Foreign Assistance and Domestic Financial Markets in the Developing Countries

This paper explores the impact of foreign financial assistance on the promotion of domestic financial markets in the developing countries. It claims that the disbursing of large amounts of foreign aid may be a more complex exercise than is usually recognized. The paper reviews the debate on the impact of foreign financial assistance on domestic savings flows and on the efficiency of investment. It explores the role of financial markets in economic growth and the elements of efforts to promote the development of those markets. Finally, it examines the role of foreign inflows in the process of adjustment to external shocks. From a new political-economy perspective, that explains fiscal crises in terms of the accumulation of entitlements to income transfers, it claims that the elasticities of response to adjustment programs are not independent of the amount of foreign aid received. By bailing governments out, aid allows otherwise unsustainable entitlements and distortions. The concepts are illustrated with a review of the Central American experience in the early 1980s