What is Foreign Aid
Foreign aid is the transfer of resources from one country (usually a developed country) to another (usually a developing or underdeveloped country) to support economic needs and development goals of recipient. It can be in the form of grants, loans, technical assistance, or goods like food and medicines.
Types of Foreign Aid
Tied aid refers to financial assistance that comes with certain conditions, often requiring the recipient country to purchase goods or services from the donor country. This aid can benefit the donor country by boosting its exports.
Untied aid refers to financial assistance that comes without any conditions. Therefore, untied aid provides more flexibility and freedom to the recipient country. This type of aid is generally more advantageous for the recipient country.
Unilateral aid is financial assistance given directly by one country to another. This aid includes only one recipient and one donor. Bilateral aid can be in the form of loans, grants and technical assistance.
Multilateral aid refers to financial assistance provided by multiple countries or international organizations like World Bank, IMF, Asian Development Bank to support development projects and economic stabilization in developing countries.
Role of Foreign Aid in Economic Development
Economic Development: Foreign aid helps improve infrastructure, boost agriculture, and promote industries—leading to overall economic growth.
Poverty Reduction: It supports poverty alleviation programs by funding health, education, food, and shelter for poor communities.
Human Development: Aid improves access to education, health services, and clean water, enhancing the quality of life and human capital.
Disaster Relief: Foreign aid is crucial during natural disasters, wars, or pandemics, providing emergency food, shelter, and medical supplies.
Environmental Sustainability: Foreign aid aims to mitigate the negative effects of climate change which include investment in renewable energy.
Employment Opportunities: Aid-funded projects create jobs, build skills, and promote entrepreneurship, especially in rural or backward areas.
Infrastructure Development: It is used for building roads, bridges, schools, hospitals, and electricity networks—critical for long-term growth.
Promotion of International Relations: Aid strengthens diplomatic and trade ties between donor and recipient countries, fostering peace and cooperation.
Technological Transfer: Foreign aid can bring new technology, research, and innovation to underdeveloped countries, enhancing productivity.
Support for Reforms: It can be tied to reforms in governance, institutions, and economic policy, leading to better administration.
Negative impacts of foreign aid
Death of Local Industries: Foreign aid, especially in the form of cheap food, hurts local farmers. They can’t compete with imported aid goods and go out of business.
Neocolonialism: Donor countries use aid to influence policies of poor nations. These nations lose economic independence. Aid becomes a tool for political and economic control.
Aid Dependency: Foreign aid makes governments rely on external funding. Basic services can’t function without donor money or experts.
Corruption: Aid money is often misused by corrupt leader. In this way billions in aid get lost through mismanagement and theft.
Public Debt (Govt. borrowing)
Public Debt is the sum total of the borrowings of the federal government of a country. It is also called Sovereign debt or national debt. It includes both internal an external debt.
Internal debt
The loan borrowed by the government from lenders inside the country like individuals, public or private organizations, central banks, commercial banks, and non-bank financial institutions is called internal debt.
Sources of Internal Debt
- Market borrowing refers to the loan that is raised by selling transferable securities like treasury bills and development bonds, and other government securities. These loans are borrowed from (i) individuals, (ii) commercial banks, (iii) central banks, (iv) insurance companies (v) Other financial institutions.
- Non-market borrowing refers to the loan received by means of nontransferable credit instruments like national saving certificates, post office savings etc. Govt. borrows these loans from either private sector or public sector.
- Central Bank Borrowing: A government can borrow directly from its central bank by creating money or using the central bank as an intermediary for loans. While it offers immediate funds, overuse of this source can lead to inflation.
External Debt
The loan borrowed by the government from lenders outside the country like foreign individuals, foreign government, and international financial institutions like world bank, IMF is called external debt.
Sources of external debt
- Bilateral borrowing means the government of one country borrows a loan from another country`s government. For example, the loan taken by the Government of Pakistan from the Government of USA, Saudi Arab, etc. is bilateral borrowing. Characteristics: favorable terms and conditions, lower interest rates and long repayment periods..
- Multilateral borrowing means the government of a country borrows a loan from international organizations like UNDP, World Bank, IMF, ADB etc.
- Foreign Private Borrowing: Governments may also borrow from private foreign lenders, such as foreign banks, multinational corporations, or investors. These loans are usually offered on the international capital markets (e.g., through issuing Eurobonds).
Importance of debt
To Cover Budget Deficits: When expenditures exceed revenues, borrowing helps governments bridge fiscal gaps. This is particularly common in low- and middle-income countries.
To Fund Development Projects: Large scale infrastructure investments like roads, schools, hospitals, and energy that have long-term benefit s require large amount of funds.
To Manage Economic Cycles: During economic downturns or crises, borrowing enables governments to inject liquidity into the economy and stabilize growth. For instance, during the COVID-19 pandemic, Germany and Japan relied heavily on sovereign debt.
Negative effects of debt
Rising Debt Servicing Costs: As debt accumulates, governments face increasing interest payments, which can crowd out spending on essential public services.
Crowding Out Private Investment: Excessive domestic borrowing can drive up interest rates, making credit costlier for businesses and households which crowd out private activities.
Economic Stagnation: Excessive amount of debt lead to economic stagnation because when burden of debt repayment is too high Govt. implements austerity policies in which Govt. increase taxes and reduces public spending to reduce budget deficit.
Which one more suitable
Suitability of sources of borrowing depends on various factors. But in general, a combination of both types of borrowing (internal & external) is more suitable. Domestic borrowing is used to finance routine expenditure, and foreign borrowing is used for larger infrastructure or development projects.
External Debt Problem of Pakistan
What is external debt
External debt or foreign debt refers to the money borrowed by a country from foreign lenders, including international institutions, foreign governments, and commercial banks. Pakistan, like many developing countries, relies on external borrowing to meet budget and BOP deficits, development projects and stabilize foreign exchange reserves.
Bilateral and Multilateral Borrowing
Loan taken by one country from another country is called bilateral loan. Sources of Pakistan bilateral debt include China, USA, Saudi Arabia, Japan etc. And loan taken by one country from international financial institutions such as World Bank, IMF, ADB etc is called multilateral loan.
Causes of foreign debt crises of Pakistan
Trade deficits: When a country imports more than it exports, it creates a trade deficit. This deficit can lead to a foreign debt crisis if the country borrows money to finance its imports.
High interest rates: Countries that borrow money from other countries or organizations often pay high interest rates. This can lead to a debt spiral where the country borrows more to pay off its existing debt.
Economic Mismanagement: Adoption of poorly designed government policies such as excessive borrowing, overspending, high inflation, overvalued exchange rates lead to failure to generate enough revenue to repay debt.
Corruption and political instability: They leads to misuse of resources, reducing the effectiveness of economic policies, discourages investment and slows economic growth.
Poor Debt Management: Poor debt management arises when countries borrow without a clear repayment strategy. Taking excessive short-term or foreign-currency loans increases vulnerability.
External shocks: External shocks include events such as global commodity price changes, oil price hikes, or natural disasters. These shocks reduce export earnings and increase import bills.
Rapid capital inflow: Globalization brought large capital inflows to developing countries. Beside their benefits, these inflows led to rapid accumulation of external debt.
Financial Contagion: Financial contagion refers to the rapid spread of financial crises from one country to another due to global interconnectedness. When investors panic in one market, they often pull-out funds from other economies as well.
Solution of foreign debt crises
Diversification of the Economy: Diversifying the economy reduces dependence on a single sector and lowers vulnerability to external shocks. This makes the economy more resilient and reduces the chances of a foreign debt crisis.
Fiscal Discipline: Fiscal discipline involves maintaining a balance between government revenues and expenditures. By reducing wasteful spending and prioritizing essential sectors.
Strengthening Institutions: Strong and transparent institutions ensure responsible use of public funds, effective financial regulation. promote accountability and reduce corruption.
Debt Restructuring: It involves new terms with creditors such as longer repayment periods, lower interest rates, or partial debt forgiveness which provide temporary relief.
Composition of external debt of Pakistan
- Around 92% of Pakistan’s external debt is owed by three major sources including multilateral and bilateral creditors as well as through international bonds.
- China is the biggest creditor of debt from bilateral sources.
- Almost 56% of total external debt of Pakistan is sourced from multilateral lenders including World Bank, ADB, IMF and others.
- 28% of the external debt is sourced from bilateral partners such as Paris club. 14% of external debt is from commercial sources; 8% from international Bond issuances and 6% from commercial banks.
- The total value of public debt till January-2025 stood at Rs74.4 trillion including Rs50.2 trillion domestic and Rs24.2 trillion external debt.
- The central government external debt till February-2025, is Rs21.73 trillion long term debt, Rs288.6 billion short term debt and Rs2.3152 trillion is International Monitory Fund (IMF), etc.
