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Article for Feb 01, 2011

An Obituary of FDI
by
Dr. Ashfaque H. Khan

The first month of the new calendar year has seen the Government taking two ill-conceived
economic decisions, tantamount to the systematic destruction of the economy in general and
investors’ confidence in particular. What is more surprising is the fact that the economic team led
by the Finance Minister administered the last rites of FDI in Pakistan.

The first decision pertains to the forced withdrawal of the retrenchment order of the KESC
management of its 4460 non-core (drivers, security guards, sanitary workers, bill distributors and
office attendants) workforce by the Government. This was nothing but brute interference by the
Government in the affairs of a private company. The second ill-judged decision of the
Government pertains to allowing the import of five–year old cars. This flawed decision is
equivalent to destroying manufacturing sector in general and auto-industry in particular.

These decisions will have far-reaching impact on Pakistan’s economy generally and investment
climate specifically. It goes without saying that foreign direct investment (FDI), being the single
largest source of private capital flows, has contributed immensely to investment and growth in
developing countries. It has also become a vehicle for transferring technology, skills and
organizational and managerial practices to recipient countries.

Given the effective role that the FDI can play in accelerating economic growth, developing
countries have been making efforts to improve their policy environment to attract such
investment. The countries that have lagged behind in attracting FDI are the ones that have faced
macroeconomic instability, pursued inconsistent policies, had relatively poor physical and human
infrastructure, and showed indifferent and unsympathetic attitude towards foreign investors.

The fundamental requirement that governs FDI in developing countries including Pakistan
revolves around ten main factors, which could be called the ten checkpoints. These are political
stability, law and order situation, economic strength, government economic policies, government
bureaucracy, local business environment, infrastructure, quality of labour force, quality of life,
and welcoming attitude. These ten checkpoints constitute an investment environment and can be
classified into four C’s, namely cost, convenience, capability and concessions.

Pakistan made considerable efforts in improving investment climate by improving upon the ten
checkpoints. Constant interaction with local and foreign investors and resolving their issues on
priority basis were the hallmark of the government policy. Such efforts brought fruits to the
country. Foreign investment surged from $543 million in 1999-2000 (or 0.8% of GDP) to $8423
million in 2006-07 (or 5.9 % of GDP) – a more than 15 fold increase in just seven years.

Investment climate, as described by the ten checkpoint, has deteriorated rapidly during the last
three years and the two decisions mentioned above are likely to prove to be the last nail in the
coffin of foreign investment in Pakistan. Foreign investment has declined from its peak at $8423
million in 2006-07 to $2086 million in 2009-10 – a decline of $6337 million. During the first
half of the current fiscal years, foreign investment stands only at $1051 million.

The brute interference of the government in KESC affairs was unjustified. The KESC is a private
company meant to provide electricity to the people of Karachi. It is not an employment bureau to
provide unnecessary jobs. A Dubai-based private equity firm, Abraaj Capital, has 50 percent
shares with management control. They have posted a loss of Rs.14.64 billion last year and the
management is making efforts to turn KESC into a profitable company. They have every right to
run the company the way they want to make it a profitable one. They offered a Voluntary
Separation Scheme to 4460 non-core employees with amount ranging from Rs. 700,000 to Rs.
4.5 million. The government not only failed to protect the lives and properties of the foreign
investors but also prevented them from determining the size and skill of their workforce.

As far as allowing imports of five year old cars, the government has damaged not only the
automobile sector but also the auto parts industries in Pakistan. The auto industries have invested
heavily and expanded their production capacities. Against their capacity of 275,000 cars per
year, they were expected to produce 160,000. In other words, these industries are operating at 58
percent capacity. Allowing import of five year old cars would further reduce their capacity
utilization, thus raising the fixed cost per unit produced. The auto industry value chain has
created over a million jobs and contributed billions of rupees in taxes. The government’s
argument is that car prices are higher in Pakistan. Has anybody taken into account Shaukat
Tareen’s effect (depreciation of rupee)? Pakistani rupee has depreciated viz US dollar by 30
percent. US dollar itself has depreciated viz. Japanese Yen by 22 percent. The multi-currency
depreciation along with the rise in input prices in the range of 26 to 82 percent are responsible
for the rise in car prices.

By taking these two decisions the Government has further worsened the investment climate. It
will discourage foreign investment at a time when the country needed more non-debt creating
inflows. Do we still need the Ministry of Privatization and Board of Investment? Would they still
claim Pakistan being a “heaven for foreign investors”? The credibility of Pakistan has been
damaged. We invite foreigners to invest in Pakistan but at the same time we set their profit
margins and control their HR operations. Why should any one come to Pakistan? There are
countries who offer better investment climate with more welcoming attitude.

The Government has caused serious damage to the investment climate. It is nothing short of
systematic destruction of the economy of Pakistan. The economic team, led by the Finance
Minister, has become party to this destruction. Welcome to investment–friendly Pakistan which
offers little protection to the lives and properties of foreign investors – at least under this
democratic dispensation.

The writer is Principal & Dean at NUST Business School, Islamabad. Email:
ahkhan@nbs.edu.pk