This book studies the welfare effects of external capital flows in small open developing countries with special emphasis on primary commodity export dependent countries. Welfare cost of macroeconomic volatility in the developing countries is several times larger than that in the developed countries. Further, most of this macroeconomic volatility is a result of exogenous shocks such as terms of trade or world price changes. External capital flows (coming largely from official creditors in the case of developing countries)have the potential to reduce these fluctuations. Focusing in particular on aid flows and external debt, I find that indexing these flows to external shocks can significantly improve the welfare outcome in developing countries.