Does foreign aid influence economic growth? Evidence from South Asian countries

Abstract

We analyse the effectiveness of foreign aid on economic growth of eight South Asian countries, such as Afghanistan, Bangladesh, Bhutan, India, Maldives, Nepal, Pakistan, and Sri Lanka from 1996 to 2018. By using the panel Fully Modified Least Squares (FMOLS) model, we find a long‐run equilibrium relationship between economic growth, trade openness, foreign aid, gross fixed capital formation, financial sector development, and inflation. Further, we find that there is a positive association between foreign aid and economic growth in short-run and long-run. This study has some policy implication. The gross fixed capital formation and foreign aid complement each other for promoting economic growth and foreign aid does not crowd out private investment. Hence, for the sustainability of growth in this region, a combination of trade openness, foreign aid, gross fixed capital formation, financial sector development is required. This study supports the aid efficacy theory for this region.