Effect of foreign aid on domestic savings in Uganda

Abstract

The main objective of the study was to examine the effect of foreign aid on domestic savings in Uganda from 2003 to 2017. It used the Autoregressive Distributed Lag model on quarterly time series data to analyze the long-run effects, Error Correction Model for analyzing the short-run effects and also speed of adjustment between short and long run equilibrium and the granger causality test for testing the causality between the study variables which included foreign aid, domestic savings, exports, inflation, gross domestic product and interest rate. The results revealed that in both short and long- run, foreign aid (-0.401) and inflation (-0.163) had a significant negative effect on domestic savings while exports (0.559) had a significant positive effect on domestic savings at 5% level of significance. This implies that an increase in foreign aid by 1% leads to approximately 0.40% decrease in domestic savings and increase in inflation by 1% leads to 0.16% decrease in domestic savings; while a 1% increase in exports will lead to 0.56% increase in domestic savings in the long run. Gross domestic product had a negative effect on domestic savings while interest rate had a positive effect on domestic savings in both the short and long run. The results further showed that the deviations in the short run will be adjusted quarterly by about 33% in the long run for the economy to be in equilibrium. Pairwise granger causality test results showed that foreign aid does not granger cause domestic savings and domestic savings does not granger cause foreign aid. The study recommends the government to put in place strategies that promote domestic savings so as to reduce on dependence on foreign aid and also maintain economic stability by controlling the rate of inflation in the country in order to promote higher domestic savings.