Foreign aid: Can it work for new Nepal?
Following the implementation of Foreign Aid Policy, 2002, grants have exceeded loans, projects have been prioritised, Poverty Reduction Fund has been established and Nepal has been receiving Poverty Reduction Support Credit. Similarly, aid has started to flow according to government priorities, though it is questionable if these are government’s independent priorities.
The quality of aid has improved to some extent, especially after promulgation of the act. However, there are serious problems with management of such aid, including lack of proper recording, impractical conditionality and lack of transparency. A recent aid effectiveness study conducted by B P Bhattarai shows that both bilateral and multilateral aid can be effective in the long run. However, relationship between aid and per capita GDP has been found to be negative in both aggregate and disaggregated forms in the short-run, implying that
the country suffers from lack of absorptive capacity and high aid volatility. This study can be complemented with other findings from the ADB, which show that while macro-policy environment and quality of governance have a direct bearing on poverty reduction, aid effectiveness is not critically contingent on them.
Effectiveness rather differs under different environments, with differing quality of governance. On an average, aid is effective when it is moderate in volume. It becomes ineffective when its size exceeds the absorptive capacity of the target country. A cross-country empirical analysis by the World Bank conducted under Stephen Knack reveals that a high level of aid erodes institutional quality, increases rent-seeking and corruption, and therefore, has an adverse impact on growth.
It is recognised that aid helps economic growth in developing countries with sound policies and high quality public institutions. The problem lies with the compatibility of policy choice under different structural settings in conflict-prone countries like Nepal. Linking internationally practiced macroeconomic policies in assistance strategies without restructuring the institutional framework has backfired on development missions in Nepal.
In fact, aid rarely manages to get things done which the countries could do themselves. Even with incredibly high aid inflows, poor countries are just as poor now as they were a decade ago. In most cases, aid has only fostered corruption and irresponsible policy-making. This is indeed the case with Nepal.
In Nepal, foreign assistance has not contributed to growth, especially with regard to its ability to supplement savings, foreign exchange and government revenues. The country’s failure to reduce aid and foreign borrowing by closing resource gaps has also not facilitated economic policy autonomy. The new government faces the challenge of reducing debt burden and increasing revenue by properly managing resource allocation under the proposed federal structure. Analysis of fiscal impact under a federal state should be our priority. Attention should go towards making aid money accessible to the poor, providing safe drinking water to villagers and guaranteeing poor children primary education.
As external assistance has not been able to make a significant contribution to Nepal’s integration process, advocates of liberalisation have been disappointed. With billions of outstanding debt under the reform programme, Nepal has made a poor showing in public finance, price and supply situation, money and banking, international trade, transport and communications, agriculture and tourism, and social services. There is a big question mark on enhancing the competitive edge of Nepal’s development projects.
A crucial determinant of competitiveness is productivity of key inputs. It is the key to improving national economic well-being by attracting domestic and foreign investors to the local economy. Nepal’s competitive advantage in lower wages is offset by low labour productivity. Out of 200 countries, the majority of Nepal’s indices in one of the top priority sectors, viz tourism, fall way behind other countries.
Nepal is characterised by red light in infrastructure, technology, human resources, openness and social index. This is the reason why revolutionary leaders in new Nepal should carefully assess trade-offs between assets and liabilities created by external assistance.
Emerging from the ‘poverty trap’ does not necessarily mean a push for larger aid. It is also no guarantee that aid will increase productivity by bridging the ‘financing gap’. An increase in foreign aid and debt relief has not eliminated poverty in Africa. As much as 39% of Africa’s capital is believed to be held by those outside the continent. This clearly shows that investment depends upon the rate of return and increased bank lending. The need of the hour is to create an environment for investment where rates of return are higher than debt.
Dr Pyakuryal is professor of Economics, TU