Dealing with scaled-up aid

• Author: Sanjeev Gupta/Catherine Pattillo/Yongzheng Yang
• Position: IMF African Department
• Pages: 128

Page 128

With the expected doubling of aid to Africa by 2010, the continent's policymakers will face a host of macroeconomic challenges. How recipients and their development partners can address these challenges was the focus of a workshop hosted by the IMF and the U.K. Department for International Development (DfID) in Washington April 19-20. African finance ministers, central bank governors and other officials, donors, academics, and representatives from multilateral development institutions took up seven issues that recipients of sharply increased aid are likely to deal with.

Appreciating exchange rates. Aid recipients can experience a large real exchange rate appreciation that reduces export competitiveness (Dutch disease). To offset such a loss of competitiveness, they can use aid to improve productivity. There is little evidence to date that large aid inflows have significantly reduced the competitiveness of African exports, but participants cautioned that policymakers should be alert to this phenomenon.

In certain circumstances, they observed, countries should use some aid to build up reserves.

Coordinating fiscal and monetary policies. Managing scaled-up aid will require effective coordination between different parts of government, especially central banks and finance ministries. It is often a challenge for policymakers to determine the appropriate trade-off between exchange rate appreciation and interest rate increases.

Increasing the supply response. There was a consensus on the importance of increasing the supply response to aid inflows. A strong response-in the form of improved productivity and higher employment- can mitigate Dutch disease. Countries will need to create a favorable business environment to attract both foreign and domestic investment and address supply bottlenecks, such as underdeveloped infrastructure and agriculture. Thus, they must strike a balance between spending aid resources on social and productive sectors...