Determining factors of foreign investment in Pakistan

Dr Ayub Mehar

Publishing date: 03 February 2026

Published in: Business Recorder

The alleviation of poverty and increase in decent employment opportunities, and GDP growth are certainly obvious advantages of the inflow of foreign direct investment.

However, the more important and immediate advantage for countries like Pakistan is the direct association of foreign direct investment with improvements in the balance of payments and foreign exchange reserves. Moreover, there is a direct relation between foreign direct investment and the balance of trade.

As a result of direct investment, the production of goods and services within the country can facilitate import substitution, thereby reducing import bills. Similarly, the goods produced locally can provide a source of foreign exchange earnings through the export of locally produced goods.

Despite the obvious advantages, Pakistan has not succeeded in attracting the required volume of foreign direct investment.

The inflow of foreign investment as a percentage of GDP has been continuously less than 1 percent since 2011.

The highest inflow of foreign investment as a percentage of GDP was 3 percent in 2007, which is the highest level of FDI in the history of Pakistan.

The highest inflow of foreign investment was recorded from 2004 to 2008. During these 5 years, the inflow of foreign direct investment was USD 18.6 billion, which is more than 60 percent of the inflows of foreign investment from 2009 to 2025.

Similarly, the net inflow of foreign portfolio investment was USD 5 billion from 2004 to 2008, which is more than 90 percent of the net inflow of portfolio investment from 2009 to 2025.

The return of the Pakistani investment abroad to the homeland from 2018 to 2020 is another interesting observation in the economic history of Pakistan.

During this period, the resident Pakistanis who invested their capital outside Pakistan have decided to bring their capital back to their homeland. More than USD 150 million in outflow of investment was brought back to Pakistan.

However, the present trends of foreign investment do not show a rosy picture. Since 2019, the yearly inflow of foreign direct investment has been less than USD 2.5 billion.

The size of aggregate foreign investment in Pakistan is USD 29.5 billion, while the aggregate investment of Pakistani residents abroad is USD 2.7 billion. These are the indicators that Pakistan is not a globally well-integrated country. This situation unleashes the hidden causes of deterioration in trade balance, foreign exchange earnings, lower GDP growth, and unemployment.

The recent statistics of foreign investment show that the net inflow of foreign direct investment was USD 808 million during July-December 2025, compared to USD 1.4 billion in the same period of 2024. It reflects a decline of USD 616 million in the net inflow of foreign direct investment.

During this period, inflows of foreign direct investment were USD 1.8 billion as against outflows of USD 1 billion. This high magnitude of the outflow of investment is not a good sign. The analysis of the inflows indicates that China is the main origin of investment in Pakistan, which invested USD 583 million in 2025 and USD 1.1 billion in 2024.

No other country invested more than USD 200 million in current or last year. The major inflows of investment are in the power sector. The investment in the power sector was USD 1.1 billion last year, and USD 586 million this year.

After the power sector, the second largest investment was recorded in the financial sector, which was USD 401 million last year, and USD 434 million this year. This growth of foreign investment in the financial sector highlights investors’ interest in banking and financial services.

The telecommunication sector recorded a substantial outflow of USD 431 million in 2025, which reflects the impact of major divestments. Surprisingly, despite an improvement in stock market performance, portfolio investment shows an outflow of USD 225 million from July to December 2025.

Total Foreign Investment in the country, including direct investment, portfolio investment, and public sector investment, stood at USD 207 million in this period, compared to USD 1.3 billion in the corresponding period of last year.

Notably, the foreign direct investment is directly related to the establishment of new business entities or expansion in existing entities. It directly contributes in construction of buildings, the installation of plant and machinery, and the hiring of staff.

The foreign investors prepare a long-term plan for direct investment. They prepare feasibility and risk assessment reports.

Contrary to direct investment, portfolio investment is the sale and purchase of shares and bonds in the secondary market. A portfolio investor can sell its securities in the secondary market at any time. This option is not available in the case of direct investment.

Net inflows of foreign direct investment refer to direct investment inflows to Pakistan in the form of equities and reinvestment of earnings. It is a category of cross-border investment associated with a resident of a foreign country having control or a significant degree of influence on the management of an enterprise in Pakistan.

Ownership of 10 percent or more of the ordinary shares of voting stock is the criterion for determining the inflow of foreign direct investment.

Similarly, the net outflow of foreign direct investment refers to direct investment outflows abroad in the form of equities and reinvestment of earnings. It is associated with resident Pakistanis having control or a significant degree of influence on the management of an enterprise that is in a foreign country.

There are several factors of foreign investment, including political certainty and socioeconomic conditions.

However, these factors are transformed into the ultimate expected return to the investors. In determining their expected (or required) return, the foreign investors consider the economic and political risksas a major element.

The exchange rate fluctuation, high interest rates, high inflation rate, high taxes on businesses, large number of taxes, harsh regulations, rigidity in business documentations, corruption, redtapism, hurdles in doing business, deteriorated infrastructure, political uncertainty, problematic law and order situation, ethnic or sectarian tensions, ransom,organized crimes, social restrictions, and several other issues can increase the risk in investment and the cost of business. These additional risks or incremental costs can increase the investors’ required rate of return on their investment. If a country cannot afford to pay the required return to the investors, the inflow of foreign investment will be restricted. If economic managers want to reduce the investors’ expected return, they will have to adopt those policies that can reduce the level of risk and the cost of business. For this purpose, they will have to handle the above-mentioned issues. There is no rocket science; it is a simplified model to attract foreign investment.

The suppliers of foreign capital make their decisions based on the comparative rate of return. They can invest their capital if the return on investment in the host country is greater than the return on investment in other countries.

The return on investment on external capital includes yields and capital gains. The capital gain on foreign investment is determined by the appreciation in the value of foreign currency in terms of the domestic currency of the host country and the appreciation (or depreciation) in the value of assets in financial markets, while yield depends on the nature of financial instruments.

Here, it is important to mention that a change in the value of financial assets will change the return on investment.

Sometimes, the host countries have to pay the extra return on foreign investment. This return may be in the form of provisions of some special facilitations to foreign investors or monetary and fiscal incentives.

The cost of such facilitations can be translated into extra return on foreign investment. The investors’ required return on investment includes several types of premiums, including the premium for taking extra risk in a specific infrastructure project, which depends on the nature and location of the project.

The premium for volume depends on the size of the investment. A higher rate of return for a higher level of investment is expected because it reduces the power of diversification of investment in various projects.

The maturity premium, which indicates a higher rate of return on longer duration projects, where the waiting time to materialize and realize the return will be much higher. The liquidity premium indicates the investment in a project where earlier encashment is not possible.

The premium for informational inefficiency is paid by the host country if it does not have complete information about the project. This incomplete information or uncertainty may be a hindrance in estimating the cost of a project. Foreign investors may demand an extra premium for their investment in a country that is not included in their priorities. It may be defined as the ‘patriotism premium’.

The foreign investors may have to incur additional costs to satisfy those vested interest groups that can influence the economic policies of the host country. An accelerated growth in foreign investment cannot be planned without considering these factors.

The most important thing to induce foreign investment is confidence-building in domestic investors. The foreign investors must consider the actions of domestic investors. The active participation of domestic investors gives a positive signal to the foreign investors.

The domestic investors should not be ignored in offering protection and incentives to the foreign investors. This was always a major shortcoming of the investment policies in Pakistan. There is no country in the world where foreign investors can establish their businesses without the participation of local investors, workers, and entrepreneurs.

In the contemporary world, the local investors induce the foreign investors in establishing subsidiaries of the transnational corporations, inclusion of foreign investors in the board of directors of domestic companies, establishing cross border mergers and acquisitions, establishing joint ventures, participation in international project finance deals, launching greenfield projects, participation in public-private partnership, agreements for transfer of technology, transfer of equity, and establishing global value chain in intensive industries and critical minerals.