## ppea2026005 ## Source details **Canonical URL:** [ppea2026005](https://www.imf.org/-/media/files/publications/pp/2026/english/ppea2026005.pdf) ## Other formats - [Markdown version](/-/media/files/publications/pp/2026/english/ppea2026005.pdf.md) - [Structured JSON version](/-/media/files/publications/pp/2026/english/ppea2026005.pdf.json) --- ### EXECUTIVE SUMMARY - Global growth projected to remain at 3.3 percent in 2026, broadly in line with 2025 and the 2024 outturn, but revised down relative to forecasts made prior to recent major policy shifts. - Downside risks: outbursts of trade tensions, lower-than-expected gains from AI leading to a decline in investment and abrupt financial market correction, and domestic political or geopolitical tensions affecting markets, supply chains, and commodity prices. - Upside scenarios: sustained easing of trade tensions and faster productivity growth from AI. - Key cross-cutting priorities: resolute domestic policies and reforms plus adequate international support to navigate uncertainties and shifting external financing. ### MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LICs - Growth and divergence: - Average weighted GDP growth in LICs: 4.2 percent in 2024, 4.8 percent in 2025, and 5.3 percent in 2026 (driven by Bangladesh, Kenya, Uzbekistan). - Median growth: 4.2 percent in 2025 and 4.3 percent in 2026; median projected to reach 4.5 percent in the medium term. - About one third of LICs projected to grow above 5 percent; a quarter of LICs (primarily FCS and SDS) expected to grow by less than 3.3 percent. - Six of the top ten world’s fastest-growing economies (based on 2024-25 average) are LICs: Benin, Ethiopia, Kyrgyz Republic, Niger, Rwanda, Tajikistan. - Inflation: - Median inflation in LICs: 4.0 percent in 2025; projected 3.7 percent in 2026. - In 2025, inflation exceeded 20 percent in eight LICs (mostly FCS); three countries recorded 50 to 100 percent due to sharp currency depreciations. - Fiscal consolidation and debt: - Median improvement in the primary deficit by 2025: 1.9 percent of GDP. - Expected median consolidation in LICs’ primary balance in 2026: 0.1 percent of GDP. - Median public debt around 50 percent of GDP in 2025—above pre-pandemic levels. - Half the LICs remain at high risk of, or already in, debt distress (share has begun to decline). - Domestic debt-to-GDP ratio doubled over the past decade; over one-fifth of LICs now hold more domestic than external debt. - In 2025 the interest bill exceeded one-quarter of fiscal revenues in nine LICs. - Current account, savings, and reserves: - Median LIC current account deficit: 3.4 percent of GDP in 2025; expected to stay within 4 percent of GDP in coming years. - Private saving rates about 14–16 percent in 2024–25 (below EMs/AEs 21–22 percent). - Median LIC reserve coverage: 3.8 months of imports in 2025; projected 4.2 months by 2029. - Top quartile reserves: 6.1 months in 2025 to projected 6.9 months by 2029. - 26 LICs below 3 months of import coverage at end-2025; 17 LICs projected to remain below 3 months by 2029. ### SHIFTS IN EXTERNAL FINANCING TO LICs - Net financial inflows: - Fell by one-third after peaking during 2010-14 to around 4¼ percent of GDP by 2024. - FDI and debt flows: - Net FDI inflows declined from an average of 2.5 percent of GDP in 2010-19 to 1.7 percent of GDP in 2020; limited gradual increase to 2.3 percent of GDP by 2024. - Total net external debt inflows: 2.1 percent of GDP in 2024 (about half 2020-21 levels; below 2010-19 average of 3.3 percent of GDP). - External private borrowing by domestic private sector: over 2 percent of GDP in 2013 and 1.1 percent of GDP over 2010-19 to nearly zero in 2024. - ODA and remittances: - Net ODA flows to LICs fell to 4.3 percent of GDP by 2023-24 (average 5 percent during 2010-14). - Share of net loans in total net ODA rose from 3 percent in 2010 to 28 percent by 2024. - OECD data indicate further reductions from 2025: ODA-type flows from traditional bilateral donors to LICs could decline by 0.7 percent of LIC GDP (US$11 billion in constant 2023 prices). - Remittances remain vital and heterogeneous: a few percent of GDP in some LICs to more than 30 percent of GDP in Nicaragua and 40–50 percent of GDP in Tajikistan; remittances expected to decline as restrictive immigration policies take effect from 2026, though uncertainties remain high. - Composition shifts: - LICs receive less than 1 percent of global FDI in absolute terms. - FDI increasingly concentrated in low R&D-intensive sectors (energy, extractives); more than two-thirds of LIC FDI flows go to diversified goods and services exporters; commodity exporters receive less than a third. ### FDI IN LICs: MAGNITUDE, COMPOSITION, AND DETERMINANTS - Scale and sources: - LICs account for less than 1 percent of global FDI in absolute terms. - Source composition shifted mid-2010s toward major EMs (China, India); recent years AE share rising again—U.S. and China largest individual source countries (cumulative 2012-24), followed by Norway, United Kingdom, Canada, Thailand, France. - Sectoral composition and quality: - More than 80 percent of LIC projects are in low-R&D activities (vs. about half in EMs). - Within manufacturing, ~one-third of LIC projects are high-R&D (vs. ~60 percent in EMs). - Capital-intensive extractives generate export earnings and fiscal revenues but few permanent jobs; manufacturing offers more potential for skills transfer and domestic linkages. - Empirical findings (gravity and local-projection models): - Fiscal discipline and fiscal institutions—particularly revenue administration and PFM—are positively associated with FDI inflows in LICs; effects stronger in LICs than EMs and amplified under high uncertainty. - Stronger fiscal institutions are associated with higher quality FDI, proxied by R&D-intensity. - When fiscal discipline, fiscal institutions, and broader institutional quality are jointly considered, fiscal institutions emerge as the more important institutional correlate of FDI. - Fiscal incentives (tax cuts, SEZs) are associated with higher FDI only where fiscal discipline and fiscal institutions are strong; otherwise ineffective. - Local-projection evidence: - SEZ legislation associated with higher FDI mainly in LICs with stronger fiscal discipline and revenue administration; effects emerge with a lag. - Tax reductions generate at most short-lived FDI increases and only in LICs with stronger fiscal discipline. ### POLICY PRIORITIES AND RECOMMENDATIONS - Macroeconomic and fiscal frameworks: - Continued fiscal consolidation in most LICs via domestic revenue mobilization and spending prioritization; strengthen PFM and debt management; calibrate pace to country circumstances. - Greater scrutiny of public sector borrowing—especially non-concessional—to preserve debt sustainability. - Monetary and exchange rate policies should focus on price stability while safeguarding financial stability. - Improve quality and coverage of data to support policies. - Revenue mobilization and spending efficiency: - More than half of LICs mobilize less than 15 percent of GDP in tax revenue. - Simultaneous tax-policy and tax-administration advances needed; rationalize tax expenditures and incentives. - About 40 percent of resources allocated to LIC infrastructure are lost due to inefficiencies; strengthen PIM, procurement, cash management, medium-term frameworks, transparency, and accountability. - Safeguard and strengthen targeted social safety nets. - Fiscal incentives and SEZs: - Use fiscal incentives selectively, subject to ex-ante assessment; prioritize cost-based, time-bound tools (accelerated depreciation, investment allowances, training-related deductions). - Exercise caution with SEZs: risk of fiscal costs, resource misallocation, rent-seeking, limited additional investment without strong governance and integration. - Publish tax-expenditure reports; enforce clear eligibility and sunset clauses. - Re-assess incentives given the 15 percent global minimum tax (GMT) implications. - Debt management and market access: - Anchor borrowing plans in credible medium-term debt strategies and debt sustainability analyses; enhance debt transparency and capacity in debt management offices. - Proactive prefinancing/rollover of large maturities, use risk-sharing and credit enhancements, consider debt exchanges and buybacks where appropriate. - When ready, obtain sovereign credit ratings to potentially lower borrowing costs and attract portfolio flows and FDI. - Develop domestic financial markets to mobilize private savings. - Sequencing and reform strategy: - Prioritize macro-fiscal credibility first (realistic medium-term plans, transparent reporting), then institutional reforms (tax administration, PFM), then targeted tools (SEZs, sectoral regimes), and later broader business-environment reforms. - Near-term pragmatic reforms: digitalize e-filing/e-payments, publish valuation and exemption rules, strengthen oversight of exemptions, deploy targeted GovTech solutions, enhance extractive-sector governance. ### MONETARY POLICY, FINANCIAL STABILITY, AND THE SOVEREIGN–BANK NEXUS - Monetary policy: - Remain alert to renewed inflation risks; keep policy tight where inflation or expectations are not anchored. - Improve liquidity management and clarify operational targets; increase exchange-rate flexibility where appropriate. - Sovereign–bank nexus and banking sector: - Banks’ holdings of sovereign debt reached 15 percent of banking sector assets for the median LIC. - Average total banking sector assets ~63 percent of GDP; nonperforming loans 4.5 percent of total loans; median regulatory capital-to-risk-weighted assets ratio 19 percent (end-2024). - Shift toward domestic debt concentrated in banks raises crowding out and transmission risks; about 40 percent of new domestic debt placed at short maturities by 2025; central banks held 9 percent of total domestic debt in 2024 (about half of what they held a decade ago). - Policy priorities: strengthen prudential oversight, stress-testing, risk‑based capital requirements for sovereign holdings, improved disclosure, and deeper domestic markets over time. - Data gaps: - Many LICs report Financial Soundness Indicators with lag; fewer than seven LICs report key liquidity metrics (liquidity coverage ratio, net stable funding ratio). ### ROLE OF INTERNATIONAL PARTNERS AND THE IMF - Prioritization of concessional resources: - Scarce concessional resources should be targeted to poorer and fragile LICs; more advanced LICs can rely more on market financing with international support for private finance mobilization. - ODA shifting toward project-based support; recommend rolling project pipelines linked to national plans and on-budget integration to strengthen PFM oversight. - IMF role and instruments: - IMF delivered about 55 percent of single‑country capacity development to LICs during FY2022‑24; fiscal-related CD represented more than 60 percent of CD in FY2025. - Since March 2020, IMF committed SDR 39.5 billion to 57 LICs through PRGT and General Resource Account. - RSF: 16 LICs benefitted since 2022 with total commitment SDR 5.5 billion. - IMF provides policy advice, capacity development, lending, program tools (Policy Coordination Instrument, Staff Monitored Program) and leads debt work with the World Bank (joint DSA, Common Framework, GSDR, “3‑pillar approach”). - Coordination and debt architecture: - Strengthen the Common Framework and Global Sovereign Debt Roundtable; advance coordinated support for countries with reform agendas facing short-term financing gaps. ### SPECIAL TOPICS: REMITTANCES, CRYPTO, AND TRADE SHOCKS - Remittances: - Sources: roughly 17 percent from the United States, 11 percent from the European Union, 4 percent from the United Kingdom. - Example: Honduras and Nicaragua saw remittances rise by about 20-25 percent in 2025; expected to unwind from 2026 as stricter U.S. immigration policies and a new tax on outgoing remittances take effect. - G20 Roadmap targets: reduce average retail payment fees to below 1 percent by 2027; remittance fees to below 3 percent by 2030. - Mobile-money fees in country-pairs average about 3 percentage points; lowering average fees from 4.5 percentage points to mobile-money levels would raise remittances by 2.5 percent (based on Cerutti, Firat, Perez‑Saiz (2025) elasticity). - Crypto-related inflows: - Increasing and can reach a few percent of GDP; benefits include lower transaction costs and faster settlement; risks include balance-of-payments volatility, AML/CFT circumvention, and “cryptoization” undermining monetary sovereignty. - Trade shock example (Box 1): - Average US tariffs on LIC exports rose from 1.2 to 14.4 percent between January and September 2025; implications include diversification of products and markets, improved trade facilitation, and regional integration. ### DATA, EMPIRICAL APPROACH, AND KEY ECONOMETRIC RESULTS - Empirical methods: - Gravity-model PPML estimates (bilateral FDI flows using World Bank HBFDI and Orbis project-level data) and local-projection (LP) event-study analyses for discrete reforms (SEZ legislation, tax-burden reductions). - Fiscal and institutional variables: CPIA fiscal policy/debt policy, CPIA budgetary/financial management, CPIA efficiency of revenue mobilization, ISORA operational strength/digitalization, Open Budget Index, WGI PCA, Chinn–Ito index. - Select quantitative results: - A one–standard-deviation increase in public debt associated with an estimated decline in FDI of about 14 percent (gravity-model marginal effect). - Comparable improvements in fiscal discipline and fiscal institutions associated with increases in FDI on the order of 10–20 percent. - Gravity baseline excerpts: L. GDP (PPP US$, log) — Host for LICs 1.335*** (0.354); Distance (log) for LICs -0.991*** (0.073); Observations LICs 36,984; Pseudo R-squared LICs 0.553. - Sovereign spreads: VIX (logged) for LICs - FE: 0.594*** (0.107); US Treasury Rate (10-year) for LICs - FE: 0.194** (0.077). - Banking sector outliers: Zambia fiscal GFN 85.56 percent of GDP with 24.98 percent sovereign exposure; Mozambique fiscal GFN 152.93 percent of GDP with 23.83 percent sovereign exposure. - Robustness and heterogeneity: - Fiscal institutions emerge as more important than fiscal discipline or broader institutional quality when principal components are jointly included. - Effects of fiscal discipline and institutions on FDI are stronger in LICs than in EMs and amplified under high uncertainty (World Uncertainty Index splits). ### ANNEX HIGHLIGHTS: CLASSIFICATION AND METRICS - LIC definition: 70 countries eligible for PRGT facilities. - Historical PRGT counts: 83 countries classified as PRGT-eligible since 2008; 65 remain on the list; 6 entered since establishment; 13 graduated to EM status. - IDA cutoff for FY26: US$ 1,325 (US$1,325=100 percent) used to segment poorest LICs (<=100, 32 countries) and more advanced LICs (>100 categories). - Annex I Table 3 lists country groupings by income bands and explicit country names. *Prepared by the Strategy, Policy, and Review Department and the Fiscal Affairs Department; Approved by Guillaume Chabert (SPR) and S. Ali Abbas (FAD). Source: International Monetary Fund — “MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW‑INCOME COUNTRIES - 2026” (selected excerpts, ppea2026005).* ### EXECUTIVE SUMMARY ### EXECUTIVE SUMMARY ### A Challenging Global Context - Sweeping policy shifts in major economies are reshaping the global environment—spanning trade, migration, digital finance, and spending priorities, including national security and foreign aid—with persistently high uncertainty. - Global growth is projected to remain at 3.3 percent in 2026, broadly in line with the estimates for 2025 and with the 2024 outturn, but marking a downward revision relative to forecasts made prior to the noted policy shifts. - Downside risks include outbursts of trade tensions, lower-than-expected gains from artificial intelligence (AI) leading to a decline in investment and abrupt financial market correction, and domestic political or geopolitical tensions that could weigh on financial markets, supply chains, and commodity prices. Upside scenarios include sustained easing of trade tensions and faster productivity growth from AI. ### Recent Macroeconomic Developments and Prospects in LICs - Average GDP growth in LICs is projected to accelerate from 4.8 percent in 2025 to 5.3 percent in 2026, but outcomes remain heterogeneous across countries. - Some LICs rank among the world’s fastest-growing economies, while others experience growth insufficient to secure meaningful gains in per capita income. - Inflation is continuing to ease overall, though hotspots persist. - Gradual fiscal consolidation has contributed to modest reductions in public debt levels, but high debt service burdens continue to constrain space for development spending. - Tighter external borrowing conditions have accelerated a shift toward domestic borrowing, deepening sovereign-bank linkages and related financial stability risks. - Foreign exchange reserves, despite significant improvements, remain thin in many LICs, leaving vulnerability to changes in commodity prices, global interest rates, and aid cuts. - Recent months brought some easing of balance of payments pressures for most LICs due to lower food and energy prices and a weaker dollar, while cuts in official development assistance (ODA) and ongoing immigration policy restrictions are impacting LICs directly or indirectly and are expected to affect remittances going forward. ### Shifts in External Financing to LICs - External financing to LICs is undergoing major shifts: risks of near-term declines in remittances are growing, ODA envelopes are projected to shrink as donors reassess spending and policy priorities and tilt support toward loan- and project-based financing. - FDI equity inflows and, more recently, external debt flows are below pre-COVID levels. - The analysis links subdued international capital flows to LICs with a widening gap in the marginal product of capital (MPK) between LICs and advanced economies, particularly for public capital, suggesting the need for appropriate policy responses. ### FDI in LICs: Magnitude, Composition, and Determinants - LICs continue to receive less than 1 percent of global FDI, broadly in line with their share of global GDP. - Inflows are increasingly concentrated in low R&D intensive and less job-creating sectors—such as energy and extractive industries. - Section II documents four key empirical findings using gravity and local-projections models: - Fiscal discipline and fiscal institutions—particularly revenue administration and public financial management (PFM)—are positively associated with FDI inflows in LICs, with effects stronger in LICs than in emerging markets (EMs) and amplified in high-uncertainty settings. - Stronger fiscal institutions are associated with higher quality of FDI, proxied by R&D-intensity. - When fiscal discipline, fiscal institutions, and broader institutional quality are considered jointly, fiscal institutions emerge as the more important institutional correlate of FDI. - Fiscal incentives—such as tax cuts or special economic zones (SEZs)—are associated with higher FDI only where fiscal discipline and fiscal institutions are strong; they appear ineffective otherwise. ### Policy Priorities and Recommendations - Resolute domestic policies and reforms, plus adequate international support, are needed to navigate global uncertainties and shifting external financing: - Continued fiscal consolidation will be necessary in most LICs, including through domestic revenue mobilization and prioritization of spending, alongside strengthening PFM and debt management. Calibration and pace should depend on country circumstances. - Greater scrutiny of public sector borrowing—especially on non-concessional terms—will be essential to preserve debt sustainability. - Monetary and exchange rate policies must continue to focus on price stability while safeguarding financial stability. - Structural reforms to encourage private sector-led growth and job creation should be accelerated. - Targeted governance reforms to combat corruption and improve effectiveness of government institutions and central banks are fundamental. - These policies and reforms underpin macroeconomic stability, build buffers, and raise investment returns in LICs, fostering growth-enhancing FDI. - For attracting FDI specifically: - Strengthening macro-fiscal management—through credible medium-term frameworks, attention to debt sustainability and buffers, and stronger macro-fiscal analytical capacity—can improve investors’ risk-adjusted returns by reducing macroeconomic volatility and policy uncertainty. - Reinforcing fiscal institutions supports investor confidence by limiting discretion and governance risks. - Fiscal incentives should be used selectively and be subject to careful ex-ante assessment. - SEZs warrant particular caution: they can entail significant fiscal costs, encourage resource misallocation and rent-seeking, and yield limited additional investment absent strong governance, administrative capacity, and integration with the broader economy. - Given capacity constraints, reform sequencing matters: macro-fiscal credibility and institutional strengthening should precede the use of more targeted fiscal policy tools. ### Role of International Partners and the IMF - Scarce concessional resources from bilateral and multilateral partners should be prioritized toward poorer and fragile LICs, as more advanced LICs can rely more on market financing. - Targeted capacity development and enhanced coordination between LIC authorities and development partners would boost reform implementation and help reduce borrowing costs. - The IMF has a strong role to play through policy advice, capacity development, and lending where needed. *Prepared by the Strategy, Policy, and Review Department and the Fiscal Affairs Department; Approved by Guillaume Chabert (SPR) and S. Ali Abbas (FAD).* ### 3. Low-income Countries (LICs) are impacted both directly and indirectly by this global ### 3. Low-income Countries (LICs) are impacted both directly and indirectly by this global context, with important differences across countries. ### Impact of the global context on LICs - Negative effects: - Cuts in official development assistance (ODA) reduce available external support. - Restrictions in immigration policies are expected to have a negative impact on remittances. - External financing costs remain elevated for all LICs despite narrower spreads, as benchmark interest rates remain above pre-pandemic levels. - Positive effects: - Declines in food and energy prices have generally benefited LICs by lowering import costs. - A weaker US dollar has facilitated the repayment of external debt obligations in recent months. - Heterogeneity in effects: - Exporters of gold and some critical minerals benefit from high prices. - Fossil fuel exporters and countries largely dependent on ODA face a more challenging context. - The direct effect from changes in trade policies on most LICs has been modest thus far. *For this report, low-income countries are defined as the 70 countries eligible for the Poverty Reduction and Growth Trust (PRGT) facilities.* ### B. Macroeconomic outcomes in LICs: resilience and divergence - Growth projections and outcomes: - Average weighted GDP growth in LICs: 4.2 percent in 2024, 4.8 percent in 2025, and 5.3 percent in 2026—driven by developments in the largest LICs such as Bangladesh, Kenya, and Uzbekistan. - Median growth in LICs: 4.2 percent in 2025 and 4.3 percent in 2026. - Median growth is significantly lower than the weighted average, pointing to a widening gap between faster- and slower-growing LICs. - Based on average real GDP growth over 2024-2025, six out of the top ten world’s fastest-growing economies are LICs—Benin, Ethiopia, Kyrgyz Republic, Niger, Rwanda, and Tajikistan. - Medium-term outlook and risks: - Assuming sustained policy and reform efforts, median growth in LICs is projected to reach 4.5 percent in the medium term—consistent with its 20-year average. - About a third of LICs are projected to grow above 5 percent, led by exporters of manufactured products and non-oil commodities. - A quarter of LICs (primarily Fragile and Conflict-affected States (FCS) and SDS) are expected to grow by less than 3.3 percent due to fragility and undiversified export structures. - Downside global risks could limit export opportunities, FDI, access to technology, and productivity gains. - LICs are particularly vulnerable to domestic shocks including climate-related events, natural disasters, social unrest, armed conflict, and political instability. ### Key drivers of growth differentiation across LICs - Domestic policy efforts: - Stabilization efforts and steady implementation of sound macroeconomic policies and structural reforms support growth in countries such as Ethiopia, Ghana, Tanzania, and Uzbekistan. - Large public and public-private partnership infrastructure projects supported growth in Rwanda and Tajikistan. - Export structure: - LICs with diversified manufacturing and services exports maintain strong and steady growth. - Non-fossil fuel commodity exporters benefiting from higher prices include: - Gold: Burkina Faso, Ghana, Mali, Guinea. - Copper and cobalt: Democratic Republic of the Congo, Zambia. - Coffee: Uganda. - Fossil fuel exporting LICs’ median growth lags amid low oil prices, though some (Chad, Republic of Congo) are investing to expand medium-term oil and natural gas production while diversifying their economies. - South Sudan’s oil production recorded nearly 25 percent growth in 2025 following normalization of oil transit through Sudan. - Tourism-dependent economies (e.g., LICs in the Eastern Caribbean) are adversely affected by cautious global consumer spending on travel. - Institutional stability vs conflicts and fragility: - Growth in Fragile and Conflict-affected States (FCS) remains below the LIC median and is negative in some countries (Haiti, Myanmar, Yemen). ### Outcomes for per capita income and demographic pressures - Long-term per capita growth: - Over the past 25 years, per capita GDP growth in countries currently assessed as part of the poorest LICs has averaged 1.9 percent—around half a percentage point below more advanced LICs. - Some LICs that were among the poorest 25 years ago have improved income status (example: Moldova) and others graduated to EMs (examples: Angola, Vietnam). - Several of today’s poorest LICs are among the world’s fastest-growing economies (examples: Ethiopia, Niger, Rwanda). - Population growth and labor markets: - Rapid population growth in many poorest LICs is projected at about 2 percent—more than twice as high as in EMs and five times that of AEs. - In many of these countries, employment growth has not kept pace with labor force expansion, contributing to higher unemployment and informality and weighing on productivity and convergence. - The difference in population growth is largely driven by African LICs, where population growth is projected at 2.6 percent, compared to 1.2 percent in other LICs. ### Inflation dynamics - Broad disinflation: - Median inflation in LICs: 4.0 percent in 2025 and projected to decline to 3.7 percent in 2026. - Disinflation supported by declines in global food and energy prices and a weaker US dollar. - LICs with hard pegs or well-established inflation-targeting frameworks generally recorded lower inflation. - Tight monetary policy settings in some countries reinforced disinflation; over half the African Union LICs maintained a contractionary monetary policy stance in 2025. - Credit growth to the private sector remained subdued. - Monetary policy and framework reforms: - Ghana: enhanced liquidity operations by expanding open market instruments and adopting transparent FX auctions while maintaining a tight stance. - Zambia: implemented a forward-looking interest-rate–based framework underpinned by a new central bank law reinforcing operational independence. - Democratic Republic of the Congo: introduced a permanent standing lending facility and adopted a new FX intervention strategy to allow greater exchange rate flexibility. - Liberia: operationalized a new interest rate corridor and improved liquidity management through open market operations and expanded collateral frameworks. - Ethiopia: transitioned to an interest rate-based monetary policy while liberalizing the FX market; tight fiscal and monetary policies contributed to cutting inflation in Ethiopia by a third following exchange rate depreciation. - Persistent hotspots: - In 2025, inflation exceeded 20 percent in eight LICs (mostly FCS). - The highest rates (50 to 100 percent) were recorded in three countries with sharp currency depreciations. - Sudan and South Sudan: depreciations driven by conflict-related disruptions, weak institutions, monetary financing, low external buffers, and severe supply constraints. - Zimbabwe: excess domestic liquidity linked to quasi-fiscal operations and central-bank financing fueled depreciation and inflation. - Risks to inflation outlook: - Potential reversal of recent declines in global food and energy prices is the most immediate concern. - LICs with intermediate exchange rate regimes, large macroeconomic imbalances, or weak monetary policy credibility are particularly exposed. - Renewed external price pressures could rapidly translate into domestic inflation where import dependence is high and policy credibility is limited. ### C. Reforms, fiscal consolidation, and debt vulnerabilities - Fiscal consolidation progress: - Since 2022, LICs have been reducing large post-pandemic deficits. - By 2025, the median improvement in the primary deficit was 1.9 percent of GDP. - More advanced LICs achieved stronger improvements than the poorest LICs (respectively 2.1 and 1.5 percent of GDP). - Expected median consolidation in LICs’ primary balance in 2026 is 0.1 percent of GDP. - Revenue mobilization and tax reforms: - Domestic revenue mobilization progressed in most LICs, with gains more pronounced in advanced LICs. - Ghana, Rwanda, Tanzania, and Togo advanced tax policy and administration reforms, including digitizing systems, improving audits and case management, and enhancing transparency. - Some countries compiled inventories and estimated foregone revenue from tax expenditures (TE); a third of countries in Sub-Saharan Africa still lack these estimates. - The Gambia will soon complete its first comprehensive TE report. - Expenditure patterns: - Expenditure compression has been used heavily by the poorest and fragile LICs; in FCS, consolidation driven mostly by cuts in current spending. - Energy subsidy reforms contributed to adjustment in countries including Cameroon, Chad, and Haiti. - The poorest LICs also cut capital spending, which can reflect better prioritization but may negatively affect growth and development. - Interest payments and fiscal space: - Interest payments have risen across all LICs and sometimes crowd out critical development spending. - In 2025, the interest bill exceeded one-quarter of fiscal revenues in nine LICs. - Public debt levels and composition: - Median public debt around 50 percent of GDP in 2025—above pre-pandemic levels. - Half the LICs remain at high risk of, or already in, debt distress, though the share has begun to decline. - Domestic debt is rising; the domestic debt-to-GDP ratio doubled over the past decade. - Over one-fifth of LICs now hold more domestic than external debt; this pattern is more pronounced in FCS. - Gross financing needs are projected to remain above pre-COVID levels in 2026–27. - External financing is becoming more expensive relative to past years while international capital markets remain accessible to only a few LICs and concessional flows decline. - External debt service ratios have stabilized but remain above pre-pandemic levels. - Renewed dollar appreciation could increase external debt ratios and debt service burdens in countries with predominantly dollar-denominated liabilities. *MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW-INCOME COUNTRIES - 2026, INTERNATIONAL MONETARY FUND* ### 14. While reducing FX risks, t he shift towards domestic debt raises several concerns that ### 14. While reducing FX risks, the shift towards domestic debt raises several concerns that need to be addressed ### Risks from greater reliance on domestic debt - Domestic borrowing costs in LICs are generally higher than for external borrowing, and the effective costs may be obscured by non-marketable instruments and financial repression (IMF, 2025b). - Domestic instruments being issued at higher rates and shorter maturities have been adding to fiscal pressures and rollover risks and keeping gross financing needs elevated. - In Kenya, Malawi, Sierra Leone, Uganda, and Zambia, reliance on expensive domestic financing has resulted in significant debt service pressures. - About 40 percent of new domestic debt placed at short maturities by 2025 (IMF, 2025a)—though about 80 percent of the existing domestic debt stock remains medium- or long-term. - Domestic debt is increasingly concentrated in the domestic banking system, reflecting underdeveloped domestic markets and a limited non-bank investor base. - These dynamics raise concerns about crowding out of private sector credit and heighten the risk that sovereign stress could transmit to the banking system. - These dynamics increase the risk of fiscal dominance and weakening of the effectiveness of monetary and exchange rate policies. - Central banks in LICs held 9 percent of total domestic debt in 2024, about half of what they held a decade ago. - On the upside, the shift toward local-currency instruments reduces FX risks; realization of benefits and development of local currency bond markets will depend on the strength of policy frameworks and robustness of financial market structures (IMF, 2025c). ### Fiscal and governance reforms to lower risk premia - Accelerating fiscal and governance reforms is needed to help reduce risk premiums. - Recent measures cited: - Steps to improve fiscal transparency and energy governance in Chad. - Ghana’s adoption of a revised Fiscal Responsibility Law with stricter deficit and debt ceilings. - Continued SOE restructuring and liberalization in Ethiopia and Uzbekistan. - Advances in Madagascar’s energy-sector reforms. - Establishment of a dedicated anti-corruption adjudication infrastructure in Moldova. - These efforts build on earlier gains reflected in improvements in political stability, regulatory quality, and control of corruption—three of six dimensions of the World Governance Indicators. - Over the past five years, worrying signs include deterioration in voice and accountability, and stagnation in government effectiveness and the rule of law. - LICs, especially FCS, continue to rank in the lower percentiles of the global distribution. ### Banking sector conditions and reforms - Banking sector aggregates at end-2024: - Median regulatory capital-to-risk-weighted assets ratio was 19 percent. - Nonperforming loans were 4.5 percent of total loans. - Aggregates mask mounting vulnerabilities linked to growing reliance by governments on shorter-term and expensive domestic financing, often from domestic banks, exacerbating sovereign-bank linkages. - Data gaps complicate risk assessment: many LICs report Financial Soundness Indicators to the IMF with a lag and less than seven LICs report key liquidity metrics (e.g., the liquidity coverage ratio and net stable funding ratio). - Examples of financial sector reforms and inclusion efforts: - Ghana: bank recapitalization following Domestic Debt Exchange Program under the Ghana Financial Stability Fund, with near-full compliance by 2026. - Rwanda: sustained financial market reforms to improve interbank operations and monetary transmission under its interest-rate-based framework. - Somalia: strengthened regulatory oversight and AML/CFT compliance through legislative reforms, including amendments to its AML/CFT law and adoption of the Financial Institutions Law in May 2025. - Uganda: launched its second National Financial Inclusion Strategy (2023–28), emphasizing digital and green finance. - Kenya: new strategy for 2025–28 focused on digital innovation and consumer protection. - Cameroon: implemented its 2023–27 strategy to broaden access to affordable financial services. ### Current account balances, savings, and reserves - Median LIC current account (CA) deficit: - Shrunk to 3.4 percent of GDP in 2025. - Expected to stay within 4 percent of GDP in the coming years—assuming gradual export diversification, productivity improvements, and stable commodity prices. - Savings and investment: - Private saving rates about 14–16 percent in 2024–25. - Private saving rates remain well below the 21–22 percent observed in EMs and AEs. - Commodity price effects: - Two-thirds of LICs (out of 56 with available data) are benefiting from improved terms of trade for 2024-25. - Terms of trade worsened for LIC fossil-fuel exporters, led by oil price developments. - Remittances: - Some countries (Haiti, Honduras, Nicaragua) are experiencing strong inflows amid concerns over tighter immigration policies. - Remittances are projected to decline as restrictive immigration policies take effect, though uncertainties remain high. - Foreign exchange reserves: - Median LIC reserve coverage was 3.8 months of imports in 2025 and is projected to rise gradually to 4.2 months of imports by 2029. - The top quartile: from 6.1 months of imports in 2025 to a projected 6.9 months by 2029. - 26 LICs remained below the recommended 3-month threshold at end-2025. - 17 LICs (nearly one-quarter of all LICs—mostly FCS) are projected to remain below 3 months by 2029, leaving them vulnerable to commodity price swings, shifts in global interest rates, and interruptions in concessional support. ### Shifts in external financing and implications - Net financial inflows to LICs: - After peaking during 2010-14, net financial inflows fell by one-third, to around 4¼ percent of GDP by 2024. - Share of external debt flows: - Fell from 60 percent in 2010-14 to half in 2024, primarily reflecting retrenchment of external debt taken on by the domestic private sector. - Composition changes and trends: - Declines in both FDI equity flows and, more recently, external debt flows to LICs. - ODA flows to LICs since 2022 have also declined substantially. - Remittances have been steadily growing so far, but future declines are possible given immigration policy shifts. - Preliminary 2025 data: external financing to LICs remained subdued, with sharp declines in ODA, some stability in FDI, and a small rise in portfolio investment as several LICs returned to international markets on expensive terms. ### Foreign Direct Investment (FDI) patterns - Net FDI inflows: - Declined from an average of 2.5 percent of GDP in the pre-pandemic decade (2010-19) to 1.7 percent of GDP in 2020, with a limited gradual increase to 2.3 percent of GDP by 2024. - Distributional shifts: - Number of LICs with net FDI inflows above 7 percent of GDP fell from 16 to 7 between 2011 and 2024. - FDI has moved away from commodity exporters toward exporters of more diverse goods and services. - More than two-thirds of LIC FDI flows now go to diversified goods and services exporters; commodity exporters receive less than a third (down from nearly a half in the early 2010s). - FDI to FCS remains lackluster amid fragility, conflict, and weaker investment in the commodities sector. ### Net external debt inflows: tighter and more expensive - Total net external debt inflows to LICs were 2.1 percent of GDP in 2024, about half their 2020-21 levels, and significantly below the 2010-19 average of 3.3 percent of GDP. - External private borrowing by the domestic private sector in LICs declined sharply: - From over 2 percent of GDP in 2013 and 1.1 percent of GDP over 2010-19 to nearly zero in 2024. - Public borrowing composition changes: - Multilateral financing increased while bilateral financing declined overall—except in FCS, where multilaterals did not fully replace the drop in bilateral financing. - Multilateral and Paris Club lenders significantly increased non-concessional lending, while disbursements from non-Paris Club bilateral lenders, in particular China, declined for both concessional and non-concessional loans. - Public sector borrowing from private external creditors and net inflows of short-term external debt are much smaller than before and have also experienced declines. *International Monetary Fund. Macroeconomic Developments and Prospects in Low-Income Countries - 2026 (selected excerpts).* ### 24. Market-based public sector borrowing has become more expensive, while multilateral ### 24. Market-based public sector borrowing has become more expensive, while multilateral and bilateral creditors have protected concessionality for the most vulnerable LICs ### Key findings on external borrowing and debt terms - New lending commitments from external private creditors have been contracted at higher interest rates, shorter maturities, and lower grant elements (based on the IDS measure of concessionality)—increasing rollover and interest-rate risks. - The share of new external debt issued at variable rates has risen in recent years, especially for more advanced LICs, heightening sensitivity to global financial conditions for those relying more heavily on market-based financing. - Official (multilateral and bilateral) creditors have adjusted terms more gradually: the grant element on new debt commitments from multilateral and bilateral sources has been preserved—or even increased—for the poorest LICs and FCS, with unchanged or lower interest rates and longer maturities. - Concessional debt is defined here as loans with an original grant element of 35 percent or more, using a 5 percent discount rate. - Average indicators presented in Figure 18 include: Average Interest on New External PPG Debt Commitments (In percent, median); Average Grant Element on New External PPG Debt Commitments (In percent, median); Average Maturity on New External PPG Debt Commitments (Years, median); External Debt Stock at Variable Rate (In percent of total external debt, median). ### ODA: trends, magnitudes, and modalities - ODA to LICs comprises grants and concessional loans from bilateral donors and multilateral institutions. - By 2023-24, net ODA flows to LICs fell to 4.3 percent of GDP—relative to an average of 5 percent during 2010-14. - The share of net loans (vis-à-vis grants) in total net ODA flows rose from 3 percent in 2010 to 28 percent by 2024. - OECD data shared with IMF staff indicate further reductions from 2025 onwards: ODA-type flows from traditional bilateral donors to LICs could decline by 0.7 percent of LIC GDP (US$11 billion in constant 2023 prices). - Net ODA composition trends: increasing share of project support (financed by grants or loans) in total net ODA; decline in share of budget support relative to project-type interventions. ### Remittances and their role - Remittances remain a vital and highly heterogeneous source of external financing for LICs, ranging from a few percent of GDP in some LICs to more than 30 percent of GDP in Nicaragua and 40-50 percent of GDP in Tajikistan. - Historically, more advanced LICs have received larger remittance inflows in level terms; growth in remittances has been faster in the poorest LICs. - Remittances play a countercyclical role—smoothing consumption, cushioning reduced incomes and wages, supporting spending on education and health care, and reducing poverty—but are less frequently used for productive investment and can raise reservation wages, reducing labor supply and eroding competitiveness. - Increased transmission of remittances through digital channels is adding to crypto-asset risks while reducing fees. ### External flows, marginal product of capital, and investment constraints - Declining external flows to LICs may reflect a rising gap in the marginal product of capital (MPK) in LICs relative to advanced economies. - New cross-country evidence suggests the marginal product of capital in LICs has been generally lower than in other economies, and the gap with advanced economies has widened since the early 2000s—particularly following the dot-com boom and the commodity super-cycle. - The gap in MPK exists for both public and private capital but is more pronounced for public capital, pointing to inefficiencies in LIC public investment management. ### Policy priorities — resolute domestic policies and reforms - Overall guidance: - Continued fiscal consolidation will be necessary in most LICs, including well-designed and sequenced domestic revenue mobilization and prioritization of spending, along with strengthening public financial management and debt management; calibration and pace depend on country circumstances. - Greater scrutiny of public sector borrowing, especially on non-concessional terms, is essential to preserve debt sustainability and maintain adequate buffers. - Monetary and exchange rate policies must focus on price stability while safeguarding financial stability. - Improvements in the quality and coverage of data are central to supporting macroeconomic policies. - Structural reforms conducive to private sector-led growth and job creation must be accelerated. - Governance reforms to combat corruption and improve effectiveness of government institutions and central banks are fundamental to foster social support and to reduce borrowing costs. - As fiscal consolidation progresses: - Safeguard priority development spending and boost domestic revenues. - Spending should prioritize high-quality investment (including resilience to climate and natural disaster risks) and well-targeted social spending that supports durable adjustment. - Fiscal structural reforms should focus on mobilizing domestic revenue and enhancing transparency and governance, including in the extractive sector. ### Specific recommendations to mobilize revenue and improve spending efficiency - Boost domestic revenue as concessional financing declines: - Note: More than half of LICs mobilize less than 15 percent of GDP in tax revenue. - Simultaneous advances in tax policy and tax administration are needed, along with rationalization of tax expenditures and tax incentives. - Successful country experiences cited include Ghana, Rwanda, Tanzania, and Togo—measures include digitizing tax systems, piloting targeted reforms, improving cash management, investing in capacity, and fostering trust through greater transparency. - Improve efficiency of public spending: - On average, about 40 percent of resources allocated to LICs for creating and maintaining public infrastructure are lost due to inefficiencies. - Reducing inefficiencies and raising returns to public spending will require strengthening governance and institutions with a focus on public investment planning, implementation, and risk management frameworks. - Essential complementary reforms include enhancing cash management, budget planning with medium-term fiscal and macroeconomic frameworks, greater transparency and accountability (publishing key budget documents), and curtailing untargeted subsidies. - Safeguard and strengthen social safety nets: - Targeted social assistance and facilitating access to education and healthcare to limit the adverse impact of any remittance declines on households’ consumption and human capital investment. - Manage the shift in ODA to project financing: - Develop and maintain a rolling project pipeline strategically linked to national development and sector plans to give donors confidence to invest in on-budget projects. - Ensure donor-financed projects on-budget and integrated into core PFM frameworks to benefit from parliamentary approval, audit, fiscal risk analysis, integrated cash and commitment control, and alignment with country-owned public investment strategy. - Where donors work outside the budget, governments should facilitate coordination to avoid duplication and encourage synergies and sequencing across projects. ### Improvements in debt management: priorities and tools - Anchor borrowing plans in credible and proactive medium-term debt strategies, supported by debt sustainability analyses. - Enhance debt transparency and data reporting practices; build capacity in debt management offices and strengthen legal frameworks. - Proactive debt management for external commercial debt: - Timely prefinancing and rollover of large maturities to reduce external debt service burdens. - Use of risk-sharing instruments, credit enhancements, and innovative financial tools to de-risk investments and crowd in private capital at more affordable pricing. - Consider debt exchanges and debt buybacks to reduce debt service costs and increase development spending; the World Bank guarantee platform can support some efforts. - When ready, obtain sovereign credit ratings and pursue improvements in these ratings to potentially lower borrowing costs and raise portfolio flows and FDI. - Develop domestic financial markets steadily to mobilize domestic private savings and expand domestic financing sources. *International Monetary Fund, “Market-based public sector borrowing has become more expensive, while multilateral and bilateral creditors have protected concessionality for the most vulnerable LICs,” excerpt from MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW-INCOME COUNTRIES - 2026.* ### 33. Improvements in monetary frameworks and implementation of exchange rate policies ### 33. Improvements in monetary frameworks and implementation of exchange rate policies ### Monetary and exchange rate policy findings and recommendations - Monetary and exchange rate policies must remain alert to renewed inflation risks, especially given high exposure to global food and energy prices. - Where inflation remains elevated or expectations are not yet firmly anchored, policy settings may need to stay tight. - Ensuring consistency in the macroeconomic policy mix is essential to reinforce disinflation efforts. - Further improvements in monetary frameworks recommended: - Enhanced liquidity management. - Clearer operational targets. - Greater exchange-rate flexibility, where appropriate, will: - Strengthen policy credibility. - Help absorb external shocks. ### Financial stability risks and the sovereign–bank nexus - Increased risks arise from growing reliance on domestic financing and digitization. - Reliance on domestic borrowing from commercial banks (directly or indirectly through bond issuance) elevates risks of sovereign stress transmission to the banking system and the rest of the economy. - Safeguarding the banking system requires: - Strengthening prudential oversight. - Improving stress-testing frameworks. - Introducing risk‑based capital requirements for sovereign holdings. - Monitoring sovereign–bank linkages and ensuring adequate capital buffers. - For currency unions: better coordination with the regional financial supervisor. - Digitization benefits (improved financial inclusion) are accompanied by risks: - Rising volatility of cross-border flows. - Contribution to “cryptoization”, which undermines monetary sovereignty. - Managing these requires robust regulation and supervision, strong AML/CFT frameworks, and better data. ### Sovereign–bank nexus: key statistics and implications (Box 2) - Banks’ holdings of sovereign debt have increased, reaching 15 percent of banking sector assets for the median LIC. - Average total banking sector assets at around 63 percent of GDP. - LICs exhibit higher concentration of sovereign debt in domestic banks compared to AEs and EMs. - High sovereign holdings are skewed with growing extreme exposures, especially in frontier LICs and FCS, and elevated in countries with high fiscal financing needs. - Two-way transmission of risks: - Sovereign stress transmits to the banking sector when sovereign–bank linkages are strong. - Banking sector deterioration raises sovereign risk premia and can reduce banks’ demand for sovereign debt, exacerbating sovereign debt risk. - Outlier country fiscal GFN and sovereign exposure examples: - Zambia’s fiscal GFN is 85.56 percent of GDP with 24.98 percent sovereign exposure. - Mozambique’s fiscal GFN is 152.93 percent of GDP with 23.83 percent sovereign exposure. - Policy priorities to reduce excessive sovereign exposure while safeguarding financial stability: - Stronger prudential oversight. - Risk‑based capital requirements for sovereign holdings. - Improved disclosure to limit regulatory arbitrage. - Use stress tests to assess sovereign‑related vulnerabilities and ensure adequate capital buffers. - Over time: deeper domestic markets, better debt management, strengthened bank‑resolution and governance frameworks—especially for state‑owned banks. ### Structural reforms to boost resilience and growth - Accelerated structural reforms should aim to enhance domestic resilience and private sector‑led growth and jobs. - Reforms areas highlighted: - Governance. - State‑owned enterprise management. - Export diversification. - Resilience‑building. - Complementary policies to raise medium‑term growth prospects: - Improve business environment and ease barriers to entrepreneurship. - Invest in education, health, and vocational training to boost human capital and absorptive capacity. - Enhance price competition in domestic markets and raise efficiency of production in the investment goods sector. - Emphasis on inclusive outcomes: - Ensure growth dividends are widely shared and vulnerable groups are protected to sustain reforms, given post‑pandemic setbacks in poverty reduction, female labor force participation, and informality. ### External concessional financing: focus and coordination - Concessional financing should be focused where most impactful given declines in bilateral grants. - Suggested allocation approach: - More advanced LICs: larger reductions in grants/concessional loans; capacity to implement reforms faster and mobilize domestic resources; international community can support private finance mobilization via risk‑sharing instruments and blended finance. - Poorest LICs and FCS: should benefit from focused bilateral and multilateral support due to lack of access to market borrowing, shallow domestic financial markets, and limited capacity; shift from grants to loans should be more gradual for countries with lower public investment and weaker debt management capacity. - More project‑based concessional financing (in place of budget support) requires improved project management, prioritization of high‑return investment, and reduction of rent‑seeking and inefficient current spending. - When market financing needs rise, focus on public financial and debt management reforms to help reduce borrowing costs. - Enhanced coordination across LIC authorities and among multilateral and bilateral partners needed to: - Improve predictability of concessional financing flows. - Promote sustainable financing practices. - Align financing with national reform agendas. - Target high‑impact priorities such as human capital and infrastructure. - For countries in Fund‑supported programs, official bilateral creditors should endeavor to maintain exposures throughout the program period where feasible. ### Debt architecture and resolution - Priority actions: - Strengthen debt architecture and ensure timely, predictable, and efficient processes through the Common Framework and further progress at the Global Sovereign Debt Roundtable (GSDR). - Further coordinated international efforts to secure adequate financial support from bilateral and multilateral partners for countries with strong domestic reform agendas but short‑term financing challenges. - Advance the “3‑pillar approach” to support countries implementing or committed to substantial growth‑oriented reforms while facing short‑term financing challenges. ### IMF role: capacity development, financing, and debt work - Capacity development (CD) and policy advice: - The IMF supports prioritization, design, and implementation of macroeconomic, financial, and structural reforms through surveillance, lending facilities, and CD. - During FY2022‑24, around 55 percent of single‑country CD was delivered to LICs. - In FY2025, fiscal‑related CD represented more than 60 percent of total delivery. - CD focus areas: financial management, revenue administration, monetary policy and capital markets, macroeconomic frameworks, statistics, legal issues, AML/CFT, governance, digitalization, GovTech, and digital money. - IMF financing and instruments: - Since March 2020, the IMF has committed SDR 39.5 billion to 57 LICs through the PRGT and the General Resource Account. - The 2024 Review of PRGT Facilities and Financing approved reforms and an associated funding strategy to preserve long‑term PRGT support. - The Resilience and Sustainability Facility (RSF): since its inception in 2022, 16 LICs have benefited from RSF arrangements with a total commitment of SDR 5.5 billion. - IMF lending and non‑financing instruments (Policy Coordination Instrument, Staff Monitored Program) can signal reform commitment and catalyze additional public and private financing. - Debt work and collaboration: - The IMF plays a leading role on debt issues in close collaboration with the World Bank. - Joint work includes LIC debt sustainability analyses, support to the Common Framework, progress at the GSDR, advancement of the “3‑pillar approach,” and implementation of the Debt Management Facility multi‑donor trust fund. ### Box 1 (select findings): Impact of the new US tariffs policy on LICs - Average US tariffs on LIC exports rose from 1.2 to 14.4 percent between January and September 2025. - On average, the US absorbs only a small share of LIC exports; many LICs export raw materials and semi‑processed goods less targeted by recent tariff measures. - Some LICs more directly impacted—those more reliant on the US market and facing significantly higher tariffs for key exports—may see weakened export opportunities, heightened vulnerabilities, and adverse effects on employment and GDP growth in affected countries (examples cited include Lesotho, Madagascar, Bangladesh, Haiti, parts of SSA). - Policy implications: diversify products and export markets, improve trade facilitation, and deepen regional integration to reduce vulnerabilities to unilateral tariff shocks. - The tariff policy may reinforce a gradual shift in LIC trade patterns toward non‑advanced economy partners; China has emerged as the largest individual buyer of raw materials and primary goods and a key supplier of manufactured products. *Source: IMF — "MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW‑INCOME COUNTRIES - 2026" (sections 33–41, Box 1, Box 2).* ### Box 3. Remittances in LICs: Vital but Vulnerable Inflow ### Box 3. Remittances in LICs: Vital but Vulnerable Inflow ### Exposure to immigration policy changes and recent patterns - Roughly 17 percent of remittances to LICs originate from the United States, 11 percent from the European Union, and 4 percent from the United Kingdom. - LICs remain exposed to immigration policy changes in advanced economies, which could weigh on future remittance inflows. - Despite several host countries tightening their immigration policies, remittances to LICs have remained robust. - Example: Honduras and Nicaragua saw remittance inflows rise by about 20-25 percent in 2025. - The 2025 surge likely reflected precautionary transfers amid uncertainty rather than labor market strength, as U.S. Hispanic unemployment increased. - The uptick in remittances is expected to unwind from 2026 as the impact of stricter U.S. immigration policies and a new tax on outgoing remittances begin to outweigh additional transfers from remaining migrants, leading to a gradual decline in remittances as a share of GDP. ### Cost-reducing transfer methods and potential gains - New transfer methods—including mobile money and crypto—can help lower fees and partially mitigate the impact of tighter immigration policies. - The G20 Roadmap for Enhancing Cross‑Border Payments targets: - a reduction in average retail payment fees to below 1 percent by 2027, and - remittance fees to below 3 percent of transfers by 2030. - In country-pairs where mobile money is already used for remittances, fees have averaged about 3 percentage points. - Based on the elasticity estimated by Cerutti, Firat, and Perez‑Saiz (2025), lowering average fees from 4.5 percentage points to the level of mobile money fees would raise remittances by 2.5 percent. ### Crypto-related inflows: benefits and risks - Crypto-related inflows—encompassing unbacked crypto-assets and stablecoins—are increasing and can reach a few percent of GDP. - Data limitations prevent disentangling different types of crypto flows, but evidence shows that cryptocurrencies are increasingly used to send remittances and to evade capital controls in developing countries (Graf von Luckner et al., 2023). - Potential benefits of crypto-assets: - reducing transaction costs and settlement times, enhancing cross-border payments. - Risks associated with large and volatile crypto flows: - amplifying balance of payments pressures, - facilitating circumvention of AML/CFT frameworks, - contributing to “cryptoization,” which undermines monetary sovereignty. *Source: Box 3. Remittances in LICs: Vital but Vulnerable Inflow, IMF.* ### 46. The section contributes to existing research by updating the somewhat dated ### 46. The section contributes to existing research by updating the somewhat dated ### Contribution and approach - Updates literature on fiscal pull factors for FDI using newer data sources, including the International Survey on Revenue Administration (ISORA). - Focuses on low-income countries (LICs) versus emerging markets (EMs), centering analysis on LICs to complement EMDE-focused evidence. - Examines how the importance of fiscal levers varies under different uncertainty regimes and the role of policy credibility and institutional strength during periods of heightened uncertainty. - Provides a first attempt (to the authors' knowledge) to trace dynamic responses of FDI to fiscal policy changes in LICs using local-projection methods, mapping how FDI evolves over time following reforms in fiscal incentives and implementation. ### FDI in LICs: scale, sources, and sectoral composition - Quantitative role: - LICs account for less than 1 percent of global FDI in absolute terms. - Global FDI inflows fell sharply during the 2008–09 global financial crisis and have remained subdued since 2018. - In relative terms, LIC FDI inflows as a share of GDP have often been comparable to—or at times slightly higher than—those of other income groups, reflecting the small economic size of LICs. - Source composition shifts: - Early 2000s: most FDI to LICs originated from advanced economies (AEs). - Mid-2010s: share from major EMs—especially China and India, along with Russia, the UAE, and Saudi Arabia—expanded sharply. - Recent years: AE share has begun to rise again; the U.S. and China are the two largest individual source countries, followed by Norway, the United Kingdom, Canada, Thailand, and France (cumulative, 2012-24). - Sectoral evolution: - Mining share declined through the mid-2010s before rebounding in recent years, reflecting renewed interest in critical minerals and new extractive projects. - Shifts toward manufacturing and electricity and utilities supported by supply-chain expansion, rising energy needs, and infrastructure investment. - ICT and data-related activities have risen gradually from a low base; tourism-related FDI has continued to shrink. ### Quality of FDI projects in LICs - R&D intensity and job creation profile: - More than 80 percent of LIC projects are in low-R&D activities, compared with about half in EMs. - Within manufacturing, only about one-third of LIC projects are high-R&D, versus roughly 60 percent in EMs. - Capital-intensive investments (notably mining and electricity) generate sizable export earnings and fiscal revenues but create relatively few permanent jobs. - Hotels and logistics are more labor-intensive but generally low R&D; manufacturing offers a more balanced profile with greater potential for skills transfer and domestic supply-chain linkages. ### Fiscal discipline and macro-fiscal pull factors for FDI - Fiscal anchors and investor confidence: - Good fiscal discipline (sustainable public debt levels, credible medium-term fiscal paths) contains perceptions of sovereign risk and reassures investors. - Well-designed fiscal rules and medium-term fiscal frameworks strengthen credibility, limit procyclical policy shifts, and enhance transparency and accountability. - LICs with lower average inflation, lower debt-to-GDP ratios, the presence of fiscal rules, and higher ratings for fiscal discipline tend to be associated with greater FDI (correlations presented in Figure 29). - Mechanisms: - Sound fiscal discipline supports low and stable inflation, reducing uncertainty and reinforcing confidence. - Credible fiscal anchors reduce the perceived likelihood of arrears, distortionary tax measures, or inflationary financing that deter foreign investment. ### Fiscal incentives and their effectiveness - General observation: - Many LICs rely on fiscal tools—tax incentives, subsidies, regulatory reforms, and special economic zones (SEZs)—to enhance investment appeal, but impacts vary widely across policy types and country contexts. - Tax incentives: - Profit-based incentives (tax holidays, reduced rates) and cost-based measures (accelerated depreciation, investment allowances) can influence investment decisions. - Literature generally finds profit-based tax incentives on their own have only a modest effect on attracting FDI—particularly in LICs and EMs where fundamentals remain weak. - Examples: Ghana, Tanzania, and Mauritania offer multi-year corporate income tax (CIT) holidays; Liberia and Sierra Leone provide extensive CIT exemptions and import-duty waivers for large projects. - The effectiveness of aggressive tax competition is expected to diminish under the 15 percent global minimum corporate tax (OECD Pillar 2), which reduces the value of very low statutory CIT rates for multinational investors. - Subsidies and cost-based incentives: - Well-designed, time-bound, and targeted cost-based incentives (accelerated depreciation, investment allowances, wage or training subsidies, direct support for investment-related capital costs) can lower user cost of capital and encourage FDI, particularly in manufacturing and other capital-intensive sectors. - Country examples: - Ethiopia: subsidized industrial land, government-financed factory shells, preferential utility tariffs for light manufacturing projects; 2025 FDI agreements totaling $1.6 billion cited as evidence of potential growth. - Rwanda: training subsidies and co-financing for enabling infrastructure to support ICT, logistics, and tourism investors. - Uganda and Tanzania: subsidized land leases and publicly built industrial facilities to encourage agro-processing and light industry. - Empirical studies find well-targeted cost-based incentives can raise FDI inflows (Harding & Javorcik, 2011; Katitas et al., 2024); theoretical work shows these may be more effective than across-the-board corporate tax cuts (Tian, 2018). - Fiscal cost of non-tax incentives (subsidized land, publicly provided facilities) is often not transparently reported in many LICs, complicating cost–benefit assessment and raising governance challenges. - FDI policy liberalization and regulatory reforms: - Available Global Trade Alert coverage suggests LICs have shifted toward more liberal FDI policy frameworks over the past decade, with more liberalizing than restrictive measures, particularly in entry and ownership rules, investor treatment, and operational procedures. - The number of restrictive measures declines after 2009–13; reforms easing entry or simplifying administrative requirements become more common, indicating increased emphasis on procedural clarity and transparency. - Special Economic Zones (SEZs) and investment promotion: - Number of LICs adopting SEZ laws has risen sharply over the past two decades. - Descriptively, LICs with SEZ laws receive only slightly higher FDI inflows relative to GDP than those without such legislation, indicating that presence of an SEZ framework alone is not sufficient to generate large or systematic increases in FDI. - Important heterogeneity in SEZ design, governance, and implementation capacity affects outcomes; SEZs often combine tax incentives with non-tax support (subsidized land, infrastructure, regulatory facilitation). - Some LICs operate SEZ-type regimes without dedicated SEZ laws (e.g., export-processing zones or ad hoc tax-incentive schemes in Liberia or Sierra Leone), which can provide short-term benefits but may reduce transparency and limit broader spillovers absent clear legal and governance frameworks. ### Key empirical and policy implications emphasized - Fiscal discipline and credible fiscal institutions are central pull factors for FDI in LICs, reinforcing investor confidence and lowering risk premiums. - Fiscal incentives can play a role but are context-dependent: - Profit-based tax incentives alone typically have modest effects, particularly where fundamentals are weak. - Targeted, time-bound cost-based incentives may be more effective for manufacturing and capital-intensive FDI but require transparent reporting of fiscal costs and strong accompanying improvements in infrastructure, governance, and the investment climate. - SEZs and regulatory reforms can support investment attraction, but the mere existence of SEZ laws or tax incentives is insufficient without effective design, governance, transparency, and implementation capacity. - Periods of heightened uncertainty increase the importance of policy credibility and institutional strength in shaping investor responses; dynamic local-projection evidence aims to map these evolving responses following fiscal reforms. *International Monetary Fund, "MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW-INCOME COUNTRIES - 2026" (section text).* ### Box 6. Special Economic Zones (SEZs) in Developing Economies: Economic Gains, ### Box 6. Special Economic Zones (SEZs) in Developing Economies: Economic Gains, Fiscal Tradeoffs, and the Role of Tax Policy ### SEZ footprint and objectives - Rapid expansion: from 79 zones in 1975 to more than 6,000 today, with over 5,000 mapped across 169 countries. - Geographic concentration: Asia and the Pacific host about two-thirds of all SEZs, including large concentrations in China and the Philippines; the United States, India, and Vietnam also host significant numbers. - Policy rationale: Governments use SEZs to accelerate industrialization, expand exports, and offer a more efficient operating environment. ### Empirical evidence on SEZs and FDI - Heterogeneous outcomes: - Strong positive evidence concentrated in a few success cases—most notably China, where SEZs have accounted for a large share of national FDI and are associated with higher FDI per capita without crowding out domestic investment. - Additional successes observed in select middle-income economies: Poland, Vietnam, Malaysia, Mauritius, Morocco, and the Dominican Republic. - Many other studies find weak or negligible effects; establishing causality is difficult and limited additionality is a recurring concern (reallocation into zones rather than new investment; limited spillovers). - Tax incentives are not the primary driver: - Literature consistently highlights non-tax fundamentals (macroeconomic and political stability, legal/regulatory frameworks, governance quality, infrastructure, labor access, proximity to markets) as more important determinants of SEZ performance. - SEZs combining effective governance, high-quality infrastructure, and strong integration with local supply chains are more likely to attract FDI and generate localized spillovers. - Zones relying mainly on generous tax incentives without addressing institutional and structural constraints tend to underperform. ### Fiscal tradeoffs and tax-policy implications - Fiscal costs and risks: - Many SEZs offer generous profit-based incentives (CIT holidays, reduced rates, exemptions on dividends or capital gains) that are costly, distortionary, and often ineffective—especially when investment is relocated rather than additional. - Revenue forgone can be substantial; limited transparency hampers cost–benefit assessment. - Tax incentives play a secondary role in investment decisions and will matter even less under the Global Minimum Tax (GMT). - GMT implication: - Maintaining a minimum effective tax rate of 15 percent for large multinationals is increasingly important under GMT rules. - Recommended tax framework principles: - Emphasize neutrality, simplicity, and transparency. - Make incentives selective, time-bound, and aligned with clear policy objectives; incentives should complement, not substitute for, strong non-fiscal fundamentals. - Prefer cost-based incentives (accelerated depreciation, investment allowances, training-related deductions) over profit-based exemptions as generally more efficient and less distortionary. ### Governance, oversight, and SEZ design - Strong oversight and accountability are essential: - Where governance and administrative capacity are weak, SEZs can divert capital and labor toward protected or lower-productivity activities, crowding out investment elsewhere and creating enclave development with limited spillovers to employment, productivity, or domestic value chains. - SEZ frameworks place substantial demands on transparency, coordination, and enforcement; absent these conditions, zones may become fiscal liabilities rather than catalysts for development. - Design and implementation best practices: - Cautious SEZ design, clear eligibility criteria, sunset clauses, regular evaluation, and close integration with broader institutional and fiscal reforms. - Strong monitoring to allow cost–benefit assessments and guard against inefficient resource allocation. ### Role of core fiscal institutions in shaping FDI decisions - Importance of fiscal institutions: - Core fiscal institutions—particularly revenue administration and public financial management (PFM)—shape the credibility and predictability of the fiscal environment faced by foreign investors. - Revenue administration: - Competitive statutory tax rates may have limited effect if tax administration practices introduce uncertainty or high compliance costs. - Issues that raise investor concern: lengthy filing procedures, inconsistent enforcement, weak dispute-resolution mechanisms, inefficient customs administration that raises input costs for trade-intensive investment. - Reforms that improve administrative certainty: streamlined and digitalized processes (e-filing, electronic payment platforms, risk-based audit systems), large taxpayer offices, strengthened taxpayer services, fair and timely appeals procedures. - Empirical association: complex or nontransparent tax systems linked to lower FDI inflows; streamlined systems (illustrated in Liberia and the Maldives) lower compliance burdens and improve transparency. - Public financial management (PFM) and public investment management (PIM): - Effective PFM/PIM (project appraisal, selection, budgeting, procurement, execution) is associated with higher-quality and more reliable infrastructure—frequently cited in FDI location decisions. - Well-governed public investment systems can crowd in private and foreign investment by reducing project uncertainty and lowering transaction costs. - Credible budget execution, timely payments to contractors, and robust internal controls reduce risks (arrears, cost overruns, procurement disputes) that investors interpret as signals of fiscal discipline and operational predictability. - Cross-country evidence: stronger PIM and PEFA scores tend to correlate with higher returns on public capital, more efficient infrastructure delivery, and greater complementarities with private investment. ### Broader business climate and governance influences - Business climate factors: - Institutional, policy, regulatory, and infrastructure environment often matter as much as or more than tax incentives for FDI feasibility and profitability. - Reliable infrastructure (electricity, transport, logistics) is a key consideration; many LICs face intermittent power supply, high electricity costs, and limited transport connectivity that raise production costs and constrain competitiveness for export-oriented manufacturing. - Weak property-rights systems, insecure land tenure, and slow commercial court processes increase investor risk. - Governance and institutional quality: - Weak governance (including corruption) undermines institutional development and macro-fiscal credibility by eroding revenue mobilization, distorting public spending, and weakening transparency and accountability. - Poor governance is associated with political instability, policy uncertainty, discretion, and rent-seeking—reducing effectiveness of investment-related reforms and discouraging higher-quality, longer-term FDI. - Availability, reliability, and timeliness of economic and fiscal data shape investors’ ability to assess risks and policy credibility. - Empirical suggestion: LICs with stronger regulatory quality, better control of corruption, and more predictable policymaking often receive higher and more stable FDI inflows, including outside resource-intensive sectors (illustrated in Figure 32; WGI Scores range from -2.5 (weak) to 2.5 (strong); averages for 2010-24). ### Empirical strategy assessing pull factors for FDI into LICs - Dual empirical approach: - Gravity-model framework: uses World Bank HBFDI and Orbis firm-level data; PPML estimator accommodates zero FDI flows and heteroskedasticity; includes year fixed effects and, where appropriate, host- and source-country fixed effects or higher-dimensional fixed effects; sequentially introduces fiscal discipline, fiscal institutions, and broader institutional variables to assess marginal contributions while limiting multicollinearity. - Local projections (LP): event-study design tracing dynamics after discrete policy reforms (adoption of SEZ legislation, tax burden reductions) to capture signaling and medium-term credibility effects; tests variation in FDI responses with institutional strength. - Qualitative variables used in gravity analysis (selected): - Fiscal discipline: CPIA: fiscal policy; CPIA: debt policy and management. - Fiscal institutions: CPIA: quality of budgetary and financial management; CPIA: efficiency of revenue mobilization; ISORA: digitalization; ISORA: operational strength index; CPIA: transparency and accountability; OBI: fiscal transparency. - Broader institutional settings: Governance (PCA of six WGI pillars); WGI: rule of law; Chinn-Ito capital account openness index. - Note: CPIA = Country Policy and Institutional Assessment; ISORA = International Survey on Revenue Administration; OBI = Open Budget Index. ### Gravity-model findings on fiscal and institutional drivers of FDI - Core result: strong association between fiscal discipline, fiscal and broader institutional quality, and FDI inflows to LICs; relationships generally more pronounced than in EMs. - Specifics: - LICs with stronger fiscal discipline—proxied by lower public debt and higher CPIA ratings for fiscal and debt policy—tend to receive higher FDI inflows. - Higher-quality fiscal institutions (CPIA indicators for public financial management and efficiency of revenue mobilization; ISORA measures of revenue administration quality) are associated with significantly larger FDI inflows. - Broader institutional settings (governance, rule of law, property rights, capital account openness) are positively correlated with FDI inflows to LICs. - Comparison with EMs: corresponding estimates for EMs are generally smaller in magnitude and less precisely estimated, indicating a stronger association of fiscal and institutional factors with FDI outcomes in LICs. - Robustness and interpretation: - Findings robust to alternative specifications, including high-dimensional fixed effects that absorb source-year and bilateral factors and trade openness. - Contrast may partly reflect differences in FDI composition (EMs have larger share of cross-border M&A driven by asset valuations and ownership considerations). - Marginal effects are reported for variables normalized using a common standard deviation computed over the pooled LIC–EM sample; Figure 33 shows percent changes in expected FDI (US$) for a one–standard-deviation increase in each variable with 90 percent confidence intervals. *Source: Box 6, “Special Economic Zones (SEZs) in Developing Economies: Economic Gains, Fiscal Tradeoffs, and the Role of Tax Policy,” in the IMF publication excerpt provided.* ### 57. Fiscal institutions emerge ### 57. Fiscal institutions emerge ### Key empirical findings - Fiscal institutions are a more important correlate of FDI inflows to LICs than fiscal discipline or broader institutional quality when principal components for these three institutional buckets are jointly included in the gravity model. - The principal component capturing fiscal institutions is positive and statistically significant, while the contribution of fiscal discipline becomes smaller and less precisely estimated, and broader institutional quality is not statistically distinguishable from zero (see Annex IV for additional horse-race results, including pairwise comparisons). - Conditional on macro-fiscal discipline and broader governance conditions, fiscal institutions are more strongly associated with FDI inflows in LICs. ### Heterogeneity by uncertainty - Gravity estimates show larger marginal effects of fiscal discipline, fiscal institutions, and broader institutional quality under high uncertainty than under low uncertainty. - Effects are evaluated as the impact of a one–standard-deviation increase in each variable on expected FDI (US$), measured at low uncertainty (10th percentile of the standardized WUI) and high uncertainty (90th percentile). - Stronger debt management, budgetary and financial management, and revenue administration are associated with higher FDI responses under high uncertainty; elevated public debt is more negatively associated with FDI when uncertainty is high. - Differences between high- and low-uncertainty marginal effects are formally tested; red symbols indicate statistically significant differences at the 90 percent confidence level. The Open Budget Index (OBI)–based fiscal transparency measure also shows a statistically significant difference, but with the opposite sign. ### Sectoral and R&D-intensity patterns (EMDEs) - Merging the baseline gravity-model dataset with Orbis project-level greenfield FDI data reveals institutional selectivity by sector and R&D intensity: - Stronger fiscal institutions—particularly quality of budgetary and financial management and efficiency of revenue mobilization—are more strongly correlated with high-R&D manufacturing FDI than with low-R&D projects, including mining. - Broader institutional indicators (rule of law, overall governance quality) are weakly associated with low-R&D manufacturing and non-manufacturing activities but more strongly correlated with high-R&D manufacturing and non-manufacturing investment. - Capital account openness appears more closely associated with high-R&D manufacturing FDI, with limited evidence for high-R&D non-manufacturing activities. - Conclusion: credible fiscal and governance frameworks are particularly relevant for technologically sophisticated, knowledge-intensive FDI rather than labor-intensive or highly capital-intensive extractive investments. ### Local-projection evidence: SEZ legislation and tax reductions (LICs) - SEZ legislation - SEZ approval is associated with higher FDI mainly in LICs with stronger fiscal discipline and institutional frameworks; LICs with weaker capacity show little or no discernible response. - LICs with stronger fiscal discipline (CPIA fiscal policy rating) experience a larger and more persistent increase in FDI following SEZ approval; weaker-rating countries display little or no durable response. - LICs with stronger revenue administration operational strength (ISORA) exhibit a more pronounced and sustained FDI response than those with weaker administrative capacity. - Effects emerge with a lag, reflecting time between legislative approval and project implementation. - Caution: analysis focuses on FDI inflows rather than overall investment; SEZ outcomes vary widely with zone design, governance, and integration into the domestic economy. - Tax reduction episodes - Tax reductions generate at most a short-lived increase in FDI, and only in LICs with stronger fiscal discipline as measured by the CPIA fiscal policy rating. - Countries with weaker fiscal discipline show no meaningful response; ISORA-based splits yield qualitatively similar but statistically insignificant effects. - Implication: tax cuts alone are unlikely to deliver sustained FDI gains without credible fiscal policy frameworks and supporting institutions. - Identification note: tax-burden-reduction episodes are identified using the Global Tax Policy and Revenue Evaluation Database (TAPRED), a binary indicator of reforms expected at approval to reduce overall tax collection. ### Country reform experiences (illustrative cases) - Common lessons across cases: reforms to revenue administration and PFM can coincide with shifts in FDI inflows but are often constrained by uneven implementation capacity, enforcement and transparency gaps, and reliance on discretionary tax incentives; FDI often remains concentrated in enclave sectors with limited spillovers. - Liberia (revenue administration reforms) - Legal, institutional, and administrative reforms (Liberia Revenue Code and Investment Act (2010)) simplified registration and established investor protections. - Modernization of tax and customs administration (Liberia Integrated Tax Administration System, ASYCUDA) expanded electronic filing/payment, improved transparency and service quality, and reduced compliance costs. - Reforms coincided with a sharp rise in FDI, making Liberia one of the highest FDI recipients among LICs relative to GDP, though inflows remained concentrated in extractive sectors and were difficult to sustain. - Further strengthening implementation, enforcement, transparency, fuller automation, risk-based customs controls, improved system integration, rules-based tax incentives, improved dispute-resolution mechanisms, and a clean taxpayer register are recommended to broaden FDI beyond enclave sectors. - Maldives (digitalized revenue administration supporting tourism-led investment) - FDI inflows—mainly tourism and hospitality—have averaged about 12 percent of GDP over the past five years, exceeding the LIC median. - Online filing and payment increased from about 45 and 40 percent in 2018 to nearly 90 and 85 percent in 2022, respectively, reducing compliance costs, accelerating VAT refunds, and strengthening dispute-resolution mechanisms. - Heavy sectoral concentration and reliance on a narrow taxpayer base highlight the need for diversification to enhance fiscal resilience. - Côte d’Ivoire (sequenced PFM and public investment management reforms) - Since 2017, coherent reforms in program budgeting, public investment management (PIM), treasury single account, cash-management reforms, and climate integration were implemented; Decree No. 2022-742 (September 28, 2022) established a comprehensive legal PIM framework. - Reforms included climate tagging of public investment expenditures and strengthened fiscal risk statements with quantitative disaster risk analysis. - Supported by IMF technical assistance and programs, reforms accompanied fiscal consolidation toward the WAEMU deficit ceiling under the 2023 ECF/EFF arrangement and climate-related measures under the RSF. - FDI inflows increased from just over US$1 billion in 2021 to a record US$3.8 billion (about 4.4 percent of GDP) in 2024, alongside enhanced fiscal transparency and climate-aligned PFM measures. - Continued geographic and sectoral concentration of FDI underscores the need to sustain reforms, strengthen domestic linkages, and promote diversification. - Cambodia (PFM strengthening for predictability) - Reforms culminated in the 2023 Public Financial System Law modernizing budget preparation/execution, formalizing program budgeting and medium-term fiscal frameworks, strengthening transparency and National Assembly oversight, and establishing a fiscal reserve fund for crisis response. - PFM digital ecosystem reforms (FMIS strategy and review), strengthened budget execution and commitment controls, and an arrears clearance roadmap improved predictability; progress on IPSAS transition improved fiscal reporting quality and timeliness. ### Policy implications and recommendations (summary) - FDI in LICs is significantly influenced by: - Quality of fiscal policy management and strength of fiscal institutions (revenue administration and PFM). - To a notably lesser extent, fiscal incentives (including SEZs), which are effective mainly when fiscal discipline and institutions are strong. - Key characteristics of the estimated relationships: - Effects of fiscal discipline and fiscal institutions on FDI are stronger in LICs than in EMs. - Effects are amplified in high-uncertainty settings. - Stronger fiscal and governance frameworks are associated with more R&D-intensive investment. - Policy emphasis: - Strengthen macro-fiscal credibility and fiscal institutions (revenue administration and PFM). - Exercise caution in the use of fiscal incentives; sequence reforms in line with country capacity. - LICs with credible fiscal frameworks and strong institutions are better positioned to attract sustained and higher-quality FDI; those with weaker fundamentals risk being bypassed. *ppea2026005 - 57. Fiscal institutions emerge* ### 67. Consistent with the gravity results, strengthening fiscal credibility—within a broader ### 67. Consistent with the gravity results, strengthening fiscal credibility—within a broader ### Fiscal credibility and macro framework - Strengthening fiscal credibility—within a broader commitment to sound macroeconomic policy management and debt sustainability—remains the top priority. - Investors seek signals that fiscal policy is: - predictable, - transparent, - guided by clearly articulated plans. - Fiscal credibility is shaped by: - the government’s record of adhering to announced budget targets, - the quality and timeliness of fiscal data, - the extent to which policy decisions follow established procedures rather than ad hoc adjustments. - Measures to reinforce credibility include: - publishing medium-term fiscal frameworks grounded in realistic assumptions, - improving the transparency of budget execution, - strengthening internal controls to limit off-budget operations, - enhanced disclosure of SOE liabilities and other contingent risks, - well-designed fiscal rules tailored to country capacity, paired with transparent monitoring arrangements and supported by credible institutions. - Expected outcome: a more predictable fiscal policy environment that reduces abrupt policy shifts and supports investor confidence. ### Design of fiscal incentives and tax policy (Platform for Collaboration on Tax principles) - Principle: design fiscal incentives to create a predictable and cost-effective investment environment, not to provide excessive profit-based incentives for FDI. - Observations: - Profit-based incentives often have limited additionality and can erode revenues, exacerbating fiscal pressures in the medium to long run. - Incentives that appear effective in attracting FDI are not necessarily welfare-enhancing; benefits may be small relative to fiscal cost and depend on design. - Indirect incentives through the tax system provide limited benefits to loss-making firms and are unlikely to support early-stage or innovative investors unless refundable or equivalent to negative taxes. - Recommended, measured and disciplined approach (consistent with PCT principles of transparency, targeting, governance, alignment with development objectives): - Optimize tax policy: maintain clear, stable, and neutral tax parameters; minimize frequent changes that raise uncertainty for long-term projects. - Assess incentives ex ante: apply clear eligibility criteria, conduct cost–benefit analysis, include sunset provisions so incentives are targeted, time-bound, and aligned with development objectives. - Prioritize targeted, cost-based tools: use accelerated depreciation, investment allowances, or training-related incentives that link benefits to actual investment outlays and are generally less distortionary than profit-based exemptions. - Maintain sustainable corporate tax systems: ensure regimes remain competitive while supporting long-term revenue needs with predictable, broad-based rates and bases consistent with medium-term fiscal plans. - Improve transparency: publish regular tax-expenditure reports, disclose legal basis and objectives of incentive schemes, enforce provisions consistently to limit discretion and rent-seeking. - Complementary: strengthen private-sector transparency through beneficial-ownership disclosure to reduce opacity and corruption risks associated with FDI. - Global minimum tax consideration: - Carefully (re-)assess the impact of the global minimum tax on the effectiveness of existing and new tax incentives. - Recognize that simple, neutral, and administratively efficient regimes will become increasingly important as profit-based incentives lose traction under new international tax rules. ### Special Economic Zones (SEZs) — benefits and risks - SEZs may complement broader investment strategies but warrant caution: - Weak implementation can lead to revenue erosion, misallocation toward low-productivity activities, and heightened governance risks. - Empirical finding: SEZ legislation is associated with higher FDI only in LICs with stronger fiscal discipline or revenue administration capacity; countries with weaker institutions experience little or no durable gains. - Risks in low-capacity settings: - SEZs can divert capital and labor toward protected or lower-productivity activities, - operate in corruption-prone environments with discretionary approvals and complex eligibility rules, - heighten rent-seeking risks and undermine policy credibility. - Recommended SEZ design principles: - prioritize strong governance, transparent and rules-based incentive regimes, - closely integrate SEZs with domestic infrastructure and supply chains, - ensure incentives are time-bound, subject to clear eligibility criteria and regular evaluation, - design incentives to minimize revenue losses and distortions, preferably grounded in tax laws. ### Strengthening core institutions to support FDI - Priority institutional areas: - Modernizing revenue administrations: - prioritize predictability, transparency, and low-cost procedural reforms, - expand digital filing and payment systems, - simplify reporting and consolidate payment arrangements, - apply risk-based audit approaches, introduce advance rulings, and improve taxpayer services. - Enhancing public financial management: - consistent project appraisal, procurement practices, and budget execution to improve public investment reliability. - Improving accountability and the rule of law: - clearer contract enforcement, more secure property-rights frameworks, and measures to address corruption risks. - Addressing business-environment constraints: - strengthen electricity supply, transport networks, land administration systems, and dispute-resolution mechanisms, - provide accessible and well-documented data and public information for investors. ### Resource-rich countries and extractive-sector FDI policy - FDI policy for resource-rich countries should govern extractive investment effectively and leverage fiscal reforms to shift FDI toward higher-quality, non-enclave activities. - Characteristics of mining-related FDI: - substantial upfront capital needs, - long project horizons, - exposure to geological and regulatory risks, - location decisions driven more by commercial deposits than tax incentives. - Policy priorities: - establish stable and transparent fiscal regimes for extractive industries, including well-structured royalties and profit-based taxes to secure an appropriate government share of resource rents. - strengthen contracting processes to reduce information asymmetries (use model contracts, subject fiscal terms to multi-agency review, ensure independent assessment of feasibility studies, publish contracts where feasible). - complementary reforms: streamline licensing, reinforce environmental and social safeguards, design local content policies reflecting domestic capacity. - Broader goal: fiscal and institutional reforms essential for improving the quality, spillovers, and sustainability of investment and supporting diversification of FDI toward higher-value, knowledge-intensive activities outside enclave sectors. ### Sequencing and reform strategy - Recommendation: adopt a sequenced and mutually reinforcing reform strategy given administrative and human-resource capacity limits and fiscal/operational costs. - Sequencing guidance: - establish macro-fiscal stability and credibility first via realistic medium-term planning, transparent reporting, and predictable budget execution; - then advance institutional reforms (tax administration, PFM modernization, contract governance in resource industries, regulatory transparency); - implement targeted, sector-specific reforms (SEZ design, mining fiscal regimes) once institutional capacity allows consistent implementation; - subsequently improve broader business environment with regular monitoring and evaluation. - Expected benefit: phased approach reduces uncertainty, fosters investor confidence, and creates conditions for resilient, development-enhancing FDI. ### Outlook and near-term pragmatic reforms - LICs likely to face a challenging external environment for attracting FDI characterized by: - heightened global uncertainty, - tighter financial conditions, - more selective investor behavior. - Implication: strengthening fiscal institutions and policy credibility is even more important because investors place greater weight on fiscal discipline and fiscal institutions in high-uncertainty environments. - Small set of pragmatic, near-term reforms (often feasible under capacity constraints) that can deliver early credibility gains: - digitalize core revenue administration functions such as e-filing, e-payments, and risk-based compliance, - clarify and publish valuation and exemption rules, - strengthen oversight of tax exemptions—particularly in SEZs and investment schemes, - deploy targeted GovTech solutions to strengthen governance and transparency across revenue administration, PFM, and procurement, - improve governance of extractive industries by limiting discretionary incentives and increasing transparency in contracts and fiscal regimes. - Expected outcome: by anchoring expectations and reducing policy and implementation risk, these reforms can support more stable and higher-quality FDI inflows amid volatile global conditions. ### Annex I — LIC classification and key numeric definitions - For this report, LICs are defined as all IMF members eligible for borrowing under the Poverty Reduction and Growth Trust (PRGT). This list currently includes 70 LICs. - Historical and classification counts: - Since 2008, 83 countries have been classified as PRGT-Eligible (LICs) over time; 65 of the initial PRGT-eligible members remain on the list to this day. - Only 6 countries entered the list since it was established, while 13 graduated to EM status. - Income-level segmentation: - LICs are categorized into two mutually exclusive groups by GNI per capita relative to the IDA cutoff threshold: (1) at or below the IDA cutoff threshold (US$ 1,325 in FY26, =100 percent), referred to as the poorest LICs; (2) countries above the IDA cutoff threshold, referred to as more advanced LICs. - Haiti, Nepal, and Guinea are included in the first group despite having GNI per capita above the IDA cutoff threshold (for analytical consistency with the 2024 Review of PRGT Finances and Facilities). - Institutional and export-structure segmentations: - Institutional groups: (1) fragile and conflict-affected states (FCS); (2) small developing states (SDS) with populations lower than 1.5 million; (3) frontier markets (FM); (4) all other LICs. - Export-structure groups (mutually exclusive): Fuel exporters (net fuel exports ≥ 30 percent of total exports), Non-fuel commodity exporters (nonrenewable resources ≥ 25 percent of total exports), Diversified countries (non-resource-intensive with manufactured goods or multiple export categories), Tourism dependent (travel and passenger transport ≥ 10 percent of total export revenue), Other services (main source of exports are services). *Source: MACROECONOMIC DEVELOPMENTS AND PROSPECTS IN LOW-INCOME COUNTRIES - 2026, International Monetary Fund* ### Annex I. Table 3. Classification by Income ### Annex I. Table 3. Classification by Income ### Income categories and countries - Poorest LICs (GNI per capita at or below IDA cutoff of US$ 1,325. US$1,325=100 percent) - <=100 (32) - Afghanistan - Burkina Faso - Burundi - Central African Republic - Chad - Democratic Republic of Congo - Eritrea - Ethiopia - Gambia, The - Guinea - Guinea-Bissau - Haiti - Lesotho - Liberia - Madagascar - Malawi - Mali - Mozambique - Myanmar - Nepal - Niger - Rwanda - Sierra Leone - Somalia - South Sudan - Sudan - Syria - Tanzania - Togo - Uganda - Yemen - Zambia - More advanced LICs (GNI per capita above IDA cutoff of US$ 1,325. US$1,325=100 percent) - >100=<150 (6) - Benin - Cameroon - Comoros - Senegal - Tajikistan - Timor-Leste, Dem. Rep. of - >150<=300 (20) - Bangladesh - Bhutan - Cambodia - Congo, Republic of - Côte d'Ivoire - Djibouti - Ghana - Honduras - Kenya - Kiribati - Kyrgyz Republic - Lao P.D.R. - Mauritania - Nicaragua - Papua New Guinea - Sao Tome - Solomon Islands - Uzbekistan - Vanuatu - Zimbabwe - >300 (12) - Cabo Verde - Dominica - Grenada - Maldives - Marshall Islands - Micronesia - Moldova - Samoa - St. Lucia - St. Vincent and the Grenadines - Tonga - Tuvalu ### Classification note - Haiti, Nepal, and Guinea are classified within the poorest LICs, even though their GNI per capita is above the IDA cutoff, for consistency with 2024 Review of PRGT Finances and Facilities approved by the Board in October 2024. *International Monetary Fund. ppea2026005 - Annex I. Table 3. Classification by Income* ### Annex IV. Table 3. Sovereign Spreads and Sovereign ### Annex IV. Table 3. Sovereign Spreads and Sovereign Ratings ### FDI and Sovereign Ratings (Annex IV. Table 1) — EMs and LICs, LICs subsets - Logged VIX index coefficients: - EMs and LICs: 0.41 (0.31) - LICs: 0.42 (0.32) - LICs (third column): -0.381 (0.561) - G7 growth rate coefficients: - EMs and LICs: 0.0632** (0.0297) - LICs: -0.0453 (0.0564) - LICs (third column): -0.0566 (0.0577) - G7 real interest rate coefficients: - EMs and LICs: -0.158** (0.0648) - LICs: 0.0181 (0.176) - LICs (third column): -0.280 (0.204) - Domestic pull factors (lagged): - FDI/GDP: EMs and LICs -0.0623 (0.0872); LICs -0.582 (0.527); LICs -0.346 (0.270) - Sovereign ratings: EMs and LICs 6.381** (2.999); LICs 2.805* (1.668); LICs 2.428* (1.273) - Capital flow restrictiveness: EMs and LICs 1.324 (1.630); LICs -4.020 (8.768); LICs 2.980 (4.084) - Fiscal balance/GDP: EMs and LICs 0.243* (0.125); LICs -0.0719 (0.280); LICs 0.110* (0.0648) - Real growth rate: reported as 0*** (0) - Control of corruption: reported as -0.656 (2.030) - Fixed effects and sample: - Country FE: NO for reported specifications - Sample period: 1990-2023 - Number of countries: 78; 21; 20 - Note: Robust standard errors in parentheses. ### Portfolio Inflows and Sovereign Ratings (Annex IV. Table 2) - Global push factors: - Logged VIX index: -0.431* (0.235) - G7 growth rate: -0.155** (0.0782) - Real US interest rate: -0.201** (0.0964) - Real Federal Funds Rate (FFR, 10-year): 0.0774 (0.138) - Pegged ER dummy * Real FFR: 2.339** (1.180) - Domestic pull factors (lagged): - Portfolio inflow/GDP: -0.229* (0.120) - Sovereign ratings: 1.059*** (0.356) - Fiscal balance/GDP: -0.115*** (0.0571) - Fixed effects and sample: - Country FE: No - Sample period: 1990-2023 - Number of Countries: 80 - Note: Robust standard errors in parentheses. ### Sovereign Spreads — EMs and LICs; FE and RE specifications (Table segment) - VIX index (logged): - EMs - FE: 0.511*** (0.041) - EMs - RE: 0.511*** (0.041) - LICs - FE: 0.594*** (0.107) - LICs - RE: 0.575*** (0.101) - US Treasury Rate (10-year): - EMs - FE: 0.032 (0.031) - EMs - RE: 0.023 (0.030) - LICs - FE: 0.194** (0.077) - LICs - RE: 0.171** (0.068) - Domestic pull factors (lagged): - Sovereign ratings: - EMs - FE: -0.202*** (0.010) - EMs - RE: -0.195*** (0.007) - LICs - FE: -0.225*** (0.029) - LICs - RE: -0.240*** (0.019) - Real growth rate: - EMs - FE: -0.025*** (0.003) - EMs - RE: -0.026*** (0.003) - LICs - FE: -0.021* (0.011) - LICs - RE: -0.011 (0.009) - Reserves/GDP: - EMs - FE: -0.006*** (0.002) - EMs - RE: -0.005*** (0.002) - LICs - FE: -0.010 (0.008) - LICs - RE: -0.006** (0.002) - Public debt/GDP: - EMs - FE: 0.002* (0.001) - EMs - RE: 0.001 (0.001) - LICs - FE: -0.001 (0.002) - LICs - RE: -0.002 (0.002) - Current account balance/GDP: - EMs - FE: -0.011*** (0.003) - EMs - RE: -0.008*** (0.002) - LICs - FE: 0.003 (0.007) - LICs - RE: -0.001 (0.003) - Fixed effects, sample, and diagnostics: - Country FE: YES for FE columns, NO for RE columns - Sample period: 1990-2023 - R-squared: 0.524 (EMs - FE); 0.646 (EMs - RE) - Number of countries: 71; 71; 12; 12 - Hausman chi2: 15.07 (EMs panel) - Hausman p-value: 0.0351 (EMs panel); 0 for LICs panel ### Key Findings from “Foreign Direct Investment in Retreat: Policies to Turn the Tide” (World Bank 2025) — Annex V - Trends and composition: - FDI to EMDEs has fallen sharply since the global financial crisis; inflows are at the lowest level since the mid-2000s after peaking in 2008. - The retreat is broad-based across regions and concentrated in a few large EMDEs—mainly China, India, and Brazil. - FDI has shifted from manufacturing toward services, which now account for nearly two-thirds of inflows. - In EMDEs, almost 90 percent of FDI takes the form of greenfield investment. - Determinants: - FDI is strongly influenced by macroeconomic stability, institutional quality, market size, and financial development. - Trade integration and participation in global value chains are important: a one–percentage-point increase in trade openness raises FDI inflows by about 0.6 percent. - An investment treaty boosts bilateral FDI by more than 40 percent. - Restrictive investment regulations, weak governance, and geopolitical tensions deter cross-border investment. - Growth effects: - A 10 percent increase in FDI inflows raises GDP by about 0.3 percent after three years on average. - Effects reach 0.8 percent in economies with stronger institutions, higher human capital, greater openness, and lower informality. - The impact of FDI growth on GDP is weaker in LICs. - Policy recommendations: - (i) Attract FDI through stronger institutions, macroeconomic stability, and open trade and investment regimes. - (ii) Amplify the benefits of FDI via human-capital development and climate-aligned reforms. - (iii) Strengthen global cooperation to sustain a rules-based investment system and support LICs with limited capacity. ### Empirical Framework and Gravity-Model Results on FDI in LICs (Annex VI) - Purpose and methods: - The annex documents an empirical framework assessing associations between fiscal discipline, fiscal incentives, fiscal institutions, broader institutional settings, and FDI flows in LICs. - Primary estimation: Poisson pseudo–maximum likelihood (PPML) gravity model accommodating zero flows and heteroskedasticity, with year, host, and source fixed effects. - Sample for bilateral FDI flows: 2000–2019 (HBFDI database). - Key data and variables: - Bilateral FDI flows from World Bank HBFDI; bilateral frictions from CEPII (distance, shared official language). - Host- and source-country fundamentals: GDP (PPP, constant international dollars), GDP per capita (US$), real GDP growth, human capital. - Fiscal discipline: public debt-to-GDP and CPIA indicators for fiscal policy and debt policy and management. - Fiscal incentives: tax-reduction episodes; Special Economic Zone (SEZ) legislation. - Fiscal institutions: CPIA measures of budgetary and financial management, revenue mobilization, fiscal transparency and accountability; ISORA indicators on revenue administration operational strength and digitalization. - Broader institutional settings: composite governance index via PCA of Worldwide Governance Indicators and rule of law; capital account openness via Chinn–Ito index. - Econometric specification highlights: - PPML gravity model with year, host, and source fixed effects; host and source macro variables are lagged one period. - Sequential specification strategy adding fiscal discipline, fiscal institutions, and broader institutional settings one by one to limit multicollinearity. - Results interpreted as conditional associations, not causal effects. - Main gravity results: - Baseline: larger host and source economies associated with higher bilateral FDI; distance negative; shared official language positive. - Marginal effects for LICs (one–standard-deviation changes): - A one–standard-deviation increase in public debt associated with an estimated decline in FDI of about 14 percent. - Comparable improvements in fiscal discipline and fiscal institutions associated with increases in FDI on the order of 10–20 percent. - Fiscal discipline: higher public debt associated with lower FDI; stronger CPIA ratings for fiscal policy and debt management positively associated with FDI. - Fiscal institutions: stronger PFM, revenue mobilization, fiscal transparency, and revenue administration capacity (CPIA and ISORA) positively associated with FDI. - Broader institutions: governance, rule of law, and capital account openness generally positively correlated with FDI, though statistical significance is less consistent. - Robustness and extensions: - Alternative fixed-effects structure (source-country–year and host–source pair fixed effects) yields broadly consistent marginal effects for LICs. - Including trade openness for host and source does not materially alter main results; trade openness not robustly associated with FDI inflows for LICs once fixed effects and macro-fiscal controls are included. - Baseline PPML estimates excerpt (Annex VI. Table 1): - L. GDP (PPP US$, log) - Host: EMs 1.520*** (0.275); LICs 1.335*** (0.354) - L. GDP (PPP US$, log) - Source: EMs 1.028*** (0.262); LICs 1.603*** (0.302) - Distance (log): EMs -0.757*** (0.061); LICs -0.991*** (0.073) - Common official language dummy: EMs 1.060*** (0.139); LICs 0.767*** (0.120) - L. Human capital per capita - Host: EMs 0.002 (0.005); LICs 0.055** (0.027) - L. Human capital per capita - Source: EMs 0.003* (0.002); LICs 0.005** (0.002) - L. GDP per capita (US$) - Host: EMs -0.015** (0.007); LICs -0.067 (0.068) - L. Real GDP growth - Host: EMs 0.014* (0.007); LICs 0.021*** (0.008) - Top combined CIT rate - Source: EMs 0.017*** (0.006); LICs 0.010 (0.013) - Observations: EMs 75,456; LICs 36,984 - Pseudo R-squared: EMs 0.685; LICs 0.553 - With trade openness (Annex VI. Table 2) — selected coefficients: - L. Trade openness - Host: EMs 0.006** (0.002); LICs 0.000 (0.003) - L. Trade openness - Source: EMs -0.003* (0.002); LICs 0.004 (0.003) - Observations: EMs 73,561; LICs 34,730 - Pseudo R-squared: EMs 0.684; LICs 0.555 - Notes: - EM excludes China in the reported EM specifications. - Standard errors clustered at the host-source country pair level. - Statistical significance: ***p<0.01, **p<0.05, *p<0.10. *Source: Annexes IV–VI, ppea2026005.* ### conclusions of the analysis are broadly unchanged. ### ppea2026005 - conclusions of the analysis are broadly unchanged. ### Gravity results with country-specific uncertainty (World Uncertainty Index) - Purpose: assess whether the importance of fiscal discipline, fiscal institutions, and broader institutional settings for attracting FDI varies with host-country uncertainty by interacting the standardized World Uncertainty Index (WUI) with institutional variables. - Baseline gravity regularities (Annex VI Table 3): - Larger host and source economies → higher bilateral FDI inflows. - Distance (log) coefficient: -0.989*** (0.075). - Common official language dummy: 0.768*** (0.125). - L. GDP (PPP US$, log) - Host: 1.358*** (0.353). - L. GDP (PPP US$, log) - Source: 1.539*** (0.315). - L. Human capital per capita (constant 2014 th USD) - Host: 0.096* (0.050). - L. Human capital per capita (constant 2014 th USD) - Source: 0.004 (0.004). - L. GDP per capita (US$) - Host: -0.066 (0.068). - L. GDP per capita (US$) - Source: -0.005 (0.017). - L. Real GDP growth - Host: 0.019** (0.008). - L. Real GDP growth - Source: -0.016 (0.014). - Top combined CIT rate - Host: 0.006 (0.010). - Top combined CIT rate - Source: 0.007 (0.013). - L. World Uncertainty Index (WUI) - Host: 0.063 (0.176). - L. World Uncertainty Index (WUI) - Source: -0.300 (0.225). - Constant: 5.586** (2.838). - Time fixed effects: yes. - Source- and Host-country fixed effects: yes. - Observations: 31,994. - Pseudo R-squared: 0.543. - Notes: Standard errors clustered at host-source pair level. Significance: ***p<0.01, **p<0.05, *p<0.10. - Specification and marginal effect: - Estimated FDI equation includes main effects of X (institutional/fiscal variables), standardized WUI U, and interaction X×U plus baseline controls and fixed effects. - Marginal effect of an institutional/fiscal variable X on expected FDI: ∂E[FDI]/∂X = β_X + β_{XU}·U, where U denotes standardized WUI. - Figure 35 reports marginal effects evaluated at low uncertainty (10th percentile of standardized WUI) and high uncertainty (90th percentile), with confidence intervals computed by the delta method accounting for variances and covariance of β_X and β_{XU}. - Key note: Lagged host and source WUI coefficients are not statistically significant once year, host, and source fixed effects are included. ### Joint gravity estimates using principal components of fiscal and institutional variables - Approach: augment gravity model with principal components for three institutional buckets to address multicollinearity (Annex VI Table 4). - Findings: - When entered individually, principal components for fiscal discipline, fiscal institutions, and broader institutional settings are each positively and statistically significantly associated with FDI inflows. - In pairwise specifications that include fiscal institutions, both fiscal discipline and broader institutional settings lose statistical significance. - When all three principal components are included jointly, fiscal institutions emerge as the more important institutional correlate of FDI. - When fiscal discipline and broader institutional settings are included as a pair, broader institutional settings remain statistically significant. ### Local projections (LPs) — dynamic response to discrete policy reforms - Motivation: estimate impulse response functions (IRFs) for FDI following discrete policy reforms without restrictive dynamic assumptions (Óscar Jordà 2005 method), suited to LICs with infrequent reforms and limited panel lengths. - Data and policy shocks: - Core LIC panel restricted to PRGT-eligible countries, annual frequency, focusing on within-country reform episodes. - Policy shocks include: - SEZ legislation: adoption of laws establishing Special Economic Zones (Open Zone Consulting). - Tax-burden reductions: episodes of meaningful reductions in the overall CIT burden (FAD tax-policy changes database). - Heterogeneity assessed by splitting countries by CPIA fiscal policy rating and ISORA-based revenue administration operational strength. - Econometric specification (for each horizon h = 0, 1, ..., 6): - Dependent variable y_{i,t+h}: FDI inflows (real US$) for country i from time t−1 to time t+h up to h = 6. - Lags of FDI inflows: n = 2. - Country fixed effects α_i and time fixed effects λ_t included. - Policy shock indicator shk_{i,t} (binary event or continuous measure), e.g., SEZ legislation adoption; tax burden reduction. - Control vector X_{i,t−1}: real GDP growth, GDP in PPP US$, human capital, public debt, top statutory CIT rate. - Standard errors clustered at the country level. - The sequence of estimated β_h coefficients traces the impulse response of FDI to a reform shock over a six-year horizon. - Complementary LP estimates (Annex VI Figure 4): - Based on reductions in the CIT Marginal Effective Tax Rate (METR) from Hebous and Mengistu (2025). - Specification includes lagged value of the shock variable as an additional covariate. - Results: reductions in the CIT METR are associated with positive but modest short-run FDI responses in LICs with stronger revenue administration and fiscal discipline; responses in weaker-capacity LICs are statistically insignificant or counterintuitive, reinforcing conclusions in the main text. - Figure 4 shows impulse response functions for weak vs. strong ISORA operational strength and weak vs. strong CPIA fiscal policy rating; lines are point estimates and shaded areas denote 90 percent confidence intervals. Year 0 is the year of the shock. ### Data sources and variable definitions (Annex VI Table 5 highlights) - FDI data: - IMF BoP Statistics for direct investment data. - World Bank Harmonized Bilateral FDI database (2000–2019, 251 economies). - Moody’s Orbis Cross-border Investment (project-level FDI, 2003–2024). - Macroeconomic indicators: IMF World Economic Outlook (GDP, GDP growth, GDP per capita, inflation, public debt, trade, exchange rates, population). - Fiscal transparency: IBP Open Budget Index. - Fiscal rules: IMF Fiscal Rules Dataset (binary indicator for existence of main fiscal rule types). - Top combined CIT rate: IMF's Tax Rate Database (DART). - ISORA operational strength index: Atsebi et al. (2025). - Chinn-Ito capital account openness index: constructed from IMF AREAER restrictions (M. Chinn and H. Ito, updated to 2022). - Governance: authors’ PCA of the six WGI pillars (voice, stability, effectiveness, regulation, rule of law, corruption control). - CPIA ratings (fiscal policy, debt policy, efficiency of revenue mobilization, quality of budgetary and financial management, transparency and accountability): World Bank Country Policy and Institutional Assessments (1=low to 6=high). - Tax-burden reduction episodes: IMF Global tax Policy and Revenue Evaluation Database (TAPRED). - SEZ legislation indicator: Adrianople Group Open Zone Map. - Human capital: Wealth Accounting, World Bank (present value of future earnings, real chained 2014 US$). - World Uncertainty Index: World Uncertainty Index (available 1996 onwards). *Source: ppea2026005 - conclusions of the analysis are broadly unchanged.* ### References ### References ### Academic and empirical literature on FDI, taxes, and investment - Abbas, S. Ali, and Alexander Klemm (2013), “A Partial Race to the Bottom: Corporate Tax Developments in Emerging and Developing Economies.” International Tax and Public Finance 20 (4): 596–617. https://doi.org/10.1007/s10797-013-9286-8. - Alfaro, Laura, Areendam Chanda, Sebnem Kalemli-Ozcan, and Selin Sayek (2004), “FDI and Economic Growth: The Role of Local Financial Markets.” Journal of International Economics 64 (1): 89–112. - Alfaro, Laura, Areendam Chanda, Sebnem Kalemli-Ozcan, and Selin Sayek (2008), “Does Foreign Direct Investment Promote Growth? Exploring the Role of Financial Markets.” Journal of Development Economics 91 (2): 242–256. - Borensztein, Eduardo, José De Gregorio, and Jong-Wha Lee (1998), “How Does Foreign Direct Investment Affect Economic Growth?” Journal of International Economics 45 (1): 115–135. - Desai, Mihir A., C. Fritz Foley, and James R. Hines Jr. (2004), “Foreign Direct Investment in a World of Multiple Taxes.” Journal of Public Economics 88 (12): 2727–2744. - Djankov, Simeon, Tim Ganser, Caralee McLiesh, Rita Ramalho, and Andrei Shleifer (2010), “The Effect of corporate Taxes on Investment and Entrepreneurship.” American Economic Journal: Macroeconomics 2 (3): 31–64. - Hines, James R. (1996), “Altered States: Taxes and the Location of Foreign Direct Investment in America.” American Economic Review 86 (5): 1076–1094. - Klemm, Alexander, and Stefanie Van Parys (2012), “Empirical Evidence on the Effects of Tax Incentives.” International Tax and Public Finance 19 (3): 393–423. - Katitas, Aycan and Sonal Pandya (2024), “Investment Incentives Attract Foreign Direct Investment: Evidence from the Great Recession.” Public Choice 200 (1–2): 323–345. - Tian, Gang (2018), “Subsidies versus Tax Cuts in Attracting Foreign Direct Investment.” Journal of International Economics 111: 112–126. ### Public investment, infrastructure, and growth - Ang, J. B., K. C. Madsen, and R. Robertson (2010), “The Role of Public Investment in Economic Growth.” Journal of Macroeconomics 32: 789–796. - Calderón, César, and Luis Servén (2010), “Infrastructure and Economic Development in Sub-Saharan Africa.” Journal of African Economies 19 (S1): i13–i87. - Rajaram, Anand, et al. (2014), “The Power of Public Investment Management: Transforming Resources into Assets for Growth.” Washington, DC: World Bank. - Warner, Andrew (2014), “Public Investment as an Engine of Growth.” IMF Working Paper 14/148. - Eltokhy, Khaled, Feruglio, Nicoletta, Miao, Kezhou, Navarro, Arturo and Eivind Tandberg (2024), “Public Investment Management Bottlenecks in Low-income Countries.” IMF Working Paper 24/232. - Löwe, M., Papageorgiuou, C. and F. Perez-Sebastian (2019), “The Public and Private marginal Product of Capital,” Economica, 86, pp. 336-361. - An, Zidong, Alvar Kangur, and Chris Papageorgiou (2019), "On the Substitution of Private and Public Capital in Production," European Economic Review, Volume 118, September 2019, Pages 296-311. ### Capital flows, global financial linkages, and sovereign risk - Calvo, Guillermo (1998), “Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops,” Journal of Applied Economics, 1998, vol. 1, 35-54. - Milesi-Ferretti, G-M. and C. Tille (2011), “The great retrenchment: international capital flows during the global financial crisis,” Economic Policy, pp. 289-346. - Graf von Luckner, C., Reinhart, C.M. and K. Rogoff (2023), “Decrypting new age international capital flows,” Journal of Monetary Economics, 138, pp. 104-122. - Miranda-Agrippino, S. and H. Rey (2020), “U.S. Monetary Policy and the Global Financial Cycle,” Review of Economic Studies, 87, pp. 2754-2776. - Kraussl, R. (2003), “Do Changes in Sovereign Credit Ratings Contribute to Financial Contagion in Emerging Market Crises?” Center for Financial Studies, No. 2003/22. - Said, A. and A. Kangur (2026), “Sovereign Ratings, Spreads and Capital Flows: Are LICs Any Different?” IMF Working Paper (forthcoming). ### Tax policy, revenue administration, and domestic resource mobilization - Baer, K., Bellon, M., Davies, M., De Mooij, R., Gaspar, V., Lemgruber A., Mansour, M., Sawadogo, F., Takebe, M. and C. Vellutini (2025), “Building Tax Capacity for Growth and Development: Evidence-Based Analysis for Mobilizing Domestic Revenue,” IMF FAD Departmental Paper, Washington DC. - IMF (2015), “Options for Low-Income Countries’ Effective and Efficient Use of Tax Incentives for Investment.” Washington, DC: IMF, OECD, UN, and World Bank. - IMF (2018), “IMF Revenue Administration – Gap Analysis Program (RA-GAP): Methodology and Findings.” Washington, DC. - Keen, Michael, Mario Mansour, and Will Prichard (2017), “Revenue Administration Reform in Developing Countries.” Journal of Economic Perspectives 31 (3): 165–188. - Hebous, S. and Mengistu, A. (2025), “Forward-Looking Effective Tax Rates under the Global Minimum Corporate Tax”, Mimeo. - IMF–OECD (2023), “Implementation of Pillar Two: Design and Revenue Implications.” Washington, DC. ### Multilateral and institutional reports, datasets, and working papers - IMF policy and research outputs cited include: IMF (2007), (2014), (2016), (2018b), (2019), (2021a), (2021b), (2024a), (2024b), (2024c), (2024d), (2025a), (2025b), (2025c), (2025d), (2025e), (2025f), (2025g), (2025h). - World Bank analytics and reports cited include: World Bank (2017), World Bank (2020), World Bank (2021), World Bank (2023), World Bank (2024), World Bank (2025). - UNCTAD World Investment Reports cited: 2019, 2022, 2024, 2025. - Data resources cited: CEPII “Gravity Dataset”; FEENSTRA et al., "The Next Generation of the Penn World Table"; IMF Balance of Payments Statistics and World Economic Outlook Databases; IMF Fiscal Rules and Institutions Database and ISORA. ### Recent supplementary information and policy implications (supplement to the 2026 report) - The latest conflict in the Middle East has triggered a negative supply shock that intensified uncertainty and downside risks for the global economy since the publication of the report. - Immediate observed effects include higher and more volatile energy prices, disruptions in trade and regional economic activity, and financial market volatility. - The economic impact will depend on the extent and duration of the conflict, including the degree of disruption to energy and fertilizer production and trade routes. - If the conflict were to persist, it could generate significant spillovers to LICs through channels including: - commodity prices, notably oil and natural gas, alongside other commodities; - second round effects on inflation and inflation expectations; - global financial conditions and exchange rate pressures; - remittances (GCC countries account for 16.4 percent of remittance inflows to LICs); - disruptions to fertilizer supply with knock-on effects on agricultural production and food prices. - The impact will likely be most severe for net fuel and food commodity importers, LICs with high external financing needs, and LICs with limited policy space. - Policy recommendations and priorities: - Pursue macroeconomic stabilization policies tailored to address the implications of the shock. - Maintain focus on structural reforms to increase returns on capital and attract stronger FDI inflows. - Seek strong international support, especially for the poorest LICs and FCS which have limited access to affordable external financing, shallow domestic financial markets, and weakest ability to absorb additional shocks. - Supplement prepared by Strategy, Policy, and Review Department, March 13, 2026. *Source: ppea2026005 - References, International Monetary Fund.* --- _Source: https://www.imf.org/-/media/files/publications/pp/2026/english/ppea2026005.pdf_