Determinants of aid composition Work in progress June 2009 Pernilla - PowerPoint PPT Presentation

Grants or loans? Determinants of aid composition Work in progress June 2009 Pernilla Johansson Department of Economics Lund University Sweden

Background  Donors provide foreign aid as a mix of - Pure grants (71 percent of gross aid flows, 2004) - Concessional loans  Poor countries are heavily indebted - Pure grants do not add to the debt stock - Concessional loans add to the debt stock

Importance of the grant – loan mix Relation to debt sustainability  Distinct growth effect (e.g. Dovern &  Nunnenkamp 2007) Distinct fiscal impact (e.g. Odedokun 2004)  Variation of the grant – loan mix across countries  ODA/GDP Grant/ODA Bhutan 16 89 Guyana 16 42 South Africa 0.3 93 Argentina 0.1 50 Note: Average from 1970 to 2004. 

Aid allocation literature – total aid The existing aid allocation literature focuses on  total aid (e.g. Alesina and Dollar 2000, Berthélemy 2006, Easterly 2007) Recipient needs and merits as well as donors’ self -  interest influence allocation decisions

Aid allocation literature – disaggregated aid  A few studies disaggregate aid into grants and loans - Odedokun (2003): donor perspective - Bertélemy (2006): grants/GDP - Marchesi and Missale (2007): grants/GDP, loans/GDP - Ratha (2005): World Bank loans/GDP

Research question  What recipient country characteristics determine the grant – loan allocation?

Grants and loans: definition The grant ratio  Grant ratio=ODA grants/(ODA grants + ODA loans extended) The grant element  Grant element=(face value - pv of debt service payments)/face value Disbursement data (commitment data) 

Descriptive statistics, 1970 – 2004 Pure grants dominate aid disbursements (68%)  The average grant element is 43 percent.  Donors have replaced loans by grants  Allocation by region  Grants and loans by recipient region.ppt Bilateral and multilateral donors differ. 

Potential determinants of the grant – loan mix Radelet and Chiang (2003)  Recipient need  H1: Poorer countries receive a larger share of aid as grants. Prospect for growth  H2: Countries with a higher quality of institutions and polices receive a larger share of aid as loans. H3: Countries with a good growth record receive a larger share of aid as loans.

Potential determinants of the grant – loan mix Risk of shocks  H4: Countries facing greater risk in terms of price volatility receive a larger share of aid as grants. H5: Political unstable countries receive a larger share of aid as grants. Capacity to borrow  H6: More indebted countries receive a larger share of aid as grants. H7: Countries with a history of paying more debt service receive a larger share of aid as loans H8: High inflation countries receive a larger share of aid as grants.

Potential determinants of the grant – loan mix Control variables  Total level of aid (per capita) - Recipient population -

Modeling framework Time period: 1970 – 2004  70 developing countries (26 low-income)  Explanatory variables lagged and calculated as a  moving average over the three most recent years. Bilateral and multilateral aid separately (grant ratio)  Changes over time  Fixed effect and logit estimation 

Results: baseline regressions Regression table 1.ppt  Poorer countries receive relatively more grants  Some evidence that prospect for growth influence  multilateral aid composition Some evidence that political unstable countries  receive more grants as a percentage of bilateral aid No evidence that the debt stock influence aid  composition

Results: baseline regressions (contd.) Some evidence that countries who pay more debt  service receive relatively more loans (more concessional loans). The level of aid and recipient population are  significant.

Results: changes over time Comparison of the 1970 to 1989 period and 1990  to 2004 period Few changes  No evidence that indebtedness influence aid  composition in the second period (positive and significant in the first period for multilateral aid).

Conclusion and future research Recipient need rather than indebtedness  determines the grant – loan mix as poorer countries receive relatively more grants. Behavior of individual donors  Interdependencies in aid composition among  donors