# **_Aid shocks_**

**Finally we consider the impact of the volatility of aid.** In 2012, grants represented 18 percent of the country’s GDP and 55 percent of total government income. In 2008–12, they covered on average 85 percent of overall fiscal deficit excluding grants. Aid flows are generally subject to significant delays and are less predictable than other sources of revenue (World Bank 2012). Heavy reliance on this volatile source of income has been identified as an important risk to Burundi’s fiscal sustainability in the most recent Country Assistance Strategy and in the previous Public Expenditure Review. And the risk is unlikely to fall in the near future. In 2012, donors pledged US$2.5 billion in additional aid to support the country’s PRSP-II—more than double the originally anticipated amount (US$1billion).<sup>23</sup> Most of the aid will be in the form of grants and highly concessional loans, given the country’s high risk rating in the latest IMF-World Bank Debt Sustainability Analysis. Most donors reiterated their determination to tie continued support for the government to tangible improvements in the identified areas of reform including governance, corruption, democratization, and private sector development. Burundi has experienced sharp drops in donor disbursement before in response to deteriorating political situation or governance and fiduciary concerns.

**Other things being equal, grant shocks will reduce the government’s income on a one-toone basis** .<sup>24</sup> Delay in disbursement (negative shock) in any given year will reduce government revenue below the baseline projection, widen fiscal deficits, and increase gross financing needs. The deficit will be financed by new borrowing resulting in higher debt. A positive grant shock— disbursement over and above that projected in the baseline—will have the opposite effect on fiscal outcomes.

23 The World Bank accounts for nearly one-quarter of the total but other donors such as the African Development Bank, Belgium, the Netherlands, and Germany also remain important players (EIU 2013). Detailed negotiations are expected in coming months.

24 The impact of grant shocks on government revenue is assumed to be one-to-one, i.e., a $100 reduction in grants in time _t_ will reduce government revenue by $100 times the BIF/USD exchange rate in time _t_ . Based on the data (in USD) in 2008–17, a shock to grants is defined as the standard deviation of grants as a percent of GDP in time _t_ , and is assumed to be normally distributed with mean zero and a standard deviation estimated by the data (0.06). Grants before 2008 are an order of magnitude smaller than grants thereafter, and using a longer time series would have exaggerated the estimated volatility in grants. The projected exchange rate in the baseline is used to convert grant shocks to the local currency equivalent and as percent of total revenue. As before, we abstract from other possible changes like fiscal adjustment and exchange rate depreciation. The results must be interpreted with caution. The shocks are calibrated on a very short time series. The historical volatility in grants may, on one hand, underestimate the true fiscal impact because it does not capture delays in aid disbursement within year, but on the other hand, overestimate the true fiscal impact because it reflects not only exogenous shocks (donor behavior) but also endogenous shocks (the government’s behavior, e.g., implementation of agreed reforms).

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