Foreign aid, debt interest repayments and Dutch disease effects in a real exchange rate model for African countries

Ahmad Hassan Ahmad, Eric Pentecost and Marie M. Stack

Economic Modelling, 2023, vol. 126, issue C

Abstract: The international competitiveness of developing countries is integral to their economic development; hence understanding the main determinants of the real exchange rate is important. The empirical literature supports the Dutch disease hypothesis that foreign aid inflows significantly contribute to a real appreciation of African currencies, but these studies do not account for the downward pressure on the exchange rate from foreign currency payments. Using a panel of sub-Saharan African countries from 1980 to 2017, we test the hypothesis that the real exchange rate appreciation from aid inflows is moderated by interest repayments on external debt. Our findings suggest that one-third of the Dutch disease effect of aid inflows on the real exchange rate is offset by external debt interest repayments. These findings are important in showing that countries with external debt servicing obligations can mitigate the Dutch disease effect of aid inflows on competitiveness.

Keywords: Real exchange rate; Foreign aid; Debt interest repayments; Panel cointegration; African economies (search for similar items in EconPapers)
JEL-codes: F31 F32 F35 F41 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:126:y:2023:i:c:s0264999323002468

DOI: 10.1016/j.econmod.2023.106434

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