Many developing countries, including Nepal, rely on foreign aid as a key resource for developmental activities and poverty reduction initiatives. But excessive dependence on external resources without safeguard mechanisms may create political, economic and social problems having a negative impact on the society.

Nepal’s experience reveals that five decades of foreign aid injection could not uplift the living condition of the poor. We should not blame the donors for unachieved development results but should take responsibility for mismanagement, incapability and inefficiency in handling aid matters. The vision of transformation from a traditional agrarian society to a modern one became only an illusion. Every past regime with optimistic plans and programmes raised the people’s expectations but failed to deliver results. Changes in political regimes may not be sufficient to bring about economic prosperity if the thinking, structure and institutions remain unchanged.

The centrally planned model could not deliver intended results. This may thus be the right time for Nepal to consider effective decentralisation strategy, making it applicable also in foreign aided programmes and projects partially. The negative effects of foreign aid which influences the policy, institutions and growth are the areas which need careful attention of policy-makers so that aid could bring positive results in future. Excessive aid flow to poorer countries could weaken the capability of the government and the institutions due to excessive reliance on it. The government and civil service always prefer the easy option of aid rather than impose and collect taxes internally. This ‘free launch’ syndrome leads to non-responsive and unaccountable governing system, postponing home-grown reform initiatives evolved for strengthening the domestic resource base. The donors play the leadership role and the government seems to be accountable to them rather than to the people. The aid with political strings, which flows without assessment of development results and without any economic reasons, might create ‘moral hazards’ for recipient countries. The cost later on might be more in terms of political turmoil, instability and natural resources exploitation. The recipient country’s institutions could be weakened through the siphoning off of skilled manpower. In large aided projects, the corrupt group either tries to siphon off the aid or strives to control it. Such rent-seeking behaviour, including ‘white elephant’ syndrome, escalates the project cost, thereby causing financial problems, reducing the benefits and questioning the credibility of the projects.

Foreign aid characterised by unpredictability, uncertainty and conditionality if not managed properly might create negative effects in the economy. Firstly, the ‘Dutch disease’ — a syndrome seen as windfall after discovering oils, where the resource is spent on non-traded goods that increases the price of such goods, appreciates the value of the currency, making export and other sectors uncompetitive. Secondly, if countries are based on the export of primary products like minerals these countries grow more slowly than the peers, such phenomenon is recognised as ‘resource curse’. If a country’s key resource is foreign aid, the resource curse syndrome is likely to occur. Thirdly, foreign aid often helps to swell the government budget leading to inflationary pressure. If actual aid disbursement tends to fall below the commitment, it will either curtail the development spending or rely more on domestic borrowings. Curtailment on development spending will directly hit poverty reduction programmes, infrastructure development and eventually the growth. Moreover, additional domestic borrowings will have crowding-out effect, thus squeezing private sector credit and creating more pressure on foreign exchange reserve, and money creation will lead to higher inflation.

The above scenario does not mean that foreign aid cannot deliver effective results and thus be discarded. However, its proper management is suggested. Various national and international initiatives have adequately addressed those issues to improve the modalities, methods and procedures in aid delivery so that aid can contribute to development effectiveness.

Prudent macro-economic policy and reform agenda on track are the key requirements while managing aid. Similarly, instruments like Poverty Reduction Strategy Paper (PRSP), Medium Term Expenditure Framework (MTEF) and foreign aid policy can contribute to resolving the issues related to aid management. The donors should also avoid uncertainty, keep their commitments and rely on recipient country’s PRSP and MTEF. Both the recipient countries and donors should follow the framework of national and international commitments so that negative impact can be minimised to foster the effectiveness of development and achieve growth in a sustainable manner.

Acharya is ex-finance secretary