Fiscal Effects of Aid in Rwanda

Abstract

This paper analyzes the dynamic relationship between foreign aid and domestic fiscal variables in Rwanda using a co-integrated vector auto-regressive model for quarterly data over the period 1990Q1–2015Q4. The results show that aid and fiscal variables form a long-run stationary relationship and that aid is a significant element of long-run fiscal equilibrium and the hypothesis of aid exogeneity is not statistically supported; anticipated aid appears to have been taken into account in budget planning. Aid is associated with increased tax efforts, public spending, and lower domestic borrowings. Aid has contributed to improved fiscal performance in Rwanda, although the slow growth in tax revenue and regular aid shortfalls has prevented sustaining a balanced budget inclusive of aid. In terms of policy, continued efforts by donors to coordinate aid delivery systems, make aid more transparent, and support improvements in government fiscal statistics will all contribute to improving fiscal planning. Recipients need to know how much aid is available to finance spending and how this is delivered, that is, whether through donor projects or government budgets.