THE government is working hard to attract foreign investors and has been repeatedly assuring the people that things would soon change for the better. Foreign direct investment (FDI) is generally considered good, but one wonders if it is good enough to open up the entire economy for foreign investors. While it is true that FDI has the potential to transform economies, its impact on countries like Pakistan is multifaceted.

The tendency of foreign investors to repatriate profits to their home countries surely poses a significant challenge as it is bound to put a strain on the country’s foreign exchange reserves.

The impact of the targeted FDI on the country’s balance of payment (BoP) will vary, depending on the nature of investment. Projects oriented towards exports can yield positive outcomes by bolstering foreign exchange earnings. In such cases, profit repatriation will align with the inflow of foreign earnings, contributing to a favourable BoP position. However, investments geared towards the local market may exacerbate BoP deficits because repatriated profits will far outstrip foreign exchange earnings, which will lead to imbalances in trade and payments.

From a cost point of view, as any first year Business student will tell you, the cost of equity is always higher than the cost of debt. This has to do with several factors, including the fact that interest is recorded as an expense on financial statements, and so reduces a company’s tax burden.

Dividends, on the other hand, are subject to the full corporate tax rate. Other factors, such as investors’ risk perception, result in their expecting a higher return on equity than on debt.

That being so, in Pakistan’s case, FDI comes at a cost that is almost always higher than the cost of borrowing money.

To put it bluntly, if foreign money is needed, it is almost always cheaper, other factors being equal, to borrow it rather than to bring it in as FDI.

This consideration underscores the need for robust investment frameworks along with incentives to invest in export-oriented sectors to justify the higher cost of equity.

FDI, as such, presents a formidable opportunity for Pakistan’s economic transformation, yet its realisation hinges on prudent policymaking and strategic management. By navigating the various complexities of profit repatriation, BoP dynamics and cost considerations, the government of Pakistan can harness the potential of FDI while mitigating its inherent risks.

Ultimately, FDI is a double-edged sword that must be wielded calculatedly. Not all FDI is good. We would do well to remember that much while doing the calculations.

Nadeem Mumtaz Qureshi
Karachi

Published in Dawn, May 21st, 2024

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