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November/December 2012, 
Vol. 94, No. 6
Posted 2012-11-01

Do Countries with Greater Credit Constraints Receive More Foreign Aid?

by Subhayu Bandyopadhyay, Sajal Lahiri, and Javed Younas

Donor nations may recognize that some developing nations face credit constraints in the world capital market. This knowledge may prompt donors to increase aid flows to alleviate the constraint. In such a situation, flows of foreign aid and foreign loans to developing nations may be substitutes for each other. The authors use data from 114 aid-recipient countries over the 1997-2008 period to investigate the relationship between foreign aid and foreign loans. The central finding is that this relationship is negative, lending support to the substitution hypothesis.