Impact of Foreign Aid on Economic Growth of Nepal: An Empirical Evidence

Abstract

This paper examines the impact of foreign aid on economic growth in Nepal by considering time series data of the last forty years from 1975/76 to 2015/16. Foreign aid's impact on Nepalese economy was explored with Gross Domestic Product (GDP) as the dependent variable against few selected independent variables such as foreign aid, remittance, investment, labor force and lagged GDP. The study used partial adjustment model to analyze the impact of foreign aid on economic growth and further applied Chow test to examine whether there is a structural breakthrough in the economy. The results indicate that foreign aid has a positive relationship with GDP. However, the relation is not significant since higher volume of foreign aid seems to be used in humanitarian and social welfare rather than production activities in the real sectors. From the Chow test, it was found that foreign aid-GDP relationship has not undergone a structural breakthrough in Nepal over the last forty years' period. In light of such empirical findings, it is suggested to the government policy makers to allocate the foreign aid on productive sectors and human capital formation activities with special focus on capital expenditures to achieve the high rate of economic growth in order to meet the periodic plan and long term development goals.