Foreign Aid: Meaning and Types

Let us make an in-depth study of the meaning and types of foreign aid.

Meaning of Foreign Aid:

External assistance is considered to be a major element towards the advancement of the deve­loping countries. It is said that aid, and not trade, is the engine of growth.

The term foreign aid or external assistance or development assistance or development aid is often used synonymously, though there are certain subtle differences in their meanings.

In essence, all these term refer to transfer of resources (e.g., loans, growth, technical assistance) from rich to poor countries or from international agencies like the IMF, the WB.

To start with, it is better to have a clear under­standing of the notion “foreign aid”. Any transfers of capital from one country to another cannot be treated as foreign aid. In the strict sense, all governmental resource transfers from one country to another is to be called foreign aid. And resource transfers by private foreign investors need not to be confused with aid. According to economists, any flow of capital is included within the ambit of foreign aid to LDCs if it satisfies three criteria.

Transfer of resources should be:

(i) develop­mental or charitable,

(ii) non-commercial, and

(iii) concessional.

Thus, loans to LDCs are treated as foreign aid if they contain a “growth element”.

Foreign aid or external assistance can thus be defined to include all official grants and conce­ssional loans either in foreign currency or in kind, which aims at transferring resources from the deve­loped countries to the LDCs for developmental reasons.

Types of Foreign Aid:

The two main forms of external assistance are:

(i) Private foreign direct investment by MNCs/ TNCs and portfolio investment that comprises stock or equity holdings by non-residents in the recipient country’s joint stock companies, and

(ii) Public and private development assistance (call it foreign aid) from governments of foreign countries and international donor agencies.

FDI is an investment involving the setting up of a new overseas operations or the mergers and acquisitions of controlling interests in an already existing foreign company through the purchase of shares and stocks. On the other hand, portfolio investment is just a transfer of capital through equity holding from one country to another.

Broadly, loans and grants are the two forms of foreign aid. Loans are required to be repaid with interest, however, on concessional terms. One may call it ‘soft’ loan also. However, outright grants do not have any obligation of interest payment or anything else. But grant-recipient countries sometimes may be asked to purchase commodity or ‘consultancy services’ from the grant-donor countries.

Secondly, foreign aid may be project and programme aid. In the words of C.P. Kindleberger: “Project aid is embodied in loans or grants that are intended to pay for specific projects. Project aid allows the donor to influence and control the uses to which aid is put. Programme aid embodies more general support, for example, for the activities of sectors as a whole such as agriculture or education, or for balance of payments support without reference to the goods being bought with the proceeds of the transfer.”

Thirdly, there is commodity aid. It is well known that the U.S. Government provided agricultural commodities (mostly wheat) to India under PL 480 and 665 free of cost subject to the payment of transport costs in hard currency.

Such commodities may serve the purpose of capital goods if through such transfer of resources in the importing country previously used in food produc­tion are shifted out of agriculture into (i) export production to provide foreign exchange to pay for imported capital goods, and (ii) capital formation, to the extent that domestic capital is in short supply. Such transfer may also replace existing purchased agricultural imports and thus release foreign exchange for buying capital or other consumption goods.

Fourthly, aid is often given in a tied or non- tied form. Donors often force recipients to spend their loan amount in the country where the aid originated. The result of aid-tying is two-fold. First, projects with large import content are eligible for more aid than those using domestic inputs.

This imposes a permanent burden on the aid- receiving countries. Purchase of one country’s products initially implies continuing demand for spare parts and on-going technical advice on operating the imported equipment. Second, aid tied to exports from a single donor country may buy less than unrestricted (‘untied’) aid, if prices in the donor country are higher than elsewhere.

Fifthly, foreign aid may take a variety of physical forms. It may take the shape of capital goods, technical assistance, agriculture commo­dities or even military support. Again, aid may be either bilateral (i.e., nation-to-nation programmes of aid of particular countries) or multilateral (IMF, W. B, ADB, aid from global and regional develop­ment banks, some United Nations agencies, and aid consortia consisting of the principal donor countries and creditors of any given LDC, e.g., the ‘Aid India Club’). In case of the latter, the donor countries, “surrender control over the uses of those funds and agree to abide by the decisions which they make with other members of the agency or institution.”

Sixthly, foreign aid may be hard or soft loan. If repayment of loan requires foreign currency then such is called hard loan. Repayment of loan by home currency refers to soft loan. While the World Bank loan is hard loan, loan of its affiliates is soft loan.