SCALING UP ODA FOR HIV/AIDS PROGRAMS IN DEVELOPING COUNTRIES: EXCHANGE RATE MANAGEMENT ISSUES John Serieux University of Manitoba 12:15 PM

HIV/AIDS – THE HUMAN DEVELOPMENT COST The Human Development Implication threaten all other aspects of development including MDG achievements and growth HIV/AIDS tends to entrench existing poverty and generate additional poverty Vulnerability/treatment costs/loss income 12:15 PM

HIV/AIDS – THE AID IMPERATIVE A challenge to decreasing child mortality 12:15 PM

HIV/AIDS – THE AID IMPERATIVE Direct loss of productive Capacity Loss of labor and human capital 12:15 PM

HIV/AIDS – THE HUMAN DEVELOPMENT COSTS Challenge to growth Lower productivity Loss of human capital, morbidity, turnover etc. Reduced savings Reduced foreign and domestic investment 12:15 PM

HIV/AIDS – THE HUMAN DEVELOPMENT COSTS The simultaneous challenges to human development and growth threaten to create a negative feedback mechanism 12:15 PM

ODA AND HIV/AIDS – THE FEARS DUTCH DISEASE UNSUSTAINABLE DEBT BURDENS AID DEPENDENCY AID VOLATILITY 12:15 PM

THE DUTCH DISEASE STORY An aid-induced real exchange rate appreciation causes the demise of the export sector in the recipient country Exceptions Underutilized capacity – the exchange rate effect is contradicted by a strong short-run supply response Productivity effects - the effect is undermined by a strong long-run supply response 12:15 PM

ODA AND HIV/AIDS - FEARS – DUTCH DISEASE Empirical Evidence of Dutch Disease? If it occurs it occurs at high levels of aid Evidence of slower growth in export sectors (relative to the non-export sectors) is not necessarily an indication of Dutch disease because it is consistent with the case of underutilized capacity 12:15 PM

ODA AND HIV/AIDS - FEARS – AID VOLATILITY Types of Volatility Disbursements not equal to Commitments Volatility in both commitments and disbursements Pro-Cyclical aid receipts Summary of the evidence The information content of disbursements is consistently poor Yet programming is based on commitments Aid is more volatile than revenues Most investigators find aid to be pro-cyclical 12:15 PM

ODA AND HIV/AIDS - THE POLICY ENVIRONMENT PRGF/PRSP related conditionalities result in certain preferences/biases in terms of macroeconomic policy Single-digit inflation levels A distaste for large current account deficits A bias towards reserve accumulation (in money supply management) A distaste for large fiscal deficits The effect appears to be a “preventive” rather than “corrective” macroeconomic management approach 12:15 PM

ODA AND HIV/AIDS - AN ORGANIZING FRAMEWORK Complete and optimal use of ODA flows would require Macro-absorption Requires and expansion of the current account deficit –increased imports Real exchange rate appreciation (or reduced rate of depreciation) may be necessary Spending Implementation of initiatives that go through the government budget Requires an expanded budget deficit Micro-absorption Direction of aid to its intended target Achieving high rates of return per aid dollar 12:15 PM

ODA & HIV/AIDS - Two Macroeconomic Approaches The Growth-First Approach Maintain the optimal macroeconomic environment for growth Protect the exchange rate and the inflation rate Maintain low to moderate fiscal and current account deficits The result is likely to be slow and careful build-up of aid The Human Development-First Approach Ensure that aid resources are used to the maximum of existing capacity Ensure that aid reaches its target and has the most immediate and powerful effect on HD measures Use macroeconomic policy to dampen volatility and moderate extreme price movements Rapid build-up and then sustain aid at required long-term levels (or at levels dictated by micro-absorptive capacity) 12:15 PM

Why a Human Development First Approach? The evidence suggests that, historically, countries have found it much easier to move from poor growth but good human development results to good growth and with human development than vice versa In short, the best way to protect the human development-growth cycle is to intervene from the human development angle That requires orienting policy towards optimizing micro-absorption outcomes 12:15 PM

A HUMAND DEVELOPMENT-FIRST APPROACH Aid levels should be dictated by micro-absorptive needs Macro-absorption and spending should allow for the requisite fiscal and current account deficits Long-term macroeconomic stability (as well as micro-absorptive efficiency) requires Building up a necessary reserve buffer to allow for predictable and sustainable spending flows in the face of exchange rate volatility 12:15 PM

A HUMAND DEVELOPMENT-FIRST APPROACH Exchange Rates and Macro-absorption In an HD-first approach, the only justification for less than full macro-absorption would be the need to create a reserve buffer But that will be necessary only during the initial scale-up period Full macro-absorption will require a real exchange rate appreciation (or reduced depreciation) initially, but it will be moderated by: increased demand for imports A short-term supply response (use of underutilized capacity) Long-run supply response (productivity increase) Reduced macro-absorption should only be contemplated if the appreciation is large and sustained Perhaps an indication that bottlenecks are inhibiting supply responses 12:15 PM

ODA AND HIV/AIDS - POLICY RECOMMENDATIONS Exchange Rates and Spending? Less than full spending of aid is justified only by the development of the reserve buffer In this case spending shortfalls should exactly match reserve accumulation to avoid the creation of domestic macroeconomic imbalances – no exchange rate effect Less than full spending may delay HD effects and likely compromises the micro-absorption Spending contraction can be contemplated if there is strong evidence of persistent micro-absorption failings (signaled by high and persistent inflation and real exchange rates) 12:15 PM

ODA AND HIV/AIDS - POLICY RECOMMENDATIONS What about Inflation? An increase in inflation is likely to be part of the economic response to an increase in aid – signaling changes in relative prices and what is, essentially, a positive exogenous shock This will be particularly true in the case of fixed exchange rates Like the exchange rate, only high and sustained inflation should justify policy intervention (since both are transitory) High domestic interest rates are the likely consequence of trying to maintain low inflation targets – it is not a benign effect and a case has not been made that it justifies avoiding transitory inflation A high interest rate may also encourage additional private inflows when the capital account is open (the case of Uganda) 12:15 PM