Aid heterogeneity and fiscal response: the case of Pakistan

The paper explores the effect of both temporary and permanent components of foreign aid grants and loans on Pakistan’s fiscal response over the period 1973 to 2020. It shows that temporary loans cause larger fiscal adjustments than grants, by boosting revenue and public investment while decreasing government consumption and domestic borrowing, with no effect on debt servicing. Conversely, temporary grants trigger revenue-based fiscal adjustments by raising revenue and debt service without affecting domestic borrowing or government investment, while lowering at the same time current expenses. Additionally, permanent loans lead to increased domestic borrowing without impacting revenue, along with higher current expenses and debt service, and reduced public investment. Permanent grants also lead to increased domestic borrowing due to lower revenues and a larger government. These findings highlight important policy suggestions for aid donors regarding the aid design for highly indebted aid recipient countries, advocating for grants over loans and initiating debt relief programs to prevent aid fungibility into debt servicing. The findings emanating from the paper seem also to suggest that donors should provide temporary aid for fiscal adjustments and permanent grants for investments. In contrast, expenditure-based fiscal adjustments should be conditioned on permanent loans that finance the government's current spending in recipient governments.