Impact of Foreign Financial Inflows on Economic Growth of Tanzania

Abstract

This study analyses dynamic relationships between foreign financial inflows specifically external debt and foreign aid with economic growth in Tanzania from 1990 to 2024 using Granger causality, Johansen cointegration tests, and a Vector Error Correction Model (VECM). The unidirectional causality of economic growth to foreign aid according to the Granger causality test indicates that GDP growth enhances the ability of Tanzania to receive foreign aid due to perhaps increased donor confidence. But foreign aid and external debt hardly affect short-run economic growth, suggesting their effects on GDP during the short run are negligible. Support for long-run equilibrium of the macroeconomic variables being considered comes from Johansen cointegration results, warranting the use of VECM for both short- and long-term analysis. VECM results further suggest inefficient use of capital is a bane to short-run GDP growth, whereas foreign aid and external debt remain statistically insignificant in the short run. Sustained foreign aid inflows and their positive response to lagged GDP underscore the role of long-term growth in bringing aid. Moreover, the study finds a high correlation between foreign aid and external debt, with environmental degradation as a leading cause connected to increased debt levels, depicting the complex interplay between economic, financial, and ecological conditions. Robust diagnostic tests establish the validity and reliability of VECM estimates. In conclusion, the findings underscore the significance of policies that are geared towards promoting the efficiency in capital, effective management of debt, foreign aid sustainability, and environmental integration to achieve Tanzania's long-term stability and growth in the economy.