eThesis - Kauppakorkeakoulun sähköiset gradut

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The effectiveness of foreign aid has been studied from various perspectives. The current aid system has come under a lot of criticism and the relevance of aid giving in eradicating extreme poverty has been widely questioned.

Even though aid has been found to have a strong, positive impact on growth, there is a concern about other possible effects. Among them is the concern about its impact on aid receiving country government’s fiscal discipline. However the research done to date does not properly take into consideration that there exists a variety of aid instruments, which might have different impact.

This thesis addresses the question, whether foreign aid has an impact on fiscal discipline of the aid receiving country’s government, and whether different aid instruments differ in this respect. It is first shown theoretically that the traditional forms of aid, which are managed outside the government budget, distort incentives to maintain fiscal discipline, whereas supporting directly government budgets strengthens the budget process and so results in greater fiscal discipline.

The empirical part further tests the hypothesis. Fiscal discipline in terms of debt sustainability under the two aid systems is assessed for 11 Sub-Saharan African countries. Data has been collected from various publicly available sources. The debt sustainability computations indicate greater fiscal discipline in the sample countries since they receive budget support.