Counterpart fund
A counterpart fund is a technique for turning foreign aid into reserves of domestic currency. They were used by the UNRRA, and the Marshall Plan in the rebuilding of Western Europe after the Second World War,[1] and today remain a common technique for delivering developmental assistance.
One method of setting up a counterpart fund is to have businesses in the country receiving aid that want to import a commodity place an order with their government and pays for the import in their local currency. The government then uses some of their foreign assistance, still in the foreign currency, to pay for the goods. This makes importing far easier as the unstable currencies in developing nations are often of little international value. Agreements are also usually signed so that these imports can only come from the nation that gave the aid, benefiting the donor's export industry. Another method is for goods to be donated to a developing nation's government and for them to then sell the goods to the population, and use the proceeds to set up a fund.
The recipient government is also then left with the original payment in its domestic currency. These payments are amalgamated into a fund that is used to further fund development. This can take the form of investments in infrastructure or industry, paying down the debt or deficit, or stabilizing the currency. The investment of these funds can take the form of loans rather than grants, creating a permanent pool of investment capital. For instance, Germany's Marshall Plan counterpart funds were used to set up such an investment fund, and it is still in operation today.
Example
Suppose a German construction company wished to purchase an American crane for reconstruction efforts in 1949. In a counterpart fund arrangement, company would buy the crane from the West German government in Deutschmarks, which would then be deposited into the central bank. The Economic Cooperation Administration (ECA), the body mediating counterpart funds, would pay the American crane exporter in dollars authorized under the European Recovery Program (ERP). Meanwhile, the Deutschmarks would be used to finance a ECA-approved recovery project.
There are several benefits to this transaction. First, instead of a direct transfer of an asset or converting currency for import, this system incentivizes participation in the economy using the local currency. For the construction company, the entire transaction occurred in West Germany and was arranged by the fledgling government. Furthermore, because the payment was in local currency, there is not a negative effect on West German balance of payments, which was a major concern of the ERP. Lastly, instead of resorting to inflationary policies as had often been done in post-war recoveries, the central bank had an inflow of currency to loan out for projects.[2]