Limits of fungibility

Fungibility in aid describes the situation where a country gives aid to a developing country intended for a particular purpose, and the receiving government reduces its own expenditure on the purpose. So no more money gets spent on the purpose such as healthcare than before, which may not be what the donor intended.

There is a limit here. The receiving government can only reduce its expenditure to zero, so if the donor government is very generous, it does not matter so much if the receiving government diverts its own budget. The recipient country will still have an increase in money intended for the purpose.

I have neglected the possibility that the recipient government will reduce its future spending too after a single year's donation, but it seems likely that it would not be able to do so indefinitely without encountering domestic opposition. Broadly speaking, donor governments can design aid programs using exact targeting to reduce fungibility's problems.