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India-Pakistan Trade Newsletter

Published Date: Oct 31, 2012

Pakistan’s FDI in India: Potential and Prospects

The
recent announcement by the Indian Government regarding opening up of the
country ‘s Foreign Direct Investment (FDI) regime for Pakistani investors comes
at a time when India Pakistan trade normalization process is progressing at an
encouraging pace.

It is no
surprise that investors from both countries have been working closely in joint
ventures in third countries, but have not been able to progress in terms of
bilateral investments because of political barriers. However, there were some
who managed to bypass such barriers; more recently, Pakistani businessmen based
and registered in places like Dubai and Malaysia have started investing in
India through partnership agreements with Indian resident businessmen.

Investors
on both sides are ready to employ competitive advantages in their neighbourhood
and reap economies of scale. The examples of India ‘s Tata group showing
interest in Pakistan ‘s energy sector (particularly Thar Coal) and Pakistan ‘s
Mansha group showing interest in India ‘s banking sector (particularly consumer
banking) show that, on both sides, the business community has done its homework
towards exploring its niches.

Academia
and development partners have long demonstrated through empirical methods how
supply chain development in South Asian countries can benefit the region as a
whole. Sadly, not much research exists specifically for India and Pakistan at
the sectoral level. However, the recent experience of Pakistani investors in
Bangladesh proves the win-win case that will be possible for India and
Pakistan. Around 2008, several Pakistani textile firms opened branches in
Bangladesh to reap the benefits of Least Developed Country (LDC) status, which
allows Bangladesh duty free access or reduced tariffs in foreign markets,
particularly the EU and US, where major market exists for Pakistan ‘s readymade
garments. Data for 2010 on Pakistani firms that opened branches in Bangladesh
show employment creation for Bangladesh ‘s labour force, technology transfer for
Bangladesh ‘s textile sector, increased royalty for Pakistani investors and
increased exports of raw material (such as dyes, chemicals and threads) to
Bangladesh. A similar story has been observed in the case of Pakistan ‘s
investments in Sri Lanka (both countries have signed a bilateral investment
treaty) in sectors such as food processing and construction materials.

Replicating
the regional experiences for India-Pakistan should not be difficult given the
sheer size of the two economies and the opportunity presented by a large – and
growing domestic demand in both countries. While Pakistan is soon expected to
reciprocate India ‘s decision to open up FDI, several complementary reforms may
also be required to ensure smooth flow of investments between the two
countries.

First,
the home departments on both sides should ensure that the recently agreed visa
liberalization policy between the two countries is implemented fully and
expanded to other cities on an expedient basis. Allowing physical capital to
move while human capital is curtailed does more harm to the production process,
and prevents future cash flows. This happened last year when Pakistan ‘s
government drastically reduced the sensitive list and liberalized trade with
India. While this allowed steel manufacturers in Pakistan to import machinery
at much reduced rates from India in comparison to other parts of the world,
such machinery has been lying redundant for weeks, sometimes months, because of
delays in allowing visas for Indian engineers who were to come to Pakistan to
install the machinery.

Second,
there is a need to harmonise product standards with the rest of the world. For
example, in a discussion with auto part manufacturers in Pakistan it was
pointed out that while they were interested in investing in this sector in
India, the two industry standards followed by India – Bharat 1 and Bharat 2 –
are seen in no other country in the world. Such standards act as barriers to
entry for producers who can genuinely enhance consumer surplus in India. The
consumer rights organizations in both countries should take note of standards
that curtail trade and investment, leading to a decrease in consumer welfare.

Third,
a natural path in the economic integration for both countries should be to move
towards a bilateral investment treaty. This will boost both the safety of
investments and boost investor confidence. Under such a treaty, investment from
the other country should be treated on par with domestic investors. Similarly,
country-specific bias in competition policy and other sector-specific policies
needs to be removed. Such treaties allow transfer of investment-related funds
into and out of a host country without any delay at the open market exchange
rate.

Fourth,
and a point related to the above, is the need for a sovereign guarantees
framework, at least in the short term. If both countries are serious about
hosting each other ‘s investments, then physical and financial capital migration
must be protected against the risk emanating from a possible political
upheaval. Most investors we have come across in Pakistan were fearful that
future political friction between the two countries could affect their business
in India. This points towards the short-term need to provide sovereign
guarantees to investors from Pakistan (and vice versa) that ensure full
compensation if harm is caused to their investment in India! or Pakistan) due
to actions related to foreign or defence policy. It is important to note that
such a measure would be unnecessary if the two countries move towards a
comprehensive bilateral investment treaty.