The Securities and Exchange Commission of Pakistan is busy preparing a Doing Business in Pakistan report with the aim of wooing foreign investors to the country. The report is expected to highlight opportunities in various local business sectors to market the potential of investment in Pakistan.

But that could be a hard sell. According to statistics from the State Bank of Pakistan (SBP), net foreign direct investment in the country fell from a record $5.4bn in the fiscal year ending June 2008 to $820m in the fiscal year in 2012 – its lowest level since 2003. As a percentage of total economic output, FDI in 2012 reflected a 26-year low of about 0.4%. The latest year-to-date figures for 2013 released by the SBP show that net FDI inflows stood at $853m in the 10 months ending April 2013.

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Dwindling inflows can be explained partly by the global economic downturn that has led to lower inflows to the region as a whole. Net FDI inflows to south Asia fell from $33.1bn in 2008 to $23.7bn in 2011, according to data from the UN Conference on Trade and Development (Unctad).

However, the decline has been sharper in the case of Pakistan. Unctad data reveals that net FDI flows into Pakistan dropped to 5.3% of total flows into south Asia in 2011 from a little above 16% in 2008.

Rising risk

“Pakistan’s country risk is on the rise,” says Sayem Ali, senior economist at Standard Chartered Bank for the Middle East, Pakistan and north Africa regions. “Reforms are critical for the economy to build investor confidence,” he adds, referring to the country’s poor tax-to-GDP level.

The country is facing unsustainable levels of fiscal deficit with large external debt repayments due over the next two years. Tracking this macroeconomic stability, the Pakistani rupee has shed nearly 15% since June 2011, currently hovering around 99 Pakistan rupees to the US dollar.

Another major challenge is a worsening energy deficit. “The energy crisis has reached epic proportions with the shortfall between peak demand and supply standing at more than 6000 megawatts – one-third of total demand,” writes Mr Ali in a research note released in March.

To top it off, the country is also marked by security issues. Along with battles with militants in the country’s north-west, a terrorist backlash in urban centres has dampened investor confidence. Little wonder then that the Pakistan Business Council – a not-for-profit business policy advocacy platform – cites security as the top issue facing the country.

Law and order issues such as kidnapping for ransom, threats and expatriate security are also a major concern. According to the November 2012 Business Confidence Index Survey by Pakistan’s Overseas Investors Chamber of Commerce and Industry (OICCI), the issue of law and order was the second biggest factor behind low business confidence in the country. Despite these challenges, however, OICCI chief executive Abdul Aleem is hopeful.

Tainted perception

Mr Aleem agrees about the problems, but says that falling inflows do not fairly reflect the FDI potential of Pakistan. He argues that foreign companies already in Pakistan see plenty of scope for growth within the country.

A May 2012 survey conducted by the OICCI found that 86 of its 189 member companies cumulatively invested about $1bn of their retained earnings in Pakistan 2011-12. This amount is almost equal to the average FDI inflows in these two years.

“Those who are already here understand the market and are ready to take the plunge,” says Mr Aleem. He adds that a majority of OICCI’s member companies plan to invest a total of $3bn between 2012 and 2016.

“Not only do foreign firms intend to stay in the country, but many of them actually intend to expand their operations and increase their workforce too,” he says.

Game-changers

One of the reasons foreign companies are long on Pakistan is its investment regime. “Pakistan has the most liberal FDI regime in south Asia,” says Kamran Mirza, Pakistan Business Council chief executive, referring to elements such as liberal foreign exchange regulations, 100% ownership by foreign firms and zero restrictions on repatriation of profits or dividends.

The key game-changers, however, are democracy, peace and demography. While resource-seeking FDI may be more attracted towards authoritarian political regimes, FDI seeking new markets or lower cost is positively influenced by democracy.

Following the completion of what can arguably be classed as the first ever democratically elected government this year, the ongoing democratic consolidation in Pakistan is a harbinger of hope and investor confidence. “It’s about the process. If it continues, and it is likely to continue, then it will boost the confidence of foreign investors,” says Mr Aleem.

The second major driver of investor sentiment is peace along Pakistan’s eastern border with India. There is talk that Pakistan is planning to grant India ‘most favoured nation’ status, which would kick-start bilateral trade and investment relations.

Mr Ali says that a liberalised trade regime will likely attract FDI to Pakistan, as an economy with greater access to regional markets becomes more attractive to foreign investors. A similar reading comes from a 2011 OICCI survey, which revealed that 60% of its members polled saw improved Pakistan-India trade relations as a “facilitative factor” in the overall investment climate of the country.

Young demographic

The third major factor inspiring investor confidence is Pakistan's young demographic. The country’s current population is about 180 million and is expected to rise to 285 million in the next 50 years.

This boom comes along with a rising middle class that now accounts for nearly a quarter of Pakistan’s population, according to research by Dr Durre Nayab, chief of research at the Pakistan Institute of Development Economics. Even more striking is the fact that Pakistan’s middle class constitutes 40% of urban dwellers.

“Sixty percent of our population is youth and they are not going anywhere,” says Mr Aleem, referring to the potential market for this segment. Consumer-based businesses, therefore, including agricultural industries, offer attractive returns, he adds.

His views correspond with that of Mr Mirza, who adds that oil and gas exploration and production, power generation and infrastructure businesses also offer lucrative opportunities to potential investors. “We have the risk, but we also offer great returns,” says Mr Mirza.

With global economic growth being led by economies in the East, says Mr Mirza, Pakistan is not necessarily looking to the West to attract FDI flows. Since fiscal year 2011, developing economies have accounted for an average 39% of FDI inflows to Pakistan, compared with 20% between 2002 and 2004.

Plagued by slow growth at home, Western businesses may find it fruitful to reverse this trend. Whether they will take the risk and go East to the sixth most populous country in the world depends much on the ability of Pakistan’s new government to turn around the situation. Until then, FDI inflows to the country may just be a wait-and-see game.