Foreign aid and trade competitiveness in SAARC

This paper examines the nexus of foreign aid and real exchange rates of SAARC countries in the phase trade liberalization using cointegration and vector error correction methodology employing annual data from 1971 and 2008. Although foreign assistance in less developed countries is primarily aimed to alleviate poverty by reducing the domestic resource investment gap, however, the flow of aid may generate some unintended adverse consequences on the international competitiveness of the recipient country and lowers the expected gains. Our results suggest that aid tends to improve the trade competitiveness of the major SAARC countries, only with the exception of Nepal and Maldives. While the openness in trade regime and devaluation significantly improves international competitiveness; increased terms of trade and government consumption of nontradables deteriorates the trade competitiveness for some of the countries. Our results also suggest that prudent macroeconomic policy that keeps nominal exchange rate of a country favourable for its export sector can be a potent measure in enhancing the international trade competitiveness and escaping 'Dutch disease' in the economy.