Foreign Aid and Growth in Nepal: An Empirical Analysis

Using cointegration and error correction mechanism, this paper investigates the effectiveness of aid in Nepal during the period 1983-2002. Specifically, it examines the long-run relationship between aid and per capita real GDP. To address the current debate on whether aid works only in a good policy environment, we have included policy variables for macroeconomic stability, financial sector development and openness in an extended model. The results show that foreign aid has a positive and statistically significant effect on per capita real GDP in the long-run. More importantly, aid effectiveness improves in the presence of good policy environment.