Policy risks in foreign investment By Mahmud Ahmed

In a short span of time, foreign direct investment has declined sharply because of low economic growth, critical shortage of power and vulnerabilities of the external sector.

The transition from military-led regime to constitutional democracy has also enhanced political risks for foreign capital spending.

There is so much more public accountability and judicial activism. And the enormous cost of the war against militancy is consuming funds meant for upgrading social and physical infrastructure that could make the economy globally competitive for trade and investment.

While the government recognises the need for the FDI, it is not clear yet how it will stimulate the economy and create opportunities for business, notwithstanding its efforts, with the IMF on board, to achieve macroeconomic stability. Already, across-the-board incentives to even export sector are being withdrawn except for the targeted segment. The move by a cash-strapped government is intended to do away with unearned incomes.

The economy is also facing multiple risks because of the Great Recession, shrinkage of an overleveraged global financial market, tight liquidity and its squeeze on international trading volumes. It is also not yet known whether the enormous fiscal deficits that developed countries carry, would lead to double-dip recession. The IMF says the economic crisis may be moving into a new phase with rising public debt that threatens to undermine the global financial system. This observation is shared by the World Bank. All this requires a paradigm shift in national economic policies with focus on commodity producing sectors to put the economy back on trajectory of high economic growth.

Because of the severe balance of payments problem and global liquidity squeeze, the process of integration of the domestic economy into the global financial market has been halted. Capital and financial inflows and foreign trade have plummeted. The external sector vulnerability has forced the government to seek credit from the IMF. Not yet out of the IMF programme and with the growth rate low, the signal given to foreign investors is that the economy in distress and they might well seek opportunities elsewhere.

But the key issue is what kind of policies would Pakistan follow in the changing economic world order and how it proposes to resolve its multiple crises. How much space would it provide to foreign investment while focusing on the domestic market. Recently, there has been an uproar against leasing of agricultural land to foreigners. In the past decade, much of FDI has come in the import-oriented industries rather than in export-oriented manufacturing. Perhaps, there is some room for companies producing seeds,dairy products and food chains.

It is, however, crystal clear that foreign assets would be safe from any government seizure. The era of nationalisation is over. But how future policies would unfold is not clear because these are turbulent times.

The main issue is about the rules and regulations that govern foreign investment. Weak regulations and supervision brought about the near-collapse of the Anglo-Saxon global financial system at a time when markets were supposed to discipline governments. They ended by demonstrating that they lacked both financial discipline and business ethics.

Many economists in developed world believe that more value can be expected through change in laws and regulations ruling investment, or they are implemented in such a way that financial returns can be ensured. This, they describe as “policy risk,” for which Harvard scholars advise companies that they “must learn the art of political spin.” The objective should be to “manage policy risks to expand their investment options.”

But these options would not work unless they serve the development needs of the host country. In the past decade or so, the FDI came merely in two or three sectors like telecom and banks. In the wake of global financial crisis, some foreign banks have closed their operations in Pakistan.. As it is, the regulatory authorities in Pakistan are weak and largely ineffective.

Somehow, in the current global environment, foreign investment has become too much risk-prone. There is so much talk of country or sovereign risks, political uncertainties and risks, security concerns, policy risks and uncertainties, regulatory uncertainties and risks. Investors have to hedge against exchange and interest rates volatility. And the policy risks have increased after the Great Recession. They continue to mount with enormous fiscal deficits the developed countries have accumulated.

And when the multinationals press host countries too much for concessions and incentives, they create the impression of foreign meddling and stoke nationalism. Not only that. The change in governments can often lead to re-negotiations of contracts and terms of investment. Hubco’s case is one example. A World Bank study in 2004 said that up to 30 per cent of the private foreign investments worldwide were renegotiated.

Perhaps, it is because of the enormous constraints that the multinationals tend to return to the pre-capitalist mercantilism and prefer acquisitions and mergers to boosting global production. They are focused on management and restructuring, having turned hierarchical and inefficient and unable to monitor effectively their vast business empires in a complex and fast changing business world. There is unmanageable growth of frauds within the financial system. And acquisitions, mergers and alliances at an unprecedented pace are creating monopolies, cartels and oligopolies, making the global market dysfunctional.

The financial giants in the West “too big to fail” had to be bailed out by taxpayers money and “nationalisation” returned for such time they could be back on their own feet. It shows that while the fundamental principles can be guaranteed, there is escape from temporary deviations and break in continuity of policies.

There have been so much of innovations and creativity to preserve the status quo but not much has been done to re-invent capitalism to make it inclusive and to ground it on common good. Over-concentration of national wealth in few hands is a sure recipe for creating a recession. This has what been happened worldwide. And the national wealth so created is evaporating in a deepening economic crisis.

Many eminent social scientists in the West attribute the failure of the market to dogmatic thinking which reflects neither “true capitalism” nor “economic science”. They also assert that lax regulatory regime leads to market failures as demonstrated by the Great Depression of the 1930s and the current Great Recession.

Over several decades, many independent nations with agricultural economies have become semi-industrialised that has reinforced national self-reliance despite frenzied globalisation by many. And the current liquidity crunch in the global financial market and shrinking international trade is forcing the developing countries to focus on the domestic market where foreign investment may be welcomed on a selective basis through public-private partnership in building physical infrastructure or joint ventures with local entrepreneurs for food processing and marketing.

The local and foreign expertise and capital has to be blended to adapt global best practices suited to local conditions to help the host country’s economic development. The global market cannotcannot prosper while ignoring the needs of a nation’s people.

Source: http://www.dawn.com/wps/wcm/connect/dawn-content-library/dawn/in-paper-magazine/economic-and-business/policy-risks-in-foreign-investment-640