Foreign aid in South Asia : support or struggle to foreign trade?

This paper attempts to examine the effects of foreign aid on the trade competitiveness of South Asian countries over the period 1971 to 2006. Using cointegration and error correction methodology, this study investigates the long run and dynamic relationship between aid and real exchange rates of four South Asian countries to assess the aid effectiveness through the changes in competitiveness in the phase of their trade liberalisation efforts. Our results suggest that the flow of aid tends to depreciate the real exchange rates of major South Asian countries in the long run. While the econometric evidences indicate that openness in trade regime significantly improves the competitiveness of export sector in the long run, increased government consumption has different effects for different countries. The result is mixed for short run effectiveness of foreign aid in regards to the explanatory variables used in the model. In terms of policy measures, our results indicate that the nominal devaluation can be a useful means to enhancing the trade competitiveness of the countries included in this study in the short run.