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SAZH-TAF Report on FDI

Political - Political Stability

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The political stability of a country, its economy and policies are important parts of its trust system with foreign investors. They help build investor confidence. Around the world, investors have suffered greatly for investing in politically unstable countries (Khan et al., 1999). Unfortunately, historically Pakistan has seen grave political instability with frequent regime changes leading to inconsistent policies. This is cemented by the fact that no Prime Minister in the history of Pakistan has been able to complete their terms. Sudden military dictatorships, judicial overreaches and turmoil in the parliament are certainly not cordial to investors.

 

Our members unequivocally affirmed that the biggest problem in doing business in Pakistan at the moment is lack of consistency in policy. They highlighted that doing business is nigh impossible if the government does not show consistency and sustainability towards a plan or a policy for a given amount of time, which is essential for business community to plan and execute upon. In their research paper, Rehim and Munir[1] demonstrate how widespread political instability in Pakistan has led to a decrease in FDI flow. Frequent policy changes such as, going from a more liberal tax framework to a more regressive one puts investors at risk. It not only increases the risk of doing business but also endangers investments and lives of personnel during military takeovers.

 

Similarly, seasoned development professionals and experts from the World Bank, in our meetings, asserted that political instability hinders the growth of FDI in Pakistan. The political instability must be dealt with, as chaos on the streets directly impacts the taxation regime and the stability of the markets.

 

Another issue commonly pointed out by our experts was that short-term policies and political instability creates a multitude of issues for foreign investors. In times of economic instability, Pakistani governments offer lots of incentives to investors just to float the investment plan around the world but once their goal is achieved, they start reducing or arbitrarily changing the incentives scheme – this creates an uncertain investment environment and due to this the investors have started putting caps on the investment policies.

 

If we look at the previous PTI government, there was a Vote of No Confidence proposed against the then Prime Minister Imran Khan by the coalition of the opposition parties, Pakistan Democratic Movement. Khan lost this vote and was ousted from power. As a result, our experts shared, the new government brought out new economic policies, assumedly in line with the new IMF deal, by which they have been increasing prices and reducing subsidies. This has led to widespread inflation and financial despair all over the country. Some report this inflation figure to be close to 27%. In their research, Awan et al. (2014) “…concluded that military expenditure is a significant determinant of Pakistan FDI inflows. Based on the result, there is a negative relationship between military expenditure and Pakistan FDI inflows.” As Khan (1997) puts it “such a frequent change in changes in policies and programmes accompanied by abrupt change in policies and programmes are hardly congenial for foreign investors.”

 

A prime example of political instability causing colossal damage to the state, which was pointed out by one of our key experts, is the way the China Pakistan Economic Corridor (CPEC) project has been treated. The total committed amount under CPEC of $50 billion is divided into two broad categories: $35bn is allocated for energy projects while $15bn is for infrastructure (Husain, 2022). This amount is equivalent to almost 20% of Pakistan's annual GDP and it was predicted that CPEC would lead to the creation of upwards of 2.3 million jobs between 2015 and 2030, and add 2 to 2.5 percentage points to the country's annual economic growth (Shah, 2016). Imran Khan’s government took 4.5 years to establish the CPEC authority and our key expert asserted that the Authority was doing a respectable job. When the new government took over the reins, they decided to scrap the CPEC Authority terming it ‘redundant’ and ‘obstructive.’ We were informed by our key expert that such decisions where discretion is involved, creates a lot of uncertainty leading to a regressive and negative investment climate.

 

Another similar scenario was shared by our experts in the power sector, in which they had to sit with the various Independent Power Producers (IPPs) that had long-term contracts under various power policies created by the government in different eras. In a time of great desperation when Pakistan needed power, the power policies from 1994 onwards were geared towards tempting investors into power projects, with attractive incentives and sovereign guarantees[2]. It was shared that the average life of a Power Purchase Agreement (PPA) was 20-25 years, yet the last government, for several reasons, decided to have all these PPAs renegotiated. Regardless of the political and economic concerns at that time, it generated a deep distrust of the long-form investor who had sought a return on their investment following an operating contract of 20-25 years

 

Likewise, our experts in the Telecom sector, who constantly venture out to the international market for investments and capital due to the intensive need of their industry, shared that it was impossible to formulate an investment plan with their investors, as they were unclear as to which  policies of the government would subsist, what the prevailing tax rate would be, what the inflation rate or foreign exchange rate and control environment would be like, or what the politico-economic situation would look like in the next few years. Without such information in hand, and commitments that would need to be made to the investors, it was nigh impossible for them to attract the level of investment and commit the level of return on the same investment to their foreign investors.

 

In our Round Table, our foremost expert from TUV Austria Pakistan shared that attracting investors in such an economically unstable climate requires incentives and guarantees. It is the role of the state to provide these as the market is not capable of providing them. Thus, his investors who browse competitively in the region would be comparing between various countries, such as Bangladesh and Pakistan. The former of which has shown consistency in policy and economic growth, hence it has become a more attractive investment option. Hence, he shared that it boils down to consistency that can be planned for. If Pakistan can make assurances to the international market that a policy or plan will be consistently implemented for the next 5-10 years, regardless of how bad the policy may actually be, it would still be capable of attracting investment, versus a policy that may be excellent from an investment perspective yet if uncertainty and inconsistency remains in the market, no investor would care to touch it.


[1] “Determinants of Foreign Direct Investment in South Asia. Bangladesh, India, Nepal, Pakistan, & Sri Lanka” Rehim and Munir (2004) [2] As per our legal experts, sovereign Guarantees are securities offered by the state under which a project is protected by the Government of Pakistan. Depending on the terms of the agreement, this protection can be absolute i.e., any loss or damage in the project is subject to compensation by the Government of Pakistan, or limited, i.e., in event of force majeure or damages owed to the government would be covered by it. Thus, an investor/sponsor of a project is given assurances that his investment is secured, and the government will be responsible for it.

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