Foreign direct investment (FDI) is investment in existing or new facilities involving control over a foreign enterprise. It is generally associated with the over sees activities of multinational corporations (MNCs).

A developing economy is characterized by capital deficiency, low level of industrialization and a narrow industrial base, low capital-labour ratio, large disguised unemployment, lack of technical and managerial skills, culture of inefficiency and overwhelming reliance on export of primary goods. FDI can be an important instrument of overcoming these structural weaknesses necessary for transition towards development.

Probably the most important role of FDI in a developing economy is the supply of capital, as capital deficiency is the fundamental problem in case of a developing economy. Capital formation depends on investment, which, however, implies sacrifice of consumption.

The disposable income that is not consumed is saved and channelised into investment through capital and money markets. The higher the level of savings, the higher the level of investment and thus faster the rate of capital formation. In case of a developing economy, the level of domestic savings falls well below the desired level -- the main reason being low per capita income.

In case of Pakistan, for example, domestic savings account for less than 20 per cent of GDP. The gap is to be filled by transfer of resources from outside. FDI is one, and arguably, the most important, of these sources.

Because of their tremendous strength, MNCs have huge capital resources at their disposal in terms of both equity and loans. These resources can be used to supplement domestic savings.

The role of foreign investment as an impetus to economic development depends in the main on two factors: the magnitude or level of investment and the direction of investment.

Since the purpose of attracting foreign capital is to supplement the domestic resources, the level of foreign investment must be such that it fills the gap - between domestic savings and the desired level of investment. The gap in case of developing economies is rather high. In case of Pakistan, for example, domestic savings constitute only 15-18 per cent of GDP.

In order to increase the level of foreign capital inflows, developing countries liberalise their trade and investment regime by relaxing governmental controls and offering a number of financial and trade incentives like tax concessions and tariff reductions.

Though exceedingly important, the right level if foreign investment is not enough. What also matters is the direction of investment, that is, in which sectors it is made.

For this purpose, the host country has to pursue active liberalization policies. For instance, to overcome trade deficit, the host country may encourage greater investment in export-oriented sectors or require foreign enterprises to export a particular percentage of their locally made goods. To increase employment generation, special packages may be announced for investment in labour intensive industries.

To ensure that FDI stimulates domestic economic activity, the host government may, make it mandatory for the foreign investor to use a certain amount of locally made inputs in production of final goods.

This is called local content requirement. For up-gradation of technical and managerial know-how, the recipient country may require the foreign enterprise to transfer technology to domestic industry or to employ a particular proportion of local talent in managerial and technical positions.

To broaden the domestic industrial base and give a momentum to industrialisation, investment in only those sectors may be opened to foreigners which are vital to the development of other sectors.

One problem with such measures however is that they may become an impediment to FDI inflows. Secondly, under the Agreement on Trade Related Investment Measures (TRIMs) of the WTO, many of such,, measures are disallowed. A third problem is that when countries conclude international investment agreements, they.

Insist that their enterprises investing abroad should be given greater freedom in terms of choice of industries and production and marketing operations. Let's have a glance now at the level and direction of FDI in Pakistan during last 10 years.

Total FDI inflows into Pakistan from 1993-94 to 2003-04 stand at $6.68 billion which come to $610 million a year. This of course is far, below the desired level. The highest FDI-$1.1 billion-was recorded in 1995-96, which was mainly due to agreements with Independent Power Producers (IPPs) by the then Benazir Bhutto government.

However, the next year FDI registered a sharp fall as the successor government, repudiated agreements with IPPs. Thus ensued a row between the government of Pakistan (GoP) and IPPs, which severely affected foreign investor's confidence in Pakistan.

Pakistan's decision to go ,nuclear in 1998 prompted several countries to impose economic restrictions, which also reduced FDI inflows. The sudden freezing of foreign currency accounts following the nuclear blasts increased the risk of doing business in Pakistan and severely affected FDI.

The FDI level improved during the last two financial years thanks mainly due to comparatively rational and consistent economic and diplomatic policies of the President Musharraf regime. In 2002-03, FDI was $798 million, while in 2003-04,. FDI increased to $949.8 million.

As for the direction of investment, during the last one decade, the largest amount of FDI has been made in the energy sector, which accounts for more than 42 per cent of total FDI.

The share of manufacturing has been about 25 per cent followed by the services sector whose share is 21 per cent. During 2002-2003 however the banking and finance sector overtook the energy sector as the largest FDI sector.

It attracted investment worth $207 million -- 25 per cent of total investment. During 2003-04 as well, the financial sector attracted the largest amount of FDI-$242 million, about 25.5 per cent of the total investment. It was followed by the communications sector, which attracted nearly $222 million-23.4 per cent of the total FDI.

Having glanced at the level and direction of FDI in Pakistan, let's look at the country's foreign investment regime, which consists of three components: regulatory, economic and socio-political. Courtesy privatization and deregulation, Pakistan has a very liberal regulatory regime.

The regulatory framework for foreign investment consists of three laws: Foreign Private Investment (Promotion & Protection) Act 1976; Furtherance and Protection of Economic Reforms Act 1992; and Foreign Currency Accounts (Protection) Ordinance 2001.

Owing to increasing emphasis on the protection of intellectual property rights (IPRs), Pakistan has also updated its IPR laws to bring them in compliance with international requirements particularly those mandatory under the Agreement on Trade Related Intellectual Property Rights (TRIPs) of the WTO. The salient features of Pakistan's regulatory regime are:

* There is freedom to bring, hold and take out foreign currency from Pakistan in any form.

* Fiscal incentives provided by the government cannot be altered to the disadvantage of the investor.

* The privatization of an enterprise is fully protected. It cannot be re-nationalised. Nor can the government take over any foreign enterprise.

* Original foreign investment as well as profits earned on it can be repatriated to the country of origin.

* Equal treatment is provided to a foreign investor and local investor in terms of import and export of goods. FDI is not subject to taxes in addition to those levied on domestic investment.

* Foreign currency accounts are fully protected and they cannot be freezed (courtesy the Foreign Currency Accounts Ordinance 2001).

As regards investment policy, all economic sectors including the service sector are open to FDL Foreign equity up to 100 per cent is allowed in all sectors save the agriculture sector where it is allowed up to 80 per cent.

In manufacturing sector, there is no lower limit on the size of FDI. In services and other sectors it is $0.3 million. No government sanction is required for setting up an industry in terms of field of activity, location and size except in case of four sectors.

To avoid double taxation on income earned by foreign investors, Pakistan has concluded agreements with 51 countries. The list includes most of the developed countries. Pakistan has also bilateral investment protection agreements with more than 40 countries.

Pakistan has also rationalized its tariff regime. Custom duty_on import of most of the primary raw material is not more than 5 per cent, while that on imported machinery is between 0 and 10 per cent.

As for the IPRs framework, copyright law has been amended while laws regarding patents, industrial designs and trademarks have been re-enacted. The purpose of fresh legislation is to broaden the scope of IPRs, particularly to protect the works of foreign authors inventors and firms in the same manner in which the works of local authors or firms are protected.

Though IPR laws have been updated, their enforcement needs a lot to be desired. This is particularly true in case of copyright enforcement as piracy, especially that of software, is rampant in the country.

Pakistan's economic indicators have also improved. Growth rate is in well in excess of 6 per cent. The banking system has been revamped, interest rates cut and the level of liquidity improved.

The working of the capital market has also vastly improved. Add to this Pakistan's improved relations with the USA in particular and the western world in general. This is important because an overwhelming majority of MNCs in ' the world are either American or European firms.

In Pakistan itself, out of the 300 major foreign enterprises having their production facilities, 145 are European and 70 American. During the last fiscal year, country wise the largest FDI contribution-$238 million-was made by the USA.

However, there are problems with the investment environment. Take political uncertainty first. Political instability has been endemic in Pakistan. During 1990s four governments and parliaments were dismissed and three general elections held.

Towards the close of the decade, the civilian set-up was replaced with a military regime. Frequent changes in government have made continuity and predictability of policies difficult thus adding to the risk of doing business in Pakistan.

Law and order situation is another factor. During last one and half decade, the twin menaces of sectarianism and ethnicism have run rampant in Pakistan. They have told upon our economy and presented Pakistan as an intolerant, lawless 'society. In many cases, foreigners and facilities owned by foreign enterprises have been attacked.

The third factor is the lack of human capital. Wages in Pakistan are low but productivity is also low. While making investment decisions, MNCs take into account both worker productivity and wages.

Infrastructure, including rail, road and telecommunication network, and price and availability of utilities is another area that needs a lot of improvement. Poor infrastructure and high cost of utilities increase the cost of doing business and make the country a less attractive market for FDI.

Last but not least is the cultural factor. An overwhelming majority of existing or potential MNCs in Pakistan are from the West. The people of the West have a lifestyle different from us and want to continue that while staying here.

However certain self-righteous people want to impose their own values on foreigners and thus meddle in their personal private lives. Nothing irks these foreign investors and managers more than meddling into their personal lives.

In brief, Pakistan has a lot of potential to attract foreign investment However, there are factors like political uncertainty, poor law and order, low labour productivity and cultural intolerance that bottleneck the growth of FDI.