Impact of Foreign Aid on Economic Growth in Nepal

Abstract

Nepal, being one of the least developed countries,has beenreceiving aid for more than six decades. It is very important to see how the country is being able to utilize the aid receipts in the economic developmentof the nation.Using annual time series data from 1983 to 2013, the effect of foreign aid oneconomic growth of Nepal has been analysed.The empirical work has beenperformed in two phases(1983-2002 and 1983-2013). The result from Johansen’s cointegrationtest for the shorter time interval, when there was relatively a poor economic situationin the country,revealsthat aid has a negative long-run effect on per capita real GDP.In a longer time interval, including a period of improvement on macroeconomic indicators,the effectiveness of aid is increasedshowing a significantpositive effect of foreign aid on per capita real GDP. There is a negative impact of aid on per capita real GDP in the short run.A good policy environment helps increasetheaid effectiveness. However, the prevailing trade policy in the country is negatively affecting the aid effectiveness due totheextremely increased trade deficit. Keywords:Foreign aid, Economic Growth, Cointegration, Error Correction Model, Nepal