What would doubling aid do for macroeconomic management in Africa?

This briefing paper outlines challenges and recommendations for macro-economic management of increased aid flows for sub-Saharan Africa.

It outlines four combinations of policies that donor countries can chose when met with increased aid flows:

• neither absorb the foreign exchange nor spend the counterpart. The aid is saved, with the foreign exchange added to reserves. The counterpart is used by government to reduce its domestic indebtedness but macroeconomic balances are left largely unchanged
• spend the counterpart, without absorbing the foreign exchange. This is inflationary unless there is spare capacity in the economy and is apt to disadvantage the private sector
• absorb the foreign exchange, without spending the counterpart. More resources, and probably more credit, become available to the private sector but exporters may be adversely affected by an appreciated real effective exchange rate
• fully absorb the foreign exchange and spend the counterpart. Absorbing all the aid may require an appreciation of the Real Effective Exchange Rate (REER), to induce a sufficient switch in demand from domestic to imported goods and services

The absorption of the foreign exchange is critical, since it is only in this case that aid has an impact on the level of production, consumption and investment.

Overall policy recommendations for developing country governments and donors include:

• co-ordination of fiscal and monetary policies within government
• predictability of aid flows
• the quality of public financial management and effective donor conditionality
• the quality of aid data. Major problems with this include:
  • the appalling past record of donor agencies in providing recipient authorities with comprehensive, reliable and up-to-date statistics on actual and intended levels of support
  • the limited ability (and perhaps interest) of recipient governments to process data and feed it into policy decision processes

Policy recommendations for donors include:

• modest but dependable incremental increases in aid would be easier for recipients to manage than large, discontinuous jumps of uncertain sustainability
• increased aid must be accompanied by increased absorption of the aid if it is not to risk crowding-out private sector growth
• large rapid increases in aid stand a good chance of being wasted unless they are provided in the context of carefully prepared plans which are often not yet in place. Using aid to break infrastructural and other impediments to greater export success, reversing the excessive recent shift in favour of social spending, will be particularly important