Important Criterias of Foreign Aid - Case Study Example

Foreign aid and debt relief for Greece Introduction: Foreign aid and its importance Foreign aid essentially refers to granting loans and financialrelief to developing nations. Such an aid is usually provided for economic development of the recipient nation or at concessional terms of finance (De Grauwe, 2010). It incorporates transmit of real resources from public institutions of rich nations to the government emerging and poor nations. Least developed nations usually utilize such aid for improving the economic conditions so that a satisfactory growth rate gets achieved. The foreign aid can be categorized as official and private flow. Official flow can be further subdivided into bilateral and multilateral flows. Bilateral flows incorporate flow of fund from one government to the other. Multilateral flow on the other hand occurs between developing nations and institutions such as IMF (International Monetary Fund), World Bank and United Nations (De Grauwe, 2010). Foreign aid is provided in the form of grants and contributions similar to grant and loans. As per the DAC (Development Assistance Committee) foreign aid is required to satisfy three important criteria’s. Firstly the primary objective of such a flow of fund must be economic development devoid of any military aid and other private objectives. Secondly the terms and conditions available on such loans and grants must be concessional. The policies such as interest rates and other terms and conditions must be lighter than those which are commercially available. Thirdly the flow of fund must instigate from government agencies. The economic objectives of such flow of fund are to reduce poverty, increase savings, enhance educational facilities and development of infrastructure (De Grauwe, 2010). Factors leading to indebtedness The paradox associated with heavily indebted nations is that they reach such a critical stage after they have been provided with partial debt relief for a considerably long time. Researchers such as Easterl (2002) have identified that the manner in which a nation reaches a position of high indebtedness are long lasting and are not seen to be easily removed by debt acquisition. The issues with highly indebted nations are not a recent phenomenon. From Greece to Mexico and Haiti, debt related difficulties are seen to exist in many nations of the world. In many highly indebted countries it is observed that debts procured are used in a corrupt manner (Eroğlu and Yavuz, 2012). Productive investments have always seen to remain low. Such finances are utilized by indebted nations for government patronized employments and for meeting the needs of military and police forces. A share of such foreign loans also went into the pockets of rulers. According to the studies conducted by Burnside and Dollar (2000), it is observed that debt relief aid does not facilitate in improving the economic growth of a nation, where economic policies and infrastructure are weak. Since adequate profits cannot be generated, such nations find it difficult to repay debts and continue operations in their economy motivating them to further acquire foreign aid. This makes poor nations to fall into loops high indebtedness. The World Banks Africa report suggests that many African nations were not successful in removing economic weakness even after receiving financial aid (Economou, et al., 2013). Apart from government lending, such nations are in requirement of receiving support from private institutions as well for economic growth. Unless creditworthiness improves and FDI in productive sectors occur, achieving relief from indebtedness becomes difficult. A nation which goes into a crisis state and whose economy is supported through debts is seen to possess increased rate of discounts. The increased discount rates are likely to induce more risks and less profitability into the economy. A highly indebted nation is seen to continue procuring debts in accordance to the amount of debt relief received. This continues till the old ratios of GDP are adequately restored. This creates a loop of risk where the nation becomes dependent upon external relief to acquire more debt and run the economy (Sakellaropoulos, 2010). Such an economy will have low credit worthiness and is likely to ward off foreign direct investments. In order to come out of such an economic crisis, highly indebted nations are required to look at the bottom of their economy and analyse improving the same from the root level. Unless such nations can enhance their productive capabilities and their standard of living, demand conditions are not expected to change. When infrastructural conditions positively develop, it becomes possible to attract more foreign investments that are likely to induce savings, investments and job creation. In the case of Greece, although much financial support has been provided, the economy still lacks the ability to revive itself. The problem lies in the aspect that the nation is not able to service its debts adequately (Sachs and Williamson, 1985). The Greek crisis Conditionality and Debt relief The participation of Greece in the global recession was one of the most severe as compared with other poor economies. Slow growth and reduced risk appetite led the nation towards developing high dependency upon foreign aid. In 2010 the net financing from IMF by Greece stood at € 10 billion. The aid was partnered by a further € 30 billion from the European Union (EU) (Nelson, Belkin and Mix, 2010). The motive behind such a strong financial support was to facilitate the nation to be able to take strong economic actions so as to secure the future of its people. Although this is not deemed to be an easy task, but the Greek government had placed an economically and socially viable plan to improve the existing financial condition of the nation. The IMF together with the EU is providing unprecedented support to Greece (Pagoulatos and Triantopoulos, 2009). The policies framed by the Greek authorities rely upon restoration of fiscal sustainability, enhancing competitiveness and to safeguard the stability existing in the financial sector. The Greek government has designed an ambitious policy for restructuring the economic situation (Eroğlu and Yavuz, 2012). The multiyear reformation programme rests on two important pillars. Firstly the motive of the programme is to correct the grave fiscal imbalances and secondly to make the economy more competitive so that it may be able to generate adequate jobs and improve the standard of living. The government had designed the programme in a manner such that they remained focused upon all the major economic sectors. The burden of the plan will therefore be shared by all sections of society. Care will also be taken to safeguard the most vulnerable groups. The economy of Greece was seen to be shaken by the adverse conditions existing in the market. The initial attempts made to restructure the conditions had failed and had caused a spill over into the banking sector (Eroğlu and Yavuz, 2012). The strategy includes a fiscal consolidation to minimize the deficit by 3% of the net GDP by the end of the year 2014. The programme also includes imposing higher taxes upon the socially affluent, while protecting the interests of the vulnerable. Adequate measures for rationalizing the public sector were also incorporated. Authorities and policy makers were of the opinion that the short run impacts of such restoration programmes might be magnified or long lived. The short run output of the project is likely to contract as the economy of Greece adjusts itself with the global conditions. Improved market performance is identified to be the key to the nation’s performance. As financial market stability rises, it is expected that balance shall also be achieved in labour markets, competition scenario and the streamlining of public administration. The Greek government decision to extend the eligibility criteria of repurchasing Greek bonds issued by the government is expected to improve liquidity conditions existing at banks (Katsimi and Moutos, 2010). The establishment of the Financial Stability Fund is expected to ensure that organizations will remain adequately capitalized even during financial downturn. The government authorities have also determined to strengthen banking supervision and associated legal frameworks so that fraudulent activities and manipulation of funds do not occur. Although the measures taken by the Greek authorities are widespread and are expected to improve the conditions existing in the economy, there exist adequate risk elements. The primary challenge is the implementation of such reform measures at an aggressive scale (Easterly, 2002). Public consensus in respect to of such change measures is also essential. Economic analysis reveals that breach of obligations was one of the crucial factors due to which efforts of restructuring were seen to be failing earlier. To minimize the repetition of such activities, authorities have taken remedial measures for correcting data deficiencies. Actions in respect of corrective financial policies and reformulation of economic plans are taken in association with the IMF, EU and the Eurostat. Strict compliance with reporting related activities are considered to be highly essential for meeting the requirements of reformation (Popescu, 2012). Economic developments: Pros and cons Public debt had increased in the economy of Greece from below 100 to 115 per cent of the net GDP of the nation by the end of the year 2009. Despite recession, the current account deficit was at 11 per cent of the GDP. Such aspects signified the existence of demand related inflation and competitiveness related issues. The initial attempts taken by the government for addressing such vulnerabilities in the year 2010 were not convincing (Arghyrou and Tsoukalas, 2011). The macroeconomic programmes laid down for improving the economic conditions existing in Greece were seen to be too optimistic. This had increased market jitters. A number of initial investments did not reap adequate benefits as the standard of living and the investment in the nation by other major economies of the world were low. As a result the structural investments were not followed by rise in demand (Popescu, 2012). However after extensive consultation with the European Commission, additional fiscal policies had been implemented in the years 2011-2012. They too had failed to improve the market conditions. One of the reasons behind the unsettlement of the market conditions had arisen out of insufficient and unclear financing assurances from other euro nations. Access to foreign funding was dried up and the spreads on government bonds had sharpened. The overall risks existing in the economy had worsened (Karanikolos, et al., 2013). Although the immediate effects of implementation of the reform policies were not very promising, it is expected that in the coming few years, fiscal conditions are likely to improve with increased productivity and sector wise developments. Structural reforms and returns from credit markets are seen to develop in the nation from 2012 onwards (Popescu, 2012). Inflation is also seen to remain low. In fact inflation rates are expected to be lower than the euro zone nations. Price conditions are likely to improve through the tightening of the demand conditions. Public wages and pension’s situation are also likely to improve. As income situations improve, it is expected that price competitiveness will be achieved. The signs of improvement although very little is seen to slowly develop in the economy of Greece. It is expected that the GDP of the nation will enhance by 0.5% in the current fiscal year (Dieckmann and Plank, 2012). Although this is not enough for filing the debt hole, at least a small progress towards growth is likely to give confidence to the authorities of Greece to implement more polices and measures for radical economic growth. The economic condition existing in Greece can be revived through investments made in lower currencies. In order for the nation to recover strongly from the economic turmoil, strong infrastructural measures are required to be taken. Greek authorities must channelize the acquired debts in a direction that enhances the nation’s credit worthiness and attracts greater investments. The economy is seen to concentrate more upon the bond market for improving fiscal conditions. The nation is seen to rely on acquiring debts utilizing the debt aid received from foreign nation. As a result risks continuously mount up. In order to mitigate such a situation the nation must consider using the relief fund obtained for investing in market instruments which are less risky (Milios and Sotiropoulos, 2010). Role of euro zone authorities The economic crisis of Greece could be mitigated if there had been adequate and clear support from other euro zone nations. Disagreements between the governments of the member states and the lack of timely response to the Greek crisis were seen to widen the issues (Matsaganis, 2011). The European Central Bank (ECB) was also seen to create a number of ambiguities. During the financial crisis it was seen that the ECB had lowered the rating criteria for government bonds. The steps was taken in order to improve the liquidity crisis existing in the euro zone. This had however created a number of issues for the financial firms which held Greek government bonds. Many bonds therefore had become illiquid for long durations (Matsaganis, 2011). Political differences and lack of accurate policy related assistance on behalf of the governments of other euro nations were seen to adequately impact crisis in Greece. Although euro zone nations had together provided Greece with suitable finance, they were not done on timely basis leading to making investments at the wrong time together with lack of planning and foresight. Von Hagen, Schuknecht and Wolswijk (2011) are of the opinion that a bail out of Greece could have been facilitated if the euro zone nations joined hands. Financially it would not have cost them much. Lack of political unity and consensus had prevented such a bail out. Euro zone authorities had announced that their support towards Greece would have led the nation into greater financial difficulties. They were of the opinion that the Greek government must pressurize its own economy to improve (Matsaganis, 2011). Conclusion Less developed nations are seen to remain eager towards receiving financial aid. The acceptance remains even if the aid is accompanied with strict policies. A major motive behind receiving such aid is seen to be political. The existing leadership in the highly indebted nation is seen to acquire higher power leverages and utilize the same for suppressing the supremacy of opposing leaders. Nations such as Taiwan, Israel and South Korea are seen to benefit immensely from the economic perspective through such foreign aid. The challenge indebted nation’s face is to align the nation’s economic motives with that of the motives behind acquisition of such foreign relief. Many at times the conditionality and strict policies associated with such debts restrict poor nations to invest in productive activities. Donor nations are required to put their financial profit motives aside and provide adequate leverage to the highly indebted nation. Financial aid is also required to be accompanied with resource transfers. This includes technologies and skills which enables poor nations to strategically form suitable plans of improvement. Mere financial support is not adequate for releasing nations such as Greece from indebtedness. It is also essential that nations facing financial issues receive adequate support for developing their primary and secondary sectors. Much of the foreign aid received by Greece was used for strengthening the market conditions and for servicing the debts which had been taken. A very small portion of the financial aid was used to economic restructuring. This is one of the main reasons why the nation of Greece has not been yet able to improve their economic conditions. Reference List Arghyrou, M. G. and Tsoukalas, J. D., 2011. The Greek debt crisis: Likely causes, mechanics and outcomes. The World Economy, 34(2), pp. 173-191. Burnside, C. and Dollar, D., 2000. Aid, policies, and growth. American economic review, 1(1), pp. 847-868. De Grauwe, P., 2010. Crisis in the eurozone and how to deal with it. London: Centre for European Policy Studies. Dieckmann, S. and Plank, T., 2012. Default risk of advanced economies: An empirical analysis of credit default swaps during the financial crisis. Review of Finance, 16(4), pp. 903-934. Easterly, W., 2002. How did heavily indebted poor countries become heavily indebted? Reviewing two decades of debt relief. World Development, 30(10), pp. 1677-1696. Economou, M., Madianos, M., Peppou, L. E., Patelakis, A. and Stefanis, C. N., 2013. Major depression in the era of economic crisis: a replication of a cross-sectional study across Greece. Journal of affective disorders, 145(3), pp, 308-314. Eroğlu, Ö. and Yavuz, A., 2012. The role of foreign aid in economic development of developing countries. Economic Development and Cultural Change, 18(1), pp. 313-27. Karanikolos, M., Mladovsky, P., Cylus, J., Thomson, S., Basu, S., Stuckler, D. and McKee, M., 2013. Financial crisis, austerity, and health in Europe.The Lancet, 381(9874), pp. 1323-1331. Katsimi, M. and Moutos, T., 2010. EMU and the Greek crisis: The political-economy perspective. European Journal of Political Economy, 26(4), pp. 568-576. Matsaganis, M., 2011. The welfare state and the crisis: the case of Greece. Journal of European Social Policy, 21(5), pp. 501-512. Milios, J. and Sotiropoulos, D. 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The recent economic crisis in Greece and the strategy of capital. Journal of Modern Greek Studies, 28(2), pp. 321-348. Von Hagen, J., Schuknecht, L. and Wolswijk, G., 2011. Government bond risk premiums in the EU revisited: The impact of the financial crisis. European Journal of Political Economy, 27(1), pp. 36-43. Read More