3. Definition of foreign aid
4. Historical background of foreign aid
5. Foreign aid to Bangladesh
6. Motives of foreign aid
a. The recipient perspectives
b. The donor perspective
7. Foreign aid and development
b. Aid and trade
d. Debt entrapment
The effectiveness of foreign aids to the third world developing countries is a debatable issue. Liberal economists argue that aids both in the form of grants and loans can play vital role to the development of any country, if it is channeled through proper biding and use effectively to the development projects. In contrary of that, aid causes debt entrapment, dependency, domination etc. to the third world country like Bangaladesh. Jeffrey Sachs, Joseph Stiglitz, Nicholas Stern have argued that although aid has sometime failed, it has supported poverty reduction and growth in some countries, but critics such as Milton Friedman, Peter Bauer, William easterly have argued that aid has enlarged government bureaucracies, perpetuated bad governments, enriched the elite in the poor country or just been wasted, (Redelet Stefen, 2006).
Bangladesh, located in South Asia, is one of the poorest countries in the world. According to the UNDP’s 2010 Country Summary report, the country has a large population 164.7 million and having GDP per Capita is $ 1300. External debt is $ 316.7 per $ 1000 GDP. Because of its precarious economic conditions, various donor countries and agencies have provided the country with substantial amounts of public foreign assistance since its independence in 1971. In some peak years, it received a sum of $1,611 million in foreign aid, which constitutes about $14 per capita and about 7% of its GDP (Islam, 1992). More importantly, foreign aid constituted an extremely high proportion (about 90%) of the country’s development budget in some peak years, (Islam, 1992).
Bangladesh depends on foreign aid to fill the gap of budget deficit, to meet the substantially widening balance of payment deficit for international trade, and to fund the Annual Development Program (ADP),’ says Dr. M M Akash, professor of economics at Dhaka University. Usually the country receives foreign assistance under three broad categories – food aid, commodity aid, and projects aid. (Yousuf Sadek Ahmed and Alamgir Mohiuddin, 2009).
The Padma Bridge project at Mawa-Jajira point was to be co-financed by the World Bank, the Asian Development Bank, the Islamic Development Bank and Japan International Cooperation Agency (Jica). The government signed agreements with the WB for $1.2 billion loan, ADB for $615 million, Jica for $415 million and IDB for $140 million. Foreign aid in Bangladesh especially foreign aid to Padma Bridge and its impact on development or underdevelopment are discussed in the below.
After withdrawing the request to World Bank, Bangladesh government doesn’t accept proposal of Malaysia and China. Government wants to build Padma Bridge with its own funding. National board of revenue (NBR) fixed a surcharge on taxpayers but later that has been cancelled. Recently, Finance minister has declared, funding will be managed by sovereign bonding; they have targeted two years for collection of the fund and also targeted to collect $1billion within April to June. Bondholders will get 5.5% interest rate of their investment after 15 years.
Definition of foreign Aid:
The standard definition of foreign aid comes from the Development Assistance Committee (DAC) of the Organization for Economic Cooperation and Development (OECD), which defines foreign aid (or the equivalent term, foreign assistance) as financial flows, technical assistance, and commodities that are (1) designed to promote economic development and welfare as their main objective (thus excluding aid for military or other non-development purposes); and (2) are provided as either grants or subsidized loans, (Redelet Stefen, 2006).
According to Rahman Mahfuzur S M (2006), Foreign Aid is any capital inflow or other assistance given to a country which would not generally have been provided by natural market forces. In Bangladesh, foreign aid serves to bridge the gap between savings and investments and make up the deficits in the balance of payments. Foreign aid is a major means of financing the country's economic development. Economic literature generally classifies foreign aid into four main types. Firstly, the long-term loans usually repayable by the recipient country in foreign currency over ten or twenty years. Secondly, the soft loans repayable in local currency or in foreign currency but over a much longer period and with very low interest rates. The softest are the straight grants often given to the less developed countries. Sale of surplus products to a country in return for payment in the country's local currency, e.g., food aid from the USA under PL-480, is the third type and finally, the technical assistance given to the developing countries comprises the fourth type of foreign aid.
The Bangladesh Aid Group, an international consortium of donors, comprising of 14 affluent nations and 12 international development agencies, meet every year to review development in the economy of Bangladesh, and as such, aside from prescribing courses of action for the economy, also takes decision on the amount of aid. Members of the Aid Group include Australia, Belgium, Canada, Denmark, France, Finland, Germany, Italy, Japan, Netherlands, Norway, Sweden, Switzerland, UK, USA, International Development Association (IDA), Asian Development Bank (ADB), European Union EU, International Fund for Agricultural Development (IFAD), UN agencies, the Ford Foundation and Asia Foundation. (Yousuf Sadek Ahmed and Alamgir Mohiuddin, 2009).
Historical Background of foreign aid:
The international flow of capital involving borrowing and lending across political borders is a relatively modern phenomenon. The bulk of the international flows of fund during 1870-1913 comprised private flows across only developed countries and the long-term debt of these countries in 1920 was estimated at only $100 million. The aid industry, as it is termed today, was actually founded with the establishment of the International Bank for Reconstruction and Development (IBRD) and the International Monetary Fund in 1945, institutionalizing official flows of capital from developed to developing countries. IBRD, however, had the initial mandate to facilitate private investment in Europe and in developing countries. The first IBRD loans on concessional terms for specific development projects in the Third World were made to three Latin American countries in 1948 and 1949.
In the imperial days of Britain, the dependency was to meet the costs of government and of development out of local revenue. If a dependency was ever given any grant-in-aid, the British treasury took control of its finances. In this way the imperial government suppressed the development needs of its dependencies, one of which was undivided India. After World War I, when the movement for independence was intensified in the major colonies, the British rulers enacted the Colonial Development Act of 1929 to provide external help through regular funding of development activities in the colonial territories for mutual benefit. Such direct assistance to dependent territories was reserved until 1950, but India and therefore, Bengal, never came under the operation of the Act. Neither was it benefited by the Colonial Development and Welfare Act of 1940.
The United States started a program of bilateral aid in 1948 to provide support for the reconstruction of Europe and parts of Asia. The largest of these programs was the Marshall Plan spawned by the Economic Co-operation Act 1948 and administered by the Economic Co-operation Administration (ECA). The ECA was replaced in 1950 by the Act for International Development, which translated President Truman's Point IV proposal into the creation of the Technical Co-operation Administration to aid the efforts of the peoples of economically underdeveloped areas. Between 1951 and 1958, several changes have been made in the US aid policy and in 1954, the focus had shifted to India, Pakistan and some countries of the Near East. Nearly $300 million was authorized under the new Development Assistance title to provide aid to these countries. At present, the US is the largest single aid donor and the USAID (United States Agency for International Development) is the implementing agency of its foreign aid programs throughout the world. The Organization for Economic Co-operation and Development (OECD) established in 1960 is a major provider of foreign aid and capital to developing countries. Worth mentioning among the active multilateral providers of foreign aid are the IDA, ADB, EC, IFAD, NDF, UNICEF, and UN System. (Rahman Mahfuzur S M, 2006).
Foreign Aid to Bangladesh:
Foreign aid is essentially economic aid and is provided on a governmental basis. In Bangladesh the standard practice is to treat only the loans received on concessional terms and grants as foreign aid. Excluded from the category are fund transfers in the form of military assistance, aid provided by foreign private agencies, suppliers credit, export credit, foreign portfolio investment, foreign direct investment and hard-term borrowing with an interest rate of 5% and above and a repayment period of less than twelve years. The donors of foreign aid to Bangladesh include individual countries, multinational financial institutions and international agencies and organizations. Foreign aid to Bangladesh is classified on the basis of terms and conditions, source, and use. Accordingly, the various types foreign aid are loans and grants, or bilateral aid and multilateral aid, or food aid, commodity aid, project aid and technical assistance.
Table: Food, Commodity and Project aid to Bangladesh from 1971 to 2006.
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Source: ERD, Ministry of Finance, 2007.
Food aid is the supply of food from the donor countries and organizations or payment to suppliers of food to Bangladesh by them. Donor payments of costs associated with food supply such as transport, storage, distribution, etc. are also considered as food aid. Likewise, commodity aid represents donor funding of the acquisition of commodities including consumer items, intermediate inputs and industrial raw materials. Projects or activities implemented with the help of that fund also fall under food or commodity aid programs. Major commodities imported into Bangladesh under commodity aid programs are edible oil, seeds, fertilizers and chemicals. Project aid is the provision of grants and loans for the financing of project costs. It also finances the import of equipment and commodities related to projects. In Bangladesh project aid relates to a large extent to the financing of projects included in the Annual Development Program (ADP). Technical Assistance, often seen as a part of project aid refers generally to foreign aid for the improvement of the institutional capacity, transfer of technology, import of expertise (foreign consultants and technicians), and development of human resources by providing training facilities, including foreign fellowships. (Rahman Mahfuzur S M, 2006).
Motives of foreign Aid:
Motives for aid can be discussed from two perspectives: Donor motives and the Recipient motives. That are discussed in the below.
The Recipient Perspectives:
There could be a number of motives at work here, some being economic reasons and others being noneconomic reasons. Firstly, foreign aid may be desired to promote economic growth of a country. To achieve this lofty goal, the country needs to mobilize sufficient domestic savings to achieve a target rate of growth. However, Bangladesh faces serious deficiency in this respect. This deficiency is known as the domestic savings gap, which is measured by the difference between domestic savings ratio and the domestic investment ratio. For Bangladesh, this gap has remained quite high over the years (Islam, 1999). Note that the savings ratio has remained quite low since independence. As a result, it is argued that foreign resources may complement this acute savings gap.
Secondly, another major resource gap is the foreign exchange gap also known as the trade gap, which can be measured by the difference between the import ratio and the export ratio. The import ratio remained consistently at a much higher level than the export ratio for all the years since 1972 (Islam, 1999). It is argued that foreign resources can complement this resource gap as well.