Massive decline in FDI

According to statistics revealed by the State Bank of Pakistan (SBP), foreign direct investment (FDI) continued its decline during the first four months (July-October) of the current fiscal year: from 1.329 billion dollars in the comparable period in 2008-09 to 707.7 million dollars, reflecting a massive decline of 46.76 percent. The reason for this decline is mainly two-fold.
The worsening law and order situation in the country, which obviously militates against the inflow of FDI, coupled with the perception of poor governance, recently endorsed by the Transparency International report where Pakistan slipped by five paces in the global corruption index. Challenging the veracity of the report by the Interior Minister Rehman Malik is hardly likely to change global perception, though Prime Minister Gilani's directive to the Finance Minister to undertake an inquiry into the country's poor performance in the TI index may well be the first step in the right direction.
Apart from these two major factors there are a number of other structural challenges that would act as a major deterrent to FDI. These include the continuing demand-supply gap in energy, which is compromising the rise in our national output and the high cost of borrowing.
At the same time, foreign portfolio investment surged by 66% or in absolute terms from 173.9 million dollars, in July-October 2008, to 288.4 million dollars in the comparable period this year. There is little doubt that the government would take credit for this increase and insist that it is a harbinger that its economic policies are bearing fruit. Critics may well disagree and point to the fact that the Asian financial crisis that led to the tumbling of stocks in the South East Asian tigers was attributed rightly to the almost overnight withdrawal of portfolio investment. In other words, no country can be complacent over an unprecedented rise in portfolio investment and the focus must be on attracting FDI.
However, at the present moment in time, the country is suffering from a decline in private sector investment, which is a more immediate problem that needs to be tackled by the country's economic managers relative to FDI. A rise in domestic private investment may well be the yardstick, used by international players, as indicative of the existence of a business environment conducive to their own entry into the arena.
The structural issues, by definition, are having a greater negative impact on domestic productivity than law and order and poor governance. However, it is unfortunate that while the Ministry of Water and Power was forced to abandon its rental power projects, as a short to medium term measure, to meet the energy shortfall amidst criticism of lack of transparency in the contract awarding process; yet the ministry has not replaced it with any other proposal. In addition, the Governor of SBP has stated recently that interest rates will remain high. While he did present some economic rationale for this, analysts are agreed that it was the International Monetary Fund (IMF) that insisted that the cost of borrowing in Pakistan must remain high - a condition which the SBP is meticulous complying with.
The country has learned that the IMF does allow extensions in enforcing time-bound action plans, if it is convinced about the efficacy of a deferral, based on the evolving macroeconomic environment. The Minister of Finance recently convinced the IMF to delay the elimination of electricity subsidies. Thus the question is why did not the Governor SBP propose a similar deferral with respect to the high cost of borrowing? Surely he could have argued that for the private sector to take off, the cost of borrowing must be allowed to decline.