THE ROLE OF FOREIGN CAPITAL DEVELOPMENT ANALYSIS OF PAKISTAN

ECONOMY

PREPARED BY: Syeda Sadaf Kazmi

REG # 14511
Subject: Micro & Macro Economics
Course ID: 109078
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CONTENTS

EXECUTIVE SUMMARY.................................................................................................................2
1. FOREIGN CAPITAL INFLOW................................................................................................3
2. HISTORY AND ORIGIN OF FOREIGN CAPITAL GROWTH...........................................4
2.1 Foreign Direct Investment........................................................................................................4
2.2 Remittance.................................................................................................................................5
2.3 External Debt.............................................................................................................................7
3. TRENDS IN FOREIGN CAPITAL INFLOWS........................................................................7
3.1 Foreign Direct Investment........................................................................................................8
3.2 Foreign Portfolio Investment..................................................................................................10
4. CROSS COUNTRY ANALYSIS..............................................................................................11
5. CONCLUSION..........................................................................................................................12
6. LITERATURE MATRIX.........................................................................................................14
REFERENCES..................................................................................................................................17
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EXECUTIVE SUMMARY

Pakistan's shaky economy and urgent need to increase industrial production need a major

expansion in the mobilization of foreign resources. Even if long-term government help is

becoming less common, large portfolio investments are not an option since Pakistan's capital

market is too tiny to sustain such investments. There should be no significant increase in

commercial borrowings. Since this is the case, foreign investment must be prioritized (FDI).

In the last few years, Pakistan received fewer FDI inflows and less percent of all Asian sub-

inflows. Some of the most significant impediments include violence, economic instability,

and bureaucratic inconsistency. Taking remedial policy actions is essential.

Additionally, foreign currency costs, external debt, and remittances are considerable because

of FDI's concentration on the domestically oriented sector of the electrical business. Because

of this, the country's capacity to pay its payments is seriously hampered. Foreign direct

investment (FDI) should be a top priority for developing nations, especially in industries that

generate foreign currency. This is what Pakistan's history has taught us. Even the Asian

Development Bank, a multilateral development organization, should take this into account

when it comes to its private-sector efforts in developing nations.

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1. FOREIGN CAPITAL INFLOW

The movement of monetary resources for the purposes of investment, commercial trade, or

the administration of a corporation is what is referred to as "capital inflows,"   These include

monetary transactions that take place inside a country, Furthermore, the inflow of fresh

money into developing countries helps in the achievement of national economic goals, the

objectives of empowerment development initiatives, and the Millennium Development Goals.

It allows the host country to consume more than it creates, and it raises the marginal

productivity of capital in the receiving country to a larger amount than it does in rich

developing economies. If economies are permitted to become more open and friendly to the

rest of the globe, it will significantly aid in the transformation of emerging countries. These

capital inflows might take the form of international aid, external debt, foreign direct

investment, or worker remittances. (Jawaid & Saleem, 2017). The growth of developing

economies is primarily reliant on capital inflows. It is crucial for long-term prosperity

because it helps to build a financial system that encourages new technologies and

employment opportunities while also cutting borrowing costs for governments and

enterprises alike. Growing nations like Pakistan need to overcome the capital, saving-

investment, skill and innovation, and shipping gaps in order to continue their economic

expansion. Pakistan's reserves aren't at the appropriate level (Ali, 2005).

There have been studies conducted to determine how the increase of capital has contributed

to the development of Pakistan's economy since it began to expand. In light of this, there is a

great deal of dispute, both practically and conceptually, concerning the role that foreign direct

investment and reserves play in the expansion and development of the economy. Studies on

capital inflows reveal varied magnitude indications, and some studies indicate that there is a

negative effect of capital inflow on economic performance (Chenery & Strout, 1966).

However, some studies do find a significant relationship between capital inflow and
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economic performance. Government assistance for industrial development and technological

advancement is also provided by the influx of cash in the form of external debt, which opens

up new markets for the mobilization of human and material resources on a global scale. The

buildup of debt has a detrimental impact on the economic development of emerging nations,

according to some academics. As a result, it is important to study the impact of foreign debt

and economic growth in a country because of foreign capital inflows (Khan & Rahim, 1993).

External debt (EXD) and foreign direct investment (FDI) and remittance have both been

shown in several studies to be significant sources of economic stability and a major part of

foreign capital inflows.

2. HISTORY AND ORIGIN OF FOREIGN CAPITAL GROWTH

Previous research concluded that Pakistan would benefit from taking on debt from other

countries in order to achieve quick economic development and significantly reduce the

country's level of financial instability. The effects of capital inflows from outside not only on

the economics of a nation but also on its output and consumption have been the subject of a

great deal of research (Jawaid & Saleem, 2017). Moreover, Foreign direct investment (FDI)

and economic growth have long been controversial issues, especially in developing countries.

An efficient financial system is an important aspect in attracting FDI, which is heavily

impacted by the circumstances of the host nation. International investment (FDI) may help

the economy function more smoothly in times of financial crisis. The smoothing of

consumption patterns and domestic savings may help to stability as a consequence of

increasing production capacity from new technologies Local firms may be forced to close

when multinational corporations achieve market dominance in countries that are more

dependent on FDI (Reisen & Soto, 2001).

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2.1 Foreign Direct Investment

According to (Macrotrends, 2022), Investments are made using cash from a single source

Foreign direct investment (FDI) is the term used to describe equity inflows into the economy

that is the subject of the report. It is the sum of equity capital, earnings reinvested, and other

wealth. Direct investment is a sort of cross-border business in which a citizen of one nation

has the authority or a large level of control over the administration of a resident of another

nation. Pakistan’s FDI in the past 10 years is taken an up and down position, Pakistan’s direct

investment is an increase in 2016 was $2.58 billion, and a 53.97% increase from 2015. In

2017, Pakistan's FDI fell by 3.11 percent to $2.50 billion, compared to 2016. In 2018,

Pakistan's FDI fell by 30.41% to $1.74 billion, compared to 2017, and in 2019, the FDI is

increase again from 2018 by 28.61% was 2.23 billion. Here below is Pakistan’s detailed 10

years of historical data available that presents the history of foreign capital inflow’s factor

foreign direct investment details;

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2.2 Remittance

Furthermore, Foreign capital inflows also include, remittances that are viewed as a crucial

source of income for the country receiving them, helping to maintain economic growth robust

and enhance living standards. Its framework is based on the migratory experience, including

where they come from, how much money they spend in the host country, and how much

money they save and send back home. Some studies find that remittances tend to be

adversely related to GDP growth, they are compensatory in nature and it does not seek to

serve as capital for economic development. Some studies also find that Sending money back

to family members who live in countries with less developed banking systems may help the

economy grow by providing an alternative source of finance and relieving liquidity concerns

(Jawaid S. T., 2016). In contrast, foreign loans have traditionally played a crucial role in

growing countries due to the scarcity of capital and technology.

According to (Apergis, Lyroudi, & Vamvakidis, 2008), the years 2008–2009 were a

particularly tough moment for developing countries attributable to a shortage of resources

and the necessity to pay their external debt commitments. Because of the aforementioned

financial crisis, there is a definite correlation between FCI and increasing economic activity.

The past 7 years of data on remittance of Pakistan (TheGlobalEconomy, 2020), are presented

below and show that there is a gradual increase in remittance that affect positively on the

economic growth of Pakistan;

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2.3 External Debt

Due to a shortage of capital and technology, rising countries have relied heavily on external

loans. When the global financial crisis erupted in 2008–2009 and specially after covid 2019-

2020, developing countries faced problems due to a shortage of funds and the payment of

international creditors. This highlighted catastrophe reveals a strong link between Foreign

Capital Inflows and economic progress (Aizenman, Jinjarak, & Park, 2015). Here below are

the 8 years of historical data showing the emerging external debt of Pakistan

(TheGlobalEconomy, 2020);

3. TRENDS IN FOREIGN CAPITAL INFLOWS

Due to Pakistan's market size, foreign investment has been influenced by trending factors

such as interest rates, currency exchange rates, and exchange rates. International capital
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inflows to Pakistan may be explained in part by factors such as trade openness and the sort of

government in power, as well as by factors such as productivity (Chenery & Strout, 1966).

The literature focuses on the macroeconomic consequences of foreign capital inflows, but

this overlooks an important component about foreign capital inflows impact local joint

venture partners and local companies that are expected to compete with multinational

corporations. Furthermore, the impact of projects funded by FDI or financial arrangements

must be analyzed in order to truly comprehend the value of the invested capital (Akbar &

Ahsan, 2015).

As seen in the table below, Pakistan's present macroeconomic condition, which has recently

stabilized as a result of the recently reached agreement with the International Monetary Fund,

continues to exhibit modest growth over the short to medium term. Therefore, rather than

depending just on changes in macroeconomic factors to attract international capital inflows,

the country will also need robust investment diplomacy.

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3.1 Foreign Direct Investment

In the fiscal year 2022, the investment ratio is 13.1 to its nominal GDP. In comparison to

other nations, this figure is relatively low. Since 2008, private investment as a proportion of

GDP has plummeted into the single digits, posing a severe challenge to governments. This

amounts to a growth in fiscal year 2021. The CPEC initiative's foreign investment flows

showed some promise; however, the trajectory has not been promising.

CPEC is the flagship and pilot project for China's Initiative. In current history, Pakistan has

experienced CPEC inflows. In addition, between 2015 and 2017, CPEC received funding

from non-Chinese investors. Following the completion of the CPEC's "early harvest plan,"

the second phase includes the creation of Special Economic Zones (SEZs). 7 Chinese

investors contributed $1.81 billion in FY18. CPEC projects in the energy, transportation, and

port sectors used financing options other than FDI. In rare cases, loans were provided to the

federal government or relevant state-owned enterprises in Pakistan to carry out the project

(Younus, 2021).

As a result of worries over rising total foreign debt, CPEC-related flows have recently come

under scrutiny. 9 It has been estimated that CPEC-related debts make up no more than 11%

of Pakistan's total debt. The sovereign guarantees of the Pakistani federal government, on the

other hand, are not included in the opinions of these independent researchers. in order to keep

Pakistan's current account deficits as large as possible, China allowed Pakistan to borrow

short-term at commercial interest rates (and meet import requirements). Some of them are

short-term loans that Pakistan could only repay after exhausting all other borrowing options

(Malik, 2018).

Pakistan has deregulated industries with strong FDI potential. New investing possibilities

have emerged. The table below lists the most popular industries by nation. Investing in
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power, oil & gas, financial services, and building remains popular. China invested $1.2

billion in electricity generation, $0.8 billion in construction, and $1.2 billion in financial

services in Pakistan in FY17. (2017's budget was $306M). UK interests include banking, oil,

gas, and power. Switzerland invests much in banking. The US has invested heavily in

Pakistan's oil, gas, and construction sectors. International firms with operations in Pakistan

route most of these investments.

3.2 Foreign Portfolio Investment

Investors' attention has recently been piqued due to favorable rates on the local money and

capital markets. A nation's declining foreign currency reserves would often entice portfolio

investment into the country. Typically, this was accomplished by maintaining a high discount

rate. When the Pakistan Stock Exchange performed well, local investors urged international

investors to participate in order to expand their market share.

Investment portfolios are influenced by three main factors: the real rate of economic

development, the health and stability of the local financial markets, and the general credit

worthiness of the nation. U.S. investors have a commanding lead in the global stock market

because of their long-term capital gains tax advantages over their European and Asian

counterparts. Pakistan Investment Bonds and Treasury Bills are also purchased by investors
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from both countries (Uppal & Mangla, 1996). Pakistan’s current portfolio investment is

declining after covid especially as presented in below chart (TheGlobalEconomy, 2020);

4. CROSS COUNTRY ANALYSIS

In recent years, Pakistan has received a lot of unfavorable international press and media

attention. Investors from across the world would be discouraged from making a financial

commitment to Pakistan if they heard that the country is rife with corruption, has been

attacked, and makes extensive use of child labor. Karachi and other "growth poles" like

Karachi need tangible initiatives taken by Pakistan's political leaders to improve peace and

order. Here below is the table presenting the rank of Pakistan in foreign capital inflows

(Macrotrends, 2022);
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Pakistan is on 13th rank in list of foreign capital inflows in 2021, Pakistan should speed up its

foreign capital growth, at first, international investors were lured to Pakistan by its pro-

business laws and incentives. But the harsh reality they experience while setting up shop in

the country frequently over shadows those positives (Jawaid & Saleem, 2017).

In order to complete the investment process, foreign investors must still get a number of

licenses and approvals from different government entities. Efforts should be made to

streamline the government's approval and clearance process in order to be on the top 10 list.

Foreign investors are baffled by Pakistan's legal system. As a result, it is not always apparent

which of the many legal systems should be given precedence. The government's

administrative directives and SROs might further exacerbate the situation. It will be simpler

to prevent their abuse if the laws and regulations are more clearly defined (Akbar & Ahsan,

2015).
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5. CONCLUSION

Many developing nations see foreign direct investment as a vital source of finance,

innovative technology, and management expertise. A significant amount of foreign direct

investment has been attracted to these emerging economies because of their efforts to

liberalize their FDI regime, which they recognize is critical to their economic progress. It

climbed down from $2.74 trillion in 2016 to $1.23 trillion in 2020 (TheWorldBank, 2020),

accounting for a huge percent change percent of the world's FDI. In 2022, Asian nations

received an estimated $535 billion in foreign direct investment (FDI), with East and

Southeast Asian countries accounting for more than 90% of this total.

South Asian nations, however, lagged behind greatly compared with their other fellow Asian

countries. The level of foreign direct investment (FDI) that Pakistan attracts is nothing near

that of several other Asian nations (UNCTAD, 2021).

Massive foreign direct investment (FDI) in Pakistan's energy sector has been a contentious

subject since the country's 1994 power strategy. As a consequence, quite a bit of discussion

has ensued. The new power plan has resulted in an oversupply of energy, which has slowed

down industries. There were significant recurring costs to cover all fixed costs and variable

cost foreign currency expenses as a consequence of the high inflows of FDI. There are also

substantial costs for IPPs, such as debt repayment, dividend payments, and fuel payments.

Power policy and projections of the ramifications for the balance of payments show that if

these requirements and several other assumptions are met, Pakistan would be saddled with an

annual foreign currency debt of between $900 million and $1.4 billion for the next 14 years.

This is a big amount, given Pakistan's current foreign currency reserves of $1.2-1.3 billion

(Jawaid & Saleem, 2017).

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We can learn a lot from Pakistan's experience with other emerging countries. This might have

a severe influence on emerging economies in the near future if FDI is not properly handled. If

Pakistan is to attract foreign direct investment (FDI), developing countries need to

concentrate on both the sector that generates foreign currency and other sectors at the same

time. When performing build-own-transfer efforts with foreign investors, international

organizations, such as the Asian Development Bank, Pakistan should keep this in mind (Khan

& Rahim, 1993).

6. LITERATURE MATRIX

S.N

O AUTHOR METHODOLGY FINDINGS

1 (Papanek, 1973) Data from 34 nations in He observed that all three inflows
the 1950s and 51 had a statistically significant
countries in the 1960s positive impact on GDP, with aid
were utilised in his study. having a greater impact than
private investment or other
foreign inflows. He also looked at
the rate of exports, educational
attainment, and the size of the
manufacturing sector, but none of
these characteristics had a
significant influence.
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2 (Stoneman, 1975) According to Stoneman's He finds that the stock of foreign

research, the following direct investment has a slowing
variables were used in effect and the importance of this
his Ordinary Least lowers when the lag of the
Square (OLS) regression dependent variable is taken into
and the data was account. Both foreign assistance
collected from 1955 to and domestic savings have a
1970. positive influence on economic
growth.
3 (Balassa, 1978) He utilizing data from He found the positive impact of
eleven nations between foreign capital inflows on
the 1960s and 1970s. economic growth.
4 (Aizenman, Jinjarak, A early empirical Result show that there may be a

& Park, 2015)

analysis of the financial- limit to how far financial
growth nexus in 41 development can boost economic
nations, including 11 growth before the effect becomes
East Asian and 9 Latin non-linear.
American economies,
makes use of the
Groningen Growth and
Development Centre
(GGDC) database.
5 (Jawaid & Saleem, From 1976 to 2015, time- Standard least squares analysis

2017)
series data of Pakistan is suggests that remittances and
used in this investigation. foreign lending have a favourable
impact on economic
development.
6 (Khan & Rahim, For the purpose of From 1960 to 2008, aid had a

1993)
evaluating the influence significant influence on growth
of foreign aid on rates in the five nations studied.
domestic savings and
economic growth in
South Asian countries
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(Bangladesh, India Nepal

Pakistan and Sri Lanka),
this study uses the
simultaneous equation
approach.
7 (Uppal & Mangla, The method applied is Results show that the

1996)
cross-sectionally characteristics cited in previous
implications and using studies have a significant impact
economic theory. on a country's ability to access
foreign financing.
8 (Iqbal & Zahid, An examination of Economic growth was shown to

1998)
Pakistan's economic be boosted by more economic
development from 1959- openness, according to the
1996 using a multiple findings.
regression methodology
to distinguish the impacts
of significant
macroeconomic drivers.
9 (Burnside & Dollar, The aid-savings link was The results shows that even while

2000)
modelled using a TSLS there existed a direct aid-growth
regression analysis. link, it was not substantial.
However, aid's interaction with
domestic savings had a large and
detrimental impact on growth in
the form of an indirect link.
10 (Hansen & Tarp, A number of policy and There is a strong case to be made

2001)
institutional control that foreign assistance has a
parameters, as well as the positive effect on economic
volume of foreign aid, development, and this is not
were used to regress the dependent on "good" policies.
average GDP growth rate
for 56 countries during
five time periods
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between 1974 and 1993.

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