MY POINT OF VIEW

Even understanding the basic principles of economics may not even be enough to explain why flooding a country with foreign currency could rather suffocate the country’s economy rather than bolstering it as it is the popular belief.

One of the crudest accusations against the western rich nations today when it comes to fulfilling the Millennium Development Goals (which is aimed at halving poverty by 2015), is that none of them is keeping to the promise of doubling their foreign Aid to the concerned countries.

But ironically, it is mostly the civil society that complains about these failed promises, because on the corridors of government institutions of the concerned countries, and specifically the ministries of finance and economy, the story and atmosphere is always different, especially if their economist are doing their job. Many are to an extent, quite contented with the rich nations keeping their currencies away from their very often volatile economies.

I will tell you why. Since most of the foreign Aid is often in the form of private capital inflows, it turns out, that though the long run effect may be positive; the short run shocks can some times be devastating to the recipient country. For example whennet private capital inflows to developing countries increased from about US$50 billion a year during 1987-89 to more than US$230 billion a year during 1997-2003, it was evident that most of the recipient countries became net importers and realized large trade deficits.

The dilemma here is associated with the conflicting needs of supporting export competiveness whilst appealing to private capital that pose a challenge for exchange rate management. To put this in a nicer way for you, an influx of private capital inflow will provide the often needed capital for imports. In other words, imports will become more attractive and cheap. People will turn to spend more on imports and as a result, pose major challenges to the home producers in the same sector.

So the question I will be answering in the next posting will be: how good is foreign Aid, and how much is “good”.