One of the important methods of financing trade is through aid. Larger trade is possible through larger aid and it is in this context that a study of the mechanics of aid is relevant in international finance. Movement of money from one country to another in the form of aid is referred to as the foreign aid. The donor countries not only look into their own capacity to grant aid but at the recipient country’s capacity to absorb aid. The latter is judged by the efficiency and productivity in the resource allocation in the pattern of planning and investment and in priorities of allocation, the methods of raising resources and the overall performance of the economy.
Availability of foreign aid for the purpose of investment would accelerate growth by helping the cooperating factors at home to be fully deployed and by accelerating the rate of investment. This would enable the necessary technical innovation and accelerate the entrepreneurial function. Foreign aid augments domestic economic growth. The pattern of flows under foreign aid does not depend upon pure economic factors nor on pure commercial considerations but more on politico-economic factors.
The effect of foreign aid on the foreign exchange market is to:
- increase the supply and ease the pressures of demand,
- to facilitate the transfer mechanism in the currency markets and
- to obviate the need for frequent changes in the exchange rates, pending the process of structural adjustment in the domestic economy.
The inflow of foreign aid would however increase the money supply, which may not lead to inflationary pressures so long as funds are efficiently and productively used in the development process. The basic postulate is that foreign aids fills in the gaps make available non-available and complimentary resources and augments the investment process.
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