Grants vs Foreign Loans (A Comparative Study)

Grants vs Foreign Loans:

Grants from friendly Governments and Philanthropic organizations have been of immense help to developing economies in finding a part of their finance for development. The chief advantage of grants is that they have no aftermath of debt services. Some of the projects like health, sanitation, and education do not readily yield a direct return, but they are at the same time indispensable for economic development. Hence, grants from foreign countries are particularly suitable for such projects of low or uncertain productivity. However, grants have been justified even for those projects which yield direct returns. For instance, the U. N. Repost on Methods of Fiancing Economic Development in under-developed countries observes that in the poorer or more backward areas, some of the basic economic projects, such as highways construction, land clearing irrigation, and similar essential facilities cannot properly be made the subject of loans because the burden of servicing the loans would be too heavy in the light of the economic capacity of the country and the expected returns.”

In spite of the clear advantage of grants over loans, the recipients hesitate to accept them because of the fear that grants would give the donor countries some excuse for interfering in domestic, political, and economic affairs. Being suspicious of the motives which prompt gifts and grants, developing countries sometimes prefer loans to grants. The sense of independence and national pride also sometimes makes them prefer loans that will be ultimately repaid with interest.

Besides, the majority of donors are budget minded and are not whole-heartedly in favor of offering grants which is a giveaway programme. They prefer to give loans that will be repaid with interest in the future. By giving loans they are simply parting with their liquidity and not their assets. In the long run, hard loans would leave the leading countries better off than would an equivalent grant. In recent years there is a tendency among developed countries to advocate loans in preference to grants. They give the following arguments in support of this approach.

In the first place, the requirement to repay will compel the Governments of recipient countries to plan more thoroughly and select projects more carefully than would a giveaway programme.

Secondly, loans are preferred to grants in order to build up a revolving fund out of the loans rapidly for continued foreign assistance to under-developed countries.

Thirdly, the burden of servicing the debt need not be feared. “If loans flow in a steady and increasing stream from the advanced to under-developed countries, as the United Kingdom leading moved during the 19th century, no problem of repayment need arise. In the early stages, the servicing of old debts was financed by new loans. If this process continues until under-developed countries have raised their output sufficiently to permit net repayment, loans need be little more burden-some than grants.”

Another problem associated with foreign grants is the political strings attached to them. The direction and volume of aid in the form of grants have been influenced more by political factors and less by economic considerations. It appears that economic reasons determine the amount of grants given each year and political motives decide the direction of grants.

It can now safely be concluded that foreign investment can contribute to the development of backward countries only if the such flow of capital is not accompanied by relaxation of the domestic saving effort. Its efficiency will depend upon domestic policies designed to restrict consumption and channel such resources into capital formation. It is an uncertain source of development finance since the availability of external finance depends upon the political relations and international situation which are dynamic in character.