The Fiscal Effects of Foreign Aid in Lesotho

Lesotho has historically depended on foreign aid. This paper seeks to understand the fiscal effects of such aid inflows on Lesotho’s economy over the period 1982-2010. The cointegration test results indicate a strong negative long-run association between recurrent expenditure and foreign aid, and a positive but marginally significant relationship between aid and capital expenditure. These findings provide lack of evidence for the presence of aid fungibility since foreign aid is not diverted to non-development expenditure. The Lesotho Highlands Water Project also seems to have been effective in terms of changing government budgetary allocations and has had a positive impact on development spending. This supports the notion that provision of loans instead of grants results in an effective use of government funds. DOI: 10.5901/mjss.2016.v7n1p116