Should India Receive Development Aid?

(Cross-posted from The Morningside Post, November 18, 2011)

Last month, Japan announced that it will make significant cuts to its Overseas Development Assistance (ODA) program to other Asian countries, with the exception of one – India. Despite a declining economy and the twin calamities of the tsunami and Fukushima nuclear disaster, Japan has increased its commitment to fund development projects in India to the tune of $2.6 billion this year, making India the largest recipient of ODA funds from Japan for eight years in a row.

Japan’s decision underlines an important yet surprising trend in the murky and sometimes comical world of international development aid: as India continues to register strong economic growth and accumulates vast amounts of foreign reserves, it is rising to become world’s largest borrower of bilateral and multilateral development aid funds.

India’s sovereign external debt has risen steadily over the last decade to $ 78 billion, with an average growth of 18% over the last two years. Last year, India was the single largest borrower of funds from the World Bank ($9.3 billion) and the Asian Development Bank ($2.1 billion). Besides Japan, the UK too has been a longstanding bilateral donor to India. Notwithstanding the Euro zone crisis or its domestic budget cuts, UK recently announced a $1.6 billion aid package to India to be disbursed over next 5 years.

The other half of the story is even more interesting.

The Indian economy has grown at an impressive rate of 7 to 8% since 2000, resulting in growing national wealth and a rapid rise in government expenditure in infrastructure and social programs. Last week, India’s central bank reported a total of $320 billion held in foreign exchange reserves, making India the world’s seventh richest country by the size of its reserves, above Germany, South Korea, and France.

Over the past few years, India has steadily increased its aid commitments to countries in Africa and South Asia. This year, India confirmed its intention to join the ranks of big donor countries by announcing plans to set up its own development aid agency on the lines of USAID to disburse $11 billion in aid over the next five to seven years. If this wasn’t enough, India also decided to contribute $2 billion to the fund setup to fund bailouts of troubled Euro nations.

This paradox in India’s foreign aid policy has upset many analysts.

Writing in the Wall Street Journal’s blog, Rupa Dahejia questions the need for India to receive charity to build its roads when it can afford to splash money on Commonwealth Games, or for the World Bank to continue giving interest free loans to India when the money is more badly needed in the poorest nations of sub-Saharan Africa. The UK’s decision to extend aid to India was heavily criticized by its national media and politicians. Gerri Peev, writing for the Daily Mail, noted, “surely it is madness for us to be channeling precious funds to a country which… is the fourth largest economy in the world… and chooses to have prestige projects (nuclear and space programs) that are beyond our own means.”

Is India’s foreign aid policy really contradictory? Should India set its record straight, stop receiving outside development assistance and start financing its projects through its own money?  Perhaps not.

Even though India is amongst the world’s top emerging economies, over 40% of its population is still below the poverty line, far exceeding the number of poor in the entire sub-Saharan Africa region. In its 12th five year plan covering the period 2012 to 2017, the Planning Commission of India has outlined an investment need of $1 trillion in infrastructure. Undoubtedly, the government will face a tough challenge marshalling the resources to fund India’s development – social and economic – and will need to tap suitable external sources.

So the question boils down to this: What is the most efficient way for India to access global finance to fund its developmental needs? Against the popular perception, India receives very few grants or “free money”. Most of the development assistance channeled to India is in the form of long-term low interest loans.

It is true that unlike some countries, India has the option of raising funds directly from the capital markets by issuing sovereign bonds. However, India’s bonds do not receive the highest rating, and hence must pay a larger interest rate than bonds issued by the World Bank or ADB to raise funds that are eventually loaned out to borrowing countries. Simply put, it is cheaper for India to borrow from bilateral and multilateral donors than to raise funds directly. The difference in interest rates might not seem much, but adds up to significant amounts when the money being loaned runs into the tens of billions.

But what explains the fact that institutions like World Bank have steadily increased their loans to India, at the expense of funding other poor and more deprived nations?

The reality is that in today’s increasingly multi-polar world, countries tend to secure their interests through a complex web of bilateral relations and regional affiliations. Most multilateral institutions are battling to stay relevant, and see good reason in aligning themselves with countries like India that are fighting extreme poverty, yet have a significant say in shaping the future global economic order. Besides, with political turmoil in Africa and a deepening global economic crisis, India – with its excellent track record of debt repayment – is a more reliable borrower than other countries.

This leaves us with one final, and seemingly the most contradictory of India’s foreign aid policy decisions. If India is really serious about its development, shouldn’t it stop giving out vast amounts of aid to other countries, and use its scarce resources to fund its own road construction and anti-poverty programs?

India’s response here is better understood from the viewpoint of its national interest than a normative view of the country’s responsibility towards its citizens. Unlike the past, “bilateral aid” today is largely a political and diplomatic tool to advance the foreign policy interests of both aid-giving and aid-receiving nation. As India joins the league of the world’s top economies, it is eager to assert its dominance in the region and in the world. The world too sees a good trade partner in India, and is keen to have a counter-balance to the growing dominance of China. Hence it plays in.

Further, most critics who argue that India should spend all its money on internal development projects fail to acknowledge the biggest challenge that India faces – the sheer lack of capacity to implement large scale development projects. Earlier this year, in March 2011, India’s auditor general released an incriminating report which revealed that India is sitting on $2 billion worth of unused foreign aid for water supply and sanitation projects. In fact, during the period 2009-10, India ended up paying $16 million in fines to the World Bank and ADB for delay in utilisation of approved assistance.

“With such high foreign reserves and an open access to capital markets, surely India doesn’t need this money,” says Dr Arvind Panagariya, an economist and a professor at SIPA who teaches a course on Indian economy. Dr Panagariya is right. India doesn’t need this money, but it surely wants it. And the world has its own reasons to give it to India.