As foreign aid is mainly directed to the public sector of Pakistan, one can only recognize the broader macroeconomic impact of aid if one first understands its impact on fiscal behaviour of the government. To this end, the present study has estimated a fiscal response model using the annual time series data for the period 1972 to 2016.Foreign aid is disaggregated into two components, namely, foreign loans and foreign grants. Whereas public expenditures are classified as current expenditure, socio-economic expenditure and development expenditure while on revenue side tax revenue and domestic borrowing are used. The estimation task has been accomplished by using the generalized method of moments (GMM) technique. Results reveal that foreign aid (loans and grants) is a significant contributor in inducing the fiscal activities of the government of Pakistan. Aid has been found to increase development and non-development expenditures but at the same time it adversely impacts tax effort and domestic borrowing. The study suggests that government of Pakistan should devise ways for developmentoriented use of foreign aid to enhance the productive capacity of the economy. A suitable mechanism ought to be chalked out by donors for monitoring tax revenue generating behaviour of the government of Pakistan in response to their financial assistance. More and unceasing aid is ensured only if the government of Pakistan maintains a certain threshold level of tax to GDP ratio. 

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