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Innovative ways of making aid effective in Ghana: Tied aid versus direct budgetary support

Research Paper No. 2005/58

Peter Quartey

United Nations Global Policy Forum

September 2005

SARPN acknowledges the Global Policy Forum as the source of this document.
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Developing countries, including Ghana, have been burdened with severe resource problems. A number of these countries are aid-dependent (Table 1) and their fiscal and current account deficits are unsustainable in the face of severe debt problems. The debt stock is extremely high and the proportion of government revenue spent on debt servicing places a severe burden on many developing countries, Ghana included.1 In certain countries, debt servicing exceeds government expenditure on education (see, for instance, Osei and Quartey 2001). In an attempt to rescue the situation, donors have often used tied aid2 not just for self commercial interests but sometimes to facilitate aid effectiveness,3 but without the hoped-for results. In view of the resource constraint in many developing countries and the fall in ODA flows to these countries (Bulir and Lane 2002; Alesina and Dollar 2000), donors are faced with two complementary options: (i) develop new or innovative sources of financing for developing countries, and (ii) find new ways of making aid more effective.

The Department for International Development (DFID) and a few other donors have considered the latter option. The donor community and the government of Ghana have agreed on an aid package dubbed the multi-donor budgetary support (MDBS), which is aimed at ensuring a continuous flow of aid to enable the government to finance its poverty related expenditures. The aid is to be paid into a fund and the government has the prerogative to determine the priority areas on which the funds are to be spent, a distinct advantage over previous arrangements where a part of aid is tied. Moreover, an important conditionality is that the money is spent judiciously and donors must be satisfied that the government is pursuing the right policies before funds are released.

Laudable as this idea may seem, it raises a number of issues, which need to be examined. Given that donors may consult each other, would this affect the amount of aid inflows because bigger donors may be tempted to cut back on the amount made available to Ghana? Second, would donors restructure their aid and possibly reduce the grant component? Another worrying issue is that not all donors have signed up to support the agreement, as in the case of Japan, one of Ghana’s biggest donors after the World Bank (WB). This raises the assumption that Japan’s assistance would continue to be in the form of food aid and project support, often with high transaction costs.

Table 1
Aid dependency—Ghana
  1996 2001 2002
Net ODA or official aid, US$ 651 million 652 9 million 652.8 million
Aid per capita, US$ 37 32.8 32.2
Aid as a % of GNI 9.6 12.6 10.8
Aid as a % of gross capital formation 32.2 46.2 53.8
Aid as a % imports of goods & services 25.5 17.7 18.6
Net ODA as a % of government expenditure - 34.5 -
Debt service as a % of exports 17.4 8.4 6.6
Source: World Bank (2004), IMF (2002).

Furthermore, the multi-donor budget support would operate alongside other forms of project aid, raising the issue of the mix of aid. Would the mix between MDBS and the other forms of project aid necessarily make aid more effective? This paper examines these issues in the light of the current dimension of aid flows to Ghana. Section 2 outlines the pattern of aid flows to Ghana since its independence and examines aid’s probable impacts on the economy. The next section considers how to make aid more effective, and outlines the MDBS system and its operational framework, and examines its likely gains. The section also discusses some of the issues raised here. The final section concludes.

  1. In Ghana, debt service as a percentage of exports was 17.4 per cent in 1996, 15.1 per cent in 2000 but thanks to HIPC, the debt service ratio reduced to 6.6 per cent in 2002 (World Bank 2004, also see table 1).
  2. Tied aid is defined in this study as project aid contracted by source to private firms in the donor country. It refers to aid tied to goods and services supplied exclusively by donor country businesses or agencies. Aid can also be tied to conditions such as policy or institutional reforms but the paper narrowly defines tied aid to exclude aid tied to conditions.
  3. Defined in terms of aid’s contribution to poverty alleviation or sustained poverty reduction.

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