Measurement of cost of capital for Foreign Direct Investment in Pakistan: A neoclassical approach

Author Affiliation

Qazi Masood Ahmed is Associate Professor at Institute of Business Administration (IBA), Karachi

Faculty / School

Faculty of Business Administration (FBA)

Department

Department of Economics

Was this content written or created while at IBA?

Yes

Document Type

Article

Source Publication

Pakistan Development Review

ISSN

0030-9729

Disciplines

Geography | Growth and Development | Social and Behavioral Sciences

Abstract

This paper analyses a key element of the attractiveness of Foreign Direct Investment (FDI) in Pakistan with special emphasis on computing the cost of capital in effecting the rate of return and the internal cash flow for investment of the investing firms. Using Jorgenson's Neoclassical Investment Model, the cost of capital is computed after considering the taxation policy and the treatment of invested capital. The objective of the study is to explore a realistic and in-depth investigation of the tax concessions and the response of investors through the capital stock adjustment process. The paper argues that fiscal incentives are more appropriate in attracting FDI as these have no direct drain over public resources and increased the after-tax return by availing of the tax holidays and depreciation allowances. The paper elaborated fiscal provisions and their implications on the investment environment specifically available to foreign investors in Pakistan. The computed results show consistent and considerable impact of the cost of capital on FDI inflows. Results of the computed per unit cost of foreign capital for the period 1960-61 to 1999-2000 verify the hypothesised relationship between the real interest rates, the depreciation deduction allowances, the rate of corporate income taxes, and the tax credits that are available to the foreign investors in Pakistan. A lower tax rate, and tax holidays along with higher inflation rate, lowers the cost of capital while a higher real rate of interest-and lesser fiscal provisions-results in higher cost of capital.

Indexing Information

HJRS - Y Category, Scopus

Publication Status

Published

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