Spike in foreign aid when the economy is no longer aid-dependent: Its implications – Kazi Golam Tashfique

Published in The Financial Express on Friday 22 March 2019

Remember Zambia, one of the wealthiest countries of Sub-Saharan Africa until mid-1970s? The structural similarity between Bangladesh in the 21st century and Zambia in the mid-1970s concerns me a lot. Just like Zambia in the mid-1970s, Bangladesh is also currently passing through a phase of sound economic growth but lacking diversity in its export basket. The economy is moving towards a dualistic nature reliant on rapid urbanisation and a very traditional agriculture sector. While the ready-made garments (RMG) sector’s rise occupies the centre stage, the economy’s overwhelming dependence on this sector makes it vulnerable to external shocks. While existing government support to the agricultural sector is contributing towards innovation of high yield varieties, negligence to technological upgradation of agriculture is often pushing the actors of the sector towards informal economy.

THE STORY OF ZAMBIA

Zambia is a classic case that depicts how excessive foreign aid persuasion and misreading of the market signals can lead an economy towards a vicious cycle of macroeconomic instability. Zambia experienced moderate economic growth since its independence in 1964. Like Bangladesh (which is highly dependent on its RMG exports), Zambia, too, was highly dependent on export earnings from one item — copper, for national incomes, employment and foreign exchange earnings. However, the economy of Zambia suffered its first major setback when the oil crisis erupted in October 1973 (due to oil embargo proclaimed by the members of the Organisation of the Petroleum Exporting Countries or OPEC targeted at nations perceived as supporting Israel during the Yom Kippur War), and the subsequent economic recession in the industrialised countries depressed its copper prices drastically. In spite of the deteriorating copper industry, it remained the mainstay of the Zambian economy. Assuming the declining copper prices a temporary breakdown, the government borrowed extensively from international financial markets avoiding serious adjustment measures, which resulted in a substantial stockpiling of debt in Zambia since 1975. This eventually disturbed the macroeconomic stability and created inflationary pressures. Later, political events like elections further deteriorated the external balance of the economy, and debt sustainability became a major concern for the government.

BANGLADESH SCENARIO

Many around me sound quite content when we discuss the undertaking of mega projects by the government of Bangladesh for infrastructural development. It is clearly perceptible that the sheer visibility of such development will create a sense of euphoria amongst the mass population who are not aware of the story behind financing these mega projects. But when I see that the recent undertaking of numerous mega projects coincides with the sudden surge in foreign aid account of Bangladesh, it creates a sense of disquiet in my mind. Although it was apprehended that the inflow of foreign aid may decline after Bangladesh’s graduation to lower middle-income country (LMIC) category, the country experienced a significant rise in its foreign aid. In FY2017-18, net foreign aid (foreign aid after excluding the debt repayment) increased to USD 5.0 billion from USD 2.6 billion in FY2016-17 — the highest both in terms of volume and growth over the last 10 years. This sudden surge of foreign aid was actually driven by unusually high volume of project aid. The payment against external debt also exhibits a slight rise in the last fiscal year. Moreover, since FY2008-09, loan component has become more dominant compared to grants. Loan-to-grant ratio increased from 1.8 in FY2008-09 to 15.5 in FY2016-17, thanks to the substantial disbursements by loan providing countries.  On the flipside, both in terms of commitment as well as disbursement, the share of loan element in total aid is as high as 98.7 per cent for the large loan providers (especially China, Russia and India). There remains a considerable concern regarding the debt sustainability of the economy associated with the welcoming of such high volume of foreign aid. Outstanding debt is expected to rise at an alarming rate. Since FY2000-01, outstanding debt almost doubled. The external debt-GDP ratio is still at a comfortable position, but this may change drastically if Bangladesh cannot utilise the foreign aids in pipeline, a substantial amount of which is now subject to harder terms.

TACKLING HARDER TERMS OF FOREIGN AID

Major development partners have started to readjust their terms and conditions by either increasing the interest rate, or by shortening the maturity and grace period in view of Bangladesh’s recent elevation to higher income status. The World Bank has already increased its interest rate to 2.0 per cent from the previously applied interest rate of 0.75 per cent (in addition to 0.25 per cent commitment fee and 0.25 per cent front-end fee), while JICA (Japan International Cooperation Agency) increased its interest rate to 1.0 per cent from 0.014 per cent. Similar situation applies for the country’s second largest multi-lateral development partner — the Asian Development Bank (ADB). Development partners have also reduced maturity periods.

It is likely that in the coming days more and more loan offers will be available for Bangladesh, but only with harder terms. The loan packages in recent times are also criticised for lack of transparency which makes it difficult to assess the associated costs and benefits for the recipient country. Although Bangladesh has gradually transformed itself from an aid-dependent to a trade-dependent economy, the transformation may well reverse if policymakers undermine the downsides of foreign aid with stringent conditionality and higher costs. Foreign aid with unmanageable loan component will not only fail to serve its development purpose but also worsen the debt situation of the economy. Experiences of several developing countries like Sri Lanka, Zambia, Tanzania and Pakistan warn that pursuing excessive foreign aid associated with higher (hard term) loan elements without considering the reforms to address the underlying risks, may shove an economy towards the vicious cycle of macroeconomic instability.

 

Kazi Golam Tashfique is a Research Associate at the Centre for Policy Dialogue (CPD). The views expressed are the author’s own. tashfique@cpd.org.bd.