Curse of friendship: IMF programme, friendship with the United States and foreign direct investment

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AbstractHow do investors respond when a country participates in an International Monetary Fund (IMF) programme? While there exists some optimism in and around the IMF on the catalytic effect of a Fund programme, empirical research on the catalytic finance reports rather diverse findings; contrary to most theoretical research, empirical studies report both positive and negative effects as well as null effects. This paper revisits the question of whether and how an IMF programme catalyses other finances, focusing on the catalytic effect on foreign direct investment (FDI). We modify the core theoretical logic behind the catalytic finance to identify conditions under which an IMF programme is more likely to catalyse FDI: we highlight the credibility of an IMF programme as a key determinant of any positive catalytic effect it may have and reason that politically motivated lending by the IMF can attenuate a programme’s credibility, depressing the catalytic effect. We empirically capture politically motivated lending by looking at the relationship between a borrowing country and the United States and demonstrate that IMF loans to countries closely aligned with the United States are less likely to catalyse FDI than loans to countries that are not aligned with the United States.