Aid, Inflation, And Exchange Rate In Sub-Saharan Africa: Empirical Insights from Panel Vector Error Correction Model (PVECM) Approach

Abstract

The quests for aid arise when developing economies lack inadequate fund to embark on long-term development projects that will promote growth. Generally, aid inflow is expected to lead to capital formation and growth in the sub-Saharan African countries (SSA). The high unemployment rate, poverty rate, and weak growth still witnessed in the region, questioned the exact role of aid. This paper investigates the effect of aid on inflation and exchange rate in 35 sub-Saharan African countries (SSA) between the periods 2000 to 2016 by employing the panel vector error correction model (PVECM) approach following the co-integration properties of the variables. The variables used in the study are aid (official development assistance), inflation rate (INF), and real effective exchange rate (REXR). Control variables such as import as a percentage of GDP (IMPORT), investment as a percentage of GDP (INV) and export as a percentage of GDP (EXPORT) was also employed in the study. Findings from the study revealed that the variables are cointegrated i.e. has a long-run relationship. The outcome of the study also revealed that aid flow is associated with the depreciation of the real exchange rate in the region (SSA). In addition, the study showed that a shock in aid flows would cause a rise in the inflation rate in the region. The study also revealed that a rise in aid would lead to an increase in investment and export in the region (SSA). Furthermore, the study revealed that a shock in aid would cause a rise in import. Based on the result of the study, the study recommends the need for government in the region to determine the optimal aid that will ensure growth and eradicate/reduce poverty in the SSA region. Also, the development partners should assess the monetary conditions of the recipient’s economy before the disbursement of aid. Furthermore, the governments in the region are encouraged to utilize the inflow of aid in the importation of capital goods so as to increase the competitiveness of their export in a bid to improve the standard of living of the populace, eradicate poverty and foster growth in the region.

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