• Aid flows

Aid flows

With increasing aid entering many developing countries, there is a need for sound fiscal policy in order to manage these volatile flows. This paper reviews measures that should be taken in order to strengthen public financial management in order to ensure effective use of these scaled-up aid flows. It argues that fiscal policy formulation should be anchored in medium-term frameworks, incorporating a longer-term view of potential resource availability and spending plans.

The paper argues that the decision on how much of increased aid flows to spend should be based on country-specific circumstances, including macroeconomic stability, absorptive capacity constraints, and debt sustainability. These plans, it argues, should be consistent with available financing from all sources, both public and private. Given the volatility and uncertainty of aid flows, it recommends that one key objective should be to smooth the expenditure path so that all programmes undertaken are adequately funded. The paper suggests that the overall fiscal balance, including grants, should be used to monitor short-term fiscal developments.

The paper also argues that in the context of increased aid flows:

• wage bill ceilings such ceilings in Fund supported programmes should be used selectively, that is, only when they are warranted by macroeconomic considerations and if used should be flexible and reviewed
• effective use of aid flows may require that some of the aid be saved temporarily
• closely monitoring spending is important for ensuring debt sustainability. Achieving the MDGs will require both more spending and more efficient spending
• strengthening domestic revenue mobilisation should be an integral part of the fiscal policy response to scaled-up aid

The paper also outlines several policy choices to counteract aid volatility:

• sustaining spending by drawing down saved-up aid when the latter falls short of expectations
• building elements of flexibility into spending programs
• multiyear aid commitments by donors would help reduce aid volatility
• improving the efficiency of spending by enhancing transparency and governance in
  

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