Assignment on Foreign Direct Investment in Pakistan

Submitted By:
Sana Javaid (BC 09-070) Saira Khan (BC 09-067) Sadia Khalid (BC 09-069) Hina Masood (BC 09-066)

B.com (Hons.) Semester 4 Section A

Submitted To: Professor Farida Faisal

Table of Contents
Investment in Pakistan ...............................................................................................3 Investment: ...................................................................................................3 Types of Investment: ....................................................................................3 Local investment ..........................................................................................3 Foreign investment .......................................................................................3 Savings in Pakistan .......................................................................................4 Kinds of foreign assistance: .........................................................................5 Foreign Investment in Pakistan ....................................................................5 Foreign Portfolio investment ........................................................................6 Foreign Direct Investment ............................................................................6 Salient features of FDI; ................................................................................6 Benefits of FDI: ............................................................................................9 Disadvantages of Foreign Direct Investment .............................................10 Steps to be taken: ........................................................................................12 Conclusion: .................................................................................................12

Foreign Direct Investment (FDI) Investment in Pakistan

Investment:
It is a process of investing money or profit for profit or interest. In a country investment is really important to increase productivity of that nation.

Types of Investment:
1. Local investment
savings Bonds Shares Property

2. Foreign investment
Foreign investment has four major kinds which are: I. Foreign Direct investment (FDI): FDIs occur when a company invests in a business that is located in another country. In order for a private foreign investment to be considered an FDI, the company that is investing must have no less than 10% of the shares belonging to the foreign company. In these international business relationships, the company that is investing is known as the parent company, whereas the foreign company is known as a subsidiary of the parent company and the country is known as host country. Multinational corporations, which spread among several nations, often begin with FDIs. II. Foreign Portfolio Investment (FPI): FPIs also occur when foreign investments are made by a company. They may also be made by an individual who has mutual funds. Whereas an FDI allows the investing company to own shares of the subsidiary company, an FPI may be more temporary. Investment instruments, such as stocks and bonds, are normally traded in FPIs. Stocks and bonds are examples of investments that are easily traded. A company that has stocks and bonds from a foreign company does not necessarily have a share in that company in which it is investing. III. Official Flows:
3

The foreign investment known as official flow occurs between nations instead of between companies. In cases of official flow, a more developed or economically prosperous nation will invest money in a nation that is less developed. A recipient nation of an official flow investment will typically receive financial support, as well as higher grade technology and aid in government and economic management. IV. Commercial Loans:

It normally occurs in the form of a bank loan. This kind of investment may occur between nations or between businesses that are in different countries. While a commercial loan may be made by an individual, it would normally occur between larger organizations. Being a developing country suffering from a weak governance and consumptionoriented economic structure with most of the population not even having enough will to save at all; let alone have savings for sufficient investments to keep the boat of economy afloat, Pakistan only has a handful of major local investors which alone aren't enough for sustenance to let alone development of this economy.

Savings in Pakistan
National savings as percent of GDP were registered at 13.8 percent in FY10, up by 0.6 percentage points over the preceding year. This rise is entirely came from improvement in private household savings, as public savings declined and private corporate savings remained unchanged during the year. Although savings rate has improved but the level of saving rate in Pakistan especially with respect to investment, remains low. Savings And Investments 1 In Billions (Rupees)
I) National savings a) Public savings I. General II. Others b)Private savings I. Household II. Corporate II) Net factor income from abroad III: Domestic savings (I-II) IV) Total investment V: Resource gap (I-IV) FY 09 1677.2 285.5 264.3 21.3 1,391.7 1,136.9 254.8 344.5 1,332.7 2,414.7 -737.5 FY 10 2027.4 203.1 129.7 73.3 1,824.3 1,530.9 293.4 570.6 1,456.8 2,431.7 -404.3 FY 09 13.2 2.2 2.1 0.2 10.9 8.9 2.0 2.7 10.5 19.0

% Of GDP
FY 10 13.8 1.4 0.9 0.5 12.4 10.4 2.0 3.9 9.9 16.6

source: http://www.sbp.org.pk/reports/annual/arFY10/Real.pdf) 4

Country Comparison Of Gross National Saving2 YEAR CHINA INDIA INDONESIA PAKISTAN 2002 40.3 25.8 23.0 18.6 2003 43.6 24.9 28.9 20.7 20.8 2004 46.6 25.4 32.6 20.8 17.9 2005 48.2 25.8 33.9 24.3 17.5 2006 49.5 27.7 36.5 25.8 17.7 2007 51.8 28.7 38.1 25.1 17.4 2008 52.2 30.2 40.6 28.2 13.4

BANGLADESH 23.4

As it is evident from the above table that the saving rate in Pakistan is very low as compared to its other more developed Asian countries of China, India and Indonesia. Therefore, Pakistan is heavily dependent upon foreign assistance to support and, presumably, develop the economy.

Kinds of foreign assistance:

The foreign assistance mostly taken up by Pakistan primarily consists of three major kinds: 1. Foreign aid 2. Foreign debts 3. Foreign investments The former two almost always have more cons than pros. The burden of indebtedness is heavy in its self even without the burden of heavy interest and conditions that accompany the debts. If wisely utilized in long-term productive ventures, foreign debts aren't so harmful but given the state of governance and resource management in Pakistan, foreign debts only prove to do far more ill than good. Foreign aid, on the other hand, is accompanied with strict conditionality and agenda which are to be followed by the recipient of the loans even if they don't correspond with the national strategies, sentiments or agenda at all. Therefore the best type of external investment is foreign investment despite of its drawbacks

Foreign Investment in Pakistan

The two most prominent types of foreign investments prevalent in Pakistan are Foreign portfolio investment and Foreign direct investment.

source: http://www.sbp.org.pk/reports/annual/arFY10/Real.pdf

Foreign Portfolio investment

Foreign Portfolio investment was quite in a bloom until 2007 when a large amount of investors pulled its shares from stock market. "According to the State Bank of Pakistan (SBP) data, the USA investors withdrew $217mn, UK$64mn, Switzerland $38mn, Hong Kong $27mn and Singapore $11mn during July to Augusts 20, 2008. Commenting on the continued outflow in the equity markets, brokers and analysts said that stock markets of the country have been witnessing highly volatile and bearish trading sessions over the last four months on the back of prolong political uncertainty and economic crisis, which have not only shattered the confidence of local investors but forced the foreign investors to make a swift exit from the Pakistani equity markets." The Nation- published at August 23, '08 But during 2009-10 the inflow that had gone negative in the previous year became positive yet again but the level of foreign investment remains at a more humble level. This shows that FPI is quite volatile and can be withdrawn easily and can drain out of the system as easily as it comes into it. Therefore, it may seem to give a boost to the economic growth for the timebeing but if the companies invested into don't show as much profitability as desired by the investors, they wouldn't hesitate in withdrawing their shares from the stocks and the economy would go back to where it had started from.

Foreign Direct Investment

On the other hand, FDI is a kind of foreign investment in which the investors come with long-term interests and not only bring capital into the host nation but also new technology, expertise and possibility of commercial exposure; opening a door of opportunities for the labor, local manufacturers and service-providers. If handled and monitored with a decent amount of diligence by the host government, FDI provides an opportunity of secure and long-term development (not just growth).

Salient features of FDI;

Foreign Direct Investment (FDI) as a growth-enhancing component has received great attention of developed countries in general and less developed countries in particular in recent decades. It has been a matter of great concern for many economists that how FDI affects economic growth of the host country. In a closed economy, with no access to foreign saving, investment is financed solely from domestic savings. However, in open economy investment is financed both through domestic savings and foreign capital flows, including FDI. The investments in form of FDI enable investment-receiving (host) countries to achieve investment levels beyond their capacity to save.
6

Foreign direct investment (FDI) is a potent weapon of developing the Pakistan economy and can play an important role in achieving the countrys socio-economic objectives including poverty reduction goals.

COUNTRY-WISE ANALYSIS OF INFLOW OF FDI;3

The following pie chart reveals that on country table, U.S.A is the major contributor of foreign investment in Pakistan, with investment of 39%of total FDI inflow, followed by U.K, U.A.E and Hong Kong.

Sector-Wise FDI Inflow Pie Chart

Accordingly to sector wise analysis, the communication (IT & Telecom) sector bring highest foreign investment of 1, 625.3 million with 37% share in year 2007-08, financial business 1,607.6 million (36%), oil & gas 634.8 million (14%), power 70.3 million (6%) and trade with 175.5 million having 4% share in total FDI.

Graphical Analysis of FDI

Most of Pakistans investment comes from its War on Terror in 2008. During the year 2008, US had the largest share of 38.46% of FDI Inflow followed by UAE (17.23%), UK (13.52%), Hong Kong (9.98%) and Norway (8.08%).
3

source; http://download-reports.blogspot.com/2011/02/gdp-growth-with-economic-stability-fdi_02.html

FDis are private companies incorporated in one country and invests in the host country through franchises branches etc. there is no direct role of government in FDI except for facilitation of private parties both in country of origin and host country these are multinational companies. These MNCs net assets and net income are more than total budget of Pakistan Multinational companies Coca cola ltd. 4 Nestle 5 Net assets for 2009-2010 in million $ 72,921 111,641
Net income for 2009-2010 in million $

11,116 30,778

2001-02 2002-03 2002-03 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 Total

Foreign investment inflows in Pakistan(in million $)6 Foreign Direct Investment Foreign Portfolio Investment 485.00 -10.00 768.00 22.00 949.00 -28.00 1,524.00 153.00 3,521.00 351.00 5,139.00 1,820.00 5,409.00 19.30 3,719.00 -510.30 2,150.80 587.90 1,534.1 302.0 25,228.10 2,706.90

http://www.stock-analysis-on.net/NYSE/Company/Coca-Cola-Co/Financial-Statement/Statement-ofComprehensive-Income 5 http://www.nestle.com/Common/NestleDocuments/Documents/Library/Documents/Financial_Statements/2010Financial-Statements-EN.pdf 6 http://investinpakistan.pk/portal/index.php?option=com_content&view=article&id=180&Itemid=137

Benefits of FDI:7
1. Reliable and Reputable tool for developing countries:
One of the advantages of foreign direct investment is that it helps in the economic development of the particular country where the investment is being made. This is especially applicable for the economically developing countries. During the decade of the 90s foreign direct investment was one of the major external sources of financing for most of the countries that were growing from an economic perspective. It has also been observed that foreign direct investment has helped several countries when they have faced economic hardships.

2. Transfer of Technology:
Foreign direct investment also permits the transfer of technologies. The importance of this factor lies in the fact that this transfer of technologies cannot be accomplished by way of trading of goods and services as well as investment of financial resources. It also assists in the promotion of the competition within the local input market of a country.

3. Management skills & Human capital development:

The countries that get foreign direct investment from another country can also develop the human capital resources by getting their employees to receive training on the operations of a particular business.

4. Tax Revenues:
The profits that are generated by the foreign direct investments that are made in that country can be used for the purpose of making contributions to the revenues of corporate taxes of the recipient country. Foreign direct investment assists in increasing the income that is generated through revenues realized through taxation.

5. Mutually beneficial:
It also plays a crucial role in the context of rise in the productivity of the host countries. In case of countries that make foreign direct investment in other countries this process has positive impact as well. In case of these countries, their companies get

reference: http://www.economywatch.com/foreign-direct-investment/benefits.html

an opportunity to explore newer markets and thereby generate more income and profits.

6. Opportunity for SME's:

It becomes easier for the business entities to borrow finance at lesser rates of interest. The biggest beneficiaries of these facilities are the small and medium-sized business enterprises (SMEs). And also as a major part of FDI is in manufacturing sector, SME's in less developed areas may benefit from it if government acts as an efficient intermediate party that facilitates the merging of investor's and manufacturer's interests.

7. Addition of value-added products:

The foreign enterprises come with technology, expertise and brand names to open up the locally made product to the world-wide markets as value-added products. The goods produced thus are highly processed and get a better reception in the foreign markets due to better marketing.

8. CSR (corporate social responsibility):

CSR, also known as corporate conscience and social performance, is not just about upholding ethical standards and social work- it is also a very effective business strategy and is a very sound method of modern marketing. Therefore, multi-national companies doing business in a country always adhere to the demonstration of CSR which enables brand differentiation, aids in public image development and avoid certain taxes. Despite the motive behind the act, host country benefits from the social service that is done there. For example, Proctor & Gamble, Shell, Mobilink, ICI Pakistan, Nestle and Barclays bank are prominently carrying CSR in Pakistan.

9. Reduction of Savings-Investment Gap:

As internal investment is quite low in Pakistan; Foreign investment can be a way to somehow aid investment which cannot be supported on a mere 13.8% of saving/gdp rate.

Disadvantages of Foreign Direct Investment8

I.

Regional disparity:
A disparity between the standards of living applying within a nation is known as regional disparity. The coming of Foreign Direct Investment (FDI) into a country is said to boost the economic growth and contribute positive impact on the development of the country.

Usually the investment comes in developed areas and on consumer products so it causes
8

http://www.associatedcontent.com/article/5428752/disadvantages_of_foreign_direct_investment_pg2.html?cat= 3

10

imbalance growth like multinational food chains opens its branches in highly developed and populated areas. Even in service sector MNCs provides services in developed and highly populated areas or famous tourism spots

II.

Implementation of Undesirable Policies:

MNCs are quite influential they can easily influence and Bully the government of developing countries like Pakistan to suit their own purposes. MNCs are so large that there revenue exceeds the GDP of some smaller nations due to this at times certain foreign policies are adopted which are not favorable for the host country.

III.

Stiff competition for local investors:

Multi-national companies involved in FDIs, being very large and resourceful, give stiff competition to local enterprises of the less developed host country. Therefore, the local investors more often than not get discouraged and shy away from investing in the market against the Multi-national giants. In addition to being intimidating by just their size, MNCs are mostly very manipulative. They don't let perfect competition to prevail in the economy. Mostly these MNCs don't let small businesses survive in the market. This minimizes the consumer benefit because perfect market is required to attain consumer benefit in the economy.

IV.

Geographical or Political Instability of the Host Country:

Due to political instability in a country it is not just foreign portfolio investment that goes out of the country, but foreign direct investors also gets heavily inclined to avoid future investment and they slowly cut down their investment until political instability is maintained otherwise they could leave the country eventually. According to THE NEWS newspaper: Tuesday May 17, 2011 Foreign direct investment (FDI) declined by 28.6 percent to $1.232 billion during July-April, 2011 against $1.725 billion during the corresponding period last year, the State Bank of Pakistan (SBP)

V.

Import-orientation:

There comes a possibility of import-orientation in the economy because the material and technology may not come as part of the capital invested by the MNCs. In addition to that the MNCs may purchase the requisites from foreign markets. This way imports increase and it puts a negative effect on the country's balance of payment.

11

Steps To Be Taken:
Control over how much profit the MNC can take out of the host country by reviewing taxation policies regarding profits from a FDI project before they leave the host country's system. MNCs should have enrollment of local partners. Local enterprises should take some benefit from the profitability of an FDI project in their home country. Transfer of new and cutting edge technology, MNCs do not transfer the latest technology to the host country with a fear that their home country may loose its competitive advantage, hence the maximum potential of the host economy cannot be
achieved as a result of old technology transferred

MNCs should be encouraged to add value to the local products i.e. they should be encouraged to purchase from local markets so that imports decrease and SMEs in the host country can grow.

Conclusion:
The net advantage or disadvantage of FDI depends upon the regulation & control of MNCs operating the host country by the host country's government. If the government takes appropriate steps and making effective policies to avoid circumstances and errors like: over dependence on the foreign investor as an employer in a key industry allowing the foreign investor too much access to critical resources finding that the investor was engaged in activities hostile to the host country economy Dumping of the products at prices which make the host country unable to compete in critical markets. Undesirable outflow of foreign remittances in form of company profits. economic espionage: i. ii. "competitive executive recruitment" - hiring away key scientists and engineers stealing corporate information from host country companies

Inappropriate management of labor, or allowing for unsafe working conditions

Hence, we can conclude that despite some of it shortcomings, there is always a margin of benefit for the developing countries in indulging in FDI ventures with MNCs of more developed countries. A recent meta-analysis suggested that FDI helps increase local productivity growth. Countries like East Asian tigers have greatly benefited from the Foreign Direct Investments and so can Pakistan- with help of a responsible government and smart policy framework which, while being attractive for foreign investors, suites the geographic, demographic, economic and social aspects of Pakistan.

12

13