Foreign aid and developing countries' creditworthiness

Abstract

We explore whether foreign aid affects developing countries' creditworthiness, as proxied by the Institutional Investor's measure of country credit risk. Based on a simple model of international borrowing and lending, we develop the hypothesis that aid reduces the likelihood that borrowers in a given country default on their foreign debt. We then test this hypothesis, using a panel data set that covers a large number of developing countries in the 1980s and 1990s. Our empirical findings support the notion that aid improves countries' standing vis-a-vis international capital markets. However, the strength of this effect differs across types of aid and country groups.