Foreign Aid during tumultuous time: options for Nepal

We confront our future with a history of over five decades of foreign aid and no sign of backing-off any time soon while we continue to underperform in developing the alternatives

By Anjan Panday

In the current global financial crisis, many of the donor nations are concerned with keeping their fiscal house in order. President Obama during his run-up to the election and, immediately, after the election hinted that prioritizing home fiscal needs would mean scaling back on outside contribution.  Many of the western nations, which constitute the donor base, are the ones deeply concerned with riding out this recession safely. In doing so it is natural to expect them make adjustments in their commitment. This, indeed, has implications and as noted by the UN Secretary-General Ban Ki-moon, in the recently concluded G-8 summit, such adjustments will compromise the needs of the most vulnerable.

The impact of current crisis on aid flow can be judged tentatively by analyzing previous crises and the response of donor communities during those times.  A nearly comparable scale of the current economic crisis, since the World War II, was the “Oil Crisis” of early 1970s when the oil embargo and the crisis in middle-east sent global oil prices sky-rocketing and had an adverse impact on many nations. The first graph presents a historical perspective on aid flow by OECD DAC countries. In the period corresponding to the crisis of early 70s, there was a slight dip in the bilateral Official Development Assistance (ODA). The big fall came in the aftermath of Gulf War in 1991. Both, the bilateral and total ODA, dipped and bottomed-out by 1997.  The ODA held up after the 9/11 and as clearly seen peaked in 2005 after which it took a nose dive just to gain momentarily in 2008. Obviously, there is a natural lag in between crisis and the nations’ ability to deliver on its commitment of the development aid.

The future path for ODA based on past experiences is not very clear. However, the severity of present crisis is clear, mainly in its scope and outreach. The impact is deep and worldwide. It is, therefore, reasonable to expect that the crisis will continue to expose aid-dependent nations, especially if the recovery takes longer than expected. And, as yet, there is nothing that can definitively suggest us on when the full-scale recovery will start, though the signs lately have been optimistic. This indicates predicament for country like Nepal.

As seen in the second graph, the aid flow to Nepal, in general, has followed the trend of the global donor community. There was a slight fall in aid flow in early 1970s but it showed rising trend in 1980s despite some occasional dips. The bilateral aid flow peaked in early 1990s after which there was a clear downward trend. However, since the millennium, there has been a short-lived upward trend which, however, is looking patchy in recent years.   

In light of our dependency on foreign aid, the ramifications of current crisis can be better analyzed from a short and long term perspective. In a shorter horizon, the cut back on ODA will undoubtedly hit us hard, especially when we have become almost completely dependent on foreign aid for our evelopment expenditures . Furthermore, the global demand shock has killed our already critical export industries. The demand shock also meant loss in overseas jobs, the impact of which will become clear in near future if not already. There have been reports suggesting mass scale return of the Indian workers from the middle-east in recent days. Thus, we can prepare ourselves for what will be an inevitable fall in the sustained workers’ remittance of yesteryears. A cumulative impact of cutback in foreign aid, collapse of domestic industries, decline in repatriated fund, political imbroglio, and the deteriorating internal security will adversely impact the economy, as a whole. Although this is a characterization of chain-of-events in Nepal, a roughly similar situation can be contemplated in many developing nations, which is why secretary Ban emphasized on “the needs of the most vulnerable” at the G-8 summit. Therefore, the continuation of foreign aid now is perhaps more important than at any time in recent history.

The bigger and perhaps more important question is to reflect upon the efficacy of foreign aid in supporting the domestic economy over a longer horizon. Our documented evidence on the foreign aid dates back to 1950s, with a growing influence in later decades. A recent study by Bhattarai(2009) on the impact of foreign aid on per capita real GDP found a positive relationship during the period 1983-2002, more so in a good policy environment. This is good news in that there seems to be some evidence of positive impact of development aid which is in contrast to the belief of many aid-agonists. However, the statistical relationship is not of a matter to cherish, either. We would have been in a much better position had there been any serious effort in developing alternatives to aid dependency. The only meaningful way toward substituting aid is the promotion of private capital and/or foreign investment. Nevertheless, there is no conclusive evidence to suggest that we have made any satisfying progress on either front. This puts us in a precarious position where we remain highly vulnerable to shocks outside, as in the current case, despite our economy being relatively less integrated to the global economy.

Moreover, the challenge in front of us is to avoid our tendency to count on donors’ money. The incomplete political change of recent years and the prolonging transitionary phase can only indicate marginalizing much needed reform toward attracting private capital and investment.  The imperative of promoting sustainable alternative in the form of private capital/investment should be clear from the evidence of our two immediate neighbors, India and China. Their growth today is largely not because of aid or charity but because of private capital and investment. Thus, we confront our future with a history of over five decades of foreign aid and no sign of backing-off any time soon while we continue to underperform in developing the alternatives. The current crisis may be an opportunity for us to realize the seriousness of our dependency and work toward reducing the aid burden.  

Work Cited:
  Bhattarai, Badri Prasad. 2009. “Foreign Aid and Growth in Nepal: An Empirical Analysis”, The Journal of Developing Areas, Vol. 42, No. 2, pp. 283-302

Panday is a doctoral student in economics at the American University, Washington DC and can be reached at anjanpanday@gmail.com