Effect of foreign aid on private investment: The case of Japanese ODA in Sri Lanka
Does foreign aid promote private investment? This study aimed at answering the above question by exploring the Japanese ODA and private investment relationship for the period of 1971-2009. Sectoral distribution of Japanese ODA clearly indicated that over two-third of Japanese ODA channeled into economic and social infrastructures. Moreover, Japan has provided debt relief grants in a number of occasions thereby reducing the pressure on debt repayment requirements. This study employs both descriptive and regression techniques and data were extracted from national statistical agencies as well as from World Development Indicators. Accordingly, the responsiveness of private investment to Japanese ODA is relatively larger compared to that of the overall ODA. One per cent increase in Japanese ODA-to-GDP ratio leads to 1.03 increase in private gross fixed capital formation-to-GDP ratio. In contrast, one per cent increase in overall ODA leads to 0.44 increase in private gross fixed capital formation-to-GDP ratio. It could be postulate that this differential effect is due to two unique features related to Japanese ODA. First, Japanese ODA has largely funded economic and social infrastructures. Those projects may have largely relaxed bottlenecks for private investment in the economy. These quality infrastructures may have increased productivity and profitability of private ventures thereby stimulating private investments. Second, as the evaluation studies widely documented, majority of Japanese funded projects were implemented efficiently and effectively thereby achieving the status of ‘satisfactory’ and ‘very satisfactory’ scores. Hence, our results suggest that Japanese ODA contributed to growth and development in Sri Lanka by stimulating private investments.