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The need for foreign capital for development can be understood through the dual gap analysis from

the following national income equation: Income = C + I + E M Since saving = income consumption, we have Saving = Investment +Exports-Imports Savings Investment = Exports Imports We have a gap in both the domestic sector and the foreign sectorie there is a dual gap

Traditionally the role of foreign borrowing has been seen by countries as a supplement to domestic saving to bridge an investment-savings gap and achieve faster economic growth. Foreign borrowing may also be viewed as a supplement to foreign exchange if, to achieve a faster rate of growth and development, the gap b/n foreign exchange earnings from exports and imports is larger than the domestic investmentsavings gap, and domestic and foreign resources are not easily substitutable for one another.

Foreign aid or ODA involves the unilateral transfer of resources from donor to recipient nations for the express purpose of promoting economic development. ODA does not include : 1.military assistance 2. Private contributions to charitable organization working in developing countries. Aid can take several forms: cash grants, commodity transfer, technical assistance, concessional portion of loans

Aid can be given for specific projects or for program support. Foreign aid can be dispensed bilaterally (government to government) or multilaterally (whereby donor nations pool their funds for aid programs administered through international organizations, such as the world bank or agencies of the UN)

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The moral basis- absolute, relative and the restitution argument The economic basis: help to cover a BOT deficit without adding to foreign indebtedness, promote economic growth and development-produce dividends for donor nations. Political motivations Strategic basis

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The underlying premise that donor governments are genuinely interested in alleviating poverty and improving living conditions in LDCs is challenged. Most aid is given on conditions Aid is seen as an unwelcome interference with the market mechanism Aid may be mismanaged Sometimes leaders are in personal aggrandizement through the creation of monuments Aid may have the potential for promoting development, but experience with aid has been disappointing.

The main forms of international capital flows to developing countries are: 1. Official flows from bilateral sources including developed and OPEC countries and the multilateral sources such as the WB and its two affiliates-IDA and IFC on concessional and non-concessional terms IDA is the soft loan affiliate of the WB which dispenses loans at very low interest rate with long repayment period to member countries

The IFC concentrates on encouraging private enterprise in developing countries by making equity investments-shares and bond 2. Direct private investment: VALCO, Uniliver 3. Commercial bank loans which include export credit.

The return to international assistance is the difference b/n the nominal value of assistance and the repayments discounted by the productivity of the assistance in the recipient country. In other words, the rate of return to assistance is measured in the same way as the return to any other investment

The benefit of assistance is the difference b/n the nominal value of assistance and repayments discounted by the rate of interest at which the country would have had to borrow in the capital market. The benefit of assistance is measured as a differential, as in cost-benefit analysis. It is this calculation that we shall refer to subsequently as the grant element or aid component of the capital flow representing something for nothing to the recipient country. If there is no difference in the terms of borrowing, then there is no grant element or aid attached to the capital transfer.

The value of the assistance may in turn differ from its benefit if the assistance is tied to the purchase of donor goods that differ in price from the world market price. If the prices are higher, this reduces the value of the grant element of assistance to below what it would otherwise have been.

The WB emphasizes five major points from its analysis and indicates five policy reforms for making aid more effective Analysis: 1. Financial aid works in a good environment 2. Improvement in economic institutions and policies are the key to reducing poverty 3. Effective aid and private investment are complementary 4. The value of devt projects is to strengthen institutions and the policies so that services can be delivered effectively.

5. Aid can nurture reform even in the most distorted environment- but it requires patience and a focus on ideas, not money Reforms: 1. Financial assistance must be targeted more effectively to low-income countries with sound economic mgt. 2. Policy-based aid should be provided to nurture policy reform where needed 3. The mix of aid activities should be tailored to suit the needs of the country and sectoral conditions.

4. Projects need to focus on creating and transmitting knowledge and capacity. 5. Aid agencies need to find alternative approaches to helping highly distorted countries.
Since the fundamental purpose of aid is the relief of primary poverty, assistance should be given only to countries that are committed to poverty reduction programmes and make progress towards certain targets-literacy, basic health care provision, reducing infant mortality etc.

FDI refers to the acquisition of real or tangible assets in a foreign country. The purchase of a domestic firm by a foreign investor, establishment of a new business in a foreign country etc The potential for profits provides the primary incentive for investment.

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The falling global demand for most of their primary exports often coupled with high level of external indebtedness Persistently small domestic investment and slow economic growth Small domestic markets Poorly developed physical infrastructure, often including difficult and expensive transport and communication links with the outside world Poorly skilled labour force Sometimes, political instability and in some cases, violence and civil strife.