Session 6: Budget Support

Session 6: Budget Support Paper 6.1 - Introductory Paper on Budget Support [1] Introduction Budget support has become an increasingly important instrument of development assistance. It has not only received growing attention but also been increasingly used by both bilateral and multilateral donors. Donors and recipient countries alike have been gaining experience with this aid modality, yet the concept of budget support is still emerging and subject to different interpretations. This paper presents a conceptual synopsis of budget support as an aid instrument. Its purpose is to initiate discussion and to share the understanding on the budget support concept. The paper does not intend to provide a binding definition of budget support, but seeks to highlight a number of observations which helps to understand the concept as well as related issues that are at the core of ongoing discussions about the use of this aid instrument. The Context for the Emergence of Budget Support The years 2002 and 2003 represented a turning point in the evolution of aid flows to developing countries. The Millennium Declaration of September 2000 established the goal of developing a global partnership for development. The commitments of the Millennium Declaration were further developed at the International Conference on Financing for Development in Monterrey in March 2002, the Rome Declaration on Harmonization in February 2003, and the Development Assistance Committee (DAC) Working Party on Aid Effectiveness and Donor Practices in May 2003. All these have created the need for greater harmonization among donors, closer alignment with country-led development processes, and more efficiency and effectiveness of aid delivery. They also imply changes in donor policies resulting in the development of new partnership arrangements and appropriate aid instrument for implementation. This changing development agenda has provided the context for increasing emphasis on budget support, which is highlighted by the following trends: A vision of development cooperation based on partnership around nationally-owned development initiatives and programmes, led by recipient country governments. This vision has seen the shift from traditional conditionality, which has been unsuccessful in promoting sustainable policy reform, to a partnership based approach in which donors and the recipient country share programme, obligation and accountability. Greater emphasis on country ownership, i.e. emphasis on country policies, systems and capacity. This trend recognizes the critical importance and benefits of countrywide and sector-wide perspective, and strong policies and institutions. Change in donor behaviour towards better coordination and shared dialogue with recipient governments to reduce transaction costs, avoid duplication and harmonise priorities. The accountability has also shifted from individual donors, and an agreement on donor priorities and systems to accountability to the public/constituents. Shift from short-term to medium-term reforms. Reflecting the experience and changing needs of recipient countries, development assistance in the 1990s began to [1] Prepared by Le Thu HJuong, UNESCO BKK. 1

give increased attention to support for sustained structural and social policy programs, as well as capacity building and institutional reforms. Although the need for addressing short-term distortions remains appropriate in some cases, most of the policy programs have a medium-term perspective, supporting complex policy and institutional reforms critical to sustainable development. Increased focus on results. Both donors and recipient countries are confronted with the question of results, requiring them to focus more on achieving results, with improved monitoring and evaluation system and tool to track the results of development programmes. Increased focus on efficiency and effectiveness. Lessons learnt from the past experience of implementing development assistance projects and programmes have identified the following problems associated with traditional project type of aid: distortion of priorities (what donors want to fund is not what governments need, leading to lack of ownership and poor sustainability), high transaction costs (large number of donors, parallel systems outside the government s budget framework, no capacity development, no incentives to strengthen systems), fragmentation leading to inefficient spending and unpredictability of financing, low and delayed disbursements, and limited impact. An increasing number of donors have responded to these problems by moving from supporting specific projects to more strategic medium-term assistance, increasingly in the form of budget support. Defining Budget Support Different donor organisations use different definitions of budget support. In the most common sense, budget support typically refers to predictable, annual, medium-term resource flows that are channeled to the recipient country using its own financial management system and budget procedures. Budget support is typically based on an agreed set of performance indicators in the form of institutional or policy reform measures or outcome indicators. While there is not yet an agreed definition of budget support, the following terms are those used most frequently in discussion about it. It is useful to list them here and make some comparisons for better understanding the budget support concept. The definitions below take into account the different positions of donor organisations engaged in the use of these instruments. Policy-based lending: Provision of untied donor resources directly through the government s budget, using the government s own financial management, procurement, auditing, and implementation processes and systems, and based on a set of policy or institutional reforms fulfilled either ex ante (conditionality) if designed as a multi-tranche operation, or ex post (prior actions), if designed as a single-tranche operation. Development policy lending (DPL): The WB term for policy-based lending; replaced adjustment lending as the Bank s financing instrument to provide quick-disbursing resources to client governments. Poverty reduction support credit (PRSC): A programmatic approach to DPL in low-income countries that is tied to the country s medium-term PRSP and typically consists of a series of three or four single-tranche operations. Sector wide approach (SWAp): An approach that involves financing of a specific sector through various financing modalities, including budget support and investment financing. 2

Program-based approaches (PBA): A general term that refers to coordinated donor support to implement a comprehensive program (e.g. PRSP) or a specific sector/thematic strategy (education, environment) that is country-derived and relies on a single budget framework and domestic processes. PBAs include budget support and SWAps. The World Bank only recently formally recognized the notion of budget support with the introduction of Development Policy Lending, although it has been used informally for a number of years. Typically, budget support in the World Bank context is best characterized by the Poverty Reduction Support Credit (PRSC). In another word, PRSC is a form of (general) budget support. Bilateral donors have their own array of definitions for budget support, aligned around the premise that budget support is a sub-set of program aid (program-based approaches): The OECD definition outlined in recent DAC guidelines defines budget support as a method of financing a partner s country budget through a transfer of resources from an external financing agency to the partner government s national treasury. The funds thus transferred are managed in accordance with the recipient s budgetary procedures. 1 CIDA (2003) defines budget support as program support that is provided directly to hostcountry institutions to be spent as part of their budgets using their own financial management systems. DFID Policy Paper (May 2004) speaks about Poverty Reduction Budget Support (PRBS) as a form of financial aid in which funds are provided: (i) in support of a government program typically focusing on growth, poverty reduction, fiscal adjustment and strengthening institutions, especially budgetary processes; and (ii) directly to a partner government s central exchequer, to spend using its own financial management, procurement and accountability systems. In summary, the key features that distinguish budget support from other forms of aid modalities include: channeling of donor funds directly to a partner country s budget using its own financial management system and budget procedures; funds support a partner country s own development programmes; the policy priorities and performance assessment are agreed between recipient country and donors, and used as benchmark for funding approval and disbursement, as set out in the country s own strategy (e.g. PRSP) and medium-term expenditure framework (MTEF); and donor funding is provided at regular intervals, ideally in alignment with the country s annual budget cycle and processes General Budget Support and Sector Budget Support There is a distinction between general budget support (GBS) and sector budget support (SBS). GBS is not earmarked to a particular sector or set of activities within the government budget. It deals with dialogue and conditions focused only on macro and cross-sectoral issues. Other forms of programme aid including debt relief and other balance of payments (BoP) support may also generate resources that can be used to finance the government 1 DAC Guidelines and Reference Series, Harmonizing Donor Practice for Effective Aid Delivery: Volume 2; Budget Support, Sector-Wide Approaches and Capacity Development in Public Financial Management, OECD, 2005 3

budget, therefore they could also be considered as budget support. BoP and GBS have many similar characteristics. The case for BoP support is traditionally based on the need to fill a BoP gap. The foreign currency disbursed by donors will be used for imports (in many cases, general imports), while the counterpart fund accumulated at the central bank by selling the disbursed foreign currency to the importers is transferred to the general budget of the government. Accountability is based on the implementation of agreed macroeconomic/social policy program and/or use of the foreign currency for imports. In the latter case, donors request the Government to submit reports and/or evidence showing items imported by the foreign currency. Some donors accept the evidence of imports already made and paid before the disbursement, to encourage the quick disbursement. In these cases, the disbursed money in foreign currency is deposited as an addition to the foreign currency reserve (so called retroactive finance ). The case for GBS is typically based on the need for increased budgetary resources to reduce budgetary deficits or increase expenditure. The foreign currency disbursed by donors will be converted to the local currency as a counterpart fund and be used for the Government s general budgetary expenditure. Accountability is based on Government which produces audited accounts on Government revenue and expenditures. In some cases, donors request the Government to submit audited reports on the use of Government s general expenditures. Both of these instruments have common elements: (i) They can address a broad range of policy issues; (ii) Funds provided can be loans or grants, and give the recipient government varying levels of discretion over how they are allocated; (iii) Both instruments have a BoP supporting element (as the foreign currency is provided for the recipient and the government budget is denominated in local currency) as well as a budgetary support element as mentioned above. Thus, whether the instrument is BoP support or budget support is not an either/or question. In most cases, a single loan could be interpreted as BoP support as well as General Budget Support. Hence, different agencies use the terms according to their own understanding of the nature of its support and also its institutional requirements. The only significant practical difference is that the provision of budget support can facilitate donor s discussion with the government over budgetary processes and public financial management. In the case of SBS, funds are allocated to a specific sector or sub-sector. The primary purpose of SBS is to accelerate progress towards the government s sectoral goals. In SBS, donor funds are taken fully into account in the recipient government s planning and budget process, and are transferred into recipient government accounts to be spent according to national procedures. The main (but not necessarily exclusive) focus of monitoring, performance indicators and dialogue in SBS is around sector-specific issues. Since aid provided through budget support is provided in support of a government programme, it is not tracked separately from the rest of the budget. Thus support that limits aid to specific expenditures or expenditure categories within a sector has been called sector earmarked support, or targeted budget support (TBS), where the focus is on a sub-sector or specific areas within a sector. Under this definition, SBS is usually related to a broad area, such as education and health, or a sub-sector, such as primary health-care financing. The focus of the dialogue is not on the overall budget priorities, but on sector-specific concerns. Sector program assistance supports the implementation of reforms and other actions needed to overcome sector based development constraints. Additional sector reporting may supplement standard government accounting, although the disbursement is usually based on government procedures and regulations. 4

Confusion appears to exist in distinguishing SBS from SWAps. Some donors use SBS interchangeably with SWAp, while others suggest it is a step which should follow a SWAp. Typically, however, a SWAp represents an approach or framework rather than a modality. SWAp financing could include budget support but also project aid, technical assistance or a combination of different modalities, and may or may not be disbursed using government systems. The defining feature of a SWAp is that donor funding supports a set of sector policy reforms and a single expenditure program irrespective of how money is disbursed and accounted for. Qualifications to the Definition While the defining characteristic of budget support is that it uses national procedures, donors may insist on additional safeguard measures in some cases (e.g. requiring a special report on disbursements, or paying for independent audit). Regarding the boundary between SBS and sector basket funding, SBS uses the normal national procedures and basket funding typically uses special arrangements negotiated with donors. Basket funding would only count as SBS where money is transferred from the basket into government accounts to be mixed with domestic funding and used according to normal national procedures and does not involve any earmarking for specific items of expenditure. The boundary between SBS and GBS is blurred and overlapping to some extent. Some GBS has many sector-specific conditions (e.g. some World Bank PRSCs). Some SBS depends not only on sector-specific conditions, but also on some macro or general conditions (e.g. political governance, human rights, public finance management, anti-corruption, sound macroeconomic management). There does not seem to be uniformity of practice among donors in regards to the issue of earmarking. Some agree that any form of earmarking is not consistent with budget support and alignment with government systems and procedures. Others favour a phased approach in which earmarking initially serves to link budget support financial flows with sector expenditure, but with the expectation that over time it can be eliminated, whereas dialogue around budget allocations will still remain important. Earmarking is sometimes to a sector budget or to a narrower category of spending within the sector budget (e.g. a sub-sector, or a programme). The definition of a sector for SBS does not have to be restricted to a single ministry, but could apply to cross-sectoral or multi-ministry programmes to include those ministries and government agencies that are relevant to a policy area (e.g. rural development, decentralisation, or legal and judicial reform.). SBS can be provided into a central Ministry of Finance account or, with Ministry of Finance agreement, direct to a sector ministry or a sub-national level of government with significant policy and budgetary authority (e.g. states and provinces within large federal countries.) (The scope for doing this varies between countries, reflecting diversity in budget regulations.) SBS should observe sectoral budget ceilings as a means of expenditure control imposed by the Ministry of Finance, wherever these have been put into effect. Key Elements of Budget Support Instruments Preconditions for realizing budget support Clear articulation by Government of a policy framework, and leadership of the negotiation process; Analysis of fiduciary risk, and a credible Government programme to address any weaknesses in public financial management and accountability systems; 5

Strong donor collaboration; A focus on the outcomes that the policy implementation seeks to achieve; Agreement that the benefits of the instrument outweigh any potential risks. Elements of successful implementation of GBS/SBS A process of review, analysis and dialogue to discuss critical policy issues leading to the development of: A policy matrix owned by Government and supported by donors, which includes agreed prior actions/triggers Joint Government/donor discussion and review mechanisms (i.e. partnership groups) Shared reporting and accounting procedures among donors and Government Acceptable mechanisms for channelling resources into the Government budget Development of process indicators to ensure that stakeholders can monitor progress towards objectives, such as: monitoring of improvements in financial management practices and accountability, approval of revised polices etc.; monitoring of outcomes of the implementation of Government policies. Fiduciary risk With budget support, once donor funds are transferred into the budget of a recipient government, they can no longer be tracked or accounted for separately. Donors (and governments) need to be satisfied that overall government systems and practices ensure that resources are used effectively. Fiduciary risk is the risk that (1) funds will not be used for the purposes intended, (2) funds will not be properly accounted for, and (3) funds will not be utilized efficiently and effectively. While the concept of fiduciary risk is fundamental to all development work, it is not always explicitly acknowledged. Expectations Underlying the shift to increased budget support by many donors are a number of expectations: improved coordination and harmonization among international partners and alignment with partner country systems and policies lower transaction costs increased predictability of funding and reducing volatility better prospects for strengthening country ownership, institution and capacity ensuring sustainability of reforms strengthening partner government s policy and processes through addressing government-wide issues that can not be tackled with stand-alone and sector projects improved domestic accountability through increased focus on the Government s own accountability channels improving the efficiency and effectiveness of the state and public administration as budget support is aligned with and uses government allocation and financial management systems increased focus on results and improved performance focusing on national priorities rather than on operational issues or activities with limited scope and effect These expectations are also often referred to as objectives or benefits of budget support. ----------------- 6

List of Abbreviations and Acronyms BoP CIDA DAC DFID DPL GBS OECD PBA PRBS PRSC SBS SWAp Balance of Payment Canadian International Development Agency Development Assistance Committee Department of International Development Development Policy Lending General Budget Support Organisation for Economic Cooperation and Development Programme Based Approach Poverty Reduction Budget Support Poverty Reduction Support Credit Sector Budget Support Sector Wide Approach 7