GIVEN the current economic crisis, all analysts and pundits expect a contractionary budget. The question does not appear to be whether taxes will be increased; but rather, to what extent and for which sectors.

In March, Pakistan’s large-scale manufacturing industries decreased by 9.35 per cent, a third consecutive month of declines.

Recent years of pandemic, floods, political instability at home and global economic crisis abroad have taken a steep toll on investments and other inflows that could revive the economy.

However, historically, Pakistan has not successfully attracted investment at the scale of other countries in the region.

Overall, the consensus seems to be that a single budget in times of economic crisis cannot undo decades of policies that have allowed Pakistan to fall further behind each year.

Experts say security, stability and ease of doing business prerequisites to emulate the Chinese, Indian or Vietnamese success in attracting big money

The expected tax hikes, while necessary to address immediate fiscal imbalances, need to be complemented by long-term strategies to enhance foreign direct investment (FDI) and strengthen domestic production.

Supply chain for fries

When you think of McDonald’s, what springs to mind? It’s likely the golden arches and, of course, the iconic fries. When the fast-food giant opened its first outlet in New Delhi in 1996, it wasn’t just about flipping burgers but ensuring that the fries met the ‘gold standard’ customers expected worldwide. However, India required the franchise to source locally.

The challenge was steep, since the fries required specific varieties of potatoes not native to India. Eventually, this led to a multi-faceted operation involving cultivating the right potato species in the mountainous regions of Himachal Pradesh. McDonald’s didn’t just plant potatoes; they built an entire supply chain from scratch. This involved transporting saplings to high-altitude farms, using donkeys to ferry the harvested potatoes down the treacherous slopes, and establishing cold storage facilities to maintain the quality of the produce.

To tap into the large Indian middle-income markets, McDonald’s grew potatoes. In contrast, Pakistan’s approach to sourcing fries has been vastly different. Between 2018 and 2022, Pakistan imported approximately $9 million worth of frozen french fries annually, according to the International Trade Centre. This stark difference in strategies highlights a broader narrative about how countries handle FDI and domestic production.

Tales of different economies

FDI has revolutionised many economies, but each has had a different journey. For India, investment flowed in to tap into its large middle-income group of 200m — roughly 20 times that of Greece’s population. China, on the other hand, received investment for exports since its per capita income at that time was not high enough to attract inflows for its domestic market.

Vietnam’s success story is again different from China and India, explains former finance minister Hafeez Pasha.

“When the US eventually lost its war against Vietnam and left, Hanoi was supported by China. Given its proximity to China, especially the industrial capital Shanghai, as China’s economy grew and wages increased, low wage-oriented products were shifted to Vietnam,” he explains.

This strategic geographical advantage, coupled with a cooperative market approach, allowed Vietnam to thrive as a manufacturing hub. Over the last two decades, Vietnam’s exports, which were less than ours, are now 12x of Pakistan’s exports.

India’s story, however, is one of technological prowess and early adoption. “Indians were amongst the first in the world to get onto the IT bandwagon,” says Mr Pasha. This early start has paid off enormously, with India’s IT exports surpassing $250 billion today. .

The country’s foresight in investing in IT institutes and welcoming foreign collaborations set the stage for this boom. For example, Apple assembled $14 billion worth of iPhones in India in fiscal 2024, Bloomberg News reported earlier this year.

Conversely, Pakistan’s relationship with FDI has been tumultuous. “In the 1960s, Pakistan followed an open, private sector-oriented, capitalist model with a lot of incentives, attracting big names like Shell and Lever Brothers,” Mr Pasha recalls.

However, when East Pakistan separated in 1971, the country’s market was halved, followed by the nationalisation process in the 1970s, which also spooked foreign investors.

More recently, the China-Pakistan Economic Corridor (CPEC) brought a wave of Chinese investment, primarily in the power sector. This expansion added 8,000-10,000 MW to Pakistan’s electricity capacity but came with strings attached.

“Pakistan had to offer extremely favourable terms to attract this investment by independent power producers,” notes Mr Pasha.

The Chinese angle

Beijing’s approach to FDI also offers valuable lessons. “China started with FDI for exports because its per capita income was very low and its domestic market was not developed,” explains Saleem Raza, a former governor of the State Bank of Pakistan. This strategy transformed China into the world’s largest exporter and a lucrative market for investors.

But the same cannot be said for Pakistan. “In Bangladesh, Thailand, Vietnam, and Myanmar, Chinese companies are entering into joint ventures (JVs) with local companies as parts of supply chains. In Pakistan, most Chinese projects are through the public sector,” Mr Raza observes.

This distinction is crucial. Joint ventures create a symbiotic relationship where local firms gain expertise and infrastructure, which is not happening in Pakistan to the same extent. JVs in India created the technological and knowledge transfer, which it leveraged to become a tech juggernaut.

Another challenge is the security issue. While Vietnam’s proximity to Shanghai spurred investments and exports, Pakistan’s proximity is to the Xinjiang province, which is among the least developed regions in China. It has a high Muslim population, creating concerns in Beijing that extremist elements in the northern regions of Pakistan do not spill over into the country.

Remittances: lifeblood or money laundering?

In terms of inflows, remittances play a far more crucial role in Pakistan’s economy than FDI. At around $30 billion annually, remittances account for 8-9pc GDP.

A significant portion of these remittances comes from the labour force working abroad, such as Uber drivers in Dubai who send money back to their families. However, a substantial part of these remittances is also funnelled into the real estate sector, often as a means of laundering money, says former finance minister Miftah Ismail.

This phenomenon involves black money being transferred out of Pakistan and returned disguised as legitimate remittances, thereby inflating real estate investments without contributing fresh funds to the economy.

“Foreign remittance is sent home for loved ones, while FDI is meant to grow businesses,” explains Mr Ismail. By its nature, remittances are consumption-driven, whereas FDI drives investment, economic growth, and employment. However, Pakistan’s remittances have always far outpaced FDI.

The ease of doing business in Pakistan remains a significant challenge, with multiple factors deterring potential investors. “Lawlessness and terrorism strongly deter investors. It is also very difficult for foreigners to register companies or become directors,” Mr Ismail elaborates.

These hurdles, coupled with Pakistan’s relatively shallow reserves, create persistent concerns about the successful repatriation of profits. “If an investor is not sure he will be able to receive returns on his investment, he will not make it,” he says.

Additionally, Pakistan’s high tariff barriers pose another significant obstacle to export-focused FDI inflows. As Ismail notes, “The companies that come into Pakistan do so to tap into the large domestic market such as in the auto sector, telecommunication services, and the mobile industry.”

With imported inputs, they feed consumerism rather than loop back to further investments, local backward integration of chains, and eventual exports, as was the case for India, which maintains competitiveness through its tech sector.

Published in Dawn, June 11th, 2024