Second the likelihood of dutch disease problems can

consequences in terms of domestic interest rates) (see IMF, 2005). Second, the likelihood
of Dutch Disease problems can be minimized if grants are used to finance the purchase of
imports or for investments that relax key bottlenecks, particularly in sectors where
absorptive capacity constraints cannot be easily overcome simply by imports. So it would
be a mistake to assume that higher externally grants necessarily must create difficulties
for a country’s export industry. Coherent and well-thought out policies can address many
potential obstacles.
Moreover even if, with all best efforts, the Dutch Disease issue remains a relevant
concern, its consequences must be weighed against the long-term benefits of the spending
that can be financed by higher foreign aid inflows, viz., investments that address key
deficiencies in human capital or physical infrastructural bottlenecks that limit the
capacity of a country’s economy to escape from a low-level poverty trap. The short-to-
7

medium cost of some erosion of competitiveness may be thus worth accepting if the long-
run benefits are large enough.
Fiscal Sustainability : Explicit in the definition of fiscal space is the link to the concept
of fiscal sustainability. This relates to the capacity of a government, at least in the future,
to finance its desired expenditure programs as well as service any debt obligations
(including those that may arise if the created fiscal space arises from government
borrowing).
2
This has a number of implications. First, it suggests that exploitation of
fiscal space requires a judgment that higher expenditure in the short term, and any
associated future expenditures, can be financed from current and future revenues. If an
expenditure project is debt financed, it should be assessed in terms of its impact on the
underlying growth rate or by its effect on a country’s capacity to generate the revenue
needed to service that debt.
Second, the definition forces attention on the medium-term implications of the spending
programs for which fiscal space is created in a given year. Are the expenditures for which
fiscal space is created likely to be concentrated in the immediate term? Or are the desired
expenditures likely to require future expenditures, in which case some fiscal space will be
needed in the future as well? To illustrate, budgetary room could be made available in a
given budget year to finance a meritorious objective—say, a one-time training program
for government civil servants. Yet there are many types of government expenditures—
particularly in the health sector, where the initial spending will have implications for
subsequent spending on operations and maintenance that would require the availability of
future budgetary resources. In particular, for many of the programs for which fiscal space
is now being advocated in the health sector, the desire is for higher expenditures that can
be sustained over a long period of time, e.g., antiretroviral treatment programs for AIDS
patients. In either case, it would be insufficient to create fiscal space in the first year
2
In considering fiscal sustainability, it is necessary to consider issues of debt sustainability (as noted