Abstract
Lesotho has historically depended on foreign aid. This paper seeks to understand the fiscal effects of such aid inflows on Lesotho’s economy over the period 1982-2010. The cointegration test results indicate a strong negative long-run association between recurrent expenditure and foreign aid, and a positive but marginally significant relationship between aid and capital expenditure. These findings provide lack of evidence for the presence of aid fungibility since foreign aid is not diverted to non-development expenditure. The Lesotho Highlands Water Project also seems to have been effective in terms of changing government budgetary allocations and has had a positive impact on development spending. This supports the notion that provision of loans instead of grants results in an effective use of government funds. DOI: 10.5901/mjss.2016.v7n1p116
Highlights
Lesotho has historically depended on foreign aid
The data on government revenue and expenditure as well as gross domestic product (GDP) are sourced from the International Monetary Fund (IMF) World Economic Outlook Database (October, 2012) and the Ministry Finance, with all real variables being in 2004 prices
The augmented Dickey-Fuller (ADF) test is used to establish the presence of unit root among the series and the optimal lag length is determined by the Schwarz information criterion (SIC)
Summary
Lesotho has historically depended on foreign aid. From 1960 to 2010 (see figure 1 in section 2), the country has experienced substantial fluctuations in foreign aid flows, with an upward trend till the mid-1980s and a downward trend thereafter. In order to address some of these issues, Devarajan et al (2006) analysed the extent of aid fungibility in subSaharan Africa, including Lesotho. They discovered that aid is partially fungible in those countries, with foreign aid resulting in an equal increase in both recurrent and capital spending. Given that the effect of foreign aid on economic growth depends on how the government responds to aid flows (see Bhattarai, 2007), the paper aims at investigating the effects of aid inflows on government spending and revenue patterns as well as budgetary allocations in Lesotho during the period 1982-2010. It adds to the literature of the effects of foreign aid in emerging economies by providing the experience of Lesotho as an aid-dependent country
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