Paper short abstract:

The external financing of domestic government expenditure faces a transformation dilemma in most developing countries, which often results in convoluted and contradictory dynamics in the power relations that condition such external flows. This begs a rethink of the political economy of development.

Paper long abstract:

In most developing countries, the external financing of domestic government expenditures through aid, other official flows, or even commercial sources of finance, faces what can be called a monetary transformation dilemma. This refers to the fact that external flows are in foreign currency and hence cannot be directly used for expenditures in domestic currency. Nor do domestic expenditures require foreign currency given that they can be financed through conventional domestic monetary and fiscal operations. The extent to which external flows are actually able to fund domestic expenditures therefore involves a range of macroeconomic management concerns, which are in turn prone to exacerbate many of the political economy dimensions involved in the global and national management of such financial flows. Alternatively, the rhetorical reasons for seeking such external flows often does not conform to the actual uses of such flows. This calls for a serious rethink of many of the accepted premises in the political economy of external finance for development, particularly with respect to the often convoluted and contradictory external dynamics that domestic actors must contend with in the power relations that condition these external flows. Several examples are highlighted in this paper, including: muddled evaluations of the absorption of external flows; mismatches between absorption and the notional domestic spending of such flows; tensions between absorption and reserve accumulation, and between spending external flows and restrictions on domestic spending; and the exacerbation of concerns about fungibility, transparency and accountability.