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Foreign Aid – Concept ,Trend, Composition, Major Issues and Challenges in Nepal | Public Economics

Concept of Foreign Aid

The concept of foreign aid involves the transfer of real resources from governments or public institutions in developed countries to governments of less developed countries (LDCs) in the third world. There are many types of flows of foreign resources, and it is important to identify them. There are generally two broad categories of foreign capital flows – official and private.

There are two types of official capital flows:

  • Bilateral and
  • Multilateral

Governments of donor countries provide capital to governments of recipient countries through official bilateral flows. A multilateral capital flow is one that originates from multilateral organizations such as the World Bank, the United Nations, and the IMF. The two types of official flow can be in the form of grants, loans, or grant-like contributions. Since grants represent a net addition to the resources for development, they should be considered as the best kind of foreign aid. World Bank, for example, gives loans at lower interest rates than those on the capital markets. In cases where loans are granted to the LDCs at a concessionary rate for very long periods, such as 40-50 years, the inflow of foreign resources is characterized as foreign aid, although foreign private investments are not exactly foreign aid because they are made on commercial terms.

Over the years, the degree of reliance on foreign assistance has increased for many developing countries. It is unfortunate that many times the growth in aid flows has not been matched by adequate administrative capacity to manage them. Fiscal economists can be affected by this in several ways. Development assistance aims to relieve poverty, boost investment and increase the growth rate of GNP among developing countries.

Foreign aid, however, has not always been able to achieve these objectives since the motives of donors for giving aid and recipients for accepting it often conflict with the economic objectives of foreign aid. Over long periods of time, there has never been any historical evidence that donor countries provided their support without receiving some form of recompense (political, economic, military).

Trend of Foreign Aid

The timing of aid flows is a major problem. In some countries commodity aid is recorded by the donor (when the aid is shipped), by the central bank (when the goods clear the port), and by the ministry of finance (when the aid is sold and funds flow into the government’s bank account).

It is common for aid to be delayed considerably when commodities need to be processed, distributed, sold, and profits remitted back to the government. It is common practice for the government to deposit these commodity aid receipts into “counterpart funds,” which are jointly administered by the government and the donor.

These funds can sometimes only be released with the approval of the donor. A source of financing such as this should be referred to as tied aid as opposed to general budget support. The following should be taken into consideration in recipients of such aid:

  • Be aware of the timing of such aid flows.
  • Do not confuse financing with public expenditures.
  • Recognize such flows appropriately in government accounts.

Governments often use the reimbursement principle for project aid, whereby they first spend funds on a donor-backed project (expenditure), then claim reimbursement from the donor (financing). The processing of these claims often takes a long time, so the initial funds have to come from domestic sources. There should be a review of the extent of the delays, and if they are substantial, the implementing ministries should be instructed, in collaboration with the TR, to take measures to speed up the processing of claims.

The donor is also likely to open a special project account, sometimes at a central bank, but typically at a commercial bank, into which all project payments and disbursements will be deposited, and from which all project payments will be made. In this way, donors are able to monitor project implementation more easily, have some control over how funds are spent, and have the ability to regulate the speed of project implementation.

Although these accounts may be kept separately from the normal government accounts, these accounts often don’t follow normal accounting practices, so reporting and consolidation can be delayed when these accounts are consolidated with the government’s main accounts.

Composition of Foreign Aid in Nepal

Nepal’s economy is strongly influenced by foreign aid, which contributes significant resources both to the government and to the civil society. Due to a lack of transparent data on how resources are being utilized, the question of aid effectiveness in Nepal is more prominent than ever. By collecting data from various sources, we hope to take another step forward in ensuring transparency and effectiveness of foreign aid in Nepal.As part of the Nepal Development Forum, whose members include donor countries, international financial institutions (such as the World Bank), and intergovernmental organizations (such as the United Nations), donor countries and international financial institutions coordinate development aid policy in Nepal.

Nepal’s largest Multilateral Donors
  • World Bank and
  • Asian Development Bank
Nepal’s largest Bitilateral Donor
  • United Kingdom


Due to political interference and corruption, along with Nepal’s apparently poor capacity to utilize aid, donors have lost confidence in Nepal.

Major Issues of Foreign Aid in Nepal

It is often believed that foreign aid or (development assistance) is wasted on corrupt recipient governments despite any good intentions from the donor countries. Donor nations have not been held accountable for both the quantity and quality of aid. From humanitarian assistance to food assistance, military assistance, etc., there are many types of assistance available. Poor developing nations have long recognized the importance of development aid for helping them escape poverty.

In 1970, the world’s rich countries agreed to contribute 0.7% of their GNI (Gross National Income) to official international development aid every year. Over the past several decades, despite billions being given each year, rich nations have rarely achieved their actual targets.

For example, the United States is often the largest donor overall, but ranks near the bottom when meeting the stated 0.7% goal. Nepal has historically relied on foreign aid to develop its economy. Nepal has a high and growing trade deficit due to a lack of infrastructure, a small domestic market, and limited natural resources. Nepal faces various challenges on its path to economic development as a developing nation. Economic policy measures should be aimed at addressing as many development issues as possible. These issues and challenges are outlined below:

Major Issues of Foreign Aid

  • Mass Poverty and Inequality
  • Lack of Physical Infrastructure
  • Widespread Unemployment
  • Agricultural Stagnation
  • Economic Dependency
  • Good governance and political stability
  • Level of Savings and Investment
  • Natural Resources Utilization
  • Human Resources
  • Benefiting from Globalization

a) Mass Poverty and Inequality

At present, one of the major development issues in Nepal is reducing the number of people living below the absolute poverty line, thereby narrowing the growing wealth-poverty gap. The alarming figures of extremely low per capita income and mass poverty present an awful picture of the overall economic situation. During the last 50 years, the economy has grown at a low rate of about 2 percent, revealing structural bottlenecks. Nepal has one of the major challenges of its development facing it at present: breaking the vicious circle of poverty and underdevelopment through rapid economic growth combined with equitable income distribution.

b) Lack of Physical Infrastructure

Another major development issue has been the inadequacy and disproportionate development of the physical infrastructure like transportation, communication, and electricity. Because of the lack of basic infrastructure, such as roads, electricity, and communication in rural areas, most of Nepal’s rural areas have yet to be integrated into the economy. Despite the enormous hydroelectric potential in the country, the country has been experiencing severe energy problems, which include massive load shedding. The inability to meet demand with adequate production and supply of electricity has adversely affected all sectors of the economy. Drinking water is scarce and irrigation systems are inadequate within the economy.

Therefore, the challenge for the economy is how to develop adequate physical infrastructure in proportion to the size of the economy, such as expanding agricultural roads, ensuring the accessibility of remote districts to roads, and producing and supplying hydroelectricity as required. 

c) Widespread Unemployment

In addition to unemployment, disguised unemployment, and underemployment, there is also an issue concerning poverty and underemployment. Every year, more than 400000 new workers enter the Nepali labor market. The economy offers few opportunities for entrepreneurship, skill development, and employment creation. Among our country’s major prospective resources is the youth force.

Since there are no employment opportunities in Nepal, Nepalese youth are forced to work abroad. This leads to a brain drain of highly educated and trained professionals. Therefore, providing employment opportunities to youths including those who are marginalized has become a major challenge in order to encourage them to become part of the development process.

Additionally, challenges arising in this sector include: preparing skilled workers who can compete on the international labor market; providing help and protection to workers going abroad for foreign employment; increasing access to employment opportunities for marginalized groups, such as women, Dalits, Tribes, Madhesis, and disabled people; as well as developing and creating the sector that generates more jobs.

d) Agricultural Stagnation

Stagnation in the agricultural sector has been identified as one of the major causes of underdevelopment and poverty. Although this sector accounts for about 68 percent of employment, it contributes only 34 percent to the GDP. A low per capita output in agriculture contributes to the high level of poverty among farmers. Nepal’s economy is dominated by farming, and poverty alleviation is only possible if we are able to boost agricultural productivity and shift excess agricultural manpower into other sectors of the economy in order to create gainful employment opportunities.

A lack of irrigation facilities still results in erratic agricultural production owing to a high dependency on monsoon. Because of a lack of fertilizer, seeds, irrigation, and other facilities required to raise productivity, Nepal’s agricultural sector is poorly competitive in the international arena.

A major challenge for Nepal, therefore, is to push up agricultural growth alongside increased agricultural productivity by using various policy measures (such as improving irrigation facilities, expanding road networks, supplying fertilizer, increasing storage space etc) and to maintain its competitiveness by highlighting the importance of investments and subsidy facilities.

e) Economic Dependency

One of the grave issues Nepal faces is its growing economic dependence on foreign nations. Nepal’s trade deficit is growing astronomically each year.The basic goods of daily necessity are imported in large quantities as well as capital goods. The trade deficit in 2010 AD was Rs 31352 crores as imports exceeded exports by about 6 times. Over the last 10 years, about 60 percent of total foreign trade has been with India, showing inadequate diversification of trade at the country level and excessive dependence on India. Due to the lack of domestic resources, a large portion of the national budget is also funded by foreign aid.

f) Good governance and political stability

Corruption is rampant in the government in various forms and from the lowest to the highest levels. Currently Nepal is undergoing the process of reforming its constitution, causing an extremely high level of political instability, including frequent changes of government, programs and policies, as well as conflict due to the presence of several interest groups. Among the problems of governance are deteriorating law and order, an absence of a well-functioning judicial system, weak institutions and procedures, and lack of ownership of development projects and programs.

So, by designing a new constitution based on common consensus and in line with the aspirations of all classes, castes, genders, and suppressed communities, we can ensure the peace process reaches logical conclusion. Furthermore, creating a corruption-free environment in order to improve public service delivery has become a challenge.

g) Level of Savings and Investment

Many policy makers are concerned about the poor state of savings and investments. Because of the increasing flow of remittance income, the economy of Nepal is slowly becoming consumer-oriented, resulting in a hopeless drop in savings and investment. Consumption to GDP ratio was 93.3 percent in FY 2010/11, which resulted in a savings rate of 6.7 percent. An economy oriented toward consumption leads to increased economic dependence on others, which results in a scarcity of resources for investment. It is therefore challenging to increase the level of savings and investment by discouraging unnecessary consumption to create the foundation for economic growth.

h) Natural Resources Utilization

Utilizing natural resources in the economy is one of Nepal’s key development issues. Some of our natural resources include water, forests, minerals, etc. There are about 6000 rivers and rivulets in Nepal. Nepal’s theoretical hydropower capacity is estimated to be around 83000 MW, while sites that are technically feasible for development could generate 44000 MW. Nepal has only been able to produce a fraction of this potential resource up to FY 2009/10 – only 697MW. Our economy is also home to mineral deposits of lion, limestone, zinc and others, but we haven’t conducted a detailed survey of these resources yet. Our land has varied elevations and can produce a variety of food and cash crops, including medicinal herbs, flowers, fruits, and vegetables.

i) Human Resources

There is a substantial amount of human potential in Nepal, which, if used effectively, can become a source of development. In addition, there is a shortage of skilled manpower in various fields, and a large portion of the population is still illiterate. Additionally, South Asian nations’ human development indicators are very poor compared to others. About 250000 people leave the country to seek employment abroad due to a lack of employment opportunities in the country; the number is on the rise. We are supplying only untrained, unskilled and semi-skilled foreign workers for foreign employment, although foreign employment is a major source of foreign exchange earnings and sustains the BOP.

In order to raise demand for Nepalese workers on the international scene, it is also necessary to make this sector more systematic and to put in place institutional arrangements for imparting training and skill. Creating employment opportunities within the country will enable the youth to participate in the nation’s development. A major challenge in eradicating illiteracy is also to produce and use adequate and efficient manpower to cope with the current economic conditions, as well as to produce the manpower needed for the modern and developed economy.

j) Benefiting from Globalization

It is also important to take advantage of liberalization and globalization. In progress are the privatization of public enterprises and liberalization of sectors such as foreign trade and the financial sector. Nepal is a member of the WTO, SAFTA, and BIMISTIC. Our economy cannot progress without integration with the global economy. As a result of a number of factors such as poor infrastructure, low competitiveness of domestic products, etc., Nepal has become only an import liberalization country. Several external issues are hindering growth of the export sector, such as lack of physical infrastructure, failure to meet standard quality and standards in the production of exportable goods, difficulty in identifying niche products and markets for export promotion, and lack of competitiveness on the global market.

Despite weak peace and security, uneasy labor relations, and shortage of, investment and trade-friendly environments do not exist. As a nation, taking full advantage of the effects of globalization by creating an investment-friendly environment has become a necessity in order to achieve maximum advantages.

Challenges and Utilization of foreign Aid in Nepal

  • The government faces challenges in managing and utilizing foreign aid. There was a need to institutionalize the positive aspects of foreign assistance that would supply the country with resources, expertise, and technologies while minimizing the negative aspects of foreign assistance. Several discussions have been held about foreign assistance policy proposed by the ministry. Foreign assistance should be used to institutionalize and sustain the change in the country to the maximum extent possible.
  • The new policy incorporated national needs, past experiences, as well as international commitments, including ways that foreign assistance could be mobilized, its objectives and national priorities. The best use of foreign assistance is for the country to identify its priorities and develop the leadership and ownership for its implementation.
  • The Governor of the Nepal Rastra Bank (NRB) stated that making foreign assistance accountable to the government is a major challenge. The large amount of foreign loans in comparison to grant assistance was upsetting to the government, said the Finance Secretary. A growing number of foreign loans have exceeded foreign grant assistance, he said, noting that the government must formulate clear foreign aid policy and set a deadline to do without it.
  • The proposal draft of the foreign assistance policy at the ministry had been developed in response to donor concerns, said Madhu Kumar Marasini, the Director of the Foreign Assistance Directorate. There is an expectation that it will strengthen Nepal’s relationships with its donors and build their confidence.

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