Governance and Institutional Quality as Double-Edged Determinants of FDI Inflows: Evidence from South and Central Asia

This study examines the role of governance and institutional quality in shaping FDI inflows across twelve South and Central Asian economies from 2002 to 2023. The analysis incorporates key macroeconomic determinants, including trade openness, economic growth, population, inflation, six governance dimensions, and a composite institutional quality index constructed through principal component analysis. Driscoll–Kraay standard errors, Feasible Generalized Least Squares (FGLS), and Method of Moments Quantile Regression (MMQR) techniques are employed to capture heterogeneity and distributional effects. The findings show that trade openness, economic growth, and population consistently stimulate FDI inflows, whereas inflation discourages foreign investment. More importantly, the study reveals a counterintuitive institutional effect: stricter governance mechanisms-including stronger rule of law, regulatory quality, and anti-corruption measures-can temporarily constrain FDI inflows by increasing compliance costs, administrative complexity, and adjustment burdens for foreign investors in transitional economies. This suggests that institutional strengthening operates as a double-edged process, promoting long-term economic credibility while potentially discouraging short-term foreign capital inflows. The study therefore highlights the importance of balancing institutional reforms with procedural efficiency and investor-friendly implementation strategies in South and Central Asia.