CHAPTER 1: INTRODUCTION

Problem Area:Problem area of our project is to ascertain the impact of Foreign Direct Investment on the Economic Growth of Pakistan. Problem Statement:Like other developing countries, Pakistan too seeks to enhance the inflow of FDI aiming at sustaining high rates of economic growth, increasing employment opportunities and improving living standards. The study undertaken by us is an approach to evaluate the importance of FDI for our Economy in order to boost the investment environment. Introduction:The two main definitions of FDI are contained in the Balance of Payments Manual (Washington, D.C. International Monetary Fund, 1997 and 1993) and the second edition of the Detailed Benchmark Definitions of Foreign Direct Investment (Paris Organization for Economic Co-operation and Development, 1992 and 1996). According to the Balance of Payments Manual, FDI refers to investment made to acquire lasting interest in enterprises operating outside of the economy of the investor. Further, in cases of FDI, the investor's purpose is to gain an effective voice in the management of the enterprise. The foreign entity or group of associated entities that makes the investment is termed the "direct investor". The unincorporated or incorporated enterprise - a branch or subsidiary, respectively, in which direct investment is made - is referred to as a "direct investment enterprise". Some degree of equity ownership is almost always considered to be associated with an effective voice in the management of an enterprise; in the revised edition of the Manual, IMF suggests a threshold of 10 percent of equity ownership to qualify an investor as a foreign direct investor. Once a direct investment enterprise has been identified, it is necessary to define which capital flows between the enterprise and entities in other economies should be classified as FDI. Since the main feature of FDI is taken to be the lasting interest of a direct

investor in an enterprise, only capital that is provided by the direct investor - either directly or through other enterprises related to the investor - should be classified as FDI. The forms of investment by the direct investor which are classified as FDI are equity capital, the reinvestment of earnings and the provision of long- and short-term intracompany loans (between parent and affiliate enterprises). According to the benchmark definition of the OECD, a direct investment enterprise is an incorporated or unincorporated enterprise in which a single foreign investor either owns 10 percent or more of the ordinary shares or voting power of an enterprise (unless it can be proved that the 10 per cent ownership does not allow the investor an effective voice in the management) or owns less than 10 percent of the ordinary shares or voting power of an enterprise, yet still maintains an effective voice in management. An effective voice in management only implies that direct investors are able to influence the management of an enterprise and does not imply that they have absolute control. The most important characteristic of FDI, which distinguishes it from portfolio investment, is that it is undertaken with the intention of exercising control over an enterprise

Importance of Foreign Direct Investment:FDI has come to play a major role in the internationalization of business. Reacting to changes in technology, growing liberalization of the national regulatory framework governing investment in enterprises, and changes in capital markets profound changes have occurred in the size, scope and methods of FDI. New information technology systems, decline in global communication costs have made management of foreign investments far easier than in the past. The sea change in trade and investment policies and the regulatory environment globally in the past decade, including trade policy and tariff liberalization, easing of restrictions on foreign investment and acquisition in many nations, and the deregulation and privatization of many industries, has probably been the most significant catalyst for FDIs expanded role. As a form of international capital movement, FDI shares many of the potential benefits and costs of other forms of capital flow. However, FDI is unique in the incentive structure that it provides for foreign investors and for the host countries. Moreover, FDI is unique in producing stronger links of integration for the host countrys economy with 2

the global economy. These links go well beyond financial integration and factor mobility since they allow for the possibility of transfer of technology from the home countries of multinational enterprises (MNEs) to the host countries. It is this particular aspect which attracts the most attention in the current economics literature on the subject. Theoretically, there is a common argument among economists that one of the most important factors which favour FDI as a form of capital flow is its spill over effects on the rest of the host economy. Short-term capital flows may stop or reverse directions, but transfers of technology and the associated productivity impact of FDI can be long-lasting. FDI can, therefore, be a significant factor in enhancing the growth and development potential of the host developing countries. In the above context, many economists since the mid-1980s emphasised the positive trade-related factors which favour FDI over other forms of capital flows. These factors operate on both the import and the export sides. On the import side, FDI allows for importing foreign firms-specific technologies into the host country. These technologies may be in the form of capital technologies, and may also be in the form of managerial and marketing technologies. While these technologies are not transferable through the trade of goods, they can be transferred through the establishment of MNEs in host countries. On the export side, the MNEs may provide an opportunity for domestic firms to gain access to new markets and thus enhance more indirect mechanisms for export growth in the host country. The most likely indirect increase in exports of domestic firms can occur through their output, which is embodied in the final product of the MNEs. Since the latter are likely to have an easier access to international markets due to their multinational nature, this immediately enhances the export performance of the host economy. There is also a substantial literature identifying and assessing the role of FDI in encouraging higher real income levels in the host economy by promoting a more efficient use of domestic resources. The theme in this literature is based on the theoretical assumption that the entry of successful foreign-owned firms, particularly MNEs, to the market of the host country can result in direct knowledge transfer and productivity spillovers in the rest of the host country. There are a number of channels through which this result can occur in the host economy. In this context, the existing 3

evidence is consistent in showing that MNEs, in general, tend to be larger than their domestically-owned counterparts, have higher average labour-productivity levels, and operate with higher capital-to-labour ratios. This, in itself, contributes to higher average levels of productivity in the host economy through economies of scale and reallocation of domestic resources from less efficient to more efficient producers. The evidence mentioned above also shows that average wage levels tend to be higher in MNEs. This means that some portion of the higher average productivity associated with inward FDI is passed through to domestic factors of production. By sharing the domestic labour supply pool with other sectors in the host economy, the MNEs can also assist in raising the skill level of available workers for other firms in the host economy. Since a significant portion of technology is human capital embodied, this is a major source of direct knowledge transfer from MNEs to the host country. Similarly, internal trade between MNEs and domestic firms forms a direct link between foreign investors and domestic investors, which allows the latter to copy some of the better organisational and marketing technologies and practices of the former. Another channel for efficiency gains is through the increased competition in the host country market and in the regional market of the host countries, which promotes increased efficiency among domestic and regional firms. Taking all this into account and to the extent that foreign investors do not capture all of the associated increase in productivity in the form of higher profits, the host country will enjoy higher average income levels as a result of inward FDI. In recent years many developing countries have increasingly turned to foreign direct investment (FDI) as a source of the capital, technology, managerial skills, and market access needed for sustained economic growth and development. The move towards more open FDI regimes has been accompanied by a shift in many countries towards greater deregulation of economic activity and greater reliance on market forces in their domestic as well as external economies. The growing balance-of payment difficulties as well as decline in concessional aid have forced many developing countries to reassess their stances on FDI and have, taken substantial Foreign Direct Investment (FDI) is an important part of the massive private investment which is driving economic growth around the world, particularly in the past two 4

decades. FDI is being sought by many developing countries as a means of complementing the level of domestic investment, as well as securing economy-wide efficiency gains through the transfer of appropriate technology, management knowledge, and business culture, access to foreign markets, increasing employment opportunities, and improving living standards. Due to these advantages, policy makers have considered various incentives and policies to attract FDI, and to ensure its consistency with the domestic economic development objectives. The competition for the worlds FDI flows is fierce. Foreign private investors look for certain important pointers such as freedom to control investments, convertible currencies, greater privatisation, stock market reforms, greater political stability, and a legal framework for doing business. Apart from these general characteristics of wellfunctioning market economy, investments in infrastructure- particularly transport and telecommunications are also important. Thus, FDI flows where opportunities are ripe and where returns are safely realised. Evidence indicates that countries which offer safe and profitable investment opportunities successfully attract FDI. It has been observed that many developing countries (including India) are experiencing rapid growth and consequently development by opening up their economies to FDI under outward-oriented policies. Such policies create a climate favourable for FDI inflows, which bring with them modern managerial, production and marketing technologies- all of which are necessary for enhances in productivity and efficiency of firms at a national level. Like other developing countries, Pakistan too seeks to enhance the inflow of FDI to supplement domestic savings and investment and to benefit from the economy-wide associated gains of these financial resources. This approach is part of a broad strategy aiming at sustaining high rates of economic growth, increasing employment opportunities and improving living standards. However, since its 50 years of inception, matters have not developed so well. Indeed, up to now, Pakistan has attracted a small share of the total FDI flows to developing countries. The most profound effect has been seen in developing countries, where yearly foreign direct investment flows have increased from an average of less than $10 billion in the 5

1970s to a yearly average of less than $20 billion in the 1980s, to explode in the 1990s from $26.7billion in 1990 to $179 billion in 1998 and $208 billion in 1999 and now comprise a large portion of global FDI.. Driven by mergers and acquisitions and internationalization of production in a range of industries, FDI into developed countries last year rose to $636 billion, from $481 billion in 1998 (Source: United Nations Conference on Trade and Development.

Research Objectives: The study undertaken by us is an approach to evaluate the importance of FDI for our Economy in order to boost the investment environment. To find out the effects of FDI on other Economic indicators through economic growth. To find out the relationship between FDI and Economic growth.

Theoretical Fram ework:

Foreign D ir e c t Investment (FDI) Governm ent Policies

Economic Growth

(Independent Independent Variable ) Variable

M oderating M Variable oderating Variable

(Dependent Dependent Variables) Variable

CHAPTER 2: LITERATURE REVIEW

Foreign Direct Investment is viewed as a major stimulus to economic growth in developing countries. Its perceived ability to deal with major obstacles such shortages of financial resources, technology, and skills. This has made it the center of attention for policy makers in developing countries such as Africa, Pakistan. FDI refers to investment made to acquire a lasting management interest (usually at least 10 % of voting stock) and acquiring at least 10% of equity share in an enterprise operating in a country other than the home country of the investor. FDI can take the form of either green field investment (also called "mortar and brick" investment) or merger and acquisition (M&A), depending on whether the investment involves mainly newly created assets or just a transfer from local to foreign firms. The United States Department of Commerce defines Foreign Direct Investment (FDI) to include all foreign business organizations in which a U.S. Citizen, organization or affiliated group owns an interest of ten percent (10%) or more. This definition is limited in scope because it considers the share capital perspective of Foreign Direct Investments (FDI) in isolation of any consideration for the corporate control aspects. The United Nations on the other hand has defined Foreign Direct Investment (FDI) as investment in enterprise located in one country but effectively controlled by residents of another country. This definition not only considers Foreign Direct Investment (FDI) from an investment point of view, but also equally defines the status of corporate control. Foreign Direct Investment (FDI) is the distinctive feature of multinational enterprise hence; a theory of Foreign Direct Investment (FDI) is also a theory of the multinational enterprise as an actor in the world economy. Based on this theory, Foreign Direct Investment (FDI) is not simply (or even primarily) an international transfer of capital but rather, the extension of an enterprise from its home country into foreign host country. The extension of enterprise involves flows of capital, technology, and entrepreneurial skills and, in more recent cases, management practices to the host

economy, where they are combined with the local factors in the production of goods and services. Foreign Direct Investment (FDI) is growing faster than world Gross Domestic Product (GDP) and world trade, thus showing the rising importance of Foreign Direct Investment (FDI). Since the early 1980s, Foreign Direct Investment (FDI) outflows have grown three times faster than exports and four times faster than world output. This rising importance of Foreign Direct Investment (FDI) in the international economy reflects several factors amongst which are: a. International flow of capital reduces the risk faced by owners of capital by allowing them to diversify their lending and investments (Feldstein, 2000). b. The global integration of capital markets can contribute to the spread of best practices in corporate governance, accounting rules and legal traditions (Feldstein, 2000). c. Foreign Direct Investment (FDI) allows for transfer of technology (Feldstein, 2000). d. Economists tend to favor the free flow of capital across national borders because it allows capital to seek out the highest rate of return. e. Promotion of competition in domestic markets. In addition to the factors listed above, Foreign Direct Investment (FDI) has proved to be resilient during financial crisis. For instance in East Asian Countries, such investments were remarkably stable during the global financial crises of 1977-98. This is in sharp contrast to other forms of private capital flows portfolio equity and debt flows- which were subject to large reversals during the same period (Dadush, 2000& Lipsey, 2001). This resilience has led many developing countries to favor Foreign Direct Investment (FDI) over other forms of capital outflows furthering a trend that has been evident for many years. 9

Nigeria being a developing economy has not been any different from other developing economies in using Foreign Direct Investment (FDI) as a strategy for achieving economic growth and development. However, unlike countries like Malaysia, Nigeria in spite of its huge deposit of human, natural and material resources has failed to achieve rapid economic growth due to several factors, the principal of which is an unstable political environment occasioned by long periods of military rule. Under the military rule, Nigeria witnessed a decline in the influx of foreign investments because of various economic sanctions imposed on the country by the international community. There is a substantial empirical debate on the impact of foreign investment on economic development that utilizes a large-scale cross-national comparative framework. These authors use aggregate indicators of foreign investment and economic development with the country as the unit of analysis and the results from this research strategy are mixed and remain hotly contested. Much of the research finds that foreign investment has a deleterious impact on development. Chase-Dunn (1975) found a strong negative association between foreign investment and the rate of growth. In contrast, Bornschier and Chase-Dunn found foreign investment facilitates stimulates growth in short run but in the long run it dampens growth. Finally, there are a number of studies, which find that foreign direct investment does not have any effect on growth (Hein 1992; Dutt 1997). During the 1960s, with the exception of countries that were members of the socialist bloc, foreign direct investment was widely welcomed. Many of the newly independent countries of the Caribbean and Africa, in particular, embraced the views of W. Arthur Lewis on the need to woo foreign investors whose role in industrial development for the domestic market was regarded as central (Barclay: 2002; Mytelka. 1989). In rare cases, small market developing country, such as Singapore, with an historical tradition as a commercial hub in its region, sought to attract TNCs with an export-orientation (Wong: 2001). Countries in the developing world also introduced more restrictive policies towards foreign direct investment in the 1970s and the number of nationalization, notably in the oil and gas industry and the mining sector, increased dramatically. Constantine Vaitsos, 10

attributed the growing interest in regulating direct foreign investment in the Latin America countries in this period, to the emergence new social and political forces at the center of economic and political decision-making that were favorable to a nationalistic approach to industrialization (Vaitsos: 1973). He situated these within a rising domestic industrial class whose interests were opposed to those of foreign firms. Ted Moran, viewing this from the perspective of the nationalization of copper in Chile, located these new social forces within the state and argued that the ability of the state to move towards greater monitoring and regulation resulted from a learning process and the increase in domestic skills and confidence to which it had given rise. (Moran: 1974). Investment is a critical element in the socio-economic development of a country. Quite naturally, every government seeks an increased inflow of investments as a main plank of its development strategy. Pakistan is not an exception to this practice. Normally, national savings are the main source of investment in a country. However, at 15 per cent of gross domestic product (GDP), the national savings remain at a low level in Pakistan. The other source of investment is the flow of foreign resources in the shape of aid, loans and direct investment. At a time when foreign assistance is dwindling and private commercial borrowings are becoming costly and uneconomical, foreign direct investment (FDI) turns out to be a preferred alternate choice or mode for investment, especially when it is also impregnated with multiple benefits in the shape of technology transfer, skill development, induction of new management and aggressive marketing techniques. The successive governments in Pakistan have been trying to woo foreign investments by offering various incentives. In the 1990s, the government further liberalized the policy and opened the sectors of telecommunications, energy and insurance to FDI. However, due to rapid political changes and inconsistency in policies the level of FDI remained low. One must give credit to the present government for taking steps, which resulted in increasing the inflow of FDI in Pakistan by 71 per cent in 2003 than their level during the preceding year 2002, the total stock of FDI, in Pakistan, was $6.4 billion, which

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exceeded by $820 million during 2003. Of late, the prospects for FDI in Pakistan have further brightened (Masood, 2003). As part of the country's privatization process, Pakistan is setting up a Gas Regulatory Authority (GRA) and the Petroleum Regulatory Board (PRB), which will separate out government functions from state-owned companies to be privatized. Pakistan's government hopes to reap significant revenues from these privatizations over the next several years. The two most significant foreign oil firms in Pakistan are BP and Eni. BP operates 43 fields in Pakistan and had reported average production of 25,877 bbl/d in 2003. Other firms include BHP Billiton (Australia) OMV (Austria), Petronas (Malaysia) and Premier Oil (UK). Oil sector reforms in Pakistan are generally on track, but the privatization of several firms, including Pakistan State Oil (PSO), continues to be postponed. The government's divestiture of its 51% stake in PSO to a strategic partner has been planned for several years. PSO holds a 60% domestic market share in diesel fuel and has more than 3,750 retail outlets. Deregulation of prices for petroleum products is being pursued in parallel with the privatization of PSO. The oil, gas, petroleum refining and financial sectors attracted 58 percent of the total foreign direct investment in first seven months of this fiscal, a Board of Investment (BOI) official said. The oil and gas sector fetched $119.20 million, or 35.1 percent, worth of foreign direct investment in the July to January period this fiscal followed by petroleum refining with 12.8 percent or $43.40 million in FDI while financial business received 10.1 percent or $34.20 million. The textile sector attracted 7.5 percent or $25.6 million in foreign direct investment, trade got 4.8 percent or $16.20 million, and construction accounted for 4.7 percent or $16.10 million while other sectors received 25 percent or $84.80 million worth investment during the period under review. The inflow of foreign direct investment (FDI) dropped by 43.07 or $256.9 million in July to January 2003-04 against the corresponding period of 2002-03. 12

The Board of Investment (BOI) officials are optimistic that from next month the inflow of foreign direct investment would show improvement as the Aga Khan Fund for Economic Development (AKFED) is making payment for half the bid amount for acquiring 51 shares of Habib Bank Limited (HBL) along with management control. Staff Report (Daily Times 2 Sep 2004) Most investment has taken the form of acquisition of existing assets rather than investment in new assets ("greenfield"). Mergers and acquisitions (M&As) have become a popular mode of investment of companies wanting to protect, consolidate and advance their positions by acquiring other companies that will enhance their competitiveness. M&As are defined as the acquisition of more than 10% equity share, involve in transfer of ownership from domestic to foreign hands, and do not create new productive facilities. Based on this definition, M&As raise particular concerns for developing countries, such as the extent to which they bring new resources to the economy, the denationalization of domestic firms, employment reduction, loss of technological assets, and increased market concentration with implications for the restriction of competition. Research conducted by UNCTAD for the World Investment Report 2000 revealed that, for the host country, the benefits of M&As are lower and the risks of negative effects are greater when compared to Greenfield investments, especially at the time of entry over the short term. An UNCTAD 1999 research on M&As concluded that: FDI through M&As correspond to a smaller productive investment than Greenfield as the financial resources do not necessarily go into increasing the capital stock, FDI through M&As is less likely to transfer new or better technologies than Greenfield investment, FDI through M&As do not generate employment at the time of entry into the host economy, and may lead to lay-offs as the acquired firm is restructured, FDI through M&As can reduce competition, and may be used deliberately to reduce or eliminate competition and

13

 Over the longer term, cross-border M&As are often followed by sequential investment that do increase the capital stock. Ideally the purpose of investment is to benefit both the investing company and the host economy. However M&As are likely to result in profit for the investing firm but destruction of the domestic industry. Evidence shows that in some cases, foreign investors enter a market solely with the purpose of closing down domestic competitors and establishing a monopoly in the economy. The most noteworthy policy mechanism against such practices and which serves to protect the domestic economy is a competition policy. Other risks involve utilizing resources which may be focused on seeking investments that do not materialize; attracting the wrong types of firms; and assuming the governments ability to foresee which types of FDI are likely to have the greatest ability to integrate and link with local investment. Such risks necessitates that investment promotion agencies work closely with other parts of government to identify and create comparative advantages that are sustainable and that developmental policies do not offset each other. Targeting needs to be a continuous process and should not be taken as a once off initiative. A second reason for engaging in investor targeting, that attracts export-oriented FDI, is the increased competition for this kind of investment. Due to the fact that some countries are better known to foreign investors in their capabilities to offer substantial domestic markets, the smaller less well-known economies have to work twice as hard in their targeting efforts, and A third reason relates to cost-effectiveness. A focused approach to attract export oriented investment is likely to be less costly than the one in which an IPA tries to attract new investments in all sectors at the same time. With this background information regarding the importance of foreign direct investment and its up yielding opportunities, this research focuses on the effect of foreign direct investment on economic growth of Pakistan. REVIEW OF FDI POLICY:14

The policies of host countries have an important influence on foreign investment decisions. Host countries can adopt policies of stimulating foreign investment or they can restrict foreign participation in their economies in various ways. Pakistan inherited an agricultural economy on independence in 1947. The industrial capacity was negligible for processing the locally produced agricultural raw material. This made it imperative for succeeding governments to attend to the need of creating manufacturing capacity in the country. In order to achieve this objective, the industrial polices were laid down from time to time with various combinations and mixes of public and private sectors. Private sector was the main vehicle for industrial investment during the I950s and 1960s and the involvement of the public sector was restricted to 3 out of 27 basic industries.' By the late 1960s the economy was largely dominated by the private sector in important areas like banking, insurance, certain basic industries and international trade in major commodities. Interestingly, the services sector was reserved for local investors and foreign investment was not allowed in the field of banking, insurance and commerce. This policy was, however, liberalized and foreign banks were allowed to open branches in Pakistan. The pendulum swung to other extreme in the 1970s when government resorted to large-scale nationalization of industries, commercial banks, development financial institutions, and insurance companies which shattered private sectors confidence. The status of the public sector was upgraded from catalyst and gap filler to a dominant player in the economy. All foreign investment was, however, exempted from the purview of nationalization. After the dismal performance of industrial sector following the 1972 nationalization, a change occurred in government's approach towards the role of public and private sector in September 1978. The role of public sector was restricted to consolidating the existing enterprises and further investment in this sector was strictly restricted. Nevertheless, industries like steel, fertilizers, cement, petroleum refining and petrochemicals, automotive equipment, and engineering remained in the realm of

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public sector. The private sector was, however, permitted to participate in these fields as well. The industrial policy statement of 1984 not only accorded equal importance to public and private sectors but also encouraged private sector to come forward but the process of privatization was not initiated. Had this been initiated, Pakistan would have attracted considerable amount of foreign direct investment. The public sector retained its role in major industrial areas which obviously discouraged the inflows of FDI. The procedure for grant of permission for setting up an industry was somewhat restrictive. Clearance of the Central Investment Promotion Committee and approval of the Federal Government were required for the following categories of projects.
'

The three basic industries were (i) arms and ammunition; (ii) generation of hydro-

electric power; and (iii) manufacturing of railway wagons, telephones, telegraphs and wireless apparatus. 'It was an ideal condition to initiate the privatization process to attract FDI because the economic fundamentals were strong. For example, during the first half of the 1980s (1980-81-1984-85) the real GDP grew at an average rate of 6.7 percent per annum, manufacturing by 9.5 percent, investment and saving rates averaged 17.2 percent and 14.0 percent respectively, rate of inflation averaged 7.8 percent, budget deficit as percentage of GDP averaged 6.3 percent while current account deficit as percentage of GDP averaged 3.8 percent. Beside strong economic fundamentals there was no serious law and order problem in the major growth poles of the country. And above all, notwithstanding military dictatorship, there was political stability in the country. After all many countries in East Asia grew at a much faster rate and succeeded in attracting FDI under the leadership of military dictator.

In order to encourage FDI in export-oriented industries, an Export Processing Zone (EPZ) was set up in Karachi. Apart from foreign investors, overseas Pakistanis were also encouraged to invest in industrial projects in the EPZ on the basis of nonrepatriable investment. The concessions and facilities offered by the EPZ included duty free import and export of goods, tax exemption, etc. The foreign investment was also entitled to the facilities such as foreign nationals employed in Pakistan were

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permitted to send monthly remittances to the country of their domicile up to 50 percent of net income, and foreign nationals on returning from Pakistan were permitted to transfer their savings. Adequate legal framework for foreign investment was provided in the form of Foreign Private Investment (promotion and protection) Act, 1976 and the Protection of Economic Reforms Act, 1992. These Acts provide for security against expropriation and adequate compensation for acquisition. These Acts also guaranteed the remittance of profit and capital, remittance of appreciation of capital investment and relief from double taxation in cases of those countries with which Pakistan has agreement for Avoidance of Double Taxation. Despite these incentives, the highly regulated nature of Pakistan's economy proved a deterrent to the inflows of the FDI. Following elements discourage the foreign investors:(i) A highly regulated economy with public ownership, industrial licensing, and price controls. (ii) An inefficient financial sector with mostly public ownership, directed, credits and segmented markets. (iii)A non-competitive and distorting trade regime, with import licensing, bans, and high tariffs.

Pakistan began to implement a more liberal foreign investment policy as part of its overall economic reform program during the end of the 1980s. Based on the primary of the private sector a new industrial policy package was introduced in 1989. A number of policy and regulatory measures were taken to improve the business environment in general and attract FDI in particular. A Board of Investment (BOI), attached to the Prime Minister's Secretariat, was established to attract FDI. A `one-window' facility was established to overcome difficulties in setting up new industries. The new industrial package opened up virtually all Pakistan's industrial sectors to foreign investment. The requirement for government approval of foreign investment was removed with the exception of few industries such as arms and ammunition, security printing, currency

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and mint, high explosives, radioactive substances, and alcoholic beverages (in fact, these industries were also closed for domestic private investors). In all industrial sectors, other than those indicated above, foreign equity participation of up to 100 percent was allowed and that foreign investors were also allowed to purchase equity in existing industrial companies on a repatriable basis. There was also no requirement of having local partners. All the investors, whether domestic or foreign, were required to obtain No Objection Certificate (NOC) from the relevant provincial government for location of the project. Thus, the physical location of the investment was effectively controlled by the provincial government which was considered a major bottleneck in speedy industrialization. At present, an NOC is only required if foreign investment is envisaged in the areas which are in the negative list of the relevant provincial government. According to the authorities, there are only a small number of areas which are on the negative list of the provincial governments. The foreign investors in the past were not free to negotiate the terms and conditions of payment of royalty and technical fee suited to the requirements of foreign collaborators for transferring technology. Later this restriction was removed and the investors were allowed to negotiate the terms of conditions as suited to them as well as acceptable to the multinationals wishing to transfer the requisite technology. The Government has been stressing the need for attaining self-reliance in the engineering and technical industries since 1960. In this regard a deletion policy with reward and penalty was prepared by the government to encourage and boost indigenization with a view to ensure transfer of technology. The Deletion Committee of the Engineering Development Board (EDB) monitors the progress to see whether the deletion policy is being followed properly. However, the requirements are not rigidly followed by the industrial units and the EDB usually maintained a lenient attitude towards the defaulting industries giving them chance to improve their performance in the future. In fact, the reward and penalty system in deletion policy has never worked in reality. The US has been the single largest source (32.6 percent) of FDI in Pakistan over the last 17 years followed by UK (14.3 percent), UAE (11.4 percent), Japan (5.7 percent), and 18

Germany (5.2 percent) (See Table 3). During the post-reform period the shares of the US and the UK further rose to 41 percent and 16.2 percent respectively while those of UAE declined to 5.3 percent; and Japan and Germany remained more or less unchanged. Components of Foreign Direct Investment:The components of FDI are equity capital, reinvested earnings and intra-company loans: Equity capital:The foreign direct investor's net purchase of the shares and loans of an enterprise in a country other than its own. Reinvested earnings:The part of an affiliates earnings accruing to the foreign investor that is reinvested in that enterprise. Intra-company loans:Short- or long-term loans from parent firms to affiliate enterprises or vice versa. In the case of banks, deposits, bills and short-term loans are not included. FDI in the context of its determinants:Study shows that for foreign investors profit is the prime motive and not the objective of growth. The higher the rate of return of undertaking a project, the larger the volume of FDI into the host country. The study also shed light on the determinants of foreign direct investment. Market imperfections and custom duties can have a strong bearing on the pattern of FDI inflows. Apart from that, distortions in exchange rate can also play a vital role in determining the course of FDI. For instance if the exchange rate is undervalued it benefits the foreign investor whereas the local investors have no such incentive to invest abroad.

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It has been examined that the determinants of FDI inflows for the seven countries of East Asia and South East Asia. In his model of derived demand he included Indonesia, South Korea, Malaysia, Singapore, Taiwan and Thailand. In his empirical analysis, he used Cobb-Douglas cost function which was restricted and constant elasticity of substitution product demand. He used time series data for these countries for the period 1960-87. FDI was measured in terms of net investment divided by that country's deflator for fixed capital formation. The estimation results show that prices and costs affect FDI inflows. Study has also been conducted to measure the elasticity of FDI. The sign of the elasticity of the FDI with respect to host country wages was negative. However, the elasticity of FDI with respect to export price has positive sign in six of seven countries As far as the relationship between domestic investment and foreign investment is concerned, in case of South Korea, Malaysia and Singapore, it was positive and statistically significant. For Philippines it was not significant. There is no such relationship between Taiwan and Thailand. The results also suggest that the greater the costs within the investors' home countries, the greater the volume of FD1 in host countries. The FDI inflows are found to be less elastic with respect to the cost of capital than to wages though this may reflect difficulties in measuring capital. Apart from that, the estimation results also show that a greater share of FDI is directed toward places with major export market and high domestic demand. Perhaps, the most important finding of this study is that there is a positive relationship between domestic demand. Perhaps the most important finding of this study is that there is a positive relationship between domestic investment and foreign investment in majority of the countries. It has been emphasized on the role of political factors in determining the course of FDI. Two factors strongly influence the pattern of FDI in developing countries. These two factors are inefficient and corrupt political system and restrictive trade policies of the government to give protection to local industries. As regards the impact of volatile political situation, the evidence of the study shows mixed trends. In studies carried out in (1979) that places more emphasis on economic factors and played second fiddle to political factors. This study includes 25 countries from Africa, 20

Asia, and Latin America for the period 1965-1967. It was found that economic indicators were more important to attract FDI inflows than political considerations. Among the economic indicators, there was a positive relationship between FDI and GNP. High growth rate holds out the hope of rapid economic development. On the other hand, higher price level has negative influence on FDI inflows. A high inflation rate does not augur well for the economy. On the external front, since large trade deficit is also not a good omen, it adversely affect FDI inflows in the economy A number of location factors that might influence the scale and timing of manufacturing Foreign Direct Investment (FDI) into Pakistan for the period 1972-95. To analyse the location factor for FDI, he estimated a simultaneous model for explanatory variables. In his study, he attempted to test empirically the significance of location factors for FDI. The findings of the study reveal that there is a great need for improving the location factors in Pakistan to attract both the market seeking as well as efficiency seeking FDI. A more developed manufacturing sector, favourable exchange rate, rationalized trade policy, appropriate wage rates and the existence of civil rule accompanied by political stability are the main areas of concern in providing an attractive investment environment to MNC's in Pakistan. The existence of real competition among the developing countries, to attract FDI makes the MNC's more selective about the choice of location for their investments. The most successful are the countries which provide the most attractive location factors. In this study as the author mentioned that investment incentives and labour productivity have not been included in the study. But in our study we have also included openness policy and structural shift variable as the determinants of imports, exports and for FDI.

ESTABLISHMENT OF BOARD OF INVESTMENT:In order to tap the opportunities for investment in Pakistan, and to meet the challenge of speedy industrial 'and economic development of the country a Board of Investment has been established to act as a "One Stop Shop". The Board is performing the facilitating and coordinating role both for domestic and foreign investors to meet all their genuine requirements. Board of Investment redresses the problems faced by the private sector

21

investors, keeping in view the fact that the private sector should spearhead the drive for industrialization with government playing a complementary role of developing infrastructure facilities and taking such policy measures as are conducive to healthy growth of industries. The Board has also launched a world-wide campaign of investment promotion and projecting Pakistan as an investor friendly country. As a result of these measures, the foreign direct investment has progressively increased in the 1990s compared to previous years. {The table 5.3 reflects the pattern of FDI inflows into Pakistan during the period 1984-1997}.

Composition and quality of Foreign Direct Investment in Pakistan:-

The composition and quality of foreign direct investment in Pakistan reflects its relative stages of industrial development and the impact of past policies. Thus, in the 1980s FDI was heavily concentrated in the services sector reflecting the role of Middle East investments in property, hotels and finance. Pakistan's performance in attracting FDI in the manufacturing sector has been dismal, It should be remembered that manufacturing FDI which is classified as market seeking FDI is the most important. Countries attracting this type of investment have experienced high rates of economic growth. Due to its limited pulling power Pakistan's industrial sector has far less depth and range than other developing countries.

As defined earlier, that the components of FDI are, namely, cash brought in, capital equipment brought in and re-invested earning. Over the last 15 years (1980-1994) cash brought in has been the largest of form FDI (56 per cent) followed by reinvested earnings (30 per cent) and capital equipment brought in (14 per cent). However, during the post reform period the shares of cash brought in and reinvested earnings have declined while that of capital equipment brought in has increased.

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CHAPTER 3: METHODOLOGY

Population:This particular studys population size is from year 1947 to 10-11(May).This study is based on foreign direct investment figures made in Pakistan and economic growth figures.

23

Sample:The sample size for this study is from the year 1998-99 to May 10-11(May). The information has been obtained regarding the FDI and economic growth figures from the Board of Investment, Statistical Bureau of Pakistan, Pakistan Institute of Development Economics (PIDE) Quaid-e-Azam University, Islamabad, and Bulletins and from different other sources as journals and web sources

24

Instruments & Measures:Due to the nature of research, instrument to obtain information from the sources is not based on any questionnaire. Whole information is obtained from different sources i.e. Board of Investment, Statistical Bureau of Pakistan and Pakistan Institute of Development Economics (PIDE) Quaid-e-Azam University, Islamabad. Bulletins and from different other sources as journals and web sources. For the purpose of measurement of relationship between FDI and Economic growth, we have applied the Correlation test to measure the intensity/ nature of relationship. Correlation:Correlation, like covariance, is a measure of the degree to which any two variables vary together. In other words, two variables are said to be correlated if they tend to simultaneously vary in some direction. If both variables tend to increase (or decrease) together, the correlation is said to be direct or positive, e.g. the length of iron bar increases with increase in temperature. If one variable increase and the other decreases, the correlation is said to be negative or inverse, e.g. volume of gas decreases as the pressure increases. It is worth remarking that in correlation, we assess the strength of relationship (or interdependence) between two variables; both the variables are random variables, and they are treated systematically, i.e. there is no distinction between dependent and independent variable. For the majority of these measures, the correlation is expressed as a coefficient that ranges from 1.00 to -1.00. A value of 1 is indicating a perfect linear relationship, such that knowing the value of one variable will allow perfect prediction of the value of the related value. A value of 0 is indicating no predictability by a linear model. With negative values indicating that, when the value of one variable is higher than average, the other is lower than average (and vice versa); and positive values indicating that, when the value of one variable is high, so is the other (and vice versa).

Pearson Correlation Coefficient

A numerical measure of strength in the linear relationship between any two variables is called the Pearsons Correlation Coefficient or Total Correlation. The sample linear correlation for n pairs of observations (Xi, Yi) usually denoted by letter r, is defined by: 25

r= (X X) (Y-Y) (X- X)2 (Y-Y)2 It is important to note that the r=0 does not mean that there is no relationship at all but it actually represent non-linear relationship among variables.

Procedure
The relationship between the FDI and Economic growth was measured by collecting the figures of foreign direct investment and by collecting the figures of Economic growth. This study is based on a procedural working that includes the following steps: Collection of information regarding FDI in Pakistan to have sound base and the literature review. Collection of information regarding the investment policies in Pakistan. Collection of information regarding Economic growth of years from 1998-99 to 2007-08(May).

Application of test (Pearson Correlation) on the figures obtained.

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CHAPTER 4: FINDINGDS
WHY LOW INFLOW OF FDI IN PAKISTAN? The developing countries have experienced rapid growth in the flow of FDI in recent years. The inflow of FDI in Pakistan has however, remained far from encouraging despite numerous highly attractive incentives offered to foreign investors, particularly after the liberalization program initiated since 1991-92. Attractive incentives apart, Pakistan with a population of about 135 million offers a vast potential for the marketing of both consumer and durable goods. At the same time Pakistan with its geographical contiguity with the Central Asian Republics, also has the potential to serve as a gateway for foreign investors for extending their marketing activities into the countries of the region. By looking at the amount of FDI Pakistan has received in recent years it appears that the incentives and above-mentioned two factors have resulted in limited success. Why Pakistan could not attract FDI like those of China, Thailand, Malaysia, Hong Kong and Indonesia despite offering competitive incentives, geographical location and

27

relatively large size of population? This section attempts to provide answers to this query. The fundamental requirement which governs foreign investment revolves around ten main factors, these might be called the ten checkpoints or ten commandments. These factors are political stability; law and order situation; economic strength; government's economic policies; government bureaucracy; local business environment; infrastructure; quality of labour force; quality of life; and welcoming attitude.10 An attempt is made to consider the conditions that have prevailed in Pakistan with respect to above mentioned ten factors. Political Stability:This factor is essential to attract foreign direct investment because it creates confidence in the. foreign investors." In the absence of political stability there would be political turmoil which could wipe out overnight even the most lucrative investments and endanger the lives of personnel. Many investors have paid a heavy price for overlooking or ignoring this factor
in

other parts of the world [Jegathesan (1995]. Lack

of political stability has been the hallmark of Pakistan during the last eight years (198896). Three elected governments were dismissed on various charges while four caretaker regimes remained in power for 90 days each over the last eight years. Such a frequent change in government accompanied by abrupt changes in policies and programmes are hardly. congenial for foreign investors. Law and Order Situation:Unsatisfactory law and order situation keep the prospective foreign investors on the sidelines. Safety of capital and the security for the personnel engaged in the project are essential ingredients which govern foreign investment. Unfortunately, the law and order situation has remained far from satisfactory in the major growth poles of the country. Karachi, the largest industrial and commercial centres and the only commercial port of the country has remained disturbed in varying degree since 1989. In recent years the law and order situation has also deteriorated up their businesses in Pakistan.'2
in

the Punjab province. Notwithstanding

attractive incentives offered to foreign investors this factor has discouraged them to set

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Economic Strength:Investors would not want to invest in a country where the economic fundamentals are so weak that it is unpredictable what the government would do next to shore up a sagging economy. A country that has sound economic fundamentals is not likely to make drastic or negative changes. The investor is assured of a growing economy, and of increased opportunities for business, as more government development projects and private sector investments put purchasing power in the hands of the people. Increased purchasing power means increased positive multiplier effects on the economy and a source for stability. Furthermore, foreign investors are unlikely to increase their participation in economies that are expected to remain affected by foreign exchange scarcities for several years into the future [UNCTC (1985)]. As compared with the decade of the 1980s Pakistan's macroeconomic imbalances has worsened in the 1990s, along with the slow down of economic activity. As against an annual average growth rate of 6.4 percent in the 1980s the real economic activity (GDP) has slowed down to an average of 4.7 percent during the first seven years of the 1990s. In particular, the large-scale manufacturing has slowed down to an average of 3.5 percent as against almost 8.0 percent during the 1980s. Fiscal deficit averaged 6.9 percent of GDP, the rate of inflation remained in the double-digit level and current account deficit averaged above 5 percent of GDP during the first seven years of the 1990s. Thus, attractive incentives notwithstanding, the macroeconomic imbalances and slowing down of economic activity must have discouraged foreign investors to increase their participation in Pakistan Government's Economic Policies:Foreign investors (in fact, all investors) are concerned about government policies that could in one way or another affect business-trade and investment. In particular, the inconsistent economic policies discourage foreign investors in undertaking projects of medium-to-long-run duration. Pakistan's track record in maintaining consistent economic policies has been poor. The abrupt changes in policies with a change in government as well as a change in policy within the tenure of a government have been quite common in Pakistan. Pressures to raise revenues (for fiscal consideration), and other conflicting objectives, have led to inconsistencies in investment and 29

industrialization policies, and an ad hoc and changing incentive system. Revenue measures are not at all in harmony with the industrial policies. Government Bureaucracy:This could be the biggest `burden' in any investment environment. It does not matter how efficient the government thinks its investment machinery is; what is critical is the perception of businessmen, especially those already in the country. Do businessmen feel that they have the support of government officials in their efforts to set up and operate efficient business units, or do they feel that they have to `fight' the government to get projects off the ground? The general perception of businessmen in Pakistan is that there exist a large gap between the policies and their implementation [Shirouzu (1993)]. The implementation of policies has been slow and the bureaucracy has not responded to the initiatives with conviction. Such perception about the slow implementation of policies is not at all conducive to attract FDI in Pakistan.

Local Business Environment:This covers many factors, including the availability of local lawyers, secretarial service, accountants, and architects and building contractors, local consultants etc.-all required both before and during the life of a project. Also, there is the question of the availability of ancillary and supporting industries, their quality, and their cost. Another question would be the availability of suitable joint-venture partners, and whether there are lists of potential partners that the investors can choose from. But most importantly, foreign investor need to know if local businessmen are investing in their own country. A satisfied foreign investor, operating an efficient, growing enterprise and re-investing in that country is the best testimony to the country's "investor-friendly" environment. The business environment in Pakistan has fluctuated from one government to another. The political stability, law and order situation, and government policies determine the business environment of the country. The performance of these three elements has been far from satisfactory and have played an important role in discouraging foreign investors to undertake investment initiative in Pakistan.

30

Infrastructure:The availability, reliability, and cost of infrastructure facilities (power,

telecommunications, water supplies) are important ingredients of a business environment conducive to foreign investment. Pakistan still lacks in efficient infrastructure, more particularly it faces grave power shortage and the existing power supply system is faulty which causes frequent power break-downs, load-shedding and big voltage fluctuations, that are bound to damage electronically controlled instruments and equipments, on the one hand and production losses on the other. Pakistan also compares unfavorably in infrastructure facilities with other developing countries that have attracted higher levels of foreign investment. Pakistan has only 18 percent of paved roads in good condition as against 50 percent in Thailand, 31 percent in Philippines, and 30 percent in Indonesia. Pakistan's extensive but poorly managed railway system does not make good for this disadvantage. Telecommunication is another bottleneck: there are only 10 telephones per thousand persons in Pakistan compared with 31 and 112 in Thailand and Malaysia, respectively. Pakistan's amount of electricity produced per capita is higher than Indonesia's (435 kwh as against 233 kwh), but ranges from one fourth (Malaysia) to one half (Thailand) of the other two countries.
'

In most cases the urban infrastructure is grossly inadequate. Only 50 percent of population have access to safe drinking water as against 81, 72, and 78 percent in the case of Philippines, Thailand and Malaysia, respectively. Labor Force:A technically trained, educated and disciplined labour force along with country's labour laws are critical factors in attracting foreign investors. Pakistan has been facing acute shortage of technically trained and educated labour force, especially in middle managerial positions and engineering cadre which may have discouraged foreign investors. In particular, Pakistan is at more serious disadvantageous position in terms of education and health indications as compared with other developing countries that have attracted FDI at a much higher levels. Pakistan's adult illiteracy rate is 62 percent as against 17 percent for Malaysia, 16 percent for Indonesia, 5 percent for Philippines and 6 percent for Thailand. Only 80 percent of primary school age male children are enrolled in school (49 percent for female), and the lowest rate for the four reference 31
16

countries is 93 percent for Malaysia. Pakistan's expenditure on education accounts for only 1.1 percent of total expenditure as against 10 percent for Indonesia, 15.9 percent for Philippines, 21.1 percent for Thailand and 20.3 percent for Malaysia. It also has by
'8

far the worst indictors of public health among the five countries. With general level of education and health care being at such low levels, foreign investors may not find the workforce they need. Beside poor education and health indicators, Pakistan's labour laws are complicated and over protective which have discouraged job creation, inhibited business expansion and have frightened away much needed productive investment. Such labour laws have created unnecessary labour disputes posing problems for management and causing productivity losses which have also discouraged foreign investment in Pakistan.

Welcoming Attitude:The attitude that the country portrays to a foreign investor when he is in the country is very important. Ministers and top civil servants while on investment missions abroad encourage foreigners to visit their country-both as tourists and investors. However, is this attitude pervasive? Do all government officers, labour leaders, and opposition party politicians feel the same way? Have immigration and customs officials at the airports and other entry points been fully briefed to be made aware of the critical role they play in the entire investment promotion efforts? These attitudes play an important role in foreign investors' decision making. Although the high government officials and business leaders express their enthusiasm for inviting foreign investment, the lack of environment to accommodate foreigners and foreign investment prevails in Pakistan. The ancillary government agencies and officials seem to have a different and unsympathetic attitude toward foreign investors [Shirouzu (1993)]. The ten check points discussed above constitute an investment environment and can be classified into four "Cs", namely, cost, convenience, capability, and concessions. What is the cost of doing business in Pakistan? These include every factor that goes to make the cost of the product and those that increase costs unnecessarily. These also include the

32

social and other costs that companies and individuals must bear. How easy is it to do business in Pakistan (convenience of business, living, banking, travel, communications, etc.)? What is the capability of the infrastructure to sustain project needs, the capability of workers to meet productivity needs, the capability of the government machinery to respond to competitive needs? What concessions or incentives exist for foreign investors? These include tax holiday, export incentives, concessional funding, and other cost reducing or profit enhancing incentives.
02-03 03-04 04-05 05-06 06-07 0708(JulyMay) 3,943 5.8 559 1,261 2,135 4,485 8,416 Years 98-99 99-00 00-01 01-02 FDI 500 (79) 182 (8) Economic growth 4.2 3.9 1.8 3.1 4.7 7.5 8.6 6.6 6.8

Historical Data regarding Foreign Direct Investment (FDI) in Pakistan

33

Possible forecast if Foreign Direct Investment is raised to $20,000.

Years 98-99 99-00 00-01 01-02

FDI 500 (79) 182 (8)

Economic growth 4.2 3.9 1.8 3.1

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02-03 03-04 04-05 05-06 06-07 07-08(July-May)

559 1,261 2,135 4,485 8,416 3,943

4.7 7.5 8.6 6.6 6.8 5.8

If FDI increase to US$20,000 then economic growth may be predicted as 12.93737875

Possible Forecast on the basis of Historical Data, if FDI decreses to $10 only.

Years 98-99 99-00 00-01 01-02

FDI 500 (79) 182 (8)

Economic growth 4.2 3.9 1.8 3.1

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02-03 03-04 04-05 05-06 06-07 07-08(July-May)

559 1,261 2,135 4,485 8,416 3,943

4.7 7.5 8.6 6.6 6.8 5.8

If FDI decrease to US $100 M then economic growth will be 4.38559789%

CHAPTER 5: CONCLUSION
FDI inflows to developing countries have undergone fundamental changes during the past three decades. More recently, they have been influenced by rapid liberalization of financial markets and privatization of economic activity in developing countries. FDI inflows have increased in importance during the 1990s, becoming the single most important component of total capital flows to developing countries: their share in total flows increased from 21 per cent in 1991 to 56 per cent in 1998. It was against this backdrop that this study has been attempted to analyse the pattern of foreign direct 36

investment and its impact on economic growth and international trade. In addition, many other factors which are of immense importance in understanding the relationship between FDl, economic growth and international trade have also been discussed at length. To achieve a set of objectives as discussed in Chapter 1, we have employed the simultaneous equations model and in the framework of cointegration.. The main conclusions of the estimation results are: As regards the pattern of FDI in Pakistan, the evidence obtained suggests that changes in output level and economic growth are independent of the level of FDI inflows. In other words, it implies, that changes in output level are not influenced by FDI inflows. On the contrary, the nature of the relationship is such that economic growth leads to more FDI inflows. Economic growth is the key to promote FDI in the country. This argument rests on the fact that foreign investors invariably prefer to invest not only in large markets but also in economies which are experiencing high rates of economic growth. ii Another important feature of this study is the growing interlinkage between FDI and trade in Pakistan. This relationship has been analyzed by taking into account the determinants of exports and imports respectively. The close link between FDI and trade is demonstrated by the fact that exports and FDI are positively related to each other. A country attracting higher FDI inflows can boost its exports and thus achieve a higher level of economic growth. Imports, on the other hand, have negative sign which means that they affect FDI adversely and cause large trade deficits and balance of payments problems in the country. Our study also that export led strategy is a good recipe for economic expansion and have become the keystone of the economic progress. Thus, Pakistan can improve its growth prospects enormously by actively pursuing export led strategy to put the economy on an even keel.

37

The study also reveals that public policy can play an important role in maximizing the benefits that Pakistan could reap from FDI inflows. There are two kinds of power at issue. One is the positive power associated with increasing the attractiveness of the country to existing and potential investors. The other is the negative power associated with influencing investors to conform to certain standards and performance requirements. iv In terms of the positive power of the government, empirical analysis suggest that several policy areas are particularly important: macroeconomic stability, investment in physical and human capital infrastructure and openness. Given that FDI and trade are increasingly intertwined policies in these areas are obviously important. This raises the question of policy coherence. For instance, a policy of investment openness may not attract export creating investors when restrictive import policies are maintained. Where export creation is desired, open trade policies are becoming more important. This is of particular relevance for countries such as Pakistan, where attractiveness of FDI in the past was largely based on large and protected local markets.

v. lt is also observed that due to various opennes measures introduced in the 1990s FD1 in Pakistan has registered a marginal increase in the period under consideration but the volume is far less than warranted by its economic potential. From all this it follows that the issue of mutually supportive FDI and trade policy remains on the agenda. Pakistan's ability to enhance its share of globalized production and marketing will increasingly depend on the attractiveness for efficiency seeking FDI. The evidence from this study confirms that for investors policy coherence has critically important influence on their choices of location. vi The conclusions of the econometric analysis of FDI and economic growth can be misleading especially as regards the causality within the relationship. The positive 38

relationship can lead some people to believe that FDI generates economic growth. But our study finds that it is the other way round. Instead growth is a determinant of FDI. It is economic growth that attracts FDI. This conclusion regarding growth-FDI nexus is the focal point of our study and calls for a radical change in thinking among policy makers. It has important policy implications for the strategy of economic growth in Pakistan. Pakistan still relies heavily on foreign borrowing and Foreign Direct Investment to overcome its balance of payment problems and reduce its widening trade deficit. It is vehemently seeking FDI investment as an alternative to external borrowing. But the irony is that, Pakistan stands nowhere in attracting FDI viz-a-viz other developing countries. In 1997, it accounted for 0.2 per cent of world FD1 flows, 0.5 per cent of developing countries, less than one per cent of Asia and 16 per cent of South Asian countries. Notwithstanding, various stimulus packages for foreign investors and removal of obstacles to foreign investment, Pakistan's performance in attracting FDI has been lackluster at best. To further exacerbate the crisis, the financial contagion of 1997 in East Asia eroded investors confidence in Asian region and Pakistan was no exception. Economic sanctions imposed by some developed countries in the wake of nuclear tests of May 1998 as well as the complicated IPPs' (Independent Power Producers), issue did not help in restoring foreign investor's confidence. It must be pointed out that the first thing governing foreign investment is to honour commitment and the government must not renege on that. The IPPs' controversy reflects Pakistan's contradictory stand toward FDI. One the one hand, it introduces various reform packages to attract FDI. On the other hand, Pakistan backed out of its commitment with IPPS and thus discouraged foreign investors investing in Pakistan. It failed to realize the fact that confidence and credibility are created over years, but destroyed in a matter of minutes.

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