SUBMITTED BY:

JAVARIA KHAN
SUBMITTED TO:
PROF. Amjad
ROLL NO:
25
SECTION:
ADP(A/F)
UNIVERSITY OF CENTRAL PUNJAB
ALI PUR CAMPUS

Date : 01-July-2019

Assignment No: 3
Foreign direct investment
1. FDI is the net transfer of funds to purchase and acquire physical capital, such as factories
and machines, e.g. Nissan, a Japanese firm, building a car in factory of UK.
2. In recent years, foreign direct investment has also widened to include the purchase of
assets and shares which give investors a management interest in a firm.
3. World bank FDI definition;

“Foreign direct investment are the net inflows of investment to acquire a lasting
management interest (10 percent or more of voting stock) in an enterprise operating in an
economy other than that of the investor. It is the sum of equity capital, reinvestment of
earnings, other long-term capital, and short-term capital as shown in the balance of payments.
”

4. Foreign Direct Investment should be distinguished from portfolio transfers (e.g. moving
financial capital to foreign bank accounts) this is known as indirect investment. (However, to
complicate things, if there are portfolio transfers which leads to a foreign investor
controlling a management share in the company, then this may be considered Foreign
Direct Investment because of the transfer of ownership.)

Investment Income:

Outward investment can lead to increase overseas investment income for a country, including:

1. Profit from overseas subsidiaries.

2. Dividends from owning shares in overseas firm.
3. Interest payments from leading abroad, such as lending by UK banks.

FDI in the balance of payment accounts in two ways:

1. The initial outflow of FDI is entered as an outflow (debit) on the capital account.
2. The resulting investment income is entered as inflow (credit) on the current account.

Inward investment:
Countries receiving inward investment gain in a number of ways, including:
1. An increase in GDP, initially through the FDI itself, but this will be followed by a positive
multiplier effect on the receiving economy so that the final increase in national income is
greater than the initial injection of FDI.
2. The creation of jobs.
3. An increase in productive capacity, which can be illustrated by a shift to the right in the
Aggregate supply or the Productive Possibility Frontier(PPF).
4. Producers have access to the latest technology from abroad.
5. Less need to import because good are produced in the domestic economy.
6. The positive effect on the economy on the country’s capital account – FDI represents an
inflow(credit) on the capital account.
7. FDI is a way of compensating for the lack of domestic investment, and can help ‘kick start’
the process of economic development.

Importance of FDI in Pakistan

These developments increase the need for attracting FDI into Pakistan. FDI is a significant long-
term commitment and a part of the host economy itself. In the difficult circumstances
described above, Pakistan’s policy on foreign capital mobilization must attach priority to (i)
official multilateral assistance; (ii) official bilateral assistance; and (iii) FDI, given its very limited
absorptive capacity for portfolio investment and commercial bank loans. However, concessional
long-term development assistance, both multilateral and bilateral, will become increasingly
scarce due to domestic financial constraints in major donors, such as Japan, and Pakistan’s
increased competition with other least developed countries such as Bangladesh, Mongolia, Sri
Lanka, and Viet Nam. Multilateral development organizations including the Asian Development
Bank will focus on poverty alleviation and soft sectors (i.e., agriculture, rural development,
education, environment, poverty, and health), while the hard sectors (manufacturing and large-
scale physical infrastructure) are expected to be invested in by the private sector and foreign
investors as well as the Government of Pakistan (GOP). The positive developmental role of FDI
in general is well documented (see, for example, Chen 1992). FDI produces a positive effect on
economic growth in host countries. One convincing argument for that is that FDI consists of a
package of capital, technology management, and market access. FDI tends to be directed at
those manufacturing sectors and key infrastructures that enjoy actual and potential
comparative advantage. In those sectors with comparative advantage, FDI would create
economies of scale and linkage effects and raise productivity. For FDI, repayment is required
only if investors make profit and when they make profit, they tend to reinvest their profit rather
than remit abroad. Another benefit of FDI is a confidence building effect. While the local
economic environment determines the overall degree of investment confidence in a country,
inflows of FDI could reinforce the confidence, contributing to the creation of a virtuous cycle
that affects not only local and foreign investment but also foreign trade and production.

Policy Recommendation

1. General Recommendations
First of all, Pakistan should make stronger efforts to attract as much FDI as possible to the
foreign exchange sectors in the short term. Taking into account unfavorable balance of
payments prospects, it should refrain from attracting any further massive FDI in the non
foreign-exchange-earning sectors for some years in the future. Political stability and
satisfactory law and order are likewise critical to attract FDI. The international press and
media coverage Pakistan has received in recent years is not at all conducive to attracting
foreign investors. News items on Pakistan being one of the most corrupt countries in the
world, its bomb detonations, and its use of child labor will hardly encourage foreign
investors to undertake initiatives in Pakistan. Law based on different legal systems are
 applied independently and it is often not obvious which one will take precedence. The legal
situation is even further complicated by the fact that government agencies are empowered
to introduce certain changes through administrative orders and SROs. The laws and
regulations should be simplified, updated, modernized, made more transparent, and their
discretionary application must be discouraged.

2. Specific Recommendations
 Taxes:
Payment of taxes and contributions in Pakistan is complex and cumbersome. In addition to
corporate income taxes, a large number of indirect taxes are levied at the federal,
provincial, and local levels. Essentially, separate collection of taxes and contributions have
forced enterprises to face unnecessary, cumbersome, and costly administrative procedures,
and to deal with a large number of collecting agencies at all three levels of government.
There is an urgent need to reduce the number of taxes. Import tariffs on plant and machinery
have discouraged investment, more so in Pakistan where capital is scarce and cost of borrowing is
high. Because of this high cost, manufacturers are discouraged to modernize and the quality of local
industry products are restricted against international competition. There is a need to examine tariffs
of plant and machinery with a view to substantially reducing them.

 Credit Facilities:
Foreign firms operating in Pakistan are currently facing cash flow problems as a result of
many taxes and the Asian crisis. That these firms cannot borrow more than their equity
capital have further aggravated the cash flow problem. There is a need to review this
policy.

 Anti-monopoly Restrictions
The existing monopoly control laws that benchmark the concentration of economic
power to an unrealistically low limit of Rs 300 million for assets discourage capital
formation. The monopoly control authority must review the limit in consultation with
the Overseas Investors Chamber of Commerce and Industry in Pakistan.
  Labor Laws
Overprotective labor laws do not encourage productivity and frighten away much
needed productive investment. There is a need to rationalize the labor laws and
multiple levies on employment that inhibit business expansion and job creation

Advantages of FDI:
 Capital inflows create higher output and jobs.
 Capital inflows can help finance a current account deficit.
 Long-term capital inflows are more sustainable than short-term portfolio inflows. e.g. in
a credit crunch, banks can easily withdraw portfolio investment, but capital investment
is less prone to sudden withdrawals.
 Recipient country can benefit from improved knowledge and expertise of foreign
multinational.
Investment from abroad could lead to higher wages and improved working conditions,
especially if the MNCs are conscious of their public image of working conditions in
developing economies.

Potential Problems of FDI:

 Gives multinationals controlling rights within foreign countries. Critics argue powerful
MNCs can use their financial clout to influence local politics to gain favorable laws and
regulations.

 FDI may be a convenient way to bypass local environmental laws. Developing countries
may be tempted to compete on reducing environmental regulation to attract the
necessary FDI.
 FDI does not always benefit recipient countries as it enables foreign multinationals to
gain from ownership of raw materials, with little evidence of wealth being distributed
throughout society.

 Multinationals have been criticized for poor working conditions in foreign factories (e.g.
Apple’s factories in China).

Domestic Investment:
There are many different methods used by politicians and economists to measure the
relative health of a given country's economy. Some measurements measure the overall
health of an economy while others measure more specific factors within that economy.

 Gross private domestic investment (GPDI) falls under the latter because it is used to
measure a specific factor within a country's economy. GPDI is defined as the amount of
money that domestic businesses invest within their own country.

Types of GPDI;

Gross private domestic investment includes 3 types of investment:

 Non-residential investment: Expenditures by firms on capital such as tools, machinery,

and factories.

 Residential Investment: Expenditures on residential structures and residential

equipment that is owned by landlords and rented to tenants.

 Change in inventories (or stocks): The change of firm inventories in a given period.
(Inventory or stock is the goods that are produced by firms but kept to be sold late
Specific Factors of GPDI
In order to calculate gross private domestic investment, it is important to first know the three
factors that make up the calculation. GPDI includes the following types of investment:

1. Business expenditures for things like machines, tools, land, and buildings

2. Expenditures by landlords for things like home improvements or new buildings

3. Changes in inventories that are held by businesses. In order to determine this number,
you need to subtract the business inventories at the beginning of the year from the
business inventories at the end of the year. This number can be negative if there is a
decrease in business inventories instead of an increase.

Gross private domestic investment is the sum of these three factors. The sum will always be
expressed in a country's local currency; however, when comparing different countries, the
United States Dollar is used as a common currency

Calculating the GPDI

In order to simplify the formula used to determine gross private domestic investment, we will
use some abbreviations:

 GPDI = gross private domestic investment

 C = business expenditures for things like machines, tools, land, and buildings

 R = expenditures by landlords for things like home improvements or new buildings

 I = changes in the inventories that are held by the business

Formula: GDPI= C+R+I

Impact or FDI on the economy of

developing countries:
The inflow of foreign capital in the form of foreign direct investment has considerably increased
in developing countries during the last few decades. FDI inflow fulfills the rising investment
requirements to boost economic growth at higher pace and helps for macroeconomic stability
in the economy. This nondebt foreign inflow eases the pressure on the balance of payment
distortion. Technological transfer from developed countries to developing countries occurs
through FDI which paves the way for economic development in developing countries.
Interaction between foreign and domestic investment is of paramount important and both can
cause each other in an economy. The increase in the private investment signals high return on
the investment in the domestic economy whereas public investment shows the improvement in
infrastructure and thereby reduction in the cost of doing business. These roles of domestic
investment motivate the foreign investors to reap the benefits of high return. However foreign
capital inflow may also be beneficial for the investors of host country. The impact of FDI on
domestic investment is ambiguous that is FDI may have crowding out or crowding in impact on
domestic investment. Crowding out impact of FDI means it is meaningless for FDI recipient
country but crowding impact of FDI on domestic investment is beneficial for the host country.
Like other developing countries Pakistan is also a recipient country of bulky FDI inflow since
more than three decades. This is an important source of external finance considering the
deteriorated position of balance of payment. Moreover, FDI minimize the dependence on
foreign debt. Although considering FDI inflow has been recorded in last many years, this far less
compared to other developing countries. Pakistan is also enjoying the foreign direct investment
inflow during the past three to four decades. The implication of FDI has crucial importance for
developing economies like Pakistan because if it crowds out the domestic investment, it will
squeeze the growth of the domestic capital stock; alternatively if it crowds in the domestic
investment, it will expand the domestic investment. Therefore it is highly desirable to test
whether FDI crowds in or crowds out the domestic investment. This paper is also trying to
assess the interaction between the domestic capital stock and FDI; additionally GDP is used as a
third variable in the model in order to avert the misspecification problems.