The Impact of Disaggregated Foreign Aid on Domestic Saving in Ethiopia

Abstract

This study investigates the empirical relationship between disaggregated foreign aid and domestic saving in Ethiopia over the period 1975–2017. An autoregressive distributed lag model (or bounds testing approach) and Granger causality are applied in the analysis. The empirical finding indicates that in the long run, gross domestic product and educational expenditures have a statistically significant positive effect on Ethiopia's gross domestic savings, while multilateral grants have a statistically significant negative effect. The findings imply that, in the long run, total aid crowds out domestic savings due to the fact that the negative impact of multilateral grants outweighs the positive impact of multilateral loans, bilateral loans, and bilateral grants. Moreover, the Granger Causality Test showed a bidirectional causality between domestic saving, bilateral grant, multilateral loan, and grant. This indicates that low levels of domestic savings attract high inflows of bilateral and multilateral loans and grants. Following that, the inflows of multilateral loans and bilateral grants improve the low level of domestic saving; however, the inflow of multilateral grants causes a reduction in domestic saving. On the other hand, there is a unidirectional causality that runs from domestic savings to bilateral loan inflows, indicating that low domestic savings are a cause of high bilateral loan inflows but not vice versa. The study's key policy implication for increasing domestic savings is that the government should improve the country's GDP growth and educational expenditures. Furthermore, the government must show increased concern for the end use of multilateral grants.