Foreign Aid and Economic Performance in Tanzania

This study examines the impact of foreign aid inflows to Tanzania on macroeconomic variables such as the real exchange rate, export performance, government expenditure, investment and growth. The main hypothesis of the study is that aid inflows cause real appreciation. To test this hypothesis, we used comtegration techniques and an error-correction model to estimate the long-run equilibrium and the short-run real exchange rate, respectively. The estimated model results suggest that foreign aid inflows, openness of the economy and devaluation of the local currency lead to depreciation of the real exchange rate, while government expenditure tends to appreciate the real exchange rate. The study recommends that the correct policy response to the influx of foreign aid is to direct the aid to domestic productive investment in order to induce a positive supply response. The government should also reduce its expenditure and enhance economic liberalization.