Foreign capital: a boon or bane?
The following table indicates important elements in the recent balance of payments. The most striking feature is current account deficit, which is more than financed by a surplus on capital account thus adding to the foreign exchange reserves to make them comfortable in an otherwise difficult situation.
External resources have been a significant source of financing the budget. At Rs200 billion, they financed 53 per cent of the consolidated (federal plus provincial governments) deficit during FY 07.
They have also been a big help in meeting saving\investment gap in the country. During FY 07, net external resources are provisionally estimated to have provided five per cent of GDP as against the ratio of 23 per cent for gross total investment .
Foreign capital has certainly been a boon in the short- run as it more than met the deficit in current account of balance of payments, fiscal deficit and saving \investment gap. However, this is not an unmixed blessing since it involves cost to the economy. Foreign capital may be by way of external grants or loans and foreign investment. Foreign grants are few and generally for exceptional purposes. Foreign loans carry liability of repayment of principal on the agreed date and interest is payable regularly at the pre-determined rate according to the schedule.
Outstanding external debt, despite large write- off after 9\11, rose from $33.3 billion in FY03 to $38.7 billion in FY07 and $40.3 billion as of end September 07. Public and Publicly-Guaranteed Debt increased from $29.2 billion to $35.3 billion and $36.8 billion respectively over this period.
Foreign investment differs from external loans in that the amount invested, along with capital appreciation, if any, can be totally taken out at will and the rate of profit\dividend, to be freely remitted, is not pre-determined., This source of capital has assumed increasing importance in recent years and brought in $ 8.3 billion (net) during FY07 as against $4.4 billion in the preceding year. Of this, foreign direct investment (FDI) accounted for $ 5.1 billion, the balance being portfolio investment (FI). An important component of FDI, equity capital almost doubled from $2.9 billion to $4.2 billion, of which privatisation proceeds were $266 million (as against $1.5 billion a year earlier).
As regards the sectoral distribution of FDI, the major share was that of communication, 37.9, (telecommunication, 35.6 per cent); financial business, 18.7 percent; oil and gas exploration, 10.6; tobacco and cigarettes, 7.6; power, 3.8 and others, 22.8 per cent. Significant changes in the shares over the year were that while the share of telecommunication dropped from 54.1 per cent, that of financial business nearly doubled from 9.3 and tobacco and cigarettes shot up from 0.1 per cent.
Net inflow of foreign investment during July December 07 was $2.2 billion as against $3.2 billion in the corresponding period last year. During these periods, while foreign private investment was $2.2 billion as against $2.5 billion, foreign public investment was negative by $ 23 million in contrast to $ 691 million earlier.
Important components of PI in FY07 were equity securities, $2.3 billion, ($986 million a year earlier), reflecting mainly the issue of GDRs by the government for OGDC and UBL and by a private bank. This included investment at the stock market, which accounted for $862 million, up from $351 million in the preceding year. Debt securities brought in $977 million as against $613 million a year earlier. This included euro bonds worth $ 820 million, up from $796 million.
During July Dec. 07, PI declined from $1.3 billion in the same period of FY06 to $103 million. Of this, private investment fell from $620 million to $126 million, whereas public investment was converted from $691 million to a negative figure of $22 million.
Foreign capital entails a price by way of serving it. Repayment of principal of loans apart, interest on loans and profit and dividend on investment have to be paid regularly. This is shown under income account. The deficit in this account increased from $ 2.7 billion in FY06 to $3.6 billion, or by 33.8 per cent. During July December 07, this was $1.9 billion as against $1.8 billion in the same period last year.
The payment of interest on foreign loans (net), despite the post 9\11 rescheduling and remission of loans and interest earned on foreign exchange reserves, was $884 million in FY07 as against $749 billion an year earlier. while profit/dividend remitted was $804 million as against $504 last year. IMF charges and interest on official debt were $735 million in FY07 as against $664 million a year earlier. Profit and dividend on PI shot up from $ 88 million to as much as $ 266 million over the year. Profit remitted (net) abroad by financial business, mostly banks, was a major factor, as this went up from $84 million in FY05 to $127 million in FY06 and were $116 million in FY07.
During July December 07, interest payments were $1.1 billion against as $645 million a year earlier while repatriation of profit and dividend was $300 million as compared with $247 million earlier. Financial business accounted for $43 million, up from just $15 million.
Foreign capital has important long- term implications depending on the fact whether it supplements national effort or serves as a substitute for it and the nature of its actual use. It is welcome, if it supplements national effort and is used to enhance the productive capacity of the economy to the point where it more than pays for itself leaving a surplus to benefit the economy and improves the lot of the common man significantly. In case of Pakistan this criterion is not met and this is manifested in very low saving\investment ratio and the gap, increasing reliance on it for meeting the current deficit of balance of payments and heavy dependence of budget on this source of financing.
The magnitude of future external liabilities would not be that serious if the foreign capital paid for itself, if not more, through adequate growth of the economy through enhanced productive capacity, particularly of the real sector, and its effective utilisation to impact the external sector. There is not much to show in this regard. The structural weakness of the growth process has persisted for a long time and has not been addressed effectively. The latest report of ADB has highlighted the unproductive use of its loans. The current serous domestic economic crisis is its practical manifestation.
The cost of servicing foreign capital is to increase significantly in the near future. Prospects of maintaining the old level of foreign capital are becoming dim. There is not much “family silver” left to be sold to foreigners, the external debt rescheduled earlier would soon mature, and the benign international environment created for Pakistan by 9\1 1 is likely to change. There are already enough straws in the wind .
Dependence on foreign capital cannot be reduced without self reliance through increased national saving anchored in domestic saving. The government is actively pursuing anti- saving policies in pursuance of a strategy of consumption-led growth, As a result, the rate of domestic saving has declined, despite the higher propensity to save due to economic growth accompanied by concentration of income and wealth and increased inflow of workers’ remittances. The ratio of domestic saving to GDP (MP) had fallen from 17.4 in FY 03 to 15.2 per cent in FY06 and is provisionally estimated at 15.1 per cent for FY 09. Household saving dropped from 16.8 to 12.4 and was 13.3 per cent respectively over these periods.
The boon of foreign capital is likely to become a bane unless there is a drastic change in economic policies. The strategy of consumption-driven growth has proved inappropriate and must be replaced by investment-driven growth. This is necessary to generate adequate surplus of tradable goods and services, which may be sold in an intensely competitive international markets.