Foreign aid is one of the most important determinants of economic development outcomes in developing countries. Generally, this comes as either bilateral aid or multilateral aid.
Bilateral aid largely refers to grants while multilateral aid is a combination of grants and loans.
The Bretton Woods Institutions, mainly the World Bank and the International Monetary Fund (IMF), dominate the financing aid space. The prevalence of market and non-market failures in developing countries and the general inability to finance all their developmental needs provide a rationale for foreign aid.
It follows that increasing the aid volume to significant levels and ensuring predictable aid flows is imperative for achieving tangible results. However, the lack of predictability of aid flows affects the level, composition, and effectiveness of government spending.
The establishment of multilateral institutions was a landmark achievement due to their role in financing global growth. The impact of these institutions is mainly on developing countries that are often associated with lack of access to liquid international markets. For example, in addition to providing funding, development finance institutions like the IMF have an important role to play in developing countries.
This includes promoting greater transparency, broader consultations, building a stronger accountability dimension in the economic policies it advises on and strengthening the governance of economic institutions in developing countries. On the downside, aid institutions find themselves mired in the diplomacy of promises and thus fail to effectively execute development challenges for developing countries as enshrined in their mission statements.
This is substantiated by the assertion that, the prescription and or criteria on whom to fund, and on what financial terms and conditions lead to their perceived ineffectiveness. As a result, in some instances their stringent conditions tend to prevent developing countries from accessing funding. Such conditions have inevitably resulted in policy reforms or promises without the necessary dollars to support the developing countries.
Over the past years, the development priorities of donor agencies and recipient countries have evolved. This either reflects new development thinking, a response to changes in the development landscape and or response to empirical findings on aid effectiveness.
There are currently two contrasting approaches towards aid policy in Africa. The Bretton Woods institutions’ approaches are well known for conditionality and selectivity and focus on direct financial support, while the approach adopted by China avoids conditionality and concentrates on infrastructure building.
Analysts opine that the Chinese approach has been criticised for its failure to create direct employment and because, it is argued to be unconditional and thus hampers good governance in Africa. At the same time, the Bretton Woods institutions face a dilemma in that governance and its improvements are embedded to the economic development of a country hence cannot be practically separated.
Making aid conditional upon governance therefore unduly penalises countries at the bottom. The Chinese approach, in contrast, avoids this dilemma by directly targeting constraints to development and it may therefore be more effective in generating long-run growth, which may in turn foster good governance. Post the global adoption of the Millennium Development Goals and Sustainable Development Goals, many more sources of funding have emerged and they are likely to amplify some of the problems relating to the effectiveness of traditional aid institutions.
While the traditional aid community deserves credit for its efforts towards effective delivery of aid, achieving the ultimate goal of aid effectiveness is still a challenging task.
Thus, the premise that foreign aid is an important determinant of development outcome needs to be qualified, particularly with respect to the various characteristics, and the environment surrounding the delivery and effective use of aid.
The long-standing question is whether and under what conditions foreign aid is effective in delivering development impacts. While there is no simple answer to this question, a more pertinent practical question is how aid can be made more effective. Aid is effective when it is predictable and when it meets the country’s development priorities at the right time.
The frequently voiced concerns of developing countries which receive development aid are that assistance flows are not predictable. In most years, the amount of aid disbursed differs widely from the amounts expected, and because most aid recipients lack access to international capital markets, they cannot borrow externally when expected aid fails to arrive.
As a result, recipient governments are forced to adjust spending plans at short notice when promised aid is not provided or when additional aid is disbursed unexpectedly.
It is important to note that unpredictable aid may not only be more difficult to manage, but also affects how the money is spent, thereby reducing its intended impact. Unexpected aid shortfalls could force governments to disproportionately cut investments in physical and human capital and may result in unorthodox policies where the country may resultantly become worse off than the initial position. A government’s inability to predict aid flows affects not only the level of government spending but also its composition and effectiveness.
The Bretton Woods system of monetary management established the rules for commercial and financial relations among the United States, Canada, Western Europe, Australia and Japan in the mid-20th century. It must therefore be highlighted that there is a positive correlation between changes in the global political economy of these countries and the funding trends or decisions of Bretton Woods Institutions. As such, developing countries, including Zimbabwe, need to balance their expectations with the changes in foreign policy on Africa especially where the urgency of aid is not matched by willingness to provide funding.
This generally calls for exploring other alternative routes to manage unmet expectations from aid promises.
When aid institutions continue to lean on the fence, it calls for policies which are skewed towards promoting private investments instead of conditional aid.
A more controversial and complicated question is whether specific conditions meant to ensure that country objectives are aligned with donor objectives justify lack of predictability. Such conditions, which are typically applied to budget aid, can include specific policy actions, for example, structural changes to the economy or other economic indicators. If recipients do not comply with such conditions, aid may be reduced or delayed.
Developing countries operate under seriously constrained choices, with scarce resources for capital investments. The biggest dilemma is to manage aid promises and materialisation of the actual funding. When countries stumble in debt crisis which is occasioned by heavy foreign borrowing, structural adjustment lending becomes a logical corollary of stabilisation programs following a balance of payment crises.
For example, between 2015 and 2016, Zimbabwe made significant progress to complete the IMF Staff Monitored Programme. The expectation post completion of the staff monitored programme was that the dollars will begin flowing into the country and at least support the current meagre budgetary resources.
However, when multilateral and bilateral institutions lean on the fence, there are limited options to finance budget deficit except to seek sanctuary from local financial institutions.
For instance, currently Zimbabwe’s budget deficit is above 1% of GDP and without budgetary support from multilateral institutions, the financing options are so limited. Countries adjust to aid shortfalls by raising additional domestic financing.
When the government operates in an environment of uncertain budget aid, though painful, there is need to restrain unnecessary recurrent expenditure if there is high probability that aid will not be received within the budget cycle. For example, currently in Zimbabwe, the prospects of future IMF financing depend on the clearance of arrears with the other institutions, including the World Bank and the African Development Bank, fiscal adjustments and reforms. Persistent uncertainty about budget aid disbursements undercuts simple budget management responses to shortfalls, such as the delay of investment spending.
The challenges of lack of fruition of aid promises require strong policy reforms that restore confidence in the recipient economy and incentivise production and investment. Sometimes, there are genuine difficulties for the donors to honour their commitments to increase aid. Rising domestic revenue not only creates additional fiscal space for supporting high-priority spending, it also allows a country to maintain spending consistent with its policy priorities and getting insulated when aid is phased out.
Increased domestic revenue can also help countries mitigate the adverse impact of volatility and uncertainty in aid flows, which can complicate budgetary management.
Chishamba is a Zimbabwean banker with experience in treasury and corporate banking. He writes in his personal capacity.