Nii Kwaku Sowa, Centre for Policy Analysis (CEPA)^*

"Foreign Aid" is a post World War II phenomenon. Most European countries devastated by the war received aid to reconstruct their cities. This in fact led to the establishment of the International Bank for Reconstruction and Development; otherwise known as the World Bank. In recent times "Foreign Aid" refers to the financial support given by external donors to developing countries. There are two objectives for giving aid:

• The first objective was to promote long-term growth and poverty reduction in developing countries; the underlying motivation of donors was a combination of altruism and a more self-interested concern that, in the long term, their economic and political security would benefit if poor countries were growing.
• The second objective was to promote the short-term political and strategic interests of donors. Thus, America gave massive aid to Zaire at the height of the cold war because it served American interests. Similarly, in its role as champion of independence of African States, Ghana under Nkrumah extended aid to the tune of $10 million to Guinea to rebuild its economy after France had packed out. Naturally, with the Cold War over, foreign aid has dwindled.

"Foreign Aid" comes in all shades and guises. Official Development Assistance (ODA) comprises grants plus concessional loans that have at least a 25 percent grant component. The difference between a grant and a loan is that grants are like gifts and do not have to be paid back. Official development finance(ODF), on the other hand, is all financing that flows from developed country governments and multilateral agencies to the developing world. Some of this financing is at interest rates close to commercial rates. Often the term "Foreign aid" is associated with official development assistance and normally targeted to the poorest countries.

Aid can be divided into bilateral and multilateral components. Bilateral assistance is administered by agencies of donor governments (such as the U.S. Agency for International Development or Japan’s Overseas Economic Cooperation Fund). Multilateral assistance is funded by contributions from wealthy countries and administered by agencies, such as the United Nations Development Programme and the

World Bank. Of all official development assistance, roughly a third is multilateral.

Some bilateral aid is tied—that is, it must be used to procure goods and services from the donor country. Studies have shown that tied aid reduces the value of that assistance by about 25 percent, and there is widespread agreement that untying bilateral aid would make it more effective. Among OECD countries there has been a clear trend away from tied aid. Aid can also come in the form of technical assistance.

A couple of decades ago, the debate on aid centered on the expression "Trade not Aid". Protagonists argued that it is more important for the developed countries to engage in fair trade with the developing countries than to inebriate them with debt through aid. A famous quotable cliché during those arguments was the Chinese proverb that "It is better to teach an hungry man how to fish than to give him fish". All said and done, most of us will agree that the expression should be "Trade and Aid"; or in other words, the hungry man should be given a piece of fish for now and then be taught how to fish. Aid is necessary for development. Most countries that have gone through successful reform did so on the back of massive foreign financial support.

For a country struggling to get on its feet, it is just not possible to marshal all resources domestically to finance all of its expenditures. The resulting broad gap would have to be filled by foreign aid and also by borrowing from internal and external sources. When foreign support is taken into consideration, the resulting domestic budget is defined as "broad". Thus, if foreign grants are added to the domestic revenue and foreign supported capital expenditures are added on the expenditure side, the resulting balance will be referred to as the Overall Broad Balance. If the overall broad balance still shows a deficit then this would have to be financed by borrowing internally or externally. It is the borrowing to close the gap, which leads us into a debt situation. It is also possible for a country to receive enough foreign grants such that its budget on a broad basis shows a surplus as happened in Ghana in 1989, resulting in zero domestic finance.

Aid flows to Ghana reflect the country’s economic and political history. Aid flows remained at a low level in the seventies. This was a period of mostly chronic domestic economic mismanagement. The NRC under Acheampong had earlier 1972 got Ghana blacklisted in the international financial circles when they repudiated some external debts. With the emergence of a democratically elected government in September 1979, aid flows rose for two consecutive years. This trend reversed after 1981 following the coup d’etat by the armed forces. Starting in 1985, however, a clear and sustained increase in aid flows occurred as donors perceived greater commitment by government to better economic management and economic reform. Indeed, between 1985 and 1995 total aid flows to Ghana increased threefold from US$150.7 million to US$450.8 million. For the past decade, aid flows to Ghana have provided an average of $570 in project and programme support. In the 1990s there has been a marked decline in programme aid, while project aid has increased.

Multilateral aid has risen dramatically as a share of official development assistance to Ghana since the late seventies when it accounted for less than 10 percent. The most dramatic increase occurred in the mid eighties as the World Bank and International Monetary Fund (IMF) supported Ghana’s economic reform efforts with a series of adjustment loans and facilities. Between 1983 and 1984, multilateral aid doubled to 79.1 percent as a share of the total. While this share has fluctuated since then, it has never fallen below 71 percent. In 1996, it was 85 percent.

Sectoral distribution of aid reflects both the donors’ interests and changes in government priorities. In the first two years of the Economic Recovery Program (ERP), aid was primarily for financing imports. However, for the rest of the decade, aid was targeted at balance of payments support and the transport sector (the latter reflecting the tremendous rehabilitation needs of the roads). Between 1986-89, balance of payments support averaged just over 50 percent of total aid. During the nineties, BOP support continued to be important but increasingly aid went to community and social services – between 1993-1996 this sector averaged 37.1 percent of total aid. Both agriculture and transport (again) are important recipients of aid in the late nineties as well.

Aid flow is very much tied to economic management and performance. Thus, following the elections in 1992, total aid fell due to fiscal "slippage" in the reform program. This was linked to an 80 percent increase in wages to civil servants. The immediate consequence was a suspension of World Bank disbursements between November 1992 and the middle of 1993. This episode was short-lived, and by the end of 1993, both the World Bank and the IMF were disbursing funds and programs were back on track. Additional fiscal slippage in 1996, however, led to a temporary derailment of the IMF-supported program under the Extended Structural Adjustment Facility. In 2000 Ghana could not meet about nine conditional benchmarks for which we had to ask for waivers. This may have affected the countries chances of assessing HIPC facilities early.

1. Aid can only be effective if good economic policy management and the right institutional support support it. There is no doubt that the improved macroeconomic management by the authorities in Ghana at the inception of the ERP in the 1980s helped in the stabilization effort; but it is important to emphasize that most of the gains could not have been achieved without the financial help of the external donor community. This is not exceptional to Ghana. Other successful cases of adjustment were largely supported by external inflows. Chile’s impressive gains at adjustment in the 1970s were supported by massive inflow of funds, as were those of Bolivia and Israel. In the case of Israel the stabilization was not only supported by aid from the United States, but in addition, most of their long term loans with the US were converted into grants to ease the debt burden on the adjusting nation (Liviatan, 1988). The East Asian miracle could not have happened without the strong financial support from Japan.

2. Aid coordination is very important to aid effectiveness. In some instances donors desirous of showing results which to fly their flags on specific projects. This leads sometimes to duplication of efforts and over concentration in specific areas. Take for example, the National Poverty Reduction Program funded by the UNDP and the Social Investment Fund funded by the ADB, both running from the NDPC. Aid coordination will focus efforts in achieving specific results.

3. Given the current poor fiscal situation in Ghana, the kind of aid needed now is for fiscal support rather than balance of payments support. There are balance payments difficulties leading to the continuous depreciation of the currency; but the fiscal needs are more urgent.

4. Again given the poor state of the macroeconomy, the most urgent financing needs are for programme aid, rather than project tied assistance. Project aid comes with increased requirements for domestic financing. The situation of the economy now, demands more of budgetary and balance of payments support.

Now let us turn to Debt. Generally, debt is incurred to:

• Finance the Government deficit;
• Accumulate foreign and domestic assets; and
• Repay other previous debts.

Since independence, Ghana has always had problem with central government finances. Government has never been able to marshal enough revenue to take care of its expenditures. This creates deficits, which have to be financed either by borrowing (from domestic or external sources) or by resorting to the "printing of money". The latter form of financing the deficit can be inflationary while the former creates debt.

In the 1970s, the deficit was mostly "money-financed" leading to strong inflationary pressures. This mode of financing was forced on the economy by the financial environment of the time. The financial system, particularly the money market, was underdeveloped and Treasury bill was not a popular financial instrument; thus the Government could not borrow from domestic sources to support the budget. On the other hand, foreign borrowing was also limited, as Acheampong’s "yentua" declaration had led to the country being blacklisted in the international financial community. Hence, the only avenue open for financing the deficit was through the "printing press". This caused inflation to spiral upwards, hitting 123 percent in 1983.

Between 1983 and 1989 the hallmark of Ghana’s commitment to economic reform, under the Structural Adjustment Program, was fiscal prudence. Aided by balance of payments and budgetary support from external sources, Ghana was able to maintain broad budget surpluses between 1986 and 1990. Of course, the external borrowing created a pile up of external debt for the country. However, most of the external borrowing was on concessional basis with long moratoriums and do not pose immediate threat to the macroeconomy.

The domestic debt is a problem of the 1990s. Gross domestic bonded debt rose sharply from 3 percent of GDP in 1990 to about 25 percent of GDP at the close of the millennium. See Table 1. The evolution of the domestic debt was through fiscal excesses beginning from 1990. Unbudgeted outlays for hosting of the Non-Aligned Movement's Ministerial Conference and the Peacekeeping operations in Liberia (ECOMOG) in 1990, and later expenditures on District level elections proved to be too much strain on the fragile economy and the country has not recovered since. In the case of the district level elections, as in all other political expenditures, there were budgeted costs related to the process and unbudgeted costs to influence the process. The fiscal pressures of these unplanned expenditures were exacerbated by the fact that the availability of program aid was very limited in the 1990s and disbursement of project aid has slowed down considerably — not unrelated to the policy failures.

Comparing changes in the debt from year to year with the deficits of each year shows that the debt was driven mostly by the deficit. In 1996 the budget plunged into a deficit, which only deepened over the years. From about 3 percent of GDP in 1996, the deficit rose to about 17 percent at the close of 2000. Table 2 compares the changes in the domestic debt (less revaluation stocks) with the deficit for each year. It is clear that since 1997, creation of domestic debt was not enough to finance the deficit. Thus for the last half of the 1990s the country had to borrow externally and/or print money to finance the deficit.

It has been quite difficult to estimate the actual size of the domestic debt. The first issue relates to coverage. Total public debt must be defined to include the debt of (i) the central government; (ii) the municipal and local governments; and (iii) state owned enterprises and subvented organizations. Generally, discussion gets focused on central government debt to the neglect of the other forms of public sector debt. However, local government debt may have come about because of delays in the release of the District Assemblies Common Fund by central government. In the case of state-owned enterprises such as the Tema Oil Refinery (TOR) delays by central government in instituting proper pricing policies led to huge implicit subsidies on fuel resulting in a pile up of debt totaling trillions of cedis. Thus, the true size of the domestic public debt must include the debts of all these organizations.

The coverage issue aside, the actual size of the debt is made fluid by the existence of payment arrears in the system. For some years now, government has been postponing honoring its obligations to some contractors, particularly those in the road sector. This has created a stock of payment arrears, which is officially neglected in the computation of the gross domestic debt. The more tractable debt is that which is bonded.

Further, included in the classification of the debt is the revaluation stocks issued by government to the central bank in respect of losses incurred in the revaluation of net foreign assets owing to the depreciation of the currency. For a long time, this was on the books of the central bank, rendering its net worth negative, and creating operational problems for the Bank. In 1996, a decision was made to transfer the revaluation losses to Government in exchange for interest bearing stocks: this has since been part of the debt. Although since 1996 there has been further accumulation of losses, no new transfers have been made to the central government accounts. Indeed, revaluation losses currently on the balance sheet of Bank of Ghana are much more than what has so far been transferred to central government’s account. Since this is not an expenditure-related debt, it may be necessary to exclude the revaluation stocks from the debt in order to evaluate properly the budget-related debt.

By the year 2000, the gross domestic bonded debt of central government and the central bank has reached almost 7 trillion cedis. See Figure 1. The limited availability of different forms of financial instruments on the money market places a limitation on the forms of debt held. Much of the debt is of short-term nature. About 90 percent of the debt is held in the form of 91-day and 180-day Treasury bills. Long-term bonds are only held by the central bank. In 1993 long-term stocks issued amounted to 291 billion cedis and this was increased to 590.7 billion cedis in 1996.

The debt has both fiscal and monetary consequences. The gross domestic bonded debt is larger than or equal to (excluding revaluation stocks) the total government revenue. Interest payment on the debt is about 15 percent of total expenditure, more than development expenditure, and greater than the total of the expenditure on health and education combined. Thus, the size and rate of growth of the debt weakens the ability of the fiscal to meet social and developmental commitments.

More frighteningly, the size and high rate of growth of the debt can lead to state of bankruptcy in which the Government fails to honor its debt obligations. This situation will arise when the fiscal cannot meet the solvency criterion. The fiscal is said to be solvent if the present value of the future streams of the country’s income is larger than the size of the debt. It is important to do this computation and ensure that the fiscal never becomes insolvent.

The debt also creates monetary problems. Because government needs to borrow more to take care of the debt due and also to close the fiscal gap, interest rates are kept high and attractive. A profile of interest rates reveals real rates ranging between 10 and 21.7 percent between 1996 and 1999. The high interest rates worsen the debt burden and cause government to borrow more to service it. Thus the Government becomes a "debt junkie".

The fiscal and the monetary consequences of the debt lead to poor economic growth. Investment by the private sector is slowed because of the high rates of interest and also because the public sector "crowds out" the private sector in the credit market.

Clearly, the first recommendation for containing the debt will be to aim for surpluses on the fiscal. Participants at the first National Economic Forum agreed to this in 1997; but the Government of the National Democratic Congress did not commit itself to its implementation. The recent National Economic Dialogue has also endorsed fiscal prudence as a way to contain the debt. It is a fact that so many national development projects and social programmes are waiting to be implemented. Thus, reducing the fiscal expenditure may be problematic and may be politically costly. Elimination of waste and switching of expenditure into more productive areas may be more beneficial. The Government may also have to find ways of generating more revenue to achieve the budgetary surplus. The inflationary consequences and loss of macroeconomic policy consistency and stability that followed the introduction of the VAT in 1995, however, are a reminder that generating non-inflationary revenue may be no less problematic than restraining expenditure growth.

Some amount of surprise inflation in the system can also help to reduce the debt. Basically, the government as the debtor will gain for any rise in the general price level. But, quite apart from the inflation tax, the rise in the general price level creates seigniorage revenue for Government that can be used to pair back the debt. But, this can backfire. It has been established in the economic literature that as inflation increases seigniorage revenue can only increase up to a point, after which it then fall. However, inflation once initiated may be difficult to control.

A third method of containing the deficit will be to divest some of the national assets. For some time now some state owned enterprises have been on the divestiture list and it is about time to push them for sale. Others that have been divested for which payments have not been made should be settled as quickly as possible. It is important that the divestiture be properly indexed to either foreign exchange or inflation so that value is not lost in case of long delays in payment.

Finally, it may be necessary for government to transform some of the debt from short-term to long-term. Consensus was reached on this at the last Economic Dialogue. At the same time, if the official inflation numbers are to be believed, the rates of interest on the Treasury bills are too high, even in real terms. It is important to note that banking regulation already makes it mandatory for the banks to hold secondary reserves in the form of Treasury bills. Thus, the banks do not need too much "convincing" to invest in Treasury bills. With the non-bank public, the low rates on saving deposits makes the rates on the Treasury bills "too attractive". In sum, the Treasury bill rates can come down by some percentage points without hurting demand, while giving tremendous boost to debt reduction.

Regarding external debt, I will say that the decision of the Government to adopt the HIPC Initiative is welcome as it allows breathing space for tackling more pertinent domestic issues.

Aid is good if it is back by good policies. There is the need for proper coordination of aid projects in the country. The tendency for donors looking for results by planting their flags on specific projects should be discouraged. More grants may lead to smaller deficits and hence less borrowing.

The domestic debt is a problem not only because of its size but also the rate at which it is growing. A large portion of the debt is held in short term bonds with high real rates, which create a vicious circle for the debt burden. The fiscal and monetary consequences of the debt are enormous with a threatening possibility of insolvency occurring in the near future. It is important to move the fiscal from the chronic deficit position into surpluses, to reduce the growing threat from the debt. The prudent fiscal management while a means to proper debt management also creates the condition for more aid inflow.