Foreign aid and investment have played a critical role in Pakistan's economic development since the first years of independence. Since 1954, the government has tried to attract foreign investment to maintain economic development, provide specialized technical knowledge, and bring in much-needed foreign exchange. Incentives for private investment include guarantees for the repatriation of capital invested in approved industries, facilities for remittance of profits, and guarantees for equitable compensation in the event of nationalization of an industry. In addition, special tax concessions available to certain local industries are also available to foreign investors. Since the late 1980s, a series of regulatory reforms related to exchange controls, repatriation of profits, credit for foreign-owned firms, issuing of equity shares, foreign currency accounts, and transactions on the stock exchange have significantly reduced the restrictions on general foreign investor activity in the wider Pakistani economy.
Foreign direct investment (FDI) peaked in 1995/96 at $1.1 billion, then dropped to $548 million in 1996/97 in response to a foreign-exchange crisis. Investors were also deterred by Pakistan's listing as the second-most-corrupt nation in the world, after Nigeria. In the tension leading up to the nuclear bomb tests in May 1998, FDI fell to $432.7 million of 1998/99, and then decreased further after the military coup in 1999, to $420 million, in 1999/00. In 2000/01, FDI fell to an annual rate of less than $275 million. After the 11 September 2001 terrorist attacks on the United States, Pakistan received a windfall in foreign assistance, raising foreign reserves from $908 million in 1999/00 to $4.3 billion in 2001/02. In March 2003, on the eve of the US-led invasion of Iraq, foreign reserves stood at more than $10 billion. However, to date the overall investment climate in terms of security has only been worsened by its role in the War on Terror.
The United States has been the largest source of FDI in Pakistan, with total investment of $1.2 billion as of mid-2002. Over the three years 1998/99 to 2000/01, the US-based investment totaled $250 million. The United Kingdom was the second-largest source, with $241 million. The total for 1998/99 was $327 million, including $135 million from US sources, $77 million from the United Kingdom, and $51 million from Japan.