Nepal is becoming an aid dependent country. It is because of its limited resources to invest in socio-economic development. Infrastructure projects require huge investments that the government is incapable of. “Successful development requires public investments, but governments in impoverished countries are often too cash strapped and too indebted to finance the requisite investments. When the government is unable to build the roads, power grid and other basic infrastructure the private sector languishes the result in a fiscal policy trap in which poverty leads to low public investments and low public investments reinforce poverty. This kind of fiscal collapse is one of the most important causes of economic development failures in the poorest countries” (Sachs, 2008 p.223). In Nepal, the private sector is reluctant to invest in infrastructure because of the long gestation period bound by the risk of political instability. This leaves the country’s economic development in the hands of foreign investment. 

 

All development activities in Nepal, small or big, have largely been influenced by foreign aid. Aid in the form of grants played an important role in the construction of infrastructure projects and in the establishment of some of the key basic industries in the beginning. But foreign assistance in the form of grants has been changing over time. Grant at large is being replaced by loans as bilateral donors are gradually changing into multilateral. In this context this article aims to investigate the causal relationship between GDP and foreign aid in the short and long run. In the Nepali context, similar studies were conducted to investigate the causal relationship between energy and electricity consumption and GDP (Dhungel 2008, 2011), and the causal relationship between GDP and other macroeconomic variables such as remittance, export, and tourism earning (Dhungel, 2012). 

 

After World War II, foreign aid has played a significant role in meeting the financial requirements of developing countries of the world. Aid was invented to rebuild Europe and it worked (Collier, 2007 p.106). In the beginning, it was flown to construct war devastated infrastructure. Slowly, it was transformed from constructing war devastated infrastructure towards developing new infrastructure projects such as road, bridges, powerhouse, and airports and so on with the aim to improve economic development of backward countries. Nepal started receiving foreign aid from the beginning of mid twentieth century as a poor country and its volume increased over the years. More specifically, Nepal has been a recipient of foreign assistance since 1952 when it joined the Colombo plan for Cooperative, Economic, and Social Development in Asia and the Pacific. Agriculture, transportation infrastructure and power generation absorbed major part of the assistance received in the form of grants while the remainder was invested in other sectors that included industry, communication, education and health. India and USA were the major donors followed by China, Russia, Switzerland, Australia and New Zealand. During the 1950s, many Nepali students received Colombo Plan scholarship for studying various technical and professional courses in different countries (Wikipedia.org). 

 

 

Development projects, until the mid-1960s were totally financed by foreign grants that were based on bilateral cooperation. Table 1 presents some of the worthy projects operated under grant.

 

From the beginning of 1960s, Nepal borrowed from multilateral sources also but the size and extent of the loans as compared to bilateral grants were negligible. 

 

 

Rate of change of foreign aid over each decade is diminishing, however, the rate of increase in the volume of aid is alarming (Table 2). Historical data further make it lucid that foreign aid in the 1980s was Rs. 17.9 billion up from Rs. 1.7 billion in 1970s, a rise of 952.9%. This figure in 1990s and 2000s has reached Rs. 68.5 billion and Rs. 181.2 billion with the percentage change over each decade is 281.8% and 164.5% respectively. 

 

The Maoist insurgency started in 1996 and ended in 2006. In the beginning, the insurgency affected three hill districts of Mid-western Development Region which later in 2000 spread all over the country. Since then the country swirled into a conflict trap stalling almost all the infrastructural development activities. The resources had to be diverted from development to defence during the war and to restoring peace after the war which is yet to be achieved. During the war (1996-2006), Nepal received a total of Rs 167.8 billion as foreign aid which surpassed the total amount received in three decades - the 70’s, 80’s and the 90’s. And the trend of post-conflict foreign aid has sprinted over to Rs. 131.1 billion during 2007-2011 period. This amount, received during a five year period, is nearly the amount received during the ten years conflict period.  “In more recent times, the mistake with aid to post conflict situations has been that it has become too little and too soon. Yes too soon. The peace settlements hit the media and politicians hit their check books. Aid floods-in in the first couple of years then rapidly dies up” (Collier, 2007 p.106). Opposite to Collier’s statement, Nepal has been receiving aid continuously from both bilateral and multilateral sources at an increasing rate after the restoration of peace. 

 

The country is in political deadlock due to lack of consensus and constitution. After four years the first constituent assembly had dissolved without delivering a new constitution. Many constitutional entities are without constitutional head. The government has no power to fill in because of the lack of consensus among political parties. Viewing from this angle, it can be said that the government has a head but no heart to function properly. Nepal is getting worse over time. Lack of a proper leader with good vision and farsightedness has pushed the country into unknown crisis. The system has broken. Inefficient are promoted while efficient suffer. There are no jobs thus masses of youths fly abroad daily in search of green pasture. There is a lack of good governance while rule of law is absent out of order and is crowded out by anarchy. Corruption is rampant.  The corruption index in 2014 was 29 on a scale of 0 to 100 where 0 indicates most corrupt and 100 indicates very clean (Transparency international 2014). Controlling measures are deliberately forced and overridden by the political power. The economic policies, if any, conducive to investment through foreign capital are based on the liberalized economic system. Market is unable to capture their universal economic law which is considered prerequisite for liberalized economic system to function. Governance and policies can make the role of market effective. But the political uncertainties cripple these economic laws.