Pakistan's investment-to-GDP ratio is low and has been continuously declining despite immense potential for profitable investments considering its strategic location and prospective market size, says the World Bank (WB).
The WB, in its latest report, "Pakistan@100 Growth and Investment" states that Pakistan's low investment will place it at a disadvantage to peer countries.
Emerging economies typically focus on better infrastructure - roads, transportation and energy - to attract and facilitate private investment. The investment-to-GDP ratio in Sri Lanka, Bangladesh, Thailand, Cambodia and India has all remained higher than that of Pakistan over the past 10 years, despite huge infrastructure requirements. Pakistan's savings rate, which hovered below 15 percent of GDP during the past decade, has limited the scope for investment.
Pakistan's growth is lagging because of low public and private investment. If the current investment rates persist, Pakistan will struggle to reach middle-income status in the coming three decades. This in turn will halt Pakistan's progress toward decreasing poverty by slowing growth and increasing unemployment, says the report.
It further stats that Pakistan needs to focus on increasing investment by attaining macroeconomic stability, enhancing the business environment by removing infrastructure bottlenecks, simplifying and making tax laws more transparent, reforming institutions, developing financial markets, increasing technological readiness and market access as well as facilitating business development to encourage entrepreneurial activity and maintaining consistency in policies.
The low saving-investment equilibrium, at around 15 percent of GDP, poses a key challenge for Pakistan's long-term growth prospects. It states Pakistan's economy is on a declining long-term trend, both in potential and actual growth. Perhaps of more concern than the inability to sustain growth spurts over extended periods of time is the steady fall in the economy's growth potential.
Pakistan's savings rate of 13.8 percent of GDP (2011-15 average) compares unfavou-rably with that of its neighbouring countries. For example, the savings rates in Bangladesh and Sri Lanka were 29.7 and 24.5 percent, respectively, during the same period. The trend in the real savings rate during the past decade in these economies, proxied by real deposit rates, suggests that Pakistan's savings rate was not only low but also volatile.
One key binding constraint has been low domestic savings, which continue to decline and pose significant policy concerns. While Pakistan can access foreign savings to close the domestic saving-investment gap, it can be observed that low domestic savings have contributed to low investment levels (on average, over the past four decades, the investment-to-GDP ratio has remained below 20 percent and, in the past 5 years, this ratio has hovered at around 15 percent).
The WB report further states that lack of investment has held back labour productivity growth. The recent low contribution of physical capital to productivity is in line with the overall low investment levels in the economy over the past decade. A comparison indicates that, since 2000, on average, investment as a share of GDP in Pakistan has been about half of its regional peers.
It states that persistent macroeconomic instability has discouraged savings and private investment in Pakistan that has a long history of macroeconomic instability, which has resulted in low aggregate investment and fluctuating output levels. This has resulted in the country availing itself of a mixture of 21 stabilisation and budget support programmes from the IMF between 1958 and 2013.
Further limited fiscal space has resulted in low public investment levels. Pakistan's legacy portfolio of SOEs adds to the overall burden on public finances and constrains fiscal space even further. The report states that a relatively shallow financial market has been unable to fulfil long-term investment needs of the private sector. The volatility in macroeconomic environment has impeded the development of a well-functioning financial market.
The banking sector's deposit-to-GDP ratio was about 37.6 percent at the end June 2017. Between January 2014 and May 2018, only 11 term-finance certificates, amounting to Rs 67.5 billion, have been listed on the Pakistan Stock Exchange (PSX). Of the total Rs 135 billion raised, Rs 30 billion are outstanding. With this limited success, investors have limited options to finance long-term investments.
It stated that Pakistan's volatile economic environment remains one of the key reasons for low foreign investment. Foreign direct investment (FDI) has been declining over the years and compared with other countries' performance, Pakistan's performance is a point of concern. The FDI is also highly concentrated in a small number of sectors and countries of origin. In the past 15 years, almost 60 percent of FDI went to just three sectors: oil and gas exploration, communications, and the financial sector. Such high concentration means that negative developments in these sectors can have a disproportionate impact on overall FDI.
The law and order situation in the exploration areas has deterred FDI in oil and gas exploration, which has dragged down overall FDI in the country. In terms of sources of FDI, the US, the UK and UAE jointly contribute on average 60 percent of total FDI, making Pakistan highly vulnerable to economic conditions or changing perceptions of investors in these countries. More recently, much of the FDI has started to come from China under the China-Pakistan Economic Corridor (CPEC) initiative.
Pakistan's share in overall global investment flow is low and falling, says the report. It further states that poor tax policy design and weak administration are other challenges that complicate the business environment. The purpose of a good tax policy is to raise revenue in an equitable and fair way. Since fiscal year 2014, the Federal Bureau of Revenue (FBR) has successfully increased its tax collection by 2.4 percent of GDP. However, the revenue mobilisation focus needs to be balanced with other goals as well. Import tariff reduction and simplification is imperative to increase competitiveness and reduce anti-export bias. Over the past few years, tariffs have been reduced but this has been followed by a significant increase in the use of regulatory duties. Moreover, advance income tax through the withholding mechanism on financial transactions is positive in terms of providing incentives for registering as taxpayers, but could have been detrimental with regards to financial deepening. Consequently, the currency-to-deposit ratio jumped from a very stable 0.29 in fiscal year 2015 to 0.35 in fiscal year 2017.
The report has recommended improving coordination between federal and provincial departments to create a business-friendly environment. Several areas, such as fiscal policies, including taxes, doing business, energy, transportation etc, require proactive coordination between federating units. This is not the case at present.
The WB report states it is desirable to establish a high-level coordination mechanism to streamline and harmonise laws and regulations across all federating units to reap the benefits of a single market. While some sectors are taxed beyond their share in GDP, others are not taxed or only lightly taxed, creating adverse incentives. While domestic savings are already very low, most of them flow to relatively unproductive sectors, such as real estate for speculative purposes.
It is also important to immediately remove the financial sector transaction tax. In the medium-term, the government should invest heavily to improve the tax administration to make it more taxpayer-friendly and technologically innovative and modern.
Tax policy should be analysed to correct the incentives, so that scarce resources flow into productive sectors, not into real estate, which not only provides a haven for undocumented wealth, but also deprives the government of revenues.
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