FOREIGN AID AND

PAKISTAN ECONOMY

PREPARED BY:

SADIQ ABBAS

MALIK ALI

HADI HASSAN MUKHI

 The Role of Foreign Aid in the Pakistan Economy

INTRODUCTION

The misery of Under Developed Countries like Pakistan, which have the resources to
become a prosperous country, however, have not fully achieved their potential, is mainly
associated with the problem of poverty. Because of low incomes, the saving ratios also
remain low, resulting in low investment levels. At the same time, due to low income the
taxable capacity remains lower, i.e. government earnings also remain low. Due to low levels
of investment along with the low income on the part of the government the country faces
saving-investment deficit as well as the deficit in balance of payments.

The theory of Two Gap Model suggests that the economic development policy focuses on
two constraints: the need for savings to finance investment, and the need for foreign
exchange to finance imports”. The Two-Gap Model suggests that developing countries have
to rely on the Foreign Inflows to fill these two gaps. The Foreign Inflows are available in
various manifestations to a country, which includes the grants, loans, foreign direct
investment (FDI), export credit, project/non-project assistance, technical assistance and
emergency relief etc.

Moreover, the nature of the FI available to a country also depends upon various factors
however mainly on the size of the country its economic circumstances. African nations rely
mainly on the foreign aid however countries in East Asia enjoy the benefit of foreign direct
investments owing to their investor friendly policies and the availability of infrastructure in
the form of land and human resource. In case of Pakistan the foreign aid is mainly in the
form of foreign aid because it lacks physical, financial & human capital as well as political &
macroeconomic stability, which are the main attraction for foreign direct investments.

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PURPOSE OF THE STUDY

As mentioned in the captioned subject, our purpose of the study is to assess the role of
foreign aid in the economy of Pakistan. In this regard we would explore

a) Sources of the Foreign Inflows available,

b) The Role of Donor Agencies ,
c) Assessing the impact of Foreign Aid,
d) Trends and Composition of Aid; and
e) Conclusion

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SOURCES OF FOREIGN INFLOWS

There are many forms of the FCIs, which includes the grants, loans, foreign direct
investment (FDI), export credit, project/non-project assistance, technical assistance and
emergency relief etc. The objectives behind these inflows vary from political to humanitarian
grounds however, following objectives could be broadly categorized:

a) As a signal of diplomatic approval, or to strengthen a military ally, to reward a

government for behavior desired by the donor, to extend the donor's cultural influence, to
provide infrastructure needed by the donor for resource extraction from the recipient
country, or to gain other kinds of commercial access.

b) Humanitarianism and altruism are, nevertheless, significant motivations for the giving of
aid.

c) Aid may be given by individuals, private organizations, or governments. Standards

delimiting exactly the kinds of transfers that count as aid vary. For example, aid figures
may or may not include transfers for military use: to cite one instance, the United States
included military assistance in its aid figure until 1957 but no longer does.

We can categorize foreign inflows under following main categories, namely:

 Grants
 Foreign Direct Investments
 Loans and credits

Foreign Grants:

Grants, otherwise known as international aid, overseas aid, or foreign aid, are a voluntary
transfer of resources from one country to another. These grants could be in the form of
project assistance, commodity assistance, technical assistance or other assistance such as
relief aid and foreign aid.

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Foreign Direct Investment:

Foreign direct investment (FDI) refers to long term participation by country into another
country. It usually involves participation in management, joint-venture, transfer of technology
and expertise. There are two types of FDI: inward foreign direct investment and outward
foreign direct investment, resulting in a net FDI inflow (positive or negative).

Loans and Credits:

External loan (or foreign debt) is that part of the total debt in a country that is owed to
creditors outside the country. We can categorize the sources of these loans as official
creditors such as World Bank, Asian Development Bank and Industrial Development Bank
and bilateral loans by governments and their agencies.

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ROLES OF MALOR DONOR AGENCIES

There are three leading multilateral agencies viz. IMF, World Bank and the ADB that provide
loans and credit on soft and hard terms. The core function of IMF is to provide support to
countries facing acute imbalances between their external payments and receipts. The World
Bank or the ADB, unlike the IMF, are development banks dedicated purely for poverty
reduction and improving the living standards of people. Nevertheless, all the three
institutions pursue a common objective of promoting economic growth and reduce
unemployment.

For Pakistan all the three agencies have contributed significantly in providing assistance and
almost 50 percent of our external debt is owed to these to these institutions.

International Monetary Fund (IMF):

The IMF was established in 1945 to promote international monetary co-operation, facilitate
the expansion and balanced growth in international trade, promote exchange rate stability
and orderly exchange arrangements among members, assist in the establishment of a
multilateral system of payments in respect of current transactions, give confidence to
members by making the general resources of the Fund temporarily available to them under
adequate safeguards, etc. The Fund provides financial resources to its members to
overcome temporary balance of payments difficulties through a variety of facilities and
policies, which differ mainly in the type of BOP need they address and in the degree of
conditionality attached to them.

IMF Loans to Pakistan

IMF loans have been an important source to manage the financial problems of Pakistan
such as balance of payment deficits, stabilization of currency, rebuilding international
reserves, managing liquidity problems along with enabling the respective countries to meet
their short term needs by providing various types of loans which IMF calls as its lending
„facility‟. In the last few months, there was a lot of speculation and discussion on the
government decision to call for IMF loan to meet its liquidity and financial problems. In spite
of effective policy actions taken by State Bank of Pakistan, issues such as sharp
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depreciation of exchange rate, depletion of foreign exchange reserves of $5 billion till
November 2008, inflation rate of more than 25%, and increase in import bill by 35.2%
created immense challenges for the government and State Bank of Pakistan. Finally, the
IMF loan of $7.6 billion was approved to help Pakistan come out of the liquidity and financial
crisis albeit with certain IMF conditions. The IMF facility is still an important topic of
discussion until the real gains from IMF loans are realized.

To determine the effects of IMF loans on Pakistani economy, it is important to analyze the
history of IMF loans to Pakistan briefly. Since 1988 when Pakistan became member of IMF,
almost eleven loan arrangements (including the recent IMF loan of $7.6 billion in 2008) have
taken place under various IMF facilities/programs. Almost six loan arrangements were made
during the regime of Benazir Bhutto including standby arrangement, Structural Adjustment
Programs (SAP), Poverty reduction and Growth Facility (PRGF) and Extended SAP. Two
IMF loan arrangements were made during Nawaz Sharif regime and two standby agreement
and PRGF under Musharraf regime to stabilize the economy. It is important to note that in
the tenure of last two decades, on average almost 44% of the total lending amount has been
drawn from the original 100% agreed upon lending amount because of the failure of the
government to act upon the strict measures determined by IMF. For the first time in the year
2000, this tradition was broken in Musharraf regime when Musharraf‟s government
successfully implemented the conditions proposed by IMF and successfully drew the whole
lending amount of $1.3 billion. It is also very interesting to note that only two loan
arrangements were made during the military regime whereas nine IMF agreements
(including the recent IMF loan) were made during the civilian regime.

The conditions posed by IMF mostly include the close monitoring, reduction of government
spending, revision in tax collection policies, change in policy/discount rate etc. to make sure
that funds granted to the borrower country are utilized in optimal manner. The IMF loans
greatly impact the economic indicators and bring change in the regulatory framework which
has both positive and negative impacts on the country. Pakistan saw a decline in GDP
growth rate and other economic indicators right after infusion of IMF funds in the economy
except in the second last lending arrangement in Musharraf‟s regime when full amount of
loan was drawn from IMF. The economic indicators after IMF loans in the last two decades
followed a typical cycle. Usually the trend after IMF loans show immediate decline in GDP
growth rate, increased tax revenues to GDP ratio, increased CPI, increased debt on the

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country and then restoration of the conditions back to their previous states because of the
cancellation of loans in the later years. The cancellation of IMF loan agreements in the
previous regimes along with the initial IMF loan effects created quite negative impacts on
the economy as a whole which shows that there were very few times when IMF loans were
fully optimized.

The current IMF loan is expected to have both positive and negative impacts. The
immediate benefits include quick influx of liquidity, improvement in credit rating by reducing
the country‟s default risk, enhancement of foreign exchange reserves, stabilization of rupee
(which faced 25% depreciation against U.S. dollar till November), increased investor‟s
confidence in both money and capital markets and increased financial assistance from the
friends of Pakistan. However the negative impacts associated with the increase in policy
rate include increased costs for the banks, increase in unemployment (because many banks
and organizations will go for restructuring and downsizing to reduce their operating costs)
and increase in poverty rate.

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International Bank for Reconstruction & Development (IBRD):

The International Bank for Reconstruction and Development (IBRD), better known as the
World Bank, was established in 1944 to help Europe recover from the devastation of World
War II. The success of that enterprise led the Bank, within a few years, to turn its attention to
the developing countries. By the 1950s, it became clear that the poorest developing
countries needed softer terms than those that could be offered by the Bank, so they could
afford to borrow the capital they needed to grow.

With the United States taking the initiative, a group of the Bank‟s member countries decided
to set up an agency that could lend to the poorest countries on the most favorable terms
possible. They called the agency the "International Development Association." Its founders
saw IDA as a way for the "haves" of the world to help the "have-nots." But they also wanted
IDA to be run with the discipline of a bank. For this reason, US President Dwight D.
Eisenhower proposed, and other countries agreed, that IDA should be part of the World
Bank

The World Bank’s Role in Pakistan:

The World Bank has played an important and essential role in the development process of
Pakistan particularly in modifying the structure of the economy to restore growth through the
structural adjustment-lending program introduced in 1980.
The Bank Group‟s assistance strategy focuses intently on supporting the government‟s
development strategy and is organized around three mutually reinforcing pillars which are:
Strengthening Macroeconomic Stability and Government Effectiveness, Strengthening and
Enabling the Investment Climate and Supporting Pro-poor and Pro-gender Equity Policies.
The Bank has contributed to alleviate poverty, mitigate the social effects of economic
adjustment programs, and provides the poor greater access to health care, education and
physical infrastructure, environmentally sustainable development and to improve conditions
of women in Pakistan.
The government of Pakistan has shown a strong commitment to reducing poverty and is
receiving support from the World Bank through around US$ 1.2 billion in financing for 18
active projects and, over the past five years, an additional US$ 1.5 billion in adjustment
lending to strengthen the government's broader reform programs.
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The Country Assistance Strategy (CAS), endorsed by the Bank in 2002, was designed to
support Pakistan‟s reform program, which aimed at engendering growth, reforming
governance, creating income-generating opportunities, and improving human development.
The World Bank is the main financer of Pakistan‟s Poverty Alleviation Fund, which provides
assistance to poor communities throughout the country. The Fund has been working with
nearly 40 local organizations and has extended micro-credit loans to more than 275
thousand borrowers, of which 45 percent are women.
Recently, Pakistan has sought additional soft-term loan facility from the World Bank for its
infrastructure development and poverty alleviation efforts through a long-term development
partnership to transform the country and facilitate second generation reforms.

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Asian Development Bank (ADB):

The ADB, functioning since December, 1966, has been engaged in promoting the economic
and social progress of its developing member countries in the Asia-Pacific region. The
Bank‟s principal functions are: (i) to make loans and equity investments for the economic
and social advancement of developing member countries, (ii) provide technical assistance
for the preparation and execution of development projects and advisory services, (iii)
promote investment of public and private capital for development purposes, and (iv) respond
to requests for assistance in coordinating development policies and plans of member
countries. The Bank‟s operations cover the entire spectrum of economic development, with
particular emphasis on agriculture, energy, capital market development, transport &
communications and social infrastructure.

ADBs Role in Pakistan:

Pakistan has received more than $20 billion in loans since joining ADB in 1966, with more
than $15 billion disbursed as of 31 December 2009. A total of 288 loans were provided
through the highly concessional Asian Development Fund window and the Ordinary Capital
Resources window, with $188 million provided in grants for more than 300 technical
assistance (TA) projects.

ADB continued with its large lending program to Pakistan in 2009 with $1.10 billion
disbursement and $942.7 million in newly approved assistance. As of 31 December 2009,
the portfolio contained 42 active loans amounting to $4.36 billion, 37 ongoing loans of $3.97
billion, and 3 grants totaling $180 million, with bulk of these supporting development
initiatives in energy, social sectors, governance, and transport in the four provinces and at
the national level.

ADB is working with the government and the private sector to improve the country‟s
infrastructure, energy security, and basic public services. Aligned with national development
objectives, ADB‟s partnership priorities aim to attract investment, create industries and jobs,
and improve the quality of life of citizens.

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A new Country Partnership Strategy (CPS) for Pakistan, approved by ADB‟s Board of
Directors in March 2009, aims to support Pakistan‟s strategic objectives of prosperity and
poverty reduction.

Impact of Assistance by ADB

ADB‟s support to Pakistan in recent years has helped the government implement its
development programs, while contributing to macroeconomic stability and revived economic
growth, as well as reduced poverty levels.
This support was premised on the three cornerstones of ADB‟s strategy: sustainable
economic growth, inclusive social delivery, and pro-poor governance policies.
ADB support in various sectors is evident in the number of people whose lives have been
improved. For instance, between 2004 and 2008, ADB-supported projects helped build or
upgrade more than 80,000 classrooms and trained more than 145,000 teachers, benefiting
nearly 4 million students in the country. ADB assistance resulted in an increase of 1,500
megawatts of power generation capacity and the installation or upgrading of 450 kilometers
(km) of transmission lines, which brought electricity to about 1.6 million households. ADB
assistance to strengthen the power transmission network is helping to improve the efficiency
of the system and will lead to reduced line losses and improve availability of electricity.

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U.S Assistance to Pakistan

1
The history of U.S. assistance to Pakistan follows a predictable script: aid is tied to security
imperatives that come and go, while the country‟s political and economic well-being is
effectively ignored. As an early ally in the cold war, Pakistan received nearly $2 billion from
1953 to 1961, a quarter of which was military assistance. The United States then suspended
assistance during the Indo-Pakistan wars and following Pakistan‟s construction of a uranium
enrichment facility in 1979. Pakistan remerged as an ally in the 1980s during the Soviet
Union‟s occupation of Afghanistan and was again the recipient of aid. But following the
withdrawal of Soviet troops in the late 1980s, assistance to Pakistan took another nosedive.
Following 9/11, Pakistan became a U.S. ally once more, and unsurprisingly, almost all of the
aid provided since has gone to military operations.

Unfortunately, all the aid after the post 9/11 was either in the form of military equipment or
aid genuinely given for fighting against terrorism. This is evident form the below statistics

$7.89 billion: The amount of U.S. military assistance to Pakistan since 9/11, the majority of
which has been from “coalition support funds” intended as reimbursement for Pakistani
assistance in the war on terror.

$3.1 billion: The amount allocated to economic and development assistance, including food
aid, during the same period.

1
http://www.americanprogress.org/issues/2008/08/pakistan_aid_numbers.html

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Below is the history of US Assistance to Pakistan over previous 5 years

(Thousands of US $)

Account FY2005 FY2006 FY2007 FY2008 FY2009

CSH 21,000 22,757 22,385 29,816 27,855

DA 29,000 26,990 95,327 29,757 —

ESF 297,600 296,595 283,673 347,165 603,200

FMF 298,800 297,000 297,000 297,570 300,000

IMET 1,885 2,037 1,992 2,103 1,950

INCLE 32,150 34,970 24,000 21,822 32,000

NADR 7,951 8,585 9,977 9,725 11,250

Total 688,386 688,934 734,354 737,958 976,255

2
Child Survivor and Health (CSH)
Development Assistance (DA)
Economic Support Funds (ESF)
Foreign Military Financing (FMF)
International Military Education and Training (IMET)
Counter-narcotics and law enforcement assistance (INCLE)
Non-proliferation, Anti-terrorism, Demining and Related Programs (NADR)

2
CRS Report for Congress “U.S Foreign Aid to East and South Asia: Selected Recipients”

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ASSESSING THE IMPACT OF FOREIGN AID

THE AID AND GROWTH OF GDP

Different types of studies were under taken in order to understand the impacts of foreign
capital inflows (FCIs) on the economic development and the different methods and variables
were used to analyze the role of foreign aid in economic development. None of the studies
has shown with certainty that whether FCIs are favorable or unfavorable for an economy.
However, results of FCIs in the perspective of the Pakistan Economy can be deduced by
looking at the Table 1.1 (Trend of ODA) and Table 1.2 (Trend of GDP).

The result depicts the positive effect of aid on the GDP in Pakistan from the year 2000-2009.
It is seen that the GDP increases as the ODA increases but at the decreasing rate.

AID AND DEBT BURDEN

The burden of excessive dependence on the foreign aid has been caused by the: firstly, the
shift in the composition of foreign aid from grants to hard loans has, over the time, taken up
a relatively large share of the gross aid for debt servicing thereby reducing the amount of net
aid available for financing the imports and investments. Secondly, the terms and conditions
attached to the credits have imposed both economic as well as political costs on the
country.3

The increased debt burden in Pakistan can be depicted by the Table 1.3 (External Debt) and
Table 1.4 (Trend of Debt). It shows that the amount of external debt rises over the period of
the 1970-2002 in Pakistan. It is clear that the overall debt burden also rises as the flow of
foreign capital also increased over the same period.

3
Khan, Omar Asghar (1993). “The Impact of Foreign Aid on Economic Development”. in Viqar Ahmad and Rashid Amjad. The Management of
Pakistan’s Economy (1947-82)”. Karachi: Oxford University Press.
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CONCLUSION

The current study shows positive effects of foreign aid on the economic development.
Foreign aid, on positive side, has helped in boosting the GDP Growth through structural
transformation of the economy, laid foundations of the industrial and agricultural sectors,
provided technical assistance, policy advice and modern technology, assisted in overcoming
the budget deficits and the BOP deficits and has also funded the projects for the social
sector development projects. GDP increases at the decreasing rate, as the flow of foreign
capital increases. Thus, the overall impact of the aid on the economic development is
positive.

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TRENDS AND COMPOSITION OF AID

Table 1.1 OFFICIAL DEVELOPMENT ASSISTANCE
4
Trend of ODA from 1960 to 2008

Table 1.2 GROSS DOMESTIC PRODUCT

4
http://www.google.com/publicdata?ds=wb-
wdi&met=dt_oda_alld_cd&idim=country:PAK&dl=en&hl=en&q=trend+of+oda+in+pakistan

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Table 1.3 EXTERNAL DEBT

Profile of Total Debt and

Liabilities
billion Rupees
FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09
Total debt & liabilities
(TDL) 3856.1 3863.8 3998.4 4263.7 4549.2 5036.5 6418.1 8151.4
Growth rate -4.2 0.2 3.5 6.6 6.7 10.7 27.4 27
Total debt (TD) 3723.5 3781.4 3917 4181.6 4468.6 4956.9 6302.3 7982.6
Growth rate -1.8 1.6 3.6 6.8 6.9 10.9 27.1 26.7
Domestic debt 1717.9 1853.7 1979.5 2149.9 2321.7 2600.6 3266.1 3852.6
Growth rate -0.8 7.9 6.8 8.6 8 12 25.6 18
Share in TD 46.1 49 50.5 51.4 52 52.5 51.8 48.3
External debt 2005.6 1927.7 1937.5 2031.7 2146.9 2356.3 3036.2 4131.3
Growth rate -2.7 -3.9 0.5 4.9 5.7 9.8 28.9 36.1
Share in TD 53.9 51 49.5 48.6 48 47.5 48.2 51.8
Explicit liabilities * 132.6 82.4 81.4 82.1 80.6 79.6 115.8 168.8
Growth rate -43.2 -37.8 -1.3 0.9 -1.8 -1.3 45.5 45.8
Total debt servicing 592.4 440.4 492.1 358.9 424.7 538.5 679.9 938.2
Total interest payment 276.8 243.2 241.8 236.3 293.9 425.5 548.4 662.1
Domestic 212.5 189 185.3 181.9 237.1 358.6 473 570.2
Foreign 51.3 48.1 51.2 49.1 50.5 61.1 70.7 87.4
Explicit liabilities 12.9 6.1 5.3 5.2 6.4 5.8 4.7 4.5
Repayment of principal
(foreign) 315.7 197.2 250.3 122.6 130.7 112.9 131.5 276.2
Debt as percent of GDP -6.4 -6.1 -8.1 -5.1 -5.7 -1.8 3.3 0.8
Total debt 83.6 77.6 69.4 64.3 58.6 57.2 61.3 61
Domestic debt 38.6 38 35.1 33.1 30.5 30 31.8 29.4
External debt 45 39.5 34.3 31.3 28.2 27.2 29.5 31.5
Explicit liabilities 3 1.7 1.4 1.3 1.1 0.9 1.1 1.3

Note: Rupee value of external debt for each year computed by applying the corresponding average
annual exchange to the end-June stock.
Sources: i) SBP, ii) DM section, Finance division

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Table 1.4 (TREND OF DEBT)

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