The training workshop ‘Smart Fiscal Policy for Climate Action’ was held in Arusha, Tanzania, from January 23-25, 2018. The workshop was organized by the World Bank’s Climate Action Peer Exchange (CAPE) and the Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI).
The objective of the course was to discuss the impact of climate-smart tax and spending policies, energy subsidy reforms and innovative climate financing to help countries achieving their climate commitments agreed in Paris in 2015. Participants included technical staff from the Finance Ministries of Swaziland, Tanzania, Uganda, Kenya Zambia, Malawi, Zimbabwe, Namibia, Lesotho, Swaziland and Botswana and Mozambique, and speakers from South Africa, and the World Bank. The agenda included presentations and discussions on:
- Regional and international experience to implement climate mitigation mechanisms, including in the forestry sector.
- Policy and fiscal instruments to adapt to climate change and build a resilient economy.
- Climate budgeting and challenges to access international climate-related finance.
Fiscal instruments to fight climate change: an overview
The first session provided a broad overview of climate and fiscal issues. Africa’s contribution to greenhouse gas emissions is estimated at less than 7% of the world total. However, Africa is the most climate-vulnerable region in the world. Over the past decades Africa has experienced a rise in annual average temperatures, and changes in rainfall patterns and in the frequency of floods and droughts. The session argued that Ministries of Finance are essential to deliver efficient and equitable responses to climate change. Fiscal instruments - taxes and public spending - are key to provide the right incentives for households and firms, and for ensuring a fair distribution of the associated costs and benefits. The session discussed the economic rationale for eliminating fossil fuel subsidies, introducing environmental taxation and measures to reduce deforestation and forest degradation. It argued that taxing carbon improves efficiency, provides incentives to develop low-carbon energy alternatives and brings revenues. Most participants were skeptical about the need for Africa to contribute to mitigation. They pointed out that developed countries must do more to stop climate change and that achieving climate obligations is likely to slow down growth. There was agreement that Finance Ministries should be responsible for climate actions, as climate and development are undistinguishable. The session ended with a discussion on an ‘ideal’ fiscal package to balance environmental and growth objectives.
Introducing carbon taxation in South Africa
No country in Africa has formally adopted carbon taxation. South Africa has attempted to do so for at least 10 years and may be about to succeed. The South Africa National Treasury published the Second Draft Carbon Tax Bill for public comment on 14 December 2017 and announced that the bill will soon be tabled in Parliament. The carbon tax is predicated on the “polluter pays” principle and will enable South Africa to meet its Paris commitments. The primary objective of the tax is “to encourage companies to change their future behavior by taking steps now to gradually change their fuel inputs, production techniques and processes by encouraging investments in energy efficient, low carbon technologies to lower their emissions”. The impact of the tax on the price of electricity and energy intensive sectors is designed to be neutral. Thus, a package of tax incentives and revenue recycling measures will be introduced to minimize the impact the carbon tax in the first phase of the policy (up to 2022).
Reforming fossil fuel subsidies
Fossil fuel subsidies represent a significant share of budgets in several African countries, often crowding out sustainable development spending. Yet, reforming energy subsidies is complex and politically sensitive. Reforms take time and careful planning of policy actions on several fronts. Political economy factors must be considered and carefully communicated. The session discussed the Energy Subsidy Reform Assessment Framework (ESRAF), an integrated approach to carry out a comprehensive assessment of subsidies introduced by the World Bank and ESMAP. ESRAF helps Governments to design a reform program that is socially responsible, politically feasible and economically sustainable. A country case of an application of ESRAF was presented. It starts with a rapid diagnostic to identify the subsidies. It then estimates the direct and indirect impacts on households. Targeting methods are compared for their accuracy in compensating the poor. Finally, a public opinion survey is used to craft the messages for a communication campaign to build public support for the reform.
Energy Subsidy Reform in Egypt
This session presented the reform of energy subsidies in Egypt and its consequences. In 2014, the Government committed to an ambitious plan to eliminate energy subsidies. The goal was to progressively drive energy subsidies down to a target of 0.5 percent of GDP by FY18/19 leaving only limited support for LPG and electricity to benefit low-income consumers. Between July 2014 and July 2017, the Government implemented four annual electricity price reforms and three fuel price increases. As a result, energy subsidies fell steeply from 6.5 percent of GDP in FY14/15 to 3 percent in FY15/16. Subsidies were set to fall further to 2.5 percent of GDP in FY16/17. However, the substantial depreciation of the Egyptian pound and resulting increases in the cost of energy production meant that subsidies instead rose to 3.9 percent of GDP in FY16/17. Also, in the absence of any energy price reforms since 2014, it is conservatively estimated that subsidies would have been higher by EGP 256 billion in FY17/18, raising the energy subsidy bill to 8.9 percent of GDP.
The session highlighted that reforms in the energy sector are closely aligned with Egypt’s contribution to the Paris Agreement on climate change. By addressing the security of supply of natural gas and promoting clean energy and energy efficiency, the reforms are supporting all four priority areas of Egypt’s Nationally Determined Contribution to global efforts for mitigating greenhouse gas (GHG) emissions through: (a) more efficient use of energy, especially by end-users; (b) increased use of renewable energy; (c) use of locally appropriate and more efficient conventional energy technologies; and (d) reforming energy subsidies.
Climate Change and Fiscal Risks
Climate Action, especially for longer-term climate adaptation efforts which are more relevant for developing countries, will entail fiscal costs that will translate into a call on public budgets for many years into the future. This session highlighted the need for Ministries of Finance to better incorporate the fiscal commitments they make today, whether explicit or implicit, and the fiscal risks they pose into their fiscal policy and public investment decision-making. The session defined the sources of these fiscal risks and introduced practical analytical tools that have been developed (some in collaboration with the IMF), and are being used by the World Bank operational teams to help Ministries of Finance to assess the fiscal impacts and fiscal risks associated with contingent liabilities (such as those related to natural disasters). The Group exercise aimed to emphasize that climate-related fiscal commitments, for example those to build Climate Smart Infrastructure using public-private partnership arrangements, should be analyzed in the context of the Government’s overall Fiscal Risks Matrix and fiscal sustainability considerations over time under uncertainty. Scenario analyses and stress tests are imperative in this regard, especially in arriving at appropriate ways to mitigate and manage these fiscal risks over the life of the projects being considered.
Reducing emissions from deforestation
Forests, covering one third of the world’s land area, play an important role as sink to carbon, besides providing livelihood and other development benefits to the rural poor. It is estimated that forest loss and other changes to the use of land account for around 23 percent of current man-made CO2 emissions. What can we do to reverse land degradation trends and turn forest landscapes from source of emissions to net carbon sink? The workshop discussed Ghana’s experience in reducing carbon emissions from deforestation and forest degradation using REDD+. Ghana succeeded in building the institutional capacity for forest governance, identifying sources and level of emissions from the forest landscape, and establishing Monitoring, Reporting and Verifying (MRV) systems. The REDD+ Strategy provided the road map for addressing drivers of deforestation in a socially and environmentally responsible manner, including a result based “Emission Reductions Program for the Cocoa Forest Mosaic Landscape”, which was submitted to the Carbon Fund for financing. Participants conveyed that reducing deforestation continues to be an elusive objective despite many attempts to do so in several African countries. It was also noted that the REDD+ readiness process has taken much longer than originally anticipated.
Financing Climate Actions
This session introduced the status and trends in climate finance, spanning the public and private sectors, national and international sources, and mitigation and adaptation use of funds. It described the complexity of the climate finance market due to factors such as differing eligibility rules, readiness standards, competition between countries for limited resources, and increasing importance of private sector sources (which accounted for about two thirds % of the $383 billion in climate finance in 2016). In addition, it emphasized that there has been a steady upward trend of domestically raised investment, revealing the importance of implementing strong national policies and regulations to incentivize climate-related projects.
To help Ministry of Finance officials better prepare public climate-related investment projects, the session discussed nearly 20 aspects that make climate change projects “different” than more traditional public investment projects (say, a road or a school). These factors range from having to grapple with fundamental uncertainties (e.g., in future climate trends, carbon prices, technologies, and international negotiations), to the importance of cross-sectoral approaches (often including the need for social safety nets to offset policy impacts on the poor). The proper response to these complexities is good project economics built on good fiscal, policy and risk analysis.
Climate change adaptation: Its role in development and poverty reduction
This session focused on the important role of climate change adaptation and resilient development measures in reducing poverty. Climate-related shocks and stresses are already a major obstacle to poverty reduction. Poor people are consistently more exposed and vulnerable to natural hazards – including climate related shocks. In addition, poor people tend to have fewer social support systems available to them to assist recovery. All evidence suggests that these challenges will worsen with climate change.
At the same time this session highlighted that rapid, inclusive, and climate-informed development can prevent most adverse consequences of climate change on poverty till 2030. In other words, adaptation measures are fully aligned with development priority measures and cover a wide range of sectors including health, agriculture, infrastructure, social protection, and disaster risk reduction. Absent such good development, climate change could result in an additional 100 million people living in extreme poverty by 2030. These insights presented in this session are based on – and explained in further detail – in the World Bank’s Shockwaves report (2015).
Designing and Financing Climate Adaptation
The session started by observing not only that estimating economic costs inflicted by climate change is difficult, but that recent damage estimates seem to be rising very rapidly. Reasons include the increasing magnitude of extreme events, the increasing value of the physical assets and livelihood streams that are affected, and better understanding of indirect climate effects (such as delayed health impacts and complex agricultural crop impacts). Given these increasing damage estimates, there is a clear case for countries to be as proactive as possible in addressing critical climate impacts. Risk reduction has been shown in many cases to be far cheaper than ex-post humanitarian relief. As Nicholas Stern wrote: Climate change adaptation can be described as essentially ‘development in a hostile climate’. Good adaptation is also good development. The session then turned to developing and applying a framework for Ministry of Finance officials to think about designing cost-effective climate adaptation strategies. The framework follows a logical flow from (a) understanding physical climate impacts, to (b) determining impacts on the economy and human welfare, to (c) identifying the affected economic sectors, and (d) assigning responsibility for action to one or more government agencies. Step (b) is particularly important in determining adaptation priorities for action.
The session then worked through an exercise of setting priorities for climate adaptation actions in drylands Africa. It concluded by illustrating the benefits of examining three different pathways towards improving resilience, which are raising rural productivity, introducing safety nets, and facilitating alternative actions such as economic diversification or internal migration. The session’s final observations were that: investments in resilience are cheaper than disaster recovery; private sector participation in adaptation finance is essential (just as it is for mitigation); and capacity-building and coordination across national-level and sub-national agencies is important.
Climate change adaptation: Identifying and prioritizing investments
This session first focused on the economic and welfare impacts associated with climate change. It highlighted the important distinction between asset losses and well-being losses. Assets losses tend to be particularly large in places where high-value assets are located. However, assets losses alone do not inform about the actual wellbeing losses incurred by people. The reason for this is that the socio-economic resilience of people – i.e. their ability to manage risks and cope with shocks – differs significantly across countries. Prioritizing adaptation investments simply based on avoided asset losses biases action away from low-income and vulnerable people. Instead, physical risks must be measured with respect to the ability to manage these risks. The insights presented in this session are based on – and explained in further detail – in the World Bank’s Unbreakable report (2017).
A case study on the identification and prioritization of investments in resilient roads in Mozambique was discussed. It showed how decision criteria, such as poverty and agricultural potential, can be incorporated into the process of investment prioritization. These criteria reflect the need to account for the well-being benefits of adaptation investments, in addition to the avoidance of monetary asset losses. Most importantly, multiple uncertainties – especially on long-term climate change make standard cost-benefit approaches inapplicable. Instead, this case study introduced a frame work for decision making under uncertainty to help decision makers to stress-test possible investment options against wide range uncertainties.
Interactive group session: “Investments in adaptation infrastructure: The role of uncertainty in prioritizing actions”
This group exercise offered an interactive illustration of the approach introduced in the session ‘Decision making under uncertainty’. It challenged participants to select climate adaptation measures while faced with uncertainty about future rain fall and flood risk. It showed that decisions based on the extrapolation of past trends can result in flawed investment decisions, with potentially catastrophic outcomes. It emphasized that climate change will mean that past flood risk probabilities do not offer robust guidance for the long-term future. Instead, the session showcased how decision making under uncertainty can help to eliminate strategies with catastrophic outcomes, and prioritize strategies that perform robustly under a wide range of future climate change scenario.
The Climate Budgeting presentation focused on the use of climate budgeting techniques to align public spending to climate change priorities within the given budget framework. Participants were advised to link climate policy into the early stage of budget planning, management and coordination across government units, and coding methodologies. While this is an emerging field, useful lessons on climate budgeting are already available from the Morocco, Vietnam, Philippines and others. Course attendees participated actively in the group exercise, which brought out other learning points, such as PPP as an alternate funding option, tools to support project prioritization, and how to strengthen the budget narrative. Among the participating countries, Malawi had already conducted an Climate Public and Institutional Expenditure Review and is looking at using the results to inform efforts to integrate climate change into future budgets. South Africa also approached the CAPE team for support to conduct a trial pre-budget technical hearing with key sector ministries to discuss climate change spending. This is currently being done in the Philippines.