Foreign Aid and Its Role in Economic

Development
Definition of Foreign Aid:

Foreign Aid occurs when the recipient country receives additional resources in
foreign currency over and above the capacity to import generated by exports. In
simple words, foreign aid means those additional resources which are used to
raise the performance of the recipient country above the existing level. It can be
defined as the debt which is given by a country to another country on the
concessional rates. The concessional elements may be:

(a) Lower rates of interest than the prevailing rate of interest in the
international commercial money market.

(b) Longer period for repayments.

(c) Grants which does not entail the payment of other principal or interest,
i.e., a free gift.

A country which gives loan is called donor and the country which receives the
loan is called recipient country.

Types of Foreign Aid:

There are two types of foreign aid, according to their source:

(a) Bilateral Aid: Bilateral aid is the aid which is given from the government
of the donor country to the recipient country. It depends upon political and
economic relationships of various countries and it also depends on the will
of donor country.

(b) Multilateral Aid: Multilateral aid is the aid given by certain financial
institutions, agencies or organisations to the government of developing
country. It is distributed in a fair manner in order to raise the pace of
economic development. So it is better than bilateral aid which is given on
the basis of political considerations and the fear of the domination of a
donor country is also removed in the case of multilateral aid which may be
helpful in raising the pace of economic development.

Forms of Foreign Aid:

Following are the forms of foreign aid:

(a) Financial Aid: The simplest form of capital inflow is the provision of
convertible foreign exchange, but very little foreign capital indeed comes
to the underdeveloped world so conveniently. Financial aid is further
divided into various sub-forms, i.e.:

(i) Tied Aid: Tied aid is of two types:

• Nation Tied Aid: is given to the recipient country on the condition that
she will spend it in the donor country to solve the BOP problems of that
country and to stimulate exports, i.e., if Pakistan is given aid by US and is
asked to import raw materials or machinery from US only then it is
�nation tied aid� or �resource tied aid�.

• Project Tied Aid: is given only for specific projects and the recipient
country cannot shift it to other projects.

(ii) Untied Aid: Untied aid is the aid which is not tied to any project or
nation. It is, in all respects, better than the tied aid because it offers
more efficient use of foreign resources. It is much desired because in
the case of untied aid the recipient country is not bound to spend the
foreign resources on specific projects or in the donor country which may
charge higher prices than international market.

(iii) Grants: A grant is that form of foreign aid which does not entail either
the payment of principal or interest. It is a free gift from one
government to another or from an institution to a government. It is
much desired because it increases the internal expenditures and
generates income. It is given on the basis of humanitarianism,
especially in days of emergencies, earth quakes, floods, wars, etc.

(iv) Loans: It is the borrowing of foreign exchange by the poor country from
the rich country to finance short-term or long-term projects. They are
further sub-divided into two types:

• Hard Loans: Hard loans are also called short-term loans.

In order to finance industrial imports they are given usually for a
period less than five years, and they are paid in the currency
borrowed. It contains no concessional element but interest rate
is usually lower than the prevailing rate of interest in the
international market.
• Soft Loans: Soft loans are also known as long-term
loans. Soft loans are made for 10-20 years and it is repaid in
the currency of recipient country. Interest on these loans is
lesser than hard loans and often these loans invoice grace
period. Concessional elements are comparatively greater.
(b) Commodity Aid: Commodity aid, in fact, is another type of tied aid, which
relates to agriculture products, raw materials and consumer goods. Under
commodity aid, the donor country has much political influence on the
recipient country, for example, in 1960s, US gave wheat to Pakistan under
PL-480 and had much influence on the development policy of Pakistan.
Commodity aid may be received in cash form or in the form of food grains:

(i) In Cash Form: If it is received in cash form it may be more helpful

because then a country may buy more commodities from cheaper
sources.

(ii) In Food Grain Form: It is a special type of commodity aid, which is

given in the form of food grains only, for example, US gives food
grains to the poor country under Public Law (PL-480) and funds
obtained from it are used on American companies and agencies
operating in the recipient countries. The rest of the aid is granted.

(c) Food Aid: There is more than enough food produced each year to feed
adequately everyone on earth. However, food is so unevenly distributed
that malnutrition and hunger exist in the same country or region where
food is abundant.

During 1960s, the United States sold a sizable fraction of its agricultural
exports under a concessionary Public Law 480, where LDC recipients
could pay for the exports in inconvertible currency over a long period.
During late 1970s, about three-quarters of the food aid went to low-income
countries. It was about one-third of their cereal imports. Projections
indicate that food deficits are likely to increase in the 1980s and 1990s. In
the early 1980s, the United States, which provides the bulk of total food
aid, reduced its food assistance.

Critics of food aid argue that it increases dependence, promotes waste,

does not reach the most needy and dampens local food production.
Nevertheless, the food aid has frequently been highly effective. It plays a
vital role in saving human lives during famine or crisis, and if distributed
selectively, reduces malnutrition. Unfortunately, poor transport, storage,
administrative services, distribution networks and overall economic
complex hinder the success of food aid programmes, but the concept itself
is not at fault.

(d) Technical Aid: Technical aid is another form of tied aid and is much
useful for the recipient country to increase the pace of economic
development by using the modern technology or skill in some specific
sectors of the economy. Under this aid programme, training facilities are
provided by the donor country�s government and it bears all the
 expenditures involved in the training of advisory technocrats. Technical
assistance from the donor�s point of view takes two main forms:

(i) Through Recruitment: Technical assistance may be given through

recruitment. Selected people of recipient country are recruited in
the donor country for service overseas, partly, often largely, at the
expense of the donor government.

(ii) Through Scholarships & Training Facilities: The second form of

technical assistance is scholarship and training facilities in donor
country for foreign students (from recipient country).

(e) Foreign Direct Investment (FDI): It is also included in the category of

foreign aid. In Pakistan, the examples of FDI are Lever Brothers, Reckitt
and Colman, Bata, Philips, etc. It is often argued that FDI should be run
under strict control, like licensing, annual auditing, compulsory treatment
of foreign capital as domestic capital, etc.

(f) Double Tied Aid: It is also known as �procurement tied aid�. It is the
aid which is tied both for projects as well as for resources.

Types of Foreign Aid to Pakistan:

The foreign aid received by Pakistan can be categorised as follows:

(a) Project Assistance: The large bulk of foreign aid received by Pakistan
has been in the form of project assistance which is tied in most cases, to
both source and utilisation. Project aid is a type of aid allocated for
particular development ventures like irrigation projects or large industrial
and communication networks which require a substantial imported
component.

Besides the imported component, there is also a local finance component

of a particular project which has to be covered by raising the necessary
resources domestically. Once the domestic component of the project has
been raised, the government has to open a special account for the project
and withdrawals from the account are possible only after the approval of
Aid Mission of the donor countries or agencies.

(b) Commodity Assistance: Commodity assistance, the second largest

component amongst the different types of aid received by Pakistan, has
allowed some degree of flexibility to the country by not being tied to
utilisation although in most cases it is tied to sources. It is for this reason
that Pakistan has preferred commodity over project assistance. However,
commodity assistance as a ratio of total aid decreased from 34% in 1960-
65 to 23% in 1979-80.
 (c) Food Aid under PL 480: The third largest component of aid received by
Pakistan is commodity assistance under PL 480 provided by USA through
the sale of surplus agricultural commodities. These commodities, ranging
from wheat to edible oil, have been purchased by Pakistan Government
from US Government and were paid for Pakistani rupee till 1967 and in
rupee and dollars after 1967. The funds generated by the sale of these
surplus agricultural commodities are then deposited in a special
counterpart fund controlled by US Government through its Aid Mission to
Pakistan. The allocation of these funds, termed as aid, between different
activities has been prerogative of the US Government.

(d) Technical Assistance: This type of foreign aid is of great significance to

Pakistan, because in Pakistan, there is a shortage of technical knowledge,
entrepreneurial skill and skilled labour. This type of foreign aid helps in
increasing the intangible value of our skill and semi-skill labour in
particular projects, for example, construction of sea ports, dams and other
water projects, fly-overs, highways, motorways, underground railway
system, high rise buildings, etc.

However, as these foreign experts are paid much higher salaries than
what a local person of the same qualification can expect to receive, the
real value of technical assistance can be reduced with obvious resentment
amongst local experts.

Need of Foreign Aid:

The principal economic arguments advanced in support of foreign aid are as

follows:

(a) Foreign Exchange Constraints: External finance (both loans and grants)
can play a critical role in supplementing domestic resources in order to
relieve savings or foreign-exchange bottlenecks. This is the familiar
�two-gap� analysis of foreign assistance, which will be briefly discussed
later in this chapter.

(b) Growth and Savings: External assistance also is assumed to facilitate

and accelerate the process of development by generating additional
domestic savings as a result of the higher growth rates that it is presumed
to induce. Eventually, it is hoped, the need for concessional aid will
disappear as local resources become sufficient to give the development
process a self-sustaining character.

(c) Technical Assistance: Financial assistance needs to be supplemented

by �technical assistance� in the form of high-level manpower transfers
to assure that aid funds are most efficiently utilised to generate economic
 growth. This manpower gap filling process is thus analogous to the
financial gap filling process.

(d) Absorptive Capacity: Finally, the amount of aid is determined by the

recipient country�s absorptive capacity. Typically, the donor countries
decide which LDCs are to receive aid, how much, in what form (i.e. loans
or grants, financial or technical assistance), for what purpose and what
conditions on the basis of their assessment of LDCs absorptive capacity.

Criticism on Foreign Aid:

The problem of deficit in balance of payments

By Mohammad Ishaq Javed and Dr. Shaikh Muhammad Ashfaq

The balance of payments (BoP) means a systematic record of all the economic
transactions between residents of a country with the rest of the world during a given
period of time.

It covers exchange of visible (merchandise) and invisible (services) items. The balance of
trade (BoT) covers the exchange of visible items only. Deficit in balance of payments
means that the import bill exceeds the export bill.

Pakistan was caught in vicious deficit balance of payments trap after the pre-plan period.
During pre-plan period (1948-49 to 1954-55), Pakistan's performance in the foreign trade
sector was reasonably good.

Its exports exceeded the imports and formed 114 per cent of total imports. It had surplus
BoT up to 1954-55. The year 1955-56 was the last year in which Pakistan had a
favourable balance of trade.

Since that time, Pakistan has been facing a serious problem of deficit in her BoT and
BoP. The present article is aimed to review the performance of each government in BoP
situation after the separation of the former East Pakistan.

In 1971, Pakistan's exports decreased considerably and its imports surged, especially of
capital goods, thus creating a trade deficit. Workers remittances, especially from the
Middle East countries, increased tremendously which helped a great in stabilizing the
BoP.

The deficit in BoT was $836 million on an average while current account deficit in BoP
was $699 million on an average between 1971-72 and 1977-78 (the tenure of late Mr. Z.
A. Bhutto). The trade deficit as percentage of GNP remained 6.3 per cent while current
account deficit in BoP remained 5.6 per cent on an average during 1971-72 to 1977-78.
The inflow of workers remittance increased 1080 per cent from 1971-72 to 1977-78.The
magnitude of workers' remittances increased from $107 million in 1971-72 to $1156
million in 1977-78.

The BoP position deteriorated during Zia's regime (1978-79 to 1984-85). A deficit in
BoT increased to $2958 million on an average from 1978-79 to 1984-85. Current account
deficit in BoP increased to $993 million on an average during 1978-79 to 1984-85.

The inflow of workers remittances continued increasing, especially from the Middle East,
from 1977-78 to 1982-83 and reached a peak level of $2886 million in 1982-83. This
inflow gradually decreased in the last two years of his regime.

The magnitude of workers' remittances from 1978-79 to 1984-85 was $1849 million on
an average. The trade deficit as percentage of GNP rose to 9.9 per cent while current
account deficit in BoP on an average decreased to 3.7 per cent in this period.

The Table shows that the external BoP gained strength during Junejo's period from 1985-
86 to 1987-88. Exports grew on an average by 33 per cent while imports decreased
during first two years while increased in the last year.

Export remained at a level of $3601 million on an average during this period. Deficit in
the balance of trade decreased to $2631 million and current account deficit in the BoP
decreased to $1211 million on an average during these years.

The trade deficit as percentage of GNP declined to 6.9 per cent while the current account
deficit in balance of payment declined to 3.1 per cent during 1985-86 and 1987-88.

Workers' remittances showed a declining trend from $2595 million in 1985-86 to $2013
million in 1987-88. The magnitude of workers remittances on an average between 1985-
86 and 1987-88 was $2295 million.

The BoP position witnessed a significant improvement during first tenures of both Ms.
Benazir Bhutto (1988-89 to 1990-91) and Mohammad Nawaz Sharif (1991-92 to 1993-
94). The deficit in BoT decreased to $2728 million on an average between 1988-89 to
1990-91 and to $2501million on an average between 1991-92 to 1993-94.

The current account deficit in BoP fell to $1998 million on an average between 1988-89
to 1990-91and to $2333 million on average between 1991-92 and 1993-94. This reveals
that BoP and BoT remained stabilized during the first tenures of both- Benazir and
Nawaz Sharif - (1988-89 to 1993-94).

Trade deficit as a percentage of GDP stabilized on an average around 4.7 per cent during
Benazir's and Nawaz's tenures. The current account BoP as a percentage of GDP on an
average was 4.7 per cent in Benazir's period while 4.6 per cent in Nawaz's period.
Pakistan's external balance of payment deteriorated in the second tenure of Ms. Benazir
(1994-95 to 1996-97). The deficit in BoT and current account deficit in BoP increased to
$3128 million and $3635 million on an average between 1994-95 and 1996-97
respectively.

Trade deficit as a percentage of GDP on an average was 4.7 per cent while deficit in
current account balance of payments increased to 5.8 per cent. There was a sudden
upsurge in the inflow of workers remittances from Kuwait and were $1866 million in
1994-95.

This inflow could not maintain its momentum and was reduced in the following two
years of Benazir's government. The magnitude of inflow of workers remittances from
1994-95 to 1996-97 on an average was $1578 million.

This adverse performance in foreign balance of payment was due to the weak
macroeconomic management and lack of commitments to undertake difficult structural
reforms.

The overall balance of payment position during the second tenure of Nawaz Sharif (1997-
98 to 1999-00) witnessed a significant improvement despite the adverse external
environment.

Both current account deficit in BoP and BoT decreased in this period. The deficit in the
balance of trade decreased to $1788 million while current account in the BoP decreased
to $1833 million during 1997-98 and 1999-00 despite the sanctions imposed by the G-8
countries on bilateral and multilateral lending as a consequence of Pakistan's nuclear tests
in May 1998.

The deficit in the balance of trade as a percentage of GDP and current account deficit in
balance of payments as a percentage of GDP also showed the same trend.

The deficit in the balance of trade as percentage of GDP on an average declined to 2.5 per
cent while current account deficit in balance of payments declined to 2.9 per cent on an
average during 1997-98 and 1999-00. Workers' remittances exhibited a declining trend
during these years. The magnitude of workers remittance on an average was $1178
million.

The economy started showing signs of improvement with the start of Musharaf's regime.
His government launched a comprehensive set of economic stabilization and structural
reform measures.

Pakistan's exports increased from $7.8 billion in 1999-00 to $9.2 billion in FY00-01. The
deficit in BoT decreased to $1269 million while current account BoP decreased to $513
million in FY00-01.
The real improvement in BoP started after the event of September 11, FY01. The post-
September 11 events helped a great deal in ameliorating Pakistan's chronic external
deficit in balance of payments.

Significant reduction in the trade deficit, more than doubling of foreign remittances, and
budgetary support from coalition partners in the war against terror enabled Pakistan to
run a current account surplus for the first time since 1956-57.

There was a sharp decline in trade deficit in FY01-02. The trade deficit fell by 75.5 per
cent to $286 million over the level of $ 1338 million of FY00-01. The current account
deficit in balance of payment emerged with a surplus of $913 million in FY01-02.

The current account BoP remained in surplus from FY01-02 to FY03-04.The magnitude
of surplus in current account BoP for FY01-02 was $1338 million, for FY02-03 $ 3165
million and for FY03-04 (July-March FY03-04) was $1369 million.

The conclusion drawn from the analysis of the BoT and BoP behaviour during different
governments between 1971-74 and FY03-04 envisaged that BoT and BoP improved
during the governments of Bhutto and Junejo (1971-72 to 1977-78 and 1985-86-1987-88)
while BoT and BoP deteriorated during Zia's regime (1978-79 to 1984-85.

The BoT and current account BoP stabilized during the first tenure of both Benazir and
Nawaz Sharif while deteriorated in her second tenure while BoT and BoP stabilized in
Nawaz Sharif's second period.

The performance of Benazir in first tenure was better than in her second era despite the
workers remittances from abroad increased considerably during her second tenure.
Performance of Musharaf's government is much better than the previous governments
either military or democratic since 1971-72.

Causes: * Pakistan's balance of payments is highly dependent on workers remittances but

these remittances cannot be sustained over a long period of time. Workers' remittances
increased after 1971-72.

There was a sudden upsurge in the workers remittances in late seventies and early
eighties. They grew up from $107 million in 1971-72 to a peak level of $2989 million in
1982-83 and exceeded the total merchandise export of $2627 million.

However, these inflows began tapering off since 1982-83, excluding inflows from
Kuwait in 1994-95. This year workers remittances were $ 1866 million. After 1994-95,
workers remittances depicted a declining trend.

In 1999-00 workers remittances were reduced to $ 983 million. After the event of
September 11, FY01 workers remittances increased tremendously especially from USA,
UK and other European countries and reached to $4237 million in FY02-03. The
remittances could not maintain their momentum in FY03-04 and decreased to $3.6
billion.

* One major structural problem of exports is that it is based on relatively low value added
products. Pakistan's exports are highly concentrated in cotton group, leather group, rice,
synthetic textiles and sports goods.

These five categories of exports accounted for 82.6 per cent of the total exports during
2002-03. Among these five categories cotton group alone contributed around 63.3 per
cent of total exports, followed by leather (6.2 per cent) and synthetic textiles (5.1 per
cent) and rice (5.0 per cent). Such a high degree of concentration of exports in few items
has led to instability in export earnings.

* Although Pakistan is trading with large number of countries but her exports are highly
concentrated in few countries. More than half of Pakistan's exports are concentrated in
USA, Germany, Japan, UK, Hong Kong, Dubai and Saudi Arabia. Such a high degree of
geographic concentration of exports is dangerous as it renders the economy vulnerable to
the manipulation of the importing countries.

* Imports are concentrated on a limited number of commodities namely machinery,

petroleum & petroleum products, chemicals, transport equipments, edible oil, iron and
steel, fertiliser and tea.

These eight categories of imports accounted for 75.5 per cent of total imports during
FY03-04 while machinery, petroleum and its products and chemicals accounted for 58.7
per cent of total imports in the same year.

* Agriculture-related exports constitute a high ratio of the total exports. In FY02-03, 73

per cent of export earnings came from the export of cotton and cotton products, leather
and rice.

Such a high degree of dependency on agriculture-related products is an element of

uncertainty in export earnings. Agriculture in Pakistan is still a gamble in rainy season. A
poor crop of cotton would seriously affect balance of trade. Terms of trade are declining
against agriculture-based exports.

Terms of trade with base year 1990-91 have showed a declining trend except few years. It
was as low as 90.9 in 1991-92 but improved in 1997-98 when it reached a level of 123.5.
Thereafter it continued to decline and was recorded at 79.5 in FY03-04.

The unit value index for all exports increased from 100 in 1990-91 to 276 in FY03-04
while the unit value index for all imports increased from 100 to 347.3. This increase in
the unit price index of all import goods especially palm oil, chemicals and iron & steel
had adverse impact on Pakistan's terms of trade.
* Although Pakistan is trading with a large number of countries, yet major portion of
imports comes from a few selected countries. Almost 50 per cent of imports come from
USA, Japan, Kuwait, Saudi Arabia, Germany, the UK and Malaysia. Such a high degree
of geographic concentration of imports is undesirable and is in favour of exporting
countries.

Balance of Payments of Pakistan (1971-72 to 2003-04)

(Million US $)
As a
percentage
of
GNP*/DGP
Years exports Imports Trade Workers Current Trade Current
(F.O.P) (F.O.P) Balance Remittance A/c Balance A/C Bal
Balance
of
payment
1971-
619 946 - 327 107 - 443 - 2.8* - 3.8*
72
1972-
707 891 - 184 124 - 130 - 3.0* - 2.0*
73
1973-
1020 1493 - 473 138 - 549 - 5.3* - 6.1*
74
1974-
978 2114 - 1136 212 - 1168 - 10* - 10.3*
75
1975-
1162 2139 - 977 339 - 949 - 7.2* - 7.*
76
1976-
1132 2418 - 1286 578 - 1051 - 8.2* - 6.7*
77
1977-
1283 2751 - 1469 1156 - 605 - 7.7* - 3.1*
78
1978-
1644 3816 - 2172 1397 - 1114 - 10.3* - 5.3*
79
1979-
2341 4854 - 2513 1748 - 1140 - 9.9* - 4.5*
80
1980-
2798 5563 - 2765 2097 - 991 - 9.0* - 3.2*
81
1981-
2318 5641 - 3373 2225 - 1530 - 10.3* - 4.7*
82
1982-
2627 5616 - 2979 2886 - 554 - 9.5* - 1.8*
83
1983-
2663 6002 - 3334 2737 - 1028 - 10* - 3.1*
84
1984- 2700 6263 - 3563 2750 - 1593 - 10.6* - 3.5*
85
1985-
2942 5984 - 3042 2595 - 1234 - 8.3* - 3.4*
86
1986-
3498 5792 - 2294 2278 - 719 - 6.1* - 1.9*
87
1987-
4362 6919 - 2557 2013 - 1682 - 6.3* - 4.0*
88
1988-
4634 7207 - 2573 1897 - 1934 - 5.9 - 4.8
89
1989-
4634 7411 2483 1942 - 1891 - 4.9 - 4.7
90
1991-
6131 7619 - 3128 1848 - 2171 - 3.3 - 4.8
92
1992-
6762 8998 - 2236 1468 - 1346 - 4.8 - 2.8
93
1993-
6685 8685 - 2000 1446 - 1965 - 3.4 - 3.8
94
1994-
7759 10296 - 2537 1866 - 2484 - 3.7 - 4.1
95
1995-
8311 12015 - 3704 1461 - 4575 - 4.9 - 7.2
96
1996-
8096 11241 - 3145 1409 - 3846 - 5.7 - 6.2
97
1997-
8434 10301 - 1867 1490 - 1921 - 2.4 - 3.1
98
1998-
7528 9613 - 2085 1060 - 2429 - 2.8 - 4.1
99
1999-
8190 9602 - 1412 983 - 1143 - 2.4 - 1.6
00
2000-
8933 10202 - 1269 1087 - 513 - 2.1 - 0.7
01
2001-
9140 9434 - 294 2389 - 1338 - 1.7 + 1.9
02
2002-
10889 11333 - 444 4237 3165 - 1.3 + 3.8
03
2003-
9175 993283 - 757 2875 1369
04