Stronger Fiscal Discipline Key to Attracting Investment in Low-Income Countries – IMF

 

Low-income countries (LICs) seeking to attract sustained foreign investment must prioritise stronger fiscal discipline and institutional reforms, according to a new International Monetary Fund (IMF) assessment, which underscores the growing importance of domestic policy credibility in a tightening global financing environment.

The IMF report finds that countries with stronger fiscal institutions, particularly in revenue administration and public financial management are more likely to attract higher levels of foreign direct investment (FDI), with the impact even more pronounced in low-income economies than in emerging markets.

Beyond the volume of investment, the quality of FDI also improves in such environments. The report notes that stronger fiscal systems are associated with more innovation-driven investments, reflected in higher research and development intensity.

Crucially, the IMF cautions that widely used incentives such as tax breaks and special economic zones deliver limited results unless backed by sound fiscal governance. In countries where fiscal discipline is weak, such incentives tend to have minimal impact on investor decisions.

The findings come at a time when low-income countries are navigating a challenging global landscape marked by declining external financing and rising borrowing costs. Net financial inflows have fallen by about one-third compared to their peak between 2010 and 2014, driven by reduced foreign direct investment and lower external debt flows.

At the same time, official development assistance has declined to 4.3 percent of GDP, down from an average of 5 percent during the 2010–2014 period, with further reductions expected. The composition of financing is also shifting, with fewer grants and more loans, alongside a move away from direct budget support toward project-based funding.

These pressures are compounded by rising domestic borrowing at higher interest rates and shorter maturities, increasing debt vulnerabilities across many low-income economies. Countries with limited foreign exchange reserves remain particularly exposed to external shocks, including fluctuations in commodity prices, global interest rates, and potential disruptions to remittance flows due to changing migration policies.

Against this backdrop, the IMF emphasizes the need for decisive domestic reforms to improve investment climates and enhance returns on capital. Strengthening fiscal institutions, maintaining discipline in public spending, and improving governance frameworks are seen as critical to restoring investor confidence and unlocking private capital.

The Fund also calls for better targeting of concessional financing toward poorer and more fragile economies, alongside stronger coordination between governments and development partners to support reform implementation and reduce borrowing costs.

The IMF reaffirmed its role in supporting these efforts through policy guidance, capacity building, and financial assistance where necessary, as low-income countries work to navigate global uncertainties and rebuild more resilient economic foundations.