The Sunday Times Economic Analysis

The Sunday Times Economic Analysis By the Economist

The many dimensions of the aid package
We look to foreign aid as manna from heaven, lauding the higher and higher amounts of aid we get each year. Getting aid is one of the main achievements of a government.
This year we hailed the aid even more as we reached a new peak in aid commitments of US4.5 billion to be disbursed over a three-year period. The jubilation must be tempered by a healthy scepticism of the efficacy of the aid package.

There are many dimensions of aid. These include the composition of the aid. How much of the aid are outright grants? How much are loans that have to be repaid? What are the interest rates and periods of repayment of the loans?

Then there is the much-discussed issue of aid utilisation. This in turn has two important aspects. First, the amount of the aid that has been committed that would be ultimately utilised. Second, how and in what ways would the aid be utilised. Then there is the closely related issue of the impact of the aid on the foreign debt burden and debt servicing costs.

The description of the US $ 4.5 billion committed, as aid is a misnomer. Most people would think of the aid package as a grant that does not require to be repaid, as most of it is for reconstruction. In fact only a part of it would be a grant element. The rest would be long term loans at concessional interest rates.

In the current international scenario of low interest rates, the concessional element may in fact be lower than suggested by the nominal interest rates. The exact proportions of outright grants and loans under different interest rates and repayment periods are not known as yet.

The fact that much of the aid is in the form of loans has serious implications in its utilisation. Since much of the aid is for reconstruction, there would not be direct effects on the production of goods and services.

There would of course be indirect impacts, but most of these benefits would take time to take effect. The significant implication of this is that the loans could increase the foreign debt burden, as there may not be commensurate increases in goods and services.

The longer the grace period and the smaller the annual instalments, the lesser this burden would be. In the case of loans that are for productive purposes, it is vital that these be so utilised that they generate a return higher than the cost of aid.

Unless the goods and services produced are also ones that would increase exports or reduce imports, directly or indirectly, the aid would be an additional foreign debt burden in due course. It is therefore important that priorities in aid utilisation take this factor into account.

Much has been said about the low proportion of aid utilisation. In the past aid utilisation has been as low as 20 per cent of committed aid. If this proportion were applied, the actual aid flow would only be only US$ 0.3 billion each year.
The government has vowed to enhance the rate of aid utilisation through new institutional mechanisms.

This is easier said than done. The use of aid in the North and East is beset with complications related to building new institutional capacities, as well as the progress of the peace process. Donors have made it clear that utilisation of aid would be conditional to achievement of a durable peace.

Besides this, a tussle between the government and the LTTE to get hold of aid could itself constitute a problem that may reduce aid utilisation. There are other aspects of the aid package that must be recognised. The commitment of aid appears to have boosted confidence in the economy, especially those of foreign investors.

This is of utmost benefit to the country as foreign direct investment has a significant role to play in the country's economic growth. The inflow of aid would also strengthen the balance of payments, in a context of continued large trade deficits.

The multiplier impact of the aid expenditure on related sectors of the economy could raise the momentum of growth. There is reason to be happy about the large amount of aid received. Yet we must be mindful of the costs of some of the aid and use the assistance prudently and in an economically efficient manner. Aid utilisation must be increased to much higher levels than in the past.

Above all the resolution of the political problem speedily is vital to enhance the capacity to utilise aid. Our jubilation in receiving aid can only be justified if a large proportion of it is effectively and productively utilised to ensure that the foreign debt burden is reduced rather than increased.

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