Carrots for investors

Important factors considered by investors include presence of relevant infrastructure.

Recently, I met CEOs of a few multinationals at a social gathering. Discussing about Pakistan’s investment prospects, I asked them what do potential investors look for. Incentives, according to them, play little role in their decision to invest. Instead, they look for two things: contract enforcement and policy predictability — the former to avoid prolonged litigations and the latter so that they can account for any future costs.

There is nothing new in what these CEOs said. According to Organisation for Economic Co-operation and Development, the most important factors considered by investors, as they decide on investment location, include presence of relevant infrastructure and human capital, followed by predictable and non-discriminatory regulatory landscape and stable macroeconomic environment. In short, investors first need viability and then certainty.

But why do we care about Foreign Direct Investment (FDI)? There are two primary reasons. Firstly, Pakistan’s gross domestic savings are merely 9% of GDP, well below the world average of 25% and severely inadequate to finance economic expansion. Therefore, foreign investment can potentially compensate for lack of domestic savings. Secondly, Pakistan’s economic base is still not very sophisticated and FDI can help transform it through transfer of technology and knowhow, human capital formation and greater international trade. More recently, FDI is also expected to compensate for widening the current account deficit, which has more than doubled.



On the upside, however, CPEC has started to show its impact as investment from Chinese companies drove FDI up by 12% during the first 10 months of the current fiscal year. Standard & Poor, Moody’s and Fitch all are predicting a stable economic outlook for Pakistan in the medium term. This provides an opportunity window for Pakistan to attract FDI.

How can we rake in the benefits? Building upon the bedrock of good governance and improved business climate to attract FDI, many countries have made use of targeted incentives to sweeten the deals and increase their share in global FDI flows.

The government offers a host of lucrative incentives: some of them are specific to special economic zones and export promotion zones, while others are applied across the country. These incentives include duty-free import of capital goods and raw materials, sales and corporate income tax exemptions, etc. Provincial governments also offer their own incentives.

Surprisingly, however, the government is now considering introducing even more incentives such as provision of land on subsidised cost, heavy freight subsidies on inland transportation cost and about 50% markup subsidy on domestic loans. Is throwing in more carrots likely to entice some new investors?

Globally, there has been much debate on which incentives work and which don’t. While there are no cookie-cutter solutions, economists agree on some broad design principles for such investment incentives. Firstly, these should be back loaded to ensure that costs are incurred after investments are made. Tax and investment credits are therefore good examples, whereas upfront subsidies on land, building and machinery are not preferred.

Secondly, incentives should have minimal redundancy rate. Do we really think that a one-time subsidy in transportation of plant and machinery, for instance, can have some bearing on an investor’s decision to come to Pakistan? Thirdly, tax incentives, financial subsidies and regulatory exemptions are expensive propositions, which either result in directly draining taxpayers’ money or can lead to foregone revenues. Hence, they need to have a strong value proposition and should be targeted to remove market anomalies. Last but not the least, investment incentives should not be complex, discretionary or offered indefinitely and instead be time-barred, transparent, non-discriminatory and simple to administer.

The government must realise that endless expensive incentives can never substitute for a robust investment climate.

Published in The Express Tribune, June 15^th, 2017.

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