The external financing of fiscal deficit is key to bridging public revenue shortfalls within developing economies. However, the public expenditure responses to the incoming foreign financial assistances, as documented in the existing literature, depict ambiguity with respect to the nature of the assistances. Against this milieu, this paper attempts to perform a comprehensive analysis of the dynamics adhering to the foreign financial inflows–government expenditure nexus in Bangladesh tapping annual data from 1985 to 2017. The vector error-correction model approach to short and long-run correlations and causality analyses, variance decomposition technique, and impulse response function exercises comprise the econometric methodologies considered in this paper. In a nutshell, the results from the analyses indicate toward foreign financial inflows crowding out public investments, and reducing the tax and non-tax efforts of the government, while diminishing the amount of local public borrowings in Bangladesh. Conversely, financial assistances in the form of concessional loans and those originating from multilateral sources are found to enhance government expenditure, while the foreign aids intended for the health sector are found to be fungible in nature. Thus, these contrasting findings are expected to generate crucial policy implications with regard to structuring appropriate public policies.
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