Financial Liberalization and the Aid-Growth Relationship in India
This paper examines the impact of foreign aid in the process of economic development in India by controlling for the degree of financial liberalization. A composite index is constructed using the method of principal component analysis to capture the joint influence of various policies imposed on the Indian financial system. The results show that while foreign aid exerts a direct negative influence on output expansion, its indirect effect via financial liberalization is positive. Therefore, an important implication of the findings in this paper is that greater openness in the financial system of the host country is a crucial prerequisite to realize the effectiveness of foreign aid. Our results are robust to a number of control variables and estimation techniques.
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