Terrorism in Pakistan and Its Impact on Foreign Investment

Samreen Fahim Babar*, Abdul Sattar*, Nadir Shah*, Harris Laeque*

*Bahria University, Islamabad

Abstract
Terrorism activities decrease the foreign investor confidence, which decrease the FDI
(Kinyanjui, 2014). This paper examines the impact of terrorism, CPI, exchange rate and
interest rate on foreign investment in Pakistan. Foreign investment involves both Foreign
Direct Investment and Portfolio Investment in Pakistan. The study was based on
secondary time series data. Twelve (12) years quarterly data from 2003 to 2014 was
assimilated for the purpose of analysis. Multiple regression analysis were applied to
scrutinize the relationship among the different variables. All variables such as terrorism,
CPI, exchange rate and interest rate are significant at 5% level and have positive
relationship with foreign investment. The results indicated that terrorism events have a
short term impact on the foreign investment that consequences the lack of long-term
commitments of the foreign investors in Pakistan.
Keywords: Terrorism, foreign direct investment, foreign portfolio investment

Introduction
Terrorism means any activity that creates fear and harassment among the people of a
country and the doers who create that problem are called terrorist (Shahbaz et al.,
2013).Terrorism is used for threat of violence, a method of combat, or a strategy to
achieve certain targets and aims to induce a state of fear in the victim that is ruthless and
does not conform to humanitarian rules (Laqueru, 2015).Terrorism exists in Pakistan so it
threatens its sovereignty and has crippled the economy. The terrorist activities in Pakistan
have led to the loss of capital and investors. Moreover, tourism industry of Pakistan is
also in a dying state and the threat of terrorism compels the government to divert
resources to security spending. It hampers the prospects of good governance (World
Times, 2015).
The ongoing war against terrorism in Pakistan is a disappointment at all sides. It has
caused in closing industries, low agricultural production, no access to American and other
European markets, depreciation of rupee, rising public debt, no ray of hope for the
settlement of long standing Kashmir dispute, human losses in drone and other terrorists
incidents. Moreover, weakening of social fabric, weakening of the law enforcement
institutions and a declining trend in the life standard of the people (Farooq & Khan,
2014).
Terrorism activities are negatively affecting the FDI of a country. Terrorism activities
decrease the foreign investor confidence, which decrease the FDI (Kinyanjui, 2014). FDI
recently has been one of the major elements contributing in the global economy. They

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 Terrorism in Pakistan and Its Impact on Foreign Investment

have found that an increase in terrorist violence reduces FDI. Furthermore, the
disaggregated analysis by individual sectors explores the nuances in considerations for
FDI, where some sectors are affected while others remain immune to terrorism-related
risks. The study has further illustrated that FDI flows to certain industrial sectors are
more susceptible to terrorism than other sectors that attract investments to remotely
located facilities. All this creates demand for huge external capital for undertaking huge
projects and indirectly promoting growth (Haider & Anwar, 2014).
Foreign direct investment (FDI) is a measure of foreign ownership of productive assets,
such as factories, mines and land. Increasing foreign investment can be used as one
measure of growing economic globalization (Masood, 2015). FDI is important for a
country's development, enhancing industrial development, use resources in affective and
efficiently ways, attracting investors, enhancing innovation, increase demand of raw
material and capital goods. Pakistan must attract foreign investors, find new international
markets in the world and this is the way for its development. Pakistan creates a better
relation to developed country (Hussain et al., 2014). FDI is increased competitive
pressure and domestic firms have specific characteristics which make them to compete
internationally. However, these benefits cannot always be exploited and the production
abroad creates competitiveness and long-term survival of companies and employment in
Germany. The study suggested reforms to labor, wage and tax laws, as well as a
significant reduction in bureaucracy (Deutsche Bundes Bank, 2006).
Foreign portfolio investment and FDI investments play important role in economy
growth of a country. Every country must attract foreign investments because they bring
lots of benefits to the host country such as technology, knowledge and skills (Sharif et al.,
2014) have explored in their study by using Autoregressive Model that FDI has negative
impact on Net portfolio investment (NPI) while all other variables are positively related
to NPI. The study suggested that extra protection should be given to foreign investors by
the government of Pakistan. Terrorism should be eradicated to flourish market
capitalization as well as to improve financial institutions in Pakistan. Government of
Pakistan should provide welcoming atmosphere to the foreign investors. Interest rate on
deposit in Pakistan should increase for attracting FPI.
Foreign portfolio investment is passive investment of securities in a portfolio. It is made
with the expectation of earning a return on it. This expected return is directly correlated
with the investment's expected risk. It is distinct from direct investment, which involves
taking a sizeable stake in a target company and possibly being involved with its day-to-
day management. Portfolio investments can span a wide range of asset classes such as
stocks, government bonds, corporate bonds, Treasury bills, real estate investment trusts,
exchange-traded funds, mutual funds, certificates of deposit and so on. Portfolio
investments can also include options, warrants and other derivatives such as futures, and
physical investments like commodities, real estate, land and timber (Investopedia, 2015).
Foreign portfolio investment is not fully explored by other researchers in Pakistan. This
paper will explore the impact of terrorism on Foreign Portfolio Investment in Pakistan.
The nature of FDI's impact is explained by tracing its effect on GDP, export, import, per
capita income, employment and manufacturing in Pakistan by (Tasneem & Aziz, 2011) in
their paper. FDI effects on domestic output, employment, exports and overall growth are
62 Vol.1, Issue 1 pp. 61-83
 Terrorism in Pakistan and Its Impact on Foreign Investment

positive but negative on imports. They suggested that FDI is concentrated in import
substitution industries, then it is expected to affect imports negatively and export
positively as the goods that were imported are now produced in the host country by
foreign investors. The results of the study in their paper advocated that FDI is
complementary to local enterprises and capabilities after a certain level of development.
Amna et al. (2012) have explored in their paper that FDI and GDP are significant and
positive but inflation and GDP have significant negative relationship. The study further
suggested that FDI is an important part of economic growth in emerging countries. FDI
increases employment and profits in the host country.
Consumer Price Index is a measure that examines the weighted average of prices of a
basket of consumer goods and services, such as transportation, food and medical care.
The CPI is calculated by taking price changes for each item in the predetermined basket
of goods and averaging them; the goods are weighted according to their importance.
Changes in CPI are used to assess price changes associated with the cost of living. The
Pakistan Bureau of Labor Statistics measures two kinds of CPI statistics: COICOP
(Classification of Individual Consumption according to Purpose) is currently being used
for CPI items, while CPC (Central Product Classification) is being used for Wholesale
Price Index items. CPI is one of the most frequently used statistics for identifying periods
of inflation or deflation. When large rises in CPI during a short period of time typically
denote periods of inflation and large drops in CPI during a short period of time usually
mark periods of deflation (Investopedia, 2015)
Ahmed et al. (2013) explored in his paper that GDP growth rate and interest rate have
significant impact on FDI while inflation and exchange rate are insignificant in
determining the FDI inflows in Pakistan. Exchange rate is a price for which the currency
of a country can be exchanged for another country's currency. Factors that influence
exchange rate are included like interest rates, inflation rate, trade balance, political
stability, internal harmony, high degree of transparency in the conduct of leaders and
administrators, general state of economy, and quality of governance (Business Dictionary,
2015).
Ahmed et al. (2013) explored in his paper that GDP and interest rate have significant
relationship with FDI inflows and insignificant relationship of inflation rate and exchange
rate with FDI inflow of Pakistan. The study suggested to facilitate foreign firms with
attractive packages and encourage export oriented FDI which promote human capital,
skills and latest technology. Policy makers should not ignore business related problems
like inflation, infrastructure, interest rate and power.
Interest rates play a significant role in market economy. It is a channel flow of funds from
savers to borrowers like banks, mutual funds and insurance firms. A balance is struck
between the demand for funds by borrowers and the supply of funds from savers by an
ever-adjusting level of interest rates. Changes in the quantity of funds available to finance
the spending plans of borrowers as well as changes in borrowers' demands for funds alter
interest rates which, in turn, affect the levels of consumer and business spending, income,
the Gross National Product, the employment of resources and the level of prices. Finally,
interest rates have a big impact on our economy (Richard & Trainer, 2015).

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 Terrorism in Pakistan and Its Impact on Foreign Investment

Background of the Study

Terrorism is one of the important factors that destroys both inside and outside of the basic
system of every country. Pakistan has been fronting the big issue of terrorism events. It is
known as the fashion of the day which is like disease that effects government and public.
It is regarded as headache for federation and a nightmare for public. It has extremely
large roots inside and outside of Pakistan. The insecure condition is caused due to several
factors like weak political, weak injustice, religious clashes, nationalization and weak
governance of federal government and external terrorism events. One of inside factors is
poverty which is the main cause of terrorism. Pakistan population (65.5%) has been
gaining 2 dollar a day. The backbone of Pakistan economy is agriculture sector for
generating revenue and it is the biggest source of food but terrorism adversely affected it
as well as other industry sectors. Ali (2013) has explored in his study that origin of
terrorism in Pakistan can be traced back to two significant events that brought
obscurantism, intolerance and resultantly terrorism in Pakistan. Before 1980s, religion
has never been a controversial issue in Pakistan. The sectarian militants emerged in
Pakistan after the 1979 Iran Revolution which transformed the nature and magnitude of
sectarian violence in Pakistan. Harvard study (December, 2000) has explored that higher
levels of terrorism risk are associated with lower levels of net FDI. In case of Pakistan,
terrorism has affected foreign investment in the country. Ultimately, FDI was increased
many years in the past but terrorism events had negative effect on FDI in the country.
According to the World Economic Forum, Pakistan got 113 out of 130 countries in 2009
as tourism destination due to increasing of terrorism events and the hotel industry faced a
loss of Rs. 60 billion and a loss of Rs. 35 billion in agriculture. The loss to agriculture
alone amounts to Rs.35 billion. Economic survey of Pakistan report has explored shows
that the stock of agriculture in GDP decreasing, 25.99 % of GDP in 2000 and 21.3 % in
2008. After September 11, 2001, destruction to the Pakistani economy is estimated at 68
billion dollar for ten years. The important sources of profits are affected adversely like
agriculture, tourism, manufacturing and small-scale industries due to terrorism events in
Pakistan.
Foreign investments are important for emerging economies that support to build saving-
investment gap, makes employment opportunities, profits from transfer of technology,
and finally gives economic growth of host countries. Foreign investments not only
facilitate emerging economies with urgent capital for investment, they also improve job
creation, managerial skills as well as transfer of technology. All of these finally support
the economic growth and development. Therefore, emerging economies are very
interested to encourage foreign investments. Foreign investments are very necessary for
the economic growth of Pakistan that fulfills the gap of saving-investment. Pakistan does
not have enough inside generated facilities to keep the speed of economic activities;
therefore, FDI is very necessary to attract the local investment in order to gain economic
objectives. FDI is necessary for Pakistan in order to support projects of development,
empowering industrial sectors, enhance job opportunities, getting improved technology,
support local managerial skills, helping productivity and output, increasing balance of
payments, foreign exchange reserves, physical infrastructure and human resources and
finally getting higher rate of economic growth (Zahid, 2013).

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 Terrorism in Pakistan and Its Impact on Foreign Investment

According to the UNCTAD (2006), in 2005 FDI share of emerging economies as

percentage of GDP reached to 27.0 level points than 9.8 in 1990.The emerging countries
are changing investment policies to attract foreign investments. According to the
UNCTAD (2002) from 1991-2001 internationally 95% changes of 1393 extended to
control foreign investment which resulted in creating of investment agreements (2099).
The agreements were too safe and develop investments among two countries. According
to Dutta (2005) Chinese government permits full ownership and profit of foreign
investments and the inflow of them was 72406 million dollar that was closed to 99443
million dollars of US in 2005.
Government of Pakistan (2006) improved the economic system such as emphasizing on
liberalization, E-governance and legal framework of modernization to encourage foreign
investments. FDI was increased because privatization and liberalization polices were
implemented. Foreign investment inflow was $ 64 million in 1980 (SHRDC, 2007) as
FDI was encouraging, so, the average yearly inflow was $463 million in 2000 and $2183
million was in 2005. It showed that Pakistan FDI was increasing but there is a long
distance and gap to progress with growing countries.
The more attracting foreign investment countries are Singapore, Hong Kong and
Malaysia as compared to Pakistan. The weak political and policies has been destroying
the development in Pakistan. The wars between India and Pakistan and weak security
may not be permitting Pakistan to implement proper development policies. From the
initial stage, Pakistan had lots of troubles such as financial resources, investments, saving
and improper allocation of funds for the development that hurt economy of Pakistan. The
above serious picture of realities about foreign investment, the terrorism and foreign
investment in Pakistan is witness of this situation. Terrorism has both political and
economic implications. They manifest themselves in dwindling FDI inflows, damage to
infrastructure, extra cost incurred on security, loss of trade, disturbed balance of
payments, and increased insurance premiums, etc. As high loans, costs and distance
between saving and investments led the government of Pakistan to attract and adopt
foreign investments (Tahir, 2012).

Theories Involved
Wilkinson has explained three various types of terrorism such as revolutionary terrorism,
sub revolutionary terrorism and repressive terrorism. Revolutionary terrorism is the use
of systematic tactics of terroristic violence with the goal of getting about political
revolution. The study presented further four major attributes of revolutionary terrorism
such as it is always a group phenomenon, revolution and terror are justified by some
revolutionary ideology or program, leaders are able to organize people for terrorism and
alternative institutional structures participate in the political system and develop its own
policy-making bodies and codification of behavior.
Sub-revolutionary terrorism is defined as terror used for political reasons other than
revolution or governmental repression. Whereas revolutionary terrorism seeks total
change, Wilkinson argues that sub-revolutionary terrorism is aimed at more limited goals
such as forcing the government to change its policy on some issues, warning or punishing
specific public officials, or retaliating against government action seen as reprehensible by

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 Terrorism in Pakistan and Its Impact on Foreign Investment

terrorist. Therefore, in this respect, under the typology of sub-revolutionary terrorism

pressure groups such as Fathers for Justice and Green Peace may be deemed as 'terrorist
organizations'.
Repressive terrorism is defined as 'the systematic use of terroristic events of violence for
the goal of information, putting down, quelling, or restraining certain groups, individuals
or forms of behavior deemed to be undesirable by the oppressor. Therefore, the political
definition of terrorism under the typology of repressive terrorism relies heavily upon the
services of specialized agencies whose members are trained to torture, murder, and
deceive. The terror tools are then moved against clear opposition groups and can be later
directed against much wider groups like Nazi Germany, where the Schutz staffel, the
specialized agency, deployed terroristic apparatus against the opposition group, the Jews
(Jawlard, 2002).
Denisia (2010) has explored in his study that nowadays the problem of foreign direct
investment has attracted more attention at domestic and international level. The main
research on the motivations underlying FDI was developed by Dunning, Hymer or
Vernon. Economists trust that FDI is a significant part of economic development in all
countries, especially in the emerging ones. The opinion reached after several empirical
studies on the relationship between FDI and economic development from a macro
perspective that they increase employment, productivity, competiveness, and technology
spillovers in emerging countries, FDI means higher exports, access to international
markets and international currencies and is an important source of financing, substituting
bank loans.
The Eclectic theory, the ownership consists of intangible assets, enhances incomes or
minimized costs. While TNCs face some extra costs in various countries so a company
should have some specific characteristics which reduce operating costs. These benefits
are the clear profits of the company. The monopoly of the firm contributes in benefits
which support to receive higher marginal profitability or lower marginal cost than other
companies. The location is used by a firm rather than giving to other foreign companies.
Location benefits are the main factors to determine who will become host countries for
the activities of transnational corporations.
Internalization offers a framework for assessing various ways in which the firm will
exploit its powers from the sale of goods and services to different contracts that might be
signed between the companies. As cross-border market internalization benefits are higher,
more the firm will want to engage in foreign production rather than offering this right
under license, franchise. Ownership Location Internationalization parameters are various
among firms and depend on economic, political, social characteristics of the host country.
Therefore, the objectives and strategies of the firms' magnitude and pattern of production
will depend on the challenges and opportunities offered by various kinds of countries.
Shefrin and Statman (2000) have explored in their study that optimal portfolios of
Behavioral portfolio theory (BPT) investors resemble combinations of bonds and lottery
tickets. The study suggested that BPT efficient frontier and the mean-variance efficient
frontier don't happen together. The study further explained that BPT is presented in a
single mental account version (BPT-SA) and a multiple mental account version (BPT-

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 Terrorism in Pakistan and Its Impact on Foreign Investment

MA). BPT-SA investors have allocated their portfolios into a single mental account,
while BPT-MA investors have separated their portfolios into several mental accounts.
BPT-MA portfolios, where layers are associated with aspirations and are explored with
two layer portfolio where the low aspiration layer is designed to avoid poverty while the
high aspiration layer is designed for a shot at riches.

Problem Statement
Previous research studies have empirically shown that terrorism affects FDI negatively in
Pakistan. Most of these studies used sector-wise data of FDI and Terrorism fatalities
(2000-2013). This study is unique as it will include more variables for analysis such as
CPI, exchange rate and interest rate. Krishna et al. (2003) has explored that both FDI and
FPI are not related to each other and they are independent. Marcin et al. (2013) staved
that when there is stability economically in the country so FDI is more important than
FPI, as during insecurity and economic distress, both in source and host countries, then
FPI are more important than FDI. Pfeffer (2008) explained in his study that FPI solve the
liquidity problems and it will maintain the FDI investment position. The study suggested
that combination of both FDI and FPI will have high yield and liquidity position so
therefore, we combine FDI and FPI. FPI has not been fully explored so there is a gap in
the literature that more contribution regarding these investments can be made. This paper
will examine the effect of terrorism on foreign investment in Pakistan (2003-2014).

Research Question(s)
This research study seeks to find answers to the following questions;
1. What are the various indicators of terrorism?
2. What is the effect of terrorism on Foreign Investment in Pakistan from 2003-
2014?
3. What is the effect of CPI on Foreign Investment in Pakistan from 2003-2014?
4. What is the effect of exchange rate on Foreign Investment in Pakistan from 2003-
2014?
5. What is the effect of interest rate on Foreign Investment in Pakistan from 2003-
2014?
6. What are the various measures adopted to minimize the risk associated with
terrorism and boost up Foreign Investment in Pakistan?

Research Objectives
The main objective of this research is to examine and assess the pros and cons of foreign
investment in relation with terrorism, CPI, exchange rate and interest rate which has
ultimately affected the growth of the Pakistan economy. This will be achieved through
analyzing foreign investment in Pakistan for the period (2003 – 2014). This research aims
to achieve the following objectives;
1. To identify effect of terrorism on Foreign Investment in Pakistan.
2. To identify effect of CPI on FI in Pakistan.
3. To identify effect of exchange rate on FI in Pakistan.
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 Terrorism in Pakistan and Its Impact on Foreign Investment

4. To identify effect of interest rate on FI in Pakistan.

Significance of the Study

This study is important to point out the significant of foreign investment for investors and
for the growth of economy of Pakistan. The study will provide valuable guidelines for
investors in Pakistan. The results of present study will help investors and State Bank of
Pakistan to purse sustainable investment policies measures to promote foreign
investments that would help to enhance the economic growth. Most importantly, the
policy makers in Pakistan will consider that to what kind of investment is better while
implementing investment policies for the growth of economy. This study will also
recommend ways to cope up with growing terrorism.

Theoretical Framework
The purpose of this study is to find out the impact of total fatalities, CPI, exchange rate
and interest rate on foreign investment in Pakistan. The literature is suggesting that
terrorist events make ambiguity and increases risks which have adverse effect on FDI
because investors lose their confidence level due to terrorism events. As Foreign
investment is the combination of both FDI and FPI in this study. Earlier researchers have
used the time series data and OLS models (Muhamamd & Naeem, 2009; Shahbaz et al.,
2013). Building on the published literature, this study also uses time series data for FI,
Total fatalities, CPI, exchange rate and interest rate in Pakistan. The study will check
some tests for the significance of the model that there is no serial correlation, no
heteroskedasticity and residuals are normally distributed. The data of foreign investment
is taken from State Bank of Pakistan website, terrorism data from South Asian Terrorism
Portal while CPI, exchange rate and interest rate data is obtained from International
Monterey Fund website (2003-2014).
This theoretical structure will facilitate us to build up the model having relationship
between terrorism, CPI, exchange rate and interest rate and foreign investment.
Theoretical situation on these variables are reviewed as well as the empirical tests of the
relationship. Terrorism includes data of civilians, security force personnel, terrorists and
injured people of both bomb blasts and suicide attacks in a country, foreign investment is
measured by both FDI and FPI in $ in Pakistan.
Hypotheses
This research paper first of all tests the normality and linearity of time series data used in
study. For this purpose Ordinary Least Square (OLS) model is used and model is based
on multi regression. For goodness of OLS model will also provide information about the
serial correlation, heteroskedasticity and residuals of the given data. The model overall
should be significant. Independent variables are total fatalities, CPI, exchange and
interest rate whereas dependent variable of this study is foreign investment in Pakistan.
Total fatalities is measured by civilians, security force personnel, terrorists and injured
people of both bomb blasts and suicide attacks in a country, foreign investment is
measured by both FDI and FPI in dollar in Pakistan. Sample of this study which is used
to evaluate relationship from 2002-2014 that consist of twelve years. Secondary data is
used to conclude results on the basis of finding of study. The data of foreign investment is

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 Terrorism in Pakistan and Its Impact on Foreign Investment

taken from website of State Bank of Pakistan, data of terrorism events from South Asian
Terrorism Portal and data of CPI, exchange rate and interest rate from International
Monterey Fund 2003-2014.
Null hypothesis to be tested in this research study are:
H1: Terrorism has no effect on foreign investment in Pakistan
H2: CPI has no effect on foreign investment in Pakistan
H3: Exchange rate has no effect on foreign investment in Pakistan
H4: Interest rate has no effect on foreign investment in Pakistan

Methodology
Data
One of the important and key reasons of motivation for the study was to determine the
impact of terrorism on FI. As terrorism increases the risk and it will affect the investment
decisions and polices, the higher risk may be indicative of higher payoff FI. It permits us
to find the impact of terrorism on FI in Pakistan. We combined Both FDI and FPI, they
are components of Balance of Payment under the account of Capital and Financial
accounts. We have acquired the time series data on foreign investment from the website
of State Bank of Pakistan. The data of CPI, exchange rate and interest rate is obtained
from international monetary fund website. This study analyzes the total fatalities, CPI,
exchange rate and interest rate with FI on basis of quarterly data. (2003-2014).
Methodology
The previous literature review supports to select the Ordinary Least Square model. Many
previous studies have followed the same method and other techniques are also used like
Dickey Fuller & Augmented Dickey Fuller. Ordinary Least Square (OLS) model is used
by Awais. M (2013) and Kinyanjui. S (2014) so therefore, this study also applies the same
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 Terrorism in Pakistan and Its Impact on Foreign Investment

model OLS. The OLS model that is ordinary least square which is also called least square
errors regression also or just least squares. It is one of the most basic and most commonly
used prediction techniques among people and researchers like in statistics, finance,
medicine, economics, and psychology. It measures the accuracy which differentiates it
from other forms of regression. It was invented by the world's well known mathematician
in 1795 and rediscovered by Adrien Marie Legendre in 1805. It is easy to implement and
apply to problems. It can be easily analyzed mathematically and interpreted from others
techniques. When the distributions of random variables have same variance and zero
mean then the least squares method is the best unbiased linear estimator of the model
coefficients (Gauss-Markov Theorem).This study applied log to normalize the data and
analyzes the impact of terrorism, CPI, exchange rate and interest rate on foreign
investment in Pakistan. We have applied multi regression through OLS model for the
equation to determine the impact of terrorism, CPI, exchange rate and interest rate on
Foreign Investments in Pakistan.
There are only two analyses and three tests:
1. Trend analysis
2. Regression analysis
3. Serial Correlation LM Test
4. Heteroscedasticity Test
5. Normality Test
For the purpose of empirical analysis through OLS methodology the following equation
will be estimated.
Equation
Log(FIit)= β0 +β1log(Tit)+β2log(IRit)+β3log(Exit)+ β4log(CPIit)+E
Where: β0= intercept, βn= effect of independent variables, FI= dependent variable foreign
investment in Pakistan, T= independent variable terrorism, IR = interest Rate, EX =
exchange Rate, CPI = consumer price index, and E= error term

Results
The results are outcomes of variables and applied multi regression through OLS model.
Multi regression used to check relationship of impact of terrorism, CPI, exchange rate
and interest rate on foreign investment in Pakistan. Analysis is interpreted-based on
results of the variables.
Trend Analysis
It is the graphical analysis of time series quarterly data from 2003-2014. It will identify
that in which quarter of a year data has upward trend and downward trend. We can easily
find the movement of the data about its direction. Following graphics are presenting each
variables trend movement with its explanation.

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 Terrorism in Pakistan and Its Impact on Foreign Investment

10
9
8
7
6 Q1
5 Q2
4 Q3
3 Q4
2
1
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure 5.1 Total Fatalities in Pakistan

Given figure 5.1shows the graphical representation of Total Fatalities. It is shown that
highest total fatalities are between 2007 and 2009, in quarter four of 2007 was higher
than other quarters and again quarter two of 2009 was in highest peak, then slowly
decreased till quarter first of 2014. Where government estimated that terror war cost was
more than 35 billion dollar (Dawn News, 2009). This fluctuation results a decrease in
foreign investment in 2009, and lowest are in 2003 which was favorable for the increase
in Foreign Investments growth.

9
8
7
6
Q1
5
Q2
4 Q3
3 Q4
2
1
0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure: 5.2 FI in Pakistan

It is shown in the given Figure 5.2 that there was almost consistency in increasing of
foreign investment in Pakistan but suddenly decreased in third quarter of 2009 because of
highest peak of total fatalities in the same year. As after 2009 the total fatalities gradually
decreased so foreign investment consistently increased specially in quarter four till 2014
(Board of Investment of Pakistan).

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 Terrorism in Pakistan and Its Impact on Foreign Investment

4
Q1
3 Q2
Q3
2 Q4
1

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure: 5.3 CPI in Pakistan

It is shown in the given Figure 5.3 that there is almost consistently increasing CPI in
quarter four of each year. CPI is increasing from 2009 to till 2014.

5.2
5
4.8
Q1
4.6
Q2
4.4 Q3
4.2 Q4

4
3.8
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure: 5.4 ER in Pakistan

It is shown in the given Figure 5.4 that exchange rate was increasing first quarter of 2003
but in fourth quarter of 2009 decreased due to terrorism events and then was increasing
till 2014 in Pakistan.

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 Terrorism in Pakistan and Its Impact on Foreign Investment

2.5

2
Q1
1.5 Q2
Q3
1 Q4
0.5

0
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Figure: 5.5 IR in Pakistan

It is shown in the given Figure 5.5 that interest rate are consistently increasing in first and
fourth quarters of each year but in fourth quarter of 2009 decreased due to terrorism
events in Pakistan.
Regression Analysis
It is used to find numerical results of the data and interpret them accordingly to the
outcomes of variables. As we run multi regression through OLS model so the results are
shown in the following tables with interpretation and also Serial Correlation LM. Test is
applied on the data to check whether the data has serial correlation or not.
Heteroskedasticity Test is used to determine the Heteroskedasticity in the data. Normality
Test is applied to check whether residuals are normally distributed or not.

Table. 5.2

Variables Name Coefficient t-statistic P-value

Total Fatalities 0.38 2.31 0.02

CPI 5.08 2.32 0.02

Exchange Rate 10.42 3.07 0.00

Interest Rate 2.13 2.69 0.01

2 2
Note: R = 0.42, Adj. R = 0.36, Durbin-Watson= 1.60, Sig. (F-stat)= .00

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 Terrorism in Pakistan and Its Impact on Foreign Investment

Serial Correlation LM. Test

Obs*R-squared Probability 0.146535

Heterosedasticity Test

Obs*R-squared Probability 0.821856

Normality Test

Jarque-Bera Probability 0.178478

Note: Independent Variables: Total Fatalities, CPI, Exchange Rate and Interest Rate

In table 5.2 coefficient of total fatalities show that 38.74 percent variation is explained in
the dependent variable (foreign investment) by total fatalities. Therefore, the results
suggest that total fatalities significantly affect FI at 95 percent confidence level. The
coefficient shows that it has positive relationship with foreign investment and it is
statistically significant at less than 0.05. T-value is more than 1.96 theoretically value so
it means that there is relationship between total fatalities and foreign investment. If total
fatalities are increased by one percent so foreign investment will be increased by 38.74
percent on average quarterly.
In table 5.2 coefficient of consumer price index shows that 508.22 percent variation is
explained in the dependent variable (FI) by CPI. Therefore, the results suggest that CPI
significantly affects FI at 95 percent confidence level. The coefficient shows that it has
positive relationship with foreign investment and it is statistically significant at less than
0.05. T-value is more than 1.96 theoretically value so it means that there is relationship
between CPI and foreign investment. If consumer price index is increased by one percent
so foreign investment will be increased by 1042.17 percent on average quarterly.
In table 5.2 coefficient of exchange rate shows that 1042.17 percent variation is explained
in the dependent variable (FI) by Exchange Rate. Therefore, the results suggest that
Exchange rate significantly affects FI at 95 percent confidence level. The coefficient
shows that it has positive relationship with foreign investment and it is statistically
significant at less than 0.05. T-value is more than 1.96 theoretically value so it means that
there is relationship between exchange rate and foreign investment. If exchange rate is
increased by one percent so foreign investment will be increased by 1042.17 percent on
average quarterly.
In table 5.2 coefficient of interest rate shows that 213.70 percent variation is explained in
the dependent variable (FI) by interest rate. Therefore, the results suggest that interest rate
significantly affects foreign investment at 95 percent confidence level. The coefficient
shows that it has positive relationship with FI and it is statistically significant at less than
0.05. T-value is more than 1.96 theoretically value so it means that there is relationship
between interest rate and foreign investment. If interest rate is increased by one percent
so foreign investment will be increased by 213.70 percent on average quarterly.
The results are shown in above table that is by using of OLS model in Eviews software.
74 Vol.1, Issue 1 pp. 61-83
 Terrorism in Pakistan and Its Impact on Foreign Investment

R-square is showing that 42.32% variation of foreign investment is explained by total

fatalities, CPI, exchange rate and interest rate. Adjusted R-square is used to correct R
square to more closely reflect the goodness of fit the model. The Durbin-Watson shows
that there is no issue of multicollinearity in the data. The F-statistic is also showing that
overall model is good fit. The Obs*R-squared probability of Serial Correlation LM Test is
14.65 percent which is greater than 5% so it means that there is no serial correlation in
the data. The Obs*R-squared probability of Heteroskedasticity Test is 82.18 percent
which is greater than 5% so it means that there is no Heteroskedasticity. The Jarqu-Bera
probability is 17.84 percent which is greater than 5% so it means that residuals are
normally distributed so we can say that OLS model is good fit (Dr. Hussain, 2015).

Discussion
As we can see that terrorism doesn't have negative effect on foreign investment. The
other variables like CPI, exchange rate and interest rate have positive relationship with
foreign investment. The foreign investment may not be affected negatively by terrorism
events because there are lots of other causes like political, corruption, government
policies, investors' behavior and unskilled managers. Irrational investors who are
ignoring the rational analysis, which effect on investors investment decisions. This also
distort the price of shares and affect the risk and return characteristics of the stock and
affect the asset pricing mechanism and exaggerate the fickle nature of the stock markets.
Terrorism has not any significant effect on many countries and terrorist attacks have
small effect on stock markets. There was no evidence that 9/11 had a lasting negative
influence on FDI. It means that every terrorism attack can't influence foreign investment.
The threshold of investment decision will be used for investment.
As inflation rate is increased so FDI is also increased. The result of CPI has positive
relation with foreign investment in the study. Therefore, when inflation increases so
foreign investment also increases. The study explained that exchange rate and FDI have
positive relationship. As Pakistan is emerging country and have more natural resources
and cheap employees so the international firm checks the local currency for investment in
Pakistan. When the rupees appreciates and increases so the firm gets more money from
the investment. Therefore, it is shown in the study that exchange rate affects foreign
investment positively. Interest rate policy is changed by the government of Pakistan that
encourages the foreign investors to investment in Pakistan so result is showing that
interest rate has positive relationship with foreign investment.
Whether to select FDI or FPI for investment? According to Pfeffer (2008) has explained
in his study that investment decision is related to the investors needs like his/her need is
high yield or less liquid asset. The study further explored that world investor's want the
combination of both FDI and FPI, because they will have high yield and liquidity
position. When sell FPI so it will solve the liquidity problems and it will maintain the
FDI investment position. Marcin. H, Rober. K & Krzysztof. O (2013) when there is
stability economically in the country so FDI is more important than FPI. But during
insecurity and economic distress, both in source and host countries, then FPI are more
important than FDI. Therefore, we can conclude that the combination of FDI and FPI is
nowadays essential in Pakistan because its economy is in distress and insecurity
situations throughout the country. It will enhance foreign investment inflows and will
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 Terrorism in Pakistan and Its Impact on Foreign Investment

facilitate investment opportunities. Therefore, the investors should not only consider the
terrorism as the main reason of adverse effect on foreign investments in Pakistan.

Conclusion
Nowadays foreign investments are the backbone of economy growth in emerging
countries. Many previous studies concluded that terrorism events have negative effect on
FDI. Terrorism events decrease the foreign investors' confidence which is caused to
decrease the foreign investment. When terrorist events target the business sector and
security forces are damages of stock markets and bomb blast and suicide attack decrease
the stock markets operation. Deaths and injuries have more adverse effect on market
returns. As we combined both FDI and FPI and also FPI is increasing nowadays than FDI
in Pakistan (Board of Investment of Pakistan) so therefore, Null hypothesis is accepted
that terrorism has no effect on foreign investment in Pakistan. The others Null hypothesis
are also accepted that CPI, exchange rate and interest rate has no effect on foreign
investment in Pakistan. According to Dawn News 2015 FDI is increased to 615 million
dollar from Feb-2014-15.
Therefore, all these variables have positive relationship with foreign investment in
Pakistan. It is also found in the trend analysis that terrorist events are increased in third
quarter of 2009 so that decreased the foreign investment at the same time which reached
to minus value. As the terrorism events were short term so the foreign investment
increased again from 2009 to 2014. We can conclude that terrorist events have positive
significant impact on foreign investment in Pakistan because FPI is increasing that
investors have been diversified their portfolio in stock markets and diversified their
investment instead of direct investment. Those investors who invested directly in stock
markets and diversified their investments so their returns increased and thus foreign
investment inflows are also increased in Pakistan.
This is a good sign of foreign investment growth which will boost the economy and
development in Pakistan so therefore, we suggest that government should persuade FPI
than FDI. There is the requirement for the making of a community that talk directly with
security officers, army officers, customs officers, and immigration officers and members
of the communities for the betterment of the security and peace. The Federal
Government should provide work and jobs opportunities for unemployed and uneducated
people in order to prevent them from terrorists activities, armed robbers and in order to
empower many frustrated and unemployed able-bodied men who took up arms against
the government and multinational NGOs and Foreign nationals. Antiterrorism squad
should be created from the Pakistan Army, Air Force, Navy, Police and State Security
Service and law enforcement should be implemented.
Policy Recommendation
Government should control corruption, political groups and structures, and involve
intelligence work to detect their bank account, websites and investment activities. Even
minimize direct and indirect relation of political parties with other countries.
Policy makers should control and provide facilities to IDPs (Internal Displaced Peoples)
and implement educational programs that provide awareness about Islam.

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 Terrorism in Pakistan and Its Impact on Foreign Investment

Short term and long term strategies are necessary to implement against terror wars that
analyze all types of terrorist events, recognize their objectives, social and economic
causes of terrorists. DDR (Disarmament, Demobilization and Reintegration) should be
applied against terrorist groups and political groups and negotiate them about cease fire
and attacks (Mesa, 2008).
The government should minimize $0.15 million equity investment to $0.7 million for
foreign investors in services sector and make it compulsory that use domestic raw
materials also in production because to enhance economic activities.
Policy makers and Foreign investors should follow investment decision threshold that
whether to invest or avoid from foreign investment.
Policy makers should encourage investors towards mix of FDI and FPI because of
terrorism events impact on foreign investors and liquidity problems. Our study provides
important and significant information to policy makers and controllers in making
investment policies in Pakistan.
Limitations of the Study
Our researches include quarterly data of foreign investment from first quarter 2003 to
fourth quarter of 2014. Due to the shortage of data our study included 48 observations of
each variable of foreign investment, total fatalities, CPI, exchange rate and interest rate.
This study provides managerial and policy implications in various areas of economics
and in foreign investment, insurance planning and national security.

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