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# **Development Expenditures and The Local Financing Constraint**<sup>**1**</sup>

Inadequacy of local financing has been a major development financing problem in most low income economies, and is cited as a major factor undercutting aid absorption and "sustainability" of development projects. When inadequate local financing limits project implementation and effective aid absorption, it means that local currency funds are more valuable than project aid at the margin. Allocating local funds to leverage project aid resources becomes critical for aid productivity. Project screening and reviews of development expenditure programs need to pay as much attention to assessing the quality of projects financed fully by local funds, as those which are aided. Resource shifts from fully locally-funded projects that enhance the overall quality of public investments should be emphasized.

A fiscal adjustment program focused on matching aggregate resources against aggregate expenditures, while glossing inner local financing imbalances, stands to undercut the execution of the development expenditure program and to frustrate observance of other fiscal and financial benchmarks. A feasible program has to face the local gap directly by matching planned local fund spending against expected local fund receipts, and ensuring that planned development expenditures have adequate matching funds. Improving the local financing data base will help to develop indicators to monitor budgeting for and using local funds efficiently. Since economic growth provides scope to mobilize local funds by expanding the base for tax revenues, seigniorage and domestic borrowing, fiscal reforms need to protect high quality expenditure programs that expand the base for growth.

# **_I._** _The_ **_Importance_** _of_ **_Local Funds_**

1. For most low income economies, while external aid is instrumental for having access to capital for investment and growth, local funds are indispensable for facilitating the absorption of the aid and for ensuring that it is utilized productively. Yet, the inadequacy of local financing has been a major development financing problem over the past decades.2 Inadequate local financing has been an important factor, though not the only one, undercutting the "sustainability" of development projects; weaknesses in local financing were cited in over 60 percent of Bank projects identified as unsustainable in 1994 (World Bank, 1994a, 1995). A typical symptom of the local financing problem is the under-financing of recurrent costs. This is manifested in an inability to pay and retain skilled personnel; failure to maintain basic social and economic infrastructure; disrepair of equipment; and shortage of supplies to deliver services from projects, such as schools, health facilities, and agricultural extension schemes (Peter Heller, 1974; Uma Lele, 1975). Another symptom of the local fund problem is a lack of matching fumds even for high quality aided projects. This limits aid absorption and capital formation, and it

> Helpful comments and suggestions were received from Peter Miovic and Giovanna Prennushi on an earlier draft of this paper. The views expressed are the responsibility ofthe author. The local funds for budget finance comprise tax revenues; domestic borrowing from the bank and nonbank public; money printing; use of reserves; and various types of non-project aid, such as commodity aid, program loans and cash grants, that generate local currency counterpart funds.