Fiscal Responses to Foreign Aid in Post-Conflict Rwanda

Abstract

This study examines the impact of different types of foreign aid on Rwanda’s fiscal policy in the post-conflict period, with a particular focus on public spending, tax revenue, domestic and external borrowings. Specifically, the study seeks to assess whether aid contributes to fiscal discipline or leads to fiscal profligacy. Using quarterly data from 1996Q1 to 2023Q4 and employing a Vector Error Correction approach, the findings reveal that foreign aid significantly enhances public spending and tax revenues while reducing reliance on domestic borrowing. Furthermore, foreign aid is negatively associated with external borrowing, which may reflect its role in filling financing gaps and reducing borrowing needs, the Government of Rwanda’s strategy to optimize financing costs by substituting aid for debt, or donor-imposed restrictions aimed at discouraging excessive borrowing and safeguarding macroeconomic stability. Budgetary grants, particularly non-earmarked budget support, have a stronger influence on capital investment than on recurrent expenditures, suggesting that Rwanda prioritizes domestic resources for operational costs and directs aid toward development projects. These findings challenge the notion of aid-induced fiscal laxity, showing instead that aid can support strategic fiscal management in post-conflict settings. Nonetheless, Rwanda’s unique context cautions against broad generalization to other countries with different governance and donor dynamics.