Exports, exports, and more exports – attracting the right kind of FDI

Talk to any economic analyst and you will hear that a major long-term issue facing Pakistan’s economy is external sector instability. This instability, the argument goes, is caused by rising economic growth which leads to greater imports, leading to a widening of the current account deficit, which leads to a drawdown in foreign exchange reserves, increasing levels of external debt, and weakening of the rupee. As these imbalances grow, policymakers are forced to decelerate the economy and implement an IMF-mandated program to stabilize the economy. 

To break this so-called boom-bust cycle, the argument goes, Pakistan must manage its current account deficits and reform its economy to grow exports, such that the country has enough inflow of dollars to pay for its imports. There is no denying that Pakistan needs to grow its exports, but a key point that many miss is that a current account deficit can be sustainably plugged not just by exports, remittances, and debt, but by the inflow of foreign direct investment (FDI) into the economy.

Look at the geoeconomics pivot debate among various segments of society and you will notice that the focus is trade and connectivity. This is all well and good, barring the fact that this conversation is entirely focused on regions with limited export potential, as argued in my previous column. Another key flaw in the debate is the fact that little to no conversation is exploring the reasons why Pakistan is not attracting rising flows of FDI, especially in export-oriented sectors across the economy. 

Emerging economies around the world have recognized that FDI flows in export-oriented sectors enhance integration with global supply chains, bring modern managerial and technical capabilities, and improve overall productivity and wages in the broader economy. It is for this reason that rising FDI inflows are a key policy priority for many economies, including India, which has started the process of rolling out production-linked incentives in key export-oriented sectors including electronics and toy manufacturing.

Pakistan’s FDI inflows have been a major concern over the last few years, with annual FDI inflows declining by 11.6 percent from $3.25 billion in 2017 to $2.91 billion in 2021. Meanwhile, FDI inflows in India increased by 44.6 percent from $36.3 billion in 2017 to $52.5 billion in 2021. In addition, a significant proportion of FDI flows in Pakistan are directed is market-seeking not export-promoting, meaning that this investment does not increase the country’s ability to earn foreign exchange.

One could argue that Pakistan has had to deal with various issues in the last few years, key among them a devastating war on terror and major power shortages, meaning that foreign investors have not looked at Pakistan in the same way as they perhaps would look at an India. This argument has merit, but things have significantly improved on both the terrorism and power sector fronts over the last few years. What has not improved is the overall business environment, especially as it relates to fundamental economic reforms that create excitement around Pakistan’s economy.

As argued last week, there is significant export potential that Pakistan is failing to tap into at this point in time. Realizing this potential requires the country’s policy framework to create an enabling environment for foreign investors. This framework should improve ease of doing business, provide targeted benefits to foreign investors in key export-oriented sectors including labor intensive sectors such as seafood and agriculture, and provide turnkey solutions to minimize red tape across the economy. Given the fact that much of these issues will require reforms from provincial governments, the federal government must create an effective mechanism through which it collaborates with provincial stakeholders. Finally, none of these policies will succeed if the country is unable to provide reliable access to key inputs at competitive rates, especially electricity and water. It is therefore vital that Pakistan aggressively pursue energy market reforms.

The geoeconomics pivot is a major shift in Pakistan’s outlook. Succeeding at this pivot will require a lot of effort and time. However, incremental steps that attract foreign investors in export-oriented sectors can birth a virtuous cycle that accelerates momentum for this pivot. To catalyze such a cycle, policymakers must focus on one or two high-potential sectors at a time and seek FDI from major global companies. Successful models can then be replicated for other sectors and a positive experience for an initial set of investors will incentivize and attract others to invest in the economy.

None of this will succeed without consensus and continued focus across governments and political parties. This lack of consensus has historically undermined Pakistan’s economic potential and it is time that policymakers come together to agree upon a core set of non-negotiable priorities. Only then can the geoeconomics pivot, supported by export oriented FDI, succeed.