Foreign aid is resource assistance provided by developed countries or international institutions to support the economic, social and political development of developing nations. Ideally, it should boost economic growth, improve people’s well-being, offer grants or low-interest rates, and address long-term capital needs. The disbursement of foreign aid to least developed countries began after the Second World War. 

Foreign aid has played a crucial role in supporting Nepal’s development efforts since the early 1950s. Given Nepal’s structural bottlenecks, large fiscal and external deficits, and significant imbalance between saving and investment ratios, foreign aid has been instrumental in sustaining the economy. Nepal has received foreign aid through various channels; however, while Nepal relies heavily on foreign assistance, concerns are growing over its increasing dependence on loans. 

Foreign aid has become a hot topic, especially following the abrupt freeze and potential shutdown of USAID under the Trump administration. Unlike the UK’s gradual shift from traditional aid to private-sector investment, the sudden United States decision has left many projects in limbo and raised concerns over Nepal’s heavy reliance on external support. Over 300 NGOs, consultancy and nonprofit companies are affected by the decision. Given this dependency, there is growing apprehension that other donor nations might adopt similar abrupt measures in the future. In response, Nepal must explore strategies to mitigate these risks.

Understanding Nepal’s foreign aid landscape 

Nepal’s foreign aid landscape consists of various aid partners supporting the country through different aid modalities. Nepal receives foreign aid in the form of multilateral aid, bilateral aid, technical assistance and humanitarian aid. 

The total commitment for foreign aid in FY 2023/24 was $2,504m, with total disbursement accounting to $1,576m. Multilateral donor organizations contributed the largest share, accounting for 60-65 percent of the total disbursements. The Asian Development Bank (ADB) was the largest aid provider, committing $868m, followed by the World Bank, European Union (EU), and the United Nation (UN). 

The United States is the largest bilateral foreign aid donor to Nepal, followed by China and India. The United States has provided substantial grants totaling approximately $1.607bn between 2010 and 2022, making it the top contributor. China comes in second, with grants of around $1.042bn, while India is the third-largest donor, contributing approximately $994m. The United Kingdom and Japan also play a significant role in foreign aid to Nepal.

In FY 2023/24, the highest sectoral aid commitment was in the energy sector, with 27.71 percent, followed by infrastructural development at 19.61 percent. Agriculture received 16.43 percent, while budgetary support accounted for 16.36 percent. Climate finance stood at 9.05 percent, the economic sector received 6.62 percent, and the social sector got 2.51 percent.

The energy sector focuses on hydropower and electricity infrastructure, while Infrastructure includes roads, bridges, and urban projects. Agriculture supports irrigation and modern farming, and budgetary support provides direct financial aid for government policies. Climate finance funds disaster resilience and renewable energy, whereas the economic sector boosts banking, SMEs, and trade. Lastly, the social sector covers education, healthcare, and welfare programs.

Nepal’s government has set a target of receiving approximately $2.05bn in foreign assistance in FY 2024/25, comprising $397m in grants and a significant $1.65bn in loans.

In FY 2010/11, grants accounted for 57 percent of foreign aid, while loans made up 24.30 percent. The grants declined to 49.64 percent by FY 2015/2016 with loans rising to 34.89 percent.This trend intensified in 2020/21, the grants hit record low with 21.49 percent and loans increased with 66.88 percent. The grants for FY 2023/24 make up only 39.67 percent of total aid, while loans account for substantial 60.33 percent.

Over the past decade, loans have grown at a much faster rate than grants. This growing reliance on loans presents a concerning shift for Nepali’s economic future. While loans can provide immediate funding for development projects, they come with long-term repayment obligations that may strain Nepal’s fiscal capacity. This pattern mirrors the debt burden seen in other countries that have heavily relied on loans for development. For instance, Sri Lanka’s economic crisis that stemmed from debt, declining foreign reserves, import reliance, and policy missteps. 

Challenges in aid utilization

According to the Ministry of Finance, external aid, including concessional loans and grants, have been utilized to stabilize inflationary pressures, which may inadvertently slow economic growth, intensifying issues like unemployment, poverty, and inequality problems. As an offshoot, Nepal risks falling behind in achieving the Sustainable Development Goals (SDGs) and raising concern about increasing debt and reliance on external aid due to the rapid increase in loans. Nepal introduced its Foreign Aid Policy in 2009, aimed at enhancing the country’s ownership and ensuring that donor support aligns with government priorities. However, Nepal’s aid absorptive capacity has been found to be poor. Nepal’s limited capacity to effectively utilize foreign aid stems from several key challenges.

• Complex public procurement act: The intricate procedures mandated by the Public Procurement Act add layers of complexity, leading to delays in project initiation and execution. Post-earthquake reconstruction was slow, with international aid agencies facing year-long delays in project approvals due to weak institutional capacity and poor coordination. 
• Prolonged bureaucratic procedures: Extended bureaucratic processes in project approval and implementation slow down the utilization of foreign aid. The Melamchi Water Supply Project (2000–2021) struggled with political interference, contractor disputes, and financial irregularities.
• Administrative inefficiencies: The Pokhara International Airport, funded by Chinese loans, faced operational challenges post-completion. Operational inefficiencies within governmental agencies contribute to the sluggish deployment of aid resources.
• Inadequate infrastructure: The country’s underdeveloped infrastructure hampers the efficient implementation of aid-funded projects.

Additionally, the priorities and interests of donors can affect the alignment of aid with national needs. Aid conditions may limit the government’s autonomy in project implementation, making foreign aid less aligned with national interests. Furthermore, political instability and the prolonged political transitions have adversely affected the mobilization of foreign aid. These challenges collectively hinder Nepal’s ability to fully benefit from foreign assistance, impacting the country's development trajectory.

Lessons from the world 

Foreign aid has been a remarkable success in some countries of the world.  The aid is effective in countries where it is accompanied by sensible economic policies.

For instance, Uganda in the 1990s transformed its economy when aid coupled with their policy reforms. The government embraced economic liberalization, improved financial management, and tackled corruption, ensuring funds were used productively. Botswana in the 1960s, used aid wisely, focusing on infrastructure, education, and healthcare. The government ensured transparency, managed funds responsibly, and avoided dependency. 

We can see that aid wasn’t a crutch but a tool to support its well-planned policies, leading to long-term growth. Foreign aid has also failed at times, raising corruption and poor policies. In Zaire (now the Democratic Republic of Congo), decades of aid brought no progress as Mobutu Sese Seko, President of DRC, accumulated a vast fortune abroad. 

The illustrations demonstrate that without effective governance, proper planning, and stringent oversight, foreign aid can fail to achieve its intended objective. 

Aid optimization for future 

As Nepal nears graduation from Least Developed Country (LDC) status in 2026, a smooth transition from aid dependency to investment-driven growth becomes crucial. With this graduation, Nepal will lose access to concessional loans (below one percent), development grants, preferential trade benefits, and targeted assistance, making it more imperative to focus on attracting private investment

While tools like the Aid Management Platform (AMP) can improve transparency and donor coordination, experiences from countries like Tanzania, Uganda, and Cambodia have shown that while some progress is often hindered by governance challenges, donor cooperation issues, and data accuracy concerns.

This raises an important question for Nepal: should the focus shift more towards reducing reliance on foreign aid, or should the emphasis be on strengthening the effectiveness of existing aid structures? Perhaps it’s not an either/or situation, but a balanced approach that tackles both—ensuring that foreign aid is used more effectively while also promoting sustainable, long-term development strategies. It’s a complex but necessary conversation as Nepal navigates its transition away from aid dependency.