c

The Role of Foreign Aid in the Pakistan Economy

EMBA-BFS-2nd BATCH
Page 1 of 18
INTRODUCTION

The misery of Under Developed Countries like Pakistan, which have the resources to

become a prosperous country, however, have not fully achieved their potential, is mainly

associated with the problem of poverty. Because of low incomes, the saving ratios also

remain low, resulting in low investment levels. At the same time, due to low income the

taxable capacity remains lower, i.e. government earnings also remain low. Due to low levels

of investment along with the low income on the part of the government the country faces

saving-investment deficit as well as the deficit in balance of payments.

The theory of Two Gap Model suggests that the economic development policy focuses on

two constraints: the need for savings to finance investment, and the need for foreign

exchange to finance imports´. The Two-Gap Model suggests that developing countries have

to rely on the Foreign Inflows to fill these two gaps. The Foreign Inflows are available in

various manifestations to a country, which includes the grants, loans, foreign direct

investment (FDI), export credit, project/non-project assistance, technical assistance and

emergency relief etc.

Moreover, the nature of the FI available to a country also depends upon various factors
however mainly on the size of the country its economic circumstances. African nations rely
mainly on the foreign aid however countries in East Asia enjoy the benefit of foreign direct
investments owing to their investor friendly policies and the availability of infrastructure in
the form of land and human resource. In case of Pakistan the foreign aid is mainly in the
form of foreign aid because it lacks physical, financial & human capital as well as political &
macroeconomic stability, which are the main attraction for foreign direct investments.

c
PURPOSE OF THE STUDY
As mentioned in the captioned subject, our purpose of the study is to assess the role of
foreign aid in the economy of Pakistan. In this regard we would explore

a) Sources of the Foreign Inflows available,

b) The Role of Donor Agencies ,

c) Assessing the impact of Foreign Aid,

d) Trends and Composition of Aid; and

e) Conclusion
c
The Role of Foreign Aid in the Pakistan Economy
SOURCES OF FOREIGN INFLOWS
There are many forms of the FCIs, which includes the grants, loans, foreign direct

investment (FDI), export credit, project/non-project assistance, technical assistance and

emergency relief etc. The objectives behind these inflows vary from political to humanitarian

grounds however, following objectives could be broadly categorized:

a) As a signal of diplomatic approval, or to strengthen a military ally, to reward a

government for behavior desired by the donor, to extend the donor's cultural influence, to

provide infrastructure needed by the donor for resource extraction from the recipient

country, or to gain other kinds of commercial access.

b) Humanitarianism and altruism are, nevertheless, significant motivations for the giving of
aid.
c) Aid may be given by individuals, private organizations, or governments. Standards

delimiting exactly the kinds of transfers that count as aid vary. For example, aid figuresmay or may not

include transfers for military use: to cite one instance, the United Statesincluded military assistance in its

aid figure until 1957 but no longer does.

We can categorize foreign inflows under following main categories, namely:

Grants
Foreign Direct Investments
Loans and credits
Foreign Grants:

Grants, otherwise known as international aid, overseas aid, or foreign aid, are a voluntary

transfer of resources from one country to another. These grants could be in the form of

project assistance, commodity assistance, technical assistance or other assistance such as

relief aid and foreign aid.

The Role of Foreign Aid in the Pakistan Economy

EMBA-BFS-2nd BATCH
Page 4 of 18
Foreign Direct Investment:

Foreign direct investment (FDI) refers to long term participation by country into another

country. It usually involves participation in management, joint-venture, transfer of technology

and expertise. There are two types of FDI: inward foreign direct investment and outward

foreign direct investment, resulting in a net FDI inflow (positive or negative).

Loans and Credits:

External loan (or foreign debt) is that part of the total debt in a country that is owed to

creditors outside the country. We can categorize the sources of these loans as official

creditors such as World Bank, Asian Development Bank and Industrial Development Bank

and bilateral loans by governments and their agencies.