units do not have own power generation and shut operations during power outages. Production time losses average 33 hours per week. State Bank of Pakistan, SMEs’ Survey of Gujranwala District, 2008.

Reinvest more, repatriate less Percentage of gross foreign investment inflows Foreign firms earn profits which they can reinvest or repatriate. Note: Repatriation includes divestment. Source: State Bank of Pakistan, Foreign Liabilities and Assets and Foreign Direct investment in Pakistan.

Corporate social responsibility TNC BACKWARD SUPPLIERS FORWARD CONSUMERS A A A SUPPLY CHAIN MANAGEMENT PRODUCT STEWARDSHIP Improved productivity Higher incomes for suppliers Reduced costs for company Better products for consumers Enlarged market share for company Creates Shared Value for Company and Society across supply chain Example: Nestlé working with dairy farmers to raise milk production

4. Sustain public investment FY 2005 FY 2006 FY 2007 FY 2008 Development expenditure share of GDP 3.8 4.8 4.9 4.0 Education expenditure share of GDP 0.2 0.3

Sustain public investment Priorities: Education, Infrastructure, Health Industrial policy should promote horizontal competitiveness and avoid: Picking winners (leather, pharmaceuticals etc) is risky Fiscal incentives can be costly.

Summary FDI is more than an external resource inflow FDI can modernize industry and better integrate the economy into international production. Market-seeking FDI is viable in current global recession. Export-oriented FDI is a desirable medium- term objective.