In recent years, donors have made their aid more conditional on fiscal discipline and satisfactory policies, leading them to freeze funds if governments do not comply. What effect does this have on government spending? This paper, published by the African Economic Research Consortium, explores the relationship between public expenditure and aid fluctuations in Kenya.
Many developing countries in sub-Saharan Africa, including Kenya, have become highly dependent on foreign aid. From 1970-1999, donor funds received by Kenya averaged about 9% of GDP. This accounted for 20% of the annual budget and 80% of development expenditure. However, donor dissatisfaction with government policy resulted in two major aid freezes in 1992 and 1997. Thus, while annual aid has increased significantly, the flow has not been smooth. Such fluctuations complicate analysis of whether aid complements or substitutes for available domestic resources, which remains a question of much debate. In the case of Kenya, conclusions are drawn about the impact of aid freezes and resulting fiscal deficits by examining whether aid stimulates extra government spending and how foreign funds are utilised.
The Kenyan government’s response to aid freezes has been to borrow from the domestic market and to introduce fiscal control measures, including spending cuts. Using a welfare utility maximization approach, the study finds that:
- There is a strong, positive relationship between total expenditure and aid, supporting the proposition that aid money is not being used for tax relief.
- Conversely, aid freezes affect total spending negatively. The effect is much more serious in the short term as spending cuts are implemented to offset the shortfall.
- Domestic resource increases affect government spending less than aid, indicating that policy makers rely more on external resources to finance expenditures.
- Recurrent spending increases with levels of aid, even though all aid money is intended for development spending. However, recurrent spending does not decline with aid decreases.
- This suggests that the government uses some aid to finance recurrent expenditure, which it could have undertaken anyway. This supports the proposition that aid is fungible in Kenya.
- There is a direct, significant relationship between development spending and aid, supporting the view that the government responds to aid freezes by cutting development expenditure.
Evidently, the flow of foreign aid influences government spending patterns. As found in other country studies, aid leads to higher government spending in Kenya. However, in accordance with much research on aid fungibility, some aid finances general government spending rather than targeted development activities. The study suggests that:
- Policy makers may perceive aid commitments as increases in government revenue and, after budget approvals, switch resources for development spending to finance recurrent expenditure, such as salaries.
- As revealed by a visit to district government offices, at times of financial shortfall, staff use project funds to pay for recurrent spending, such as transport.
- Fiscal crises caused by aid freezes influence government spending more in the short than the long term. This may be because cuts in aid and spending are treated as temporary.
- It could also be because freezes affect only new commitments, not flows of emergency or previously agreed project aid.
- Other factors are that: ongoing rises in current spending mute the impact of freezes, spending ceilings are always surpassed, and the government rarely draws the full amount of contracted aid due to accounting problems.
