The Impact Of Foreign Aid And Foreign Debt on the Economic Growth in Somalia

ABSTRACT

The inflows of foreign debt and foreign aid in the post-war period had grown significantly in developing and underdeveloped countries, and Somalia is no exception. For several decades Somalia has been receiving foreign capital by debt or by aid. The study sought to find out to what extent do foreign debt and foreign aid have an impact on economic growth in Somalia. The Ordinary Least Square (OLS) method was used. The result was that foreign debt has an insignificant effect on economic growth, while foreign aid has a positive significant effect on economic growth, which indicates an increase in foreign aid will cause an increase in economic growth. The study identifies many obstacles Somalia faces when it comes to the utilization of foreign funds. The study concludes by proposing several recommendations to counter these obstacles.

Keywords:Economic growth, Foreign debt, Foreign aid

1. Introduction

For the past hundred years, developed countries had been providing debts and aids to developing and underdeveloped countries. The purpose of these debts and aids is to improve the economic performance of these countries. Foreign capital was used to build industries, infrastructures, security, the army and the service sectors. after receiving foreign capital in the form of debt or aid, many underdeveloped and developing countries started to experience some kind of growth. The main cause of foreign debt and foreign aid is that underdeveloped and developing countries have a high imbalance of revenue and expenditure. Most developing and underdeveloped countries only maintain approximately 30% of their expenditure, where the other 70% comes from foreign capital (Haider, 2014)

The lack of savings and trade deficit in underdeveloped and developing countries also cause low capital, to fill these gaps, countries need to borrow from other countries, mainly from developed countries (MOREIRA, 2005) foreign aid is a type of Official development assistance (ODA) that involves the transfer of resources from industrialized to underdeveloped countries through concessional loans. The impact of foreign aid on developing countries' evolutionary processes is a hot topic of discussion. (Abdulkadir, 2018)

The effectiveness of foreign debt and foreign aid is a subject of huge debate. For the past several decades, several research and studies have been conducted in the areas of foreign debt and foreign aid whether they promote economic growth or not. As mentioned earlier, that this is a subject of huge debate, there is no consensus on the outcome of each study. Studies normally produce three outcomes: negative, positive and mixed-effects (Ismail, 2016)

During our research, we found out that the success of foreign debt and foreign aid is hugely influenced by the government and its institutions. This has also been found in other studies. Good macroeconomic policies and good state institutions are needed for foreign debt and foreign aid to succeed. Also, in rent-seeking societies, foreign debt and foreign aid may affect economic growth negatively because governments are not accountable and foreign debt and foreign aid will be misused (Haider, 2014)

Problem statement

Somalia has been taking loans from countries and international financial institutions (IFI) for several decades, a total of $5.2 billion. With receiving that huge amount of capital, the country is on the negative sides in all indexes, from corruption to Human development index (HDI). As we will see in our study, the main problem comes form week governmental institutions and week macroeconomic policies. This amount of capital could dramatically transform the country from an underdeveloped level to a developing level, only if these funds fall into the right institutions with the right policies.

Purpose of the study

The purpose of the study is to evaluate how foreign debt and foreign aid had impacted Somalia's economic growth. The study focuses on what causes the outcomes and what possible steps could be taken.

Objectives of the study

1) To evaluate the impact of foreign debt on Somalia's economic growth
2) To evaluate the impact of foreign aid on Somalia's economic growth
3) To propose suitable solutions on how Somalia can use both foreign debt and foreign for their process of economic growth

Apart from section 1, the paper is structured as follows: in section 2 we will discuss the literature review of these topics. In section 3 we will describe the methodology, data analysis, and empirical findings. In our last section, we will conclude.

2. Literature review

The literature on this topic is large, many studies had been conducted concerning foreign debt and foreign aid and their impact on economic growth. In our review, we will review the literature of each variable individually and its impact on economic growth.

(Hayat, 2010) examined foreign debts impact on Pakistan's economic growth, with data collected from the period of 1971 to 2005 and by using time series of econometric techniques, their result was that foreign debt had a negative impact on economic growth and significantly related to economic growth and that foreign debt will only increase economic difficulties. (Anderu, 2019)in their study on Iran, founded out that foreign aid has a negative impact on economic growth. In their study, they used the Vector Autoregression Model (VAR).

(Rauf, 2017)explored foreign debt's impact on growth in Pakistan. With annual data from 1972 to 2013 and by using the ARDL econometric framework, the result shows that foreign debt has a positive impact in the short-run, but a negative one in the long run. (Munzara, 2015) assessed Zimbabwe's foreign debt, by considering data from 1980 to 2013 and by using ordinary least squared regression, the final results had shown that foreign debt negatively impacts economic growth. (Boboye, 2012) examined the impact of foreign debt on economic growth and development, by adopting regression analysis, which indicated that foreign debt had an adverse impact on growth. With high external debt, evaluation of the currency, increase retrenchment of workers, continuous industry 6strikes and poor educational systems would be experienced.

(Durbarry, 1998) studied foreign aid's impact on economic growth. By using the augmented Fischer-Easterly type model, they founded out that foreign aid has a positive impact on economic growth in the least developed countries (LDC). But they conditioned it on a stable macroeconomic policies environment. (MOREIRA, 2005)explored the impact of foreign aid on economic growth in a cross-country study. By using the Papanek-type regression, the study concluded that in the long run, foreign aid has a positive impact on economic growth. Ekanayake and (Masha, 2017)assessed the impact of foreign aid on developing countries, using data from 1980to 2007 in 83 countries, the study founded that foreign aid has a mixed impact on economic growth. The study also founded that the impact differs when it comes to a different period, different geographies and incomes.

(Carl Johan, 2004)studied the empirics of foreign aid on growth. The result of the study was that foreign aid has a positive impact on economic growth and productivity. (Girijasankar, 2008)assessed foreign aid's effect on growth in the six poorest countries in Africa. By using counteraction analysis, the study founded that foreign aid negatively impacted growth in the long run.

3.0 Methodology and Data

3.1 Concept Frame work

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The frame work of this paper consist three variables foreign aid, foreign debt and economic growth, while economic growth acts as dependent variable, foreign aid and foreign debt act as independent variable, the relationship between foreign debt and economic growth can either be positive or negative dependence on whether the debt is efficient exploit or not (Munzara, 2015),and another research it concluded that the foreign aid have significant effect on the economic growth (Sheikh Ali, 2018)

3.2 Model Specification

The model specifications for investigating the links between foreign aid and foreign debt on economic growth are explained in this section. This study utilities the ordinal least square (OLS) model to estimate the link between them, and the functional relationship between the foreign aid, foreign debt on the economic growth.

EG=F (FA, FD)

Where EG the economic growth F is the function of the economic growth, FA is foreign aid and FD is foreign debt.

the Model equation are expressed like this:

EG =ßt +FAßt + FDßt + e

EG is the economic growth; FA is the foreign aid; the FD is the foreign debt;ß0,ßi are donated as the slopeof the regression equation; and Edenotes the stochastic error term.

3.3 study hypothesis

Study hypothesis is as follow,

Ho =ßo =ßi = ß:j,= 0 Or there is no linear relationship between the variables (FA,FD) and the respond variables (economic growth)

Ha= ßo *ßi^ßz^0 Or there is a linear relationship between the variables (FA,FD) and the respond variables (economic growth)

3.4 data description

The annual data used for this study were obtained from the the statistical, economic and social research and training centre for Islamic countries (SESRIC),

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4. Data analysis

4.1 Descriptive analysis

Table1. Descriptive analysis

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GDP per capital has the highest accuracy returns of 1.18E+09 while foreign aid(AID)have the lowest average return of 621.0752 while foreign aid (AID) the has the lowest volatility in a 514.2334,as regards to the volatility of the variables GDP current price have the highest volatility of 2.20E+08 (as measured from stander deviation).

4.2 simple linear regression

Table 2. Ordinary least Squares (OLS) regression

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The regression result for GDP (economic growth),AID (foreign aid) and FD(foreign debt) in Somali economy from 1989 to 2019 are represented in table1.the value R-squared is good indicator for reliable data, the value of R-squared is 0.79 or 79% variation in the dependent variable (economic growth/GDP) was explained by the independent variables (F rrrr5r5D and AID) in this model. while F-test of the result of the table1provides that foreign aid ,foreign debt have significant influence in the economic growth since F (2, 28)=53.97901,P-value(F)= 0.00000, this paper also tests the single significant of the coefficient and it marked that AID(foreign aid) is statistically significant of 0.05% and this imply that the AID is statistical significant and have positive impact on GDP, which means that as AID increase GDP also increases, the other coefficient, however was statistical insignificant.

4.3 trend analysis.

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This section of the paper undertake the trend analysis of three variable the figures shows the period in Somalia from 1989 to 2019 the average value of the AID(foreign aid) in Somalia during that period was 621.0752 with minimum of 81.18 and the maximum of1760.37 in 1989 Somali AID(foreign aid) was 676 up 2019 the AID(foreign aid to)was 1933 it have been a good overcome in the previous years, however in the FD(foreign debt) the chart shows that in Somali from the period 1998 to 2019 the average mean of the FD for Somali was 1888.225, with the maximum of the 32220.3 and the minimum of the 32.18 but the furthermore figure shows that in the period of 1989 the FD was 13960 but in the 2019 the FD have been decreased to1966, finally the GDP(current price) in Somalia from period 1989 to 2019 the average mean of the GDP(current price ) was 1.18E+09 with maximum of the 1.61E+09 and minimum of th8.65E+08e and in other chart in the period of the 1989 the GDP(current price ) was 18756 and in period of the 2019 the GDP(current price ) was 31229 in Somali.

4.4 Correlation Analysis

Correlation coefficient shows the degree of the relationships between the two variables, correlation matrix in the tables shows the correlation coefficient between the set of variables, and it toked by the tables below.

Table3. Pairwise correlation and significance test

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After the analysis it shows that the correlation matrix of the set up variables and it shows that FD(foreign debt) and GDP(economic growth) have positive correlation coefficient (0.05) and FD(foreign debt) have negative relationship with AID (foreign aid) correlation coefficient (- 0.12)and GDP(economic growth have strong relationship of (0.85) with AID(foreign aid).

4.5 Model Diagnostic Tests

4.5.1 Normality Test

The classical linear regression model was used to test residual normality. The residues tracked a normal distribution.

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Figure 2. Jarque-Bera normality test

The found of this normally histogram distribution of the study and the from the of the test the probability of the jarque-bera test state that there is normally distribution because of probability of jarque-bera (0.4542) test is greater than the 5 percent which means the we will accept the null hypotheses that the population residual (u) is normally distributed which fill the assumption of great regression line.

4.5.2 Autocorrelation

Series correlation (autocorrelation) is statistic term of used to describe the situation when the residual is correlated with legged value of itself.

Table 4. Breusch-Godfrey LM test for serial correlation.

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The p-value (0.0246) of the Obs*R-squared is less than the 5 percent, we reject the null hypotheses which means that the residual (u) are serous correlated.

4.5.3 Heteroscedasticity test

Heteroskedasticity Test: Breusch-Pagan-Godfrey

Table 5. Breusch-Pagan test for heteroscedasticity

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Heteroscedasticity test determines the variables of the residual from model is not constant, but from the finding of the tables above, the p-value of Obs R-squared (0.4564)shows that we cannot reject null. So residuals do have constant variance which is desirable meaning that residuals are homoscedastic

4.5.4 Multi-colinearity test

We use variance inflation factor (VIF)

Table 6. variance inflation factor

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The foundation of this table state that multi-co linearity of the independent variables concluded that the VIF is no molt-colinearity because all the independent variables have less than minimum VIF

5. Conclusion and Recommendation

The main purpose of this research paper was to analyze the impact of foreign debt and foreign aid on economic growth in Somalia. With data collected from the Statistical, Economic and Social Research and Training Centre for Islamic Countries between 1989 to 2019. TheR2of the model was 79% which shows that our model fits the data: the variation of the dependent variable (GDP) is well impacted by both independent variables (foreign debt and foreign aid).

For a general significance, the F-statistics was used. The outcome was that p-value(0.00000) were significant. Based on individual P-values, the research showed that foreign aid was significant with p-value (0.0001) where foreign debt was insignificant with p-value(0.0656). The result shows that foreign aid has a positive strong relationship with economic growth, which means an increase in foreign aid will increase economic growth.

Somalia has been receiving foreign aid from international donors for many years, although foreign aid did positively affect economic growth, the expectations of growth were not met due to several reasons and are still holding the country back.

We recommend firstly, the government must make tackling corruption a priority and come up with a zero-tolerance policy against it, not only internally but also externally because most of the capital that is meant for Somalia doesn't reach its intended destination. Secondly, sound accountable institutions for carrying out economic activities by utilizing funds and capital in the right way are needed. Thirdly, prudent macroeconomic policies are needed to be laid down by governments in order to make out the best of available funds and capital.

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