Public expenditure is a necessary element of low-carbon development strategies due to the existence of market failures that cannot be resolved with revenue side fiscal policies. Yet the discourse on financing climate action has focused mostly on funds mobilization, while not enough attention has been paid to ensuring that public financial management is equal to the climate change challenge. Due to the scarcity of public funds, these expenditures require careful planning and coordination. Various policy tools are available for green budget planning and public investment management.
What are the key policy instruments?
Various tools are available to improve climate-related public expenditure. Important examples include:
- Adaptation monitoring and evaluation systems: these systems serve two purposes: i) enable countries to better understand climate risks and improve adaptation policies by producing information, for instance, on climate hazards and adaptation capacity; ii) increase accountability. These systems can be tailored to national circumstances, both in terms of capacities and priorities.
- National climate funds: governments can commit resources to climate change policy for the long term by instituting extra budget national climate funds. These funds provide policy signals that go beyond the annual budget, and can, therefore, be particularly useful to mobilize private investments.
- Targets: governments can set targets on climate change expenditure.
- Public investment management regime: a strong regime of public investment management can improve adaptation capacity in face of the uncertainty surrounding climate change impacts. Strong regimes rely, for instance, on comprehensive information on likely climate change effects on the economy, a formal project appraisal that is reviewed by independent agents, active monitoring, and periodic revisions, and expenditure adaptability to evolving needs and priorities.
- Climate Change Finance Frameworks (CCFF): a processes that aims to improve the mobilization, management, and targeting of financial resources for climate change. They help integrating climate change into standard methods of planning and budgeting, allowing governments to prioritize and monitor climate change spending to maximize its impact. CCFF have some key components, such as i) the integration of climate risks, related vulnerabilities, and losses in public management; ii) the integration of the implications of climate change into policy/program effectiveness assessments; iii) the introduction of climate budget tagging and scoring systems. This tool allows to monitor and track climate-relevant spending in national budgets. It generates data on climate-related expenditure, enabling more informed planning and improves transparency and monitoring capacity, while also incentivizing policymakers to incorporate climate considerations in their decisions; iv) the integration of climate change in annual budgeting reports and templates for planning; v) the estimation of future resources available for climate-related expenditure.
What are the challenges and opportunities ahead?
Improving public expenditure for climate change presents various challenges. The Finance Ministry plays the most important role in ensuring that the objectives of any whole-of-government climate policy framework are reflected in the national budget. Climate change mitigation and adaptation require substantial investments of a crosscutting nature at many levels of government, yet many countries - including developed countries - have not clearly demarcated climate expenditures. Guidelines for cost-effectiveness and financial management are also absent. This hinders the identification of climate-related budgetary risks, while also leaving long-term fiscal outlays chronically underfunded in favor of more near-term spending priorities.
Instruments are needed to ensure that public investment projects sufficiently reflect climate policy objectives, such as NDCs. Methodologies are also needed to assess the overall viability of public investments, such as infrastructure and public works, in the context of climate change. These tools should address the fundamental uncertainties, overlapping market failures, and cross-sectoral nature of climate change.
Challenges also exist in the use of the available instruments to improve public financial management. For instance, establishing climate change budget targets can lead to fiscal strain. Also, the governance structure of national climate funds can vary, external accountability, and project management. The best structure likely depends on the institutional context in which the funds operates, and it is, therefore, country-specific.
Implementing CCFF can also be challenging. These frameworks have various components, and different frameworks can be better suited for different countries depending on their specific priorities, needs, and capacity. Individual components of climate finance frameworks present specific challenges. For instance, setting up a climate budget tagging and scoring system requires determining which on-budget and off-budget expenditures are climate-related and weighing climate-relevance of spending.
What are good practices and what can be learnt from them?
- Nepal: with the support of ODI, Nepal was the first country to develop a budget tracking tool for the development budget, where expenditure is assessed as climate-related if it falls within one area (out of 11) identified as climate-relevant.
- Kenya: Kenya adopted a Climate Change Action Plan aims to track and develop synergies between adaptation and mitigation actions. The framework includes indicators to assess institutional capacity, e.g., the number of climate risk assessments performed in a sector, as well as vulnerabilities, such as households that need food aid.
- Ghana: Ghana has undergone a number of studies, for instance on climate spending between 2001-2014, to support the development of the 2014 National Climate Change Policy. Also, the Ministry of Finance, with the support of UNDP, has developed a climate change finance tracking system to improve the oversight of climate spending in the budget. This system attaches a weight to the expenditure to identify its climate-relevance component and avoid overestimating climate spending.
- Fiji: with the support of the World Bank, Fiji has undergone efforts to i) simplify the tax system and spur growth lead by the private sector to improve its medium-term fiscal sustainability; ii) increase foreign direct investments in climate change by ameliorate arbitration rules and reduce the cost of construction permits; iii) increase resilience to climate change by improving construction standards and construction monitoring.
Various policy advisory bodies provide support to develop Climate Change Finance Frameworks:
- Climate Change Public Expenditure and Institutional Review (WBG): This review aims to assess the effectiveness of domestic systems to deliver public finance for climate change. This tool has been applied in the Philippines and Vietnam where it has highlighted gaps in coordination, capacity, and management tools for climate action.
- Pacific Climate Change Financing Assessment Framework (PIFS): This method was developed to assess climate change financing in the context of Forum Island Countries, to account for Pacific specific aspects.
- Climate Public Expenditure and Institutional Review (UNDP/ODI): This tool allows assessing how public spending on climate change is integrated into budgetary processes at the domestic level. This tool has been used in Bangladesh, Indonesia, and Nepal.
- Readiness Needs Assessment (GIZ): This tool aims to assess the how effective are national systems in delivering public finance for climate change.
Peer exchange among Finance Ministries offers the opportunity to have a constructive debate on how to best plan the budget and manage public investments for climate change.