Everia A. Jesica

Foreign Aid is an important source of finance to a majority of developing countries since it supports the budgetary process and therefore enhances the development of these countries. The aim of this research is to assess the effect of foreign aid inflows on selected public expenditure controlling for taxes. The study focuses on foreign aid inflows into grants and foreign lending and analyzes their specific effects on public expenditure. The research seeks to establish whether there is a positive and statistically significant relationship between the share of total government expenditure in gross domestic product and recurrent expenditure on Education, Health, Agriculture and the share of net disbursement of overseas development assistance.

The study uses a welfare utility maximization function linking foreign Aid trends in Kenya to public expenditure using panel data and design to establish whether there exists a relationship between foreign aid and the public expenditure in Education, Health and Agriculture observed at the same time over a series of time from 1980 to 2008 collected from the Economic Surveys, Central Bank of Kenya publications and WDI. This research employed the descriptive statistics and tests for normality and stationary, it used the Jarque-Bera for normality test, co-integration analysis for stationary and Engle and Granger (1987) two way procedures to determine the existence of long-run relationship between the variables. The empirical results indicate that the flow of foreign aid does influence government spending patterns. There is a positive and statistically significant relationship between the share of government expenditure in gross domestic product (GDP) and the share of net disbursement of overseas development assistance (ODA). The study finds relatively little evidence that aid leads to tax relief; there are strong indications that the government renders aid fungible by financing recurrent expenditures but aid to Education, Agriculture and Health is not fungible. The research recommends that utilization of aid money should be as per budget so as to maximize on the effectiveness of aid and that the government should consider strengthening its internal controls utilization of aid money and increase allocation of more money to the education and health sector.