Foreign aid, exchange rate regime, and agricultural trade

Abstract

The least developed agrarian countries often face an ironic situation where well‐intentioned foreign aid adversely influences their economies. This study explores the unintended consequences of official development assistance (ODA) from donor countries on agricultural exports from recipient countries by appreciating their domestic exchange rates. Motivated by the fact that ODA accounts for a larger share of their total GDP, we first examine whether ODA inflows increase the real effective exchange rate of the recipient country. Leveraging data from 47 countries over the period 2001–2018, we find that ODA inflows lead to real exchange rate appreciation, particularly in recipient countries with floating exchange rate regimes that are more susceptible to exchange rate fluctuations. Moreover, our results reveal that ODA inflows decrease agricultural exports in low‐income agrarian economies adopting floating exchange rate regimes. By taking a unique perspective of ODA as an inflow of foreign capital, this study highlights the importance of understanding the exchange rate regime and agricultural trade of the agrarian economy when providing international aid.