Foreign aid, fiscal policy and growth nexus: evidence from Tanzania

This study investigates foreign aid, fiscal policy and growth nexus in Tanzania over the 1965-2004 periods. First, the study examines an econometric relationship between foreign aid, categories of government expenditure, structure of tax revenue, and economic growth, it also explores the impact of aid on revenue effort. Second, the study establishes the status of fiscal sustainability over the same period. In pursuing the first goal, the study applies time series econometrics techniques namely the Autoregressive Distributed Lag (ARDL), the impulse response, variance decomposition and Granger causality to analyze some of the fundamental fiscal variables affecting growth in Tanzania. The results from this model are that in the short run foreign aid, productive government expenditure and non-tax revenue are correlated with economic growth. These results suggest that in order to realize a self-sustained growth, the government should increase its budget towards targeted productive expenditure especially on education, health and economic services. The second major goal was pursued by applying the Present Value Budget Constraint (PVBC) approach to fiscal sustainability. The model was empirically tested by cointegration and the results indicate that over the same period of the study, fiscal sustainability in Tanzania has been weak. This implies that the government has been violating the Intertemporal Budget Constraint (IBC). The finding of weak fiscal sustainability indicates that if the current policies for deficit financing continue, the government could probably face further difficulties in financing its deficits in future as higher deficits could lead to misalignment of macroeconomic of macroeconomic of fundamentals. This could be mitigated f the government adopts a fiscal rue regime..