Strategic Planning and Fiscal Framework

The strategic planning and fiscal framework stage is an opportunity for governments to define and describe the climate targets and objectives for the country and to ensure that plans and targets are well aligned.

Green priorities and concerns should be taken on board during the strategic planning and fiscal framework phase, which sets the broad policy framework and overall fiscal constraint for the budget. The budget process is normally undertaken in the context of a broader policy framework, which is often called a national development strategy. The key steps in this phase are the creation of a strategic or development plan; the preparation of a medium-term fiscal framework (MTFF) with macroeconomic and macro-fiscal forecasts; the identification of fiscal risks, including those emanating from climate change, that could disrupt the fiscal policy objectives; and the design and description of fiscal policy in the context of the strategic plan and medium-term framework. This strategic framework could include elements on how to mobilize green financing to address climate change mitigation and adaptation targets. The strategic planning and fiscal framework stage provides not only quantitative targets and forecasts but also a descriptive narrative that contextualizes the budget.

NDCs⁷ can help anchor climate adaptation and mitigation in the planning stage. A total of 193 countries have submitted NDCs. NDCs span at least until 2025; most cover the period until 2030 and quite a few cover the period until 2050.⁸

Strategic or national development plans are a good place to highlight and project a government’s green plans, in coherence with the country’s NDC. Many countries are increasingly incorporating green goals and targets in these plans, providing justification and context for decisions taken in later stages of the budget process.

• Indonesia encourages ministries and subnational governments to integrate a green dimension in their budgeting and planning by highlighting the top six policy areas and 21 priority programs for achieving the greatest green benefits.⁹

• China’s 14th Five-Year Plan (2021–2025) contains precise goals on sustainable energy to put the country on a pathway toward achieving its carbon neutrality goal by 2060.

• Two of ten strategic objectives in the Irish national development plan (2021–2030) have a green focus, providing guidance on a transition to a low-carbon and climate-resilient society and the sustainable management of water and other environmental resources.

• The Green Deal of the European Union (EU) sets out a roadmap to make Europe climate-neutral by 2050, with an explicit commitment to foster green budgeting practices in the EU.

• Nepal’s 15th Plan (covering FY 2019/20–2023/24) includes a dedicated chapter on climate change, with the overarching objective of building a climate-resilient society, and mainstreams climate change concerns into several policy areas, including agriculture, water, transport, and tourism.

• The national development plan process of South Africa also sets out a long-term strategy to guide the country’s transition to an environmentally sustainable, climate-resilient, low-carbon economy and just society.

• Fiji’s 5-year and 20-year national development plans are closely articulated with the National Climate Change Policy (2017–2030).

The MTFF can provide an integrated green-fiscal pathway to achieving the long-term targets set in the development plan or strategy. An MTFF is a top-down specification of a government’s aggregate resource envelope. When well defined, it serves as an interface between the long-term strategic goals of a national plan and the spending, revenue, and financing plans contained in a budget. Traditionally, the path reflects an effort to optimize fiscal sustainability, employment and income growth, and price stability; however, it may be appropriate to include in the design of this aggregate fiscal path green objectives, such as reductions in greenhouse gas (GHG) emissions. These particular objectives are considered to be “macro-critical”¹⁰ and responsive to macroeconomic conditions and fiscal policy. This greening of the MTFF offers a helpful entry point for strategically important and macro-relevant green forecasts like GHG emissions reductions because they can guide both fiscal policy and the downstream budget preparation processes.

The degree to which climate change is incorporated in the fiscal framework depends on political commitment to the incorporation of climate targets and capacity to integrate these targets in the framework. A first step would be to integrate narrative elements on green priorities in those budget documents that traditionally provide context for the budget, such as economic and fiscal outlook documents, and to highlight the compatibility of fiscal policy with the green objectives. In addition, fiscal risk statements could discuss the anticipated impact of climate change on the prevalence of natural disasters in the country (see section on fiscal risks).

A more detailed and concrete step would be to include green forecasts (such as GHG emissions reductions) in the preparation of the fiscal framework and to present these forecasts and the related analysis in the budget framework documents. GHG emissions are especially well suited for inclusion in the fiscal framework because they can be modeled and forecasted using tools like those already employed in the preparation of the macroeconomic forecasts. There are already several examples of countries incorporating climate targets in macro-fiscal forecasting tools and models that underpin the budget process. A paper by the OECD¹¹ recently took stock of progress in this field in advanced economies, but there are also some examples in less advanced economies:

• Denmark is currently developing a model called GreenREFORM, which will integrate the emission of air pollutants from all Danish businesses and households and the public sector. It will also describe the effect on emissions from environmental taxes, subsidies, and regulation. The model is expected to provide yearly forecasts for each year from 2015 to 2100.¹²

• The Scottish government provides a carbon footprint assessment of its draft budgets, which estimates the GHG emissions associated with planned government purchases of goods and services.

• In Bangladesh, work is ongoing to prepare a climate-inclusive medium-term macroeconomic framework (MTMF) using a macroeconomic model that includes climate change variables. Moreover, it is also feasible to use the model to directly forecast and present the government’s GHG emissions.

• Samoa’s MTMF is closely aligned to meeting climate objectives, and climate considerations are also well reflected in the government’s strategic plans and in sectoral strategies.¹³

Although the fiscal framework is yet to be used explicitly for this purpose, it could be instrumental in defining explicit medium-term fiscal targets or numerical fiscal rules that are internally consistent with green priorities. For example, a government could establish a binding target on total GHG emissions, which may be highly responsive to fiscal policy if emissions have not been decoupled from economic activity.¹⁴ A forecast breach of the limit could trigger a tightening of fiscal policy (curbing the growth of emissions), a realignment of expenditure away from emissions-intensive activities, or adjustments to tax policy (such as a carbon tax). A variant would be to set rules or targets for public expenditure and public investment that would allow the country to reach green targets over the medium term while ensuring fiscal discipline and accounting for the reality that most of the expenditure required for mitigation purposes would have to occur in the private sector and would be steered by carbon prices. These approaches could be complex and constraining, particularly in countries where the investment needs associated with adaptation are high and might lead to wrong incentives and unintended consequences (Caselli and others, forthcoming).

Fiscal rules should remain flexible enough to allow for a fiscal response in case of a climate change–related emergency. For example, fiscal rules are often accompanied by an escape clause that allows for their suspension in the wake of large natural disasters, although even here an option exists to require that the activation of an escape clause be undertaken using environmentally and climate-sensitive principles.

• Germany’s fiscal rule includes an escape clause triggered by natural disasters or unusual emergency situations that are outside government control and have a major impact on the financial position of the government. The clause can be activated only after a majority vote in parliament.

• Brazil’s fiscal rule likewise includes an escape clause for natural disasters, which can be invoked only with congressional approval.

Fiscal risks associated with climate change should also be assessed at this stage of the budget cycle to inform the fiscal strategy. Risks related to the environment are already an integral part of the fiscal risk analysis in many countries, particularly those highly susceptible to natural disasters. However, climate change is creating new and diverse risks that all governments need to carefully analyze and manage so that the fiscal framework remains credible. These risks include (1) the uncertainty of the costs and benefits associated with mitigation and the global transition to a low-carbon economy, including side effects for a given country of measures adopted by other countries (for example, impact of a possible border adjustment tax on exports to important trade partners or of restrictions on air travel on the tourism sector) and (2) the potential costs of adaptation due to the increased prevalence of natural disasters, the expected rise in sea levels, and long-term changes in weather patterns as well as the exposure of infrastructure assets to these factors. This content is covered in more detail in the section on fiscal transparency.

Green priorities should also be factored into long-term fiscal sustainability analysis. Long-term fiscal sustainability analysis that accounts for climate and other environmental factors can help to identify the savings from early mitigation and adaptation efforts that might otherwise appear fiscally burdensome and difficult to reconcile with overall fiscal sustainability. The OECD (2021e) has also provided useful guidance on the impact of climate change on long-term fiscal sustain-ability analysis. Incorporating these impacts in such analysis and conducting sensitivity analysis can help to place into context the immediate budget decisions in the same vein as the consideration of long-term demographic factors for countries with aging populations.

• For instance, in its 2021 Report on the Long-Term Sustainability of Public Finances, Switzerland identified four main channels (prevention of climate change, damage remediation and adaptation, international commitments, impact on receipts) through which long-term fiscal sustainability could be negatively affected.¹⁵

• Georgia is quantifying the long-term fiscal implications of climate change scenarios, including the Paris Agreement, a business-as-usual scenario, and a more volatile climate scenario. Technical assistance from the IMF has projected debt-to-GDP to rise by about 18 percentage points over the next 50 years under the volatile scenario.¹⁶

• New Zealand’s 2016 Long Term Fiscal Statement was prepared using a new “living standards framework” and included a chapter on the path of natural capital.¹⁷

• The European Commission has included stress tests of extreme weather and climate-related events in its 2021 Fiscal Sustainability Report.¹⁸

Once green priorities are identified and embedded in strategic plans, it is important to assess the financing gap and prepare a strategy for green financing. Planning documents should be linked to this strategy, thus contributing to the credibility of objectives, outcomes, and targets. Meeting the ambitious climate goals requires systematically leveraging all sources of finance, including traditional loans, grants, debt swaps, national and international climate funds, carbon markets, green bonds, and insurance instruments. As of May 2021, among OECD countries, 19 sovereigns had issued green bonds to finance green projects in governments’ budgets, exceeding $130 billion, although sovereign green bonds still account for only 0.2 percent of all government debt securities (OECD 2021c). Examples include the following:

• Ireland, where the Irish National Treasury Management Agency launched in 2018 the first Sovereign Green Bond. It stipulated that any proceeds raised can be devoted only to eligible green expenditure, with the obligation for the government to report to investors on an annual basis on the disbursement of these sums.

• The United Kingdom (UK) launched its Green Gilts and Green Savings Bonds in 2021 to support projects with clearly defined environmental benefits. More than £16 billion has been raised through this process.

Budget Preparation

The budget preparation phase—crucial for the inclusion of green concerns into the budget—can be defined as a collaborative process, led by the MoF, that aims at producing the optimal resource allocation across sectors and policies under an overall fiscal constraint. The budget preparation process addresses the next fiscal year but is often underpinned by the preparation of a medium-term budget framework (MTBF) with a time horizon of several years. This phase of the budget cycle can be greened through a variety of tools, but their real effectiveness is contingent on their actual impact on budget decision-making.

“Mainstreaming” climate-related considerations into the budget process with an effective impact on decision-making is difficult. The risk is that the greening of the budget preparation process focuses only on reporting, producing useful information and transparency on climate issues but with little or no impact on actual budget choices. To avoid such a trap, thorough changes in the budget discussion and decision-making process may be required.

• In France, the decision-making process on the COVID-19 recovery plan announced as part of the 2021 budget clearly factored in environmental concerns, based on the tagging system implemented as part of France’s green budget.¹⁹

• In the UK, the government’s Net Zero targets were used as one of the five missions formulated by the prime minister to drive change throughout the Spending Review 2021 period and beyond.²⁰

Greening the budget circular is an accessible step that helps to send a clear signal to stakeholders on the importance of climate-related issues. The budget circular, also known as “budget call circular,” is typically produced by the Budget Directorate and is the key vehicle for identifying the orientation of governmental policies as well as operational guidelines and targets to sectoral ministries before preparing the budget. Providing climate indications in the circular (for example, stating that climate change will be a major criterion for budget allocation, asking line ministries to identify climate-related spending or link spending to strategic climate priorities or to justify all new policy proposals regarding their climate or wider environmental impact) compels line ministries to take them into account during the preparation of their budget submissions and helps the MoF gather useful information and improve understanding of sectoral needs. In some countries, budget guidelines or circulars have been the very first line of action to incorporate a green perspective in the budget process. They are also critical instruments to communicate instructions for green tagging processes when they are implemented.

• Bangladesh modified its budget circular to provide guidance to all line ministries on supplying information related to climate change priorities and actions in their MTBFs—notably, in line with the six thematic areas identified in the Bangladesh Climate Change Strategy and Action Plan and the Bangladesh Delta Plan. These elements must be considered in budget submissions to inform the budget decisions.

• In Burkina Faso, annual budget guidelines in 2019 and 2020 have included an obligation for ministries to take climate risks into account in their budget submissions.

• Kenya’s budget circular specifies several priority interventions, both for mitigation and adaptation to climate change. It also provides instructions for the climate budget tagging process.

Assessing climate (and wider environmental) implications of new budget measures is among the most common good green PFM practices. This effort may be mandated by legislation, which requires the systematic inclusion of the environmental and climate dimension in impact assessments and cost-benefit analyses (see Legal Framework section). In the same vein, environmental and/or climate impact assessments should inform the process for evaluation and selection of public investment projects, integrating a strong climate dimension for the sectors that have the most impact on GHG emissions (infrastructure, energy, and transport; see Annex 1).

• For example, in France, an impact assessment of budget measures has been made compulsory since a 2008 constitutional reform and includes an environmental dimension.

• In the EU, impact assessments—including on new spending programs financed by the EU budget— must address environmental issues.

• Similarly, Thailand, with UNDP support, developed a manual for climate change cost-benefit analysis²¹ that has been used in cost-benefit analyses of new budget measures since 2015.

This focus on new measures can be usefully complemented by green spending reviews. Focusing on new measures or new projects is essential but allows only for incremental changes and does not entail revisiting baseline (ongoing) spending. Developing the climate dimension of overall expenditure analysis is very important in this respect. This is why a number of countries, mostly within the OECD, have found it useful to develop spending review processes (Doherty and Sayegh 2022), both to allow for a more in-depth analysis of baseline spending and to develop a bespoke mechanism to identify and adopt savings measures that can be incorporated in the budget. Hence, conducting green spending reviews where spending is analyzed not only based on value for money but also based on contribution to climate and environmental goals can be an important tool (OECD, forthcoming). It is especially relevant when fiscal space is scarce—provided that authorities resist the risk of “greenwashing” and take a hard look at the environmental impact of recurrent expenditures.

• For example, Ireland conducted a National Biodiversity Expenditure Review (2018) to identify overall spending on biodiversity over the 2010–2015 period and to assess potential avenues for further resource mobilization.

• Bangladesh has also launched a review of existing policies (taxes, subsidies, and pricing) to identify areas where (1) revenue measures will recognize the effects of climate change and strengthen tax incentives for low-carbon green development, (2) the government can provide subsidies for green products and conversely reduce harmful subsidies, and (3) the government should adjust its energy pricing policy to promote renewable energy generation options.

Climate change should be a key consideration in the appraisal and selection of investment projects as well as in the risk management of projects. If green concerns are not taken on board at the outset, the public investment management system is very likely to yield suboptimal outcomes.

• In Peru, with the support of the German Agency for International Cooperation, a new multiyear programming and investment management scheme— INVIERTE.PE—came into force in February 2017. The new minimum requirements applicable to all public investment projects include climate risk management. This builds on research conducted following an extreme weather event (El Niño) to identify the key characteristics of infrastructure that had remained intact.

• The Netherlands requires that the effects of public investment projects on the climate, circular use of energy, climate adaptation, and a healthy environment be considered during all stages of the public investment cycle.²²

Tagging climate-related expenditure in the budget preparation phase has gained traction over the past decade and is a tool accessible to low-income countries. Giving an overall picture of climate-related expenditure helps highlight the true importance of climate concerns in resource allocation and monitor changes in spending levels and composition from one year to the next. Green budget tagging does this by assessing each individual component of the budget based on its climate impact and giving it a “tag” according to whether it is helpful or harmful to the achievement of green objectives. The success of a tagging exercise ultimately rests on the capacity to analyze and classify expenditure in an adequate and reliable manner,²³ and it is an important factor in attracting international climate finance. There is no single, widely accepted international standard for tagging green expenditure. Governments have used different taxonomies and classifications as foundations for their tagging methodologies; however, countries should strive for robustness and clarity of the classification implemented as well as consistency with their overall budget system and environmental policies.

• Although many countries such as the Philippines and Nepal have implemented some form of green budget tagging or climate budget tagging,²⁴ a recent example is provided by France, which has, starting with its 2021 budget, designed and published a green budget with a high degree of ambition: it covers the whole budget (including tax expenditures) and tracks spending not only against climate change objectives but also against other environmental objectives such as fighting waste or protecting biodiversity, based on the EU Taxonomy of Sustainable Environmental Outcomes. Moreover, the tagging system also tracks expenditures that are detrimental to the achievement of environmental goals.

The green dimension can be mainstreamed into program and performance budgeting processes.

Program-based budgeting frameworks are a critical tool in operationalizing green budgeting. By using outputs and outcomes to inform the allocation of budget envelopes, these frameworks allow for decisions to better respond to policy objectives and to report progress toward targets. The approaches developed for gender budgeting are a useful reference—gender-specific programs, or full integration of gender priorities through gender performance indicators defined under each program (for example, Austria).

• Under Uganda’s performance-based budgeting framework, budget entities can set their own performance indicators; however, the Ministry of Water and Environment and the Office of the Prime Minister provide guidance on setting climate-related performance indicators. The Uganda Bureau of Statistics supports this process by coordinating the collection of data related to climate change.

The growing importance of the multiannual dimension in budget preparation means that efforts must be made to green not just the annual budget but also the MTBF. The long-term dimension of climate change challenges makes a narrow focus on the annual budget preparation inadequate. Where such a phase exists, green concerns must also be fully reflected in the multiannual phase of budget preparation, which leads to the adoption of an MTBF outlining expenditure plans over several years per ministry or policy area. This is, however, still at a nascent phase, as efforts so far have rather prioritized work on the annual budget. That said, the elaboration of the MTBF should ideally incorporate green concerns in the determination of sectoral ceilings and present the scope and impact of green spending per broad policy area.

• Indonesia’s 2012 Mitigation Fiscal Framework as well as Morocco’s climate medium-term expenditure framework are examples of early promising, albeit one-off, efforts.

• A more recent example is Bangladesh, where since the 2018/19 budget, the MTBF integrates for each line ministry a figure for the total climate-relevant amount included in its budget for each of the three years covered by the MTBF, as well as a narrative report on the expected impact of this spending on climate change.

Budget Execution, Accounting, and Reporting

The next stage of the budget cycle—which covers budget execution and associated accounting and reporting tools—is crucial to hold authorities accountable for implementing their green expenditure goals and ambitions.

Tracking green expenditure during the budget execution phase is an important component of a tagging system; otherwise, the green or climate budget tagging system remains purely aspirational. Its real impact cannot be measured, and its effects can be undermined by possible reallocations within the budget year toward actions with lower climate relevance. This situation could give rise to perverse incentives whereby line ministries and the MoF agree to “boost” green expenditure in the preparation of the budget for communication purposes, while actually sticking to other spending patterns, possibly climate-neutral or even detrimental to the environment, during the budget year.

Tracking of green expenditure should ideally be factored in from the outset when putting in place a tagging system. Options include the following:

• Adapting the chart of accounts (CoA): The CoA provides a coding structure for the classification and recording of relevant financial information (both flows and stocks) within the financial management and reporting system and is a critical element of the PFM architecture. It is important that the CoA allow for the possibility of adequately reporting on green expenditure.

  • In Bangladesh, the CoA includes a four-digit climate change budget code segment to enable tracking of government expenditure across the six themes and 44 programs of the Bangladesh Climate Change Strategic Action Plan.

  • In the same vein, Kenya expanded the CoA in its Integrated Financial Management Information System by introducing an analytical segment to capture climate-related expenditures. Once rolled out, this eighth segment of the CoA is expected to be made up of four digits: the first two digits refer to the subject of tagging (in this case climate change, but it can also be other cross-cutting issues, such as gender), the third digit shows the focus (adaptation, mitigation, or both/cross-cutting), and the fourth digit the relevance level (principal, significant, or not targeted).

• Ensuring that the financial management information system (FMIS) can be used for green reporting purposes: The FMIS is the IT backbone of the expenditure chain and should enable monitoring and reporting of climate-related spending.

  • In Bangladesh, the local FMIS, called iBAS++, enables the monitoring of green or climate change expenditure and the production of relevant information.

• Setting up specific reporting systems if needed: Some countries may rely not on FMIS but on ad hoc reporting by line ministries to track actual green spending; however, this approach may be time consuming and may increase the risk of error.

This information may then feed into a dedicated implementation report. The report allows direct comparison between budget and actuals, as is the case for the Climate Expenditure Report in Indonesia or for the Climate Budget Reports prepared by the Climate Change Expenditure Tracking Unit in the Philippines. Depending on the degree of performance information available, such a report may also feature outputs and outcomes during the budget year.

• For example, in Nepal, climate change–relevant ministries need to prepare sector-specific climate change–related key performance indicators to monitor the financial and physical progress periodically on a trimester and annual basis, such as installation of domestic solar power systems or domestic bio-gas plans for the ministry in charge of energy.

• Pakistan has implemented a climate change expenditure tracking system where users can generate reports to track and measure the effectiveness of green expenditures on outputs and outcomes.

• In Bangladesh, the MoF prepares and presents before parliament a climate budget report with the budget documents every fiscal year. This report captures climate-relevant allocations and actual expenditure information to compare the performance of each ministry regarding spending. The report tracks progress of key national climate investment plans against the financing targets.

Because the number of climate change–related emergencies may increase in the years to come, governments should look to strengthen the in-year responsiveness of PFM systems while preserving financial integrity. Risk management mechanisms can help reduce exposure to fiscal risks related to climate change and mitigate their potential impact. However, in the event of severe disasters, governments might still have to urgently reprioritize spending during the year, possibly by swiftly adopting a supplementary budget and ensuring short-term cash availability as well as business continuity. Preparing PFM systems for the challenges associated with emergency responses—as was the case at the start of the COVID-19 pandemic (IMF 2020b)—is critical for tackling climate-related emergencies.

Accounting practices may also need to reflect green concerns. Environmental financial accounting (that is, an approach to financial reporting whereby entities report on their exposure to and management of the financial and nonfinancial impacts resulting from environmental degradation and/or climate change) is still at an early stage of conceptualization and practical use in the public sector. Although disclosure of high-level information on how public entities are affected by climate change is increasingly common, the measure-ment—and recognition—of climate-related financial impact is still rare. The ongoing work by the International Public Sector Accounting Standards Board on sustainability reporting may help further progress.²⁵

• Auckland (New Zealand) has adopted financial accounting practices in line with the recommendations of the Task Force on Climate-related Financial Disclosures, which was established in 2015 following a G20 initiative. Although the task force’s mission is to develop voluntary and consistent recommendations for disclosing climate-related financial risk by private sector entities, these recommendations can obviously be a source of inspiration for public sector entities whose advanced accrual accounting frameworks mirror those of private standards.

Finally, green public procurement (GPP), or green purchasing, can help governments achieve their climate-based environmental policy objectives. Public procurement constitutes about 12 percent of global GDP, or $11 trillion per year (Bosio and others 2020). Integrating climate change and other environmental considerations into the guidance, procedures, and methodologies for government procurement is therefore recognized as a powerful tool to address climate change. The fourth of the Helsinki Principles indicates that finance ministries should take climate change into account in procurement practices to reduce public sector impact and catalyze markets through GPP.

The European Commission (2008) defines GPP as “a process whereby public authorities seek to procure goods, services, and works with a reduced environmental impact throughout their life-cycle when compared to goods, services, and works with the same primary function that would otherwise be procured.” GPP requires public purchasing of those products and services that are less environmentally damaging over their whole life cycle. Clear and verifiable green criteria for products and services can be integrated into the procurement process at each stage of procurement, including supplier selection criteria, technical specifications, award criteria, and contract performance (World Bank 2021).²⁶ Credible standards make it easy to identify which products or services count as green, such as eco-labels.

GPP is becoming an essential part of modern procurement systems.²⁷ The European Commission and several European countries have developed guidance in this area. Several countries in Latin America and the Caribbean, such as Ecuador, Nicaragua, and Uruguay, also developed policies to promote green public procurement (OECD 2020).

• Since 2008, the European Commission has developed more than 20 common GPP criteria (such as GPP criteria for the wastewater infrastructure, road design, construction and maintenance, and electricity). The EU GPP criteria aim to facilitate the inclusion of green requirements in public tender documents while ensuring a balance between environmental performance, cost considerations, market availability, and ease of verification.²⁸

• The Dominican Republic developed a National Policy of Sustainable Public Procurement in 2021. It includes provisions explicitly supporting environmental and social criteria in bid assessment and awards. A draft procurement law prepared in 2020 incorporates binding environmental sustainability criteria.²⁹

Control and Audit

Control and audit (internal and external) aim at giving reasonable assurance to stakeholders that the processes are implemented in compliance with rules, funds are used for their intended purpose, and information provided is accurate and complete. Incentives for actors within the administration to indulge in “greenwashing” (to enhance their popularity with the wider public so it will back their claim for additional resources) give a strong relevance to this aspect of the budget cycle.

Controlling and monitoring green expenditure involves several actors. There is a usual distinction between internal control and audit and external audit:

• The internal control and audit functions are performed by the MoF, as the overall controller of budget systems and processes, and line ministries and agencies. Internal audit or inspection bodies, especially within the MoF, can be the first line of defense against inefficiencies if they adopt a climate focus in their work program. Internal control and audit functions can allow for close inspection of the effectiveness of an organization’s processes and systems and assess their compliance with the climate-related objectives and requirements. Such functions can help to identify climate risk and contribute to the improvement of climate risk management processes. Line ministries and agencies can also monitor and assess the climate outputs attached to their budget actions.

  • In the UK, the National Audit Office’s good practice guide for Audit and Risk Assurance Committees (ARACs) highlights the role of internal audit in managing climate change risk. It suggests that ARACs assess whether internal controls are in place for effective monitoring of climate-related risks and whether the organization’s internal audit function includes climate-related issues in its planned work.³⁰ o In Australia, the New South Wales’s Internal Audit and Risk Management Policy for the General Government Sector requires organizations to consider climate-related risks when assessing risks that might prevent an organization from achieving its objectives and makes audit and risk committees responsible for seeking assurance from management that climate change risks are being identified and addressed.³¹

• The external audit function is carried out independently of the executive branch of government. It is the supreme audit institution (SAI)³² in charge of assessing and auditing compliance of project proposals and transactions with the climate-related objectives and requirements; the parliament, which is the main oversight body, is responsible for examining external audit and evaluation reports on green or climate strategies.

All these stakeholders should be involved in examining and monitoring the climate impact of the government’s policies and evaluate the efficiency and effectiveness of all mitigation and adaptation policies.

After the budget has been executed, the SAI can undertake audits of the impact and effectiveness of green-related policies. The SAI has a crucial role to play in managing the increasing funds allocated to climate change by ensuring transparent and effective use of public funds through financial and compliance audits as well as performance audits. Although these three types of audits can address environmental and climate issues,³³ specific expertise must be built up to successfully integrate climate change in audit methodologies. This could include assessing whether the impacts (such as GHG reductions) are in line with the stipulated climate goals in NDC and development plans. The International Organization of Supreme Audit Institutions (INTOSAI) has recognized that climate change audit requires deep understanding of the technical details for auditors to design an effective audit approach.³⁴ Green PFM is a cross-cutting issue, and many SAIs are mandated to review a range of policy fields to enhance government functions. In 2017, the INTOSAI Working Group on Environmental Auditing published a research paper on potential criteria for conducting performance audits of specific government initiatives to strengthen resilience and adaptive capacity; the paper also included examples of how SAIs have employed these criteria in practice.³⁵ In some countries, a specific expertise is established within the auditor generals’ office to assist the auditor general in auditing the implementation of green policies.

• In Canada, the Commissioner of the Environment and Sustainable Development, appointed by the auditor general for a seven-year term, is responsible for providing parliamentarians with independent analysis and recommendations on the federal government’s efforts to protect the environment and foster sustainable development. The commissioner conducts performance audits related to the environment and sustainable development on behalf of the auditor general.

Setting up external audit mechanisms is essential to examine, measure, and monitor the efficiency and effectiveness of green policies. One approach is to make green policies the focus of performance audits; this tactic would be appropriate when the government is delivering climate-specific programs (such as the climate action plan in Ireland).³⁶ Another approach is to make green PFM an area of investigation within the audit. The examination of green PFM issues could result in important findings and recommendations related to government commitments and obligations in greening their PFM practices.

External auditors have an important role in highlighting shortfalls and risks and communicating them to the public in an understandable way; this task is even more critical for policies that would affect future generations. Performance audits, which try to specifically assess the link between policy outcomes/ outputs and the means affected to a given policy, can offer insights into complex problems and risks that cut across government programs, levels of government, and sectors. A few countries with extended green PFM experience include climate considerations in their performance audits.

• In 2016, the European Court of Auditors published a special report on the EU’s target to spend at least 20 percent of its budget on climate-related action. The report highlights the progress made and identifies weaknesses related to the tracking methodology and the lack of distinction between mitigation and adaptation measures.³⁷

• In the UK, the National Audit Office has been working on a range of climate audits covering a diverse set of topics. Among the most recently issued reports are (1) a report to support parliamentary and public scrutiny of government’s arrangements for achieving net zero, highlighting the main risks government needs to manage to achieve net zero efficiently and effectively (including the roles and responsibilities within government and the coordination arrangements)³⁸ and (2) a report examining how effectively central government and local authorities in England are collaborating on net zero target.³⁹

• In Austria, there is no specific mandate or priority for climate in the audit program of the auditor general; however, the auditor conducts performance audits that include climate-related issues. In 2020, the auditor general issued a report questioning the effectiveness of the energy industry measures against energy poverty.⁴⁰

• In Bangladesh, guidelines for climate performance audit have been introduced by the Office of the Comptroller and Auditor General.

Parliament has a central role in holding governments accountable for their green policies and actions—or lack thereof. Parliament or its committees can scrutinize the government’s performance in responding to climate issues by examining relevant audit and evaluation reports on climate strategies and recommending corrective measures in case of deviation from the approved targets.

• In Pakistan, a parliamentary Standing Committee on Climate Change deals with issues related to the environment. Its mandate includes reviewing the impact of the national strategy to counter climate change and ensuring the application of laws pertaining to all aspects of climate change.

• In Nepal, parliament, with the technical support of UNDP, is developing a handbook to provide a practical guide for members of parliament in scrutinizing the funds during the various stages of budgeting. This toolkit aims to support the federal parliament and provincial assemblies in engaging in climate change finance, analyzing allocation, and monitoring its use.

• In Uganda, parliament’s Natural Resources Committee is tasked with scrutinizing the government’s climate policies. Its chairman is also a member of the Budget Committee; this arrangement helps to ensure that climate priorities are reflected in the budget.

Many countries support the implementation and oversight of climate policies by setting up an independent special body. This body is typically an independent government body such as a national climate change advisory council, committee, or panel, typically bringing together subject matter experts from the public and private sectors and from academia. The key to success for these institutions is to have a formal mandate that is seen both by the political players (government and opposition) and by the public as an objective source of information, analysis, and advice to government and/or parliament on the consistency of current policies with government targets and commitments and what must be done to achieve targets, including through interim carbon budgets.

• In Ireland, the Climate Change Advisory Council, an independent advisory body, assesses and advises on how Ireland can achieve the transition to a low-carbon, climate-resilient, and environmentally sustainable economy established under the Climate Action and Low Carbon Development Act 2015. In 2018, the council expressed its disappointment at the Budget 2019 decision not to increase the carbon tax in Ireland.

• The Committee on Climate Change is the official climate watchdog in the Philippines. An autonomous body under the Office of the President, the committee coordinates, monitors, and evaluates government programs and ensures mainstreaming of climate change in national, local, and sectoral development plans toward a climate-resilient and climate-smart Philippines.

• In the UK, the Climate Change Committee— an independent statutory body that proposes carbon budgets and monitors the progress toward their achievement—reports to parliament on the progress made in reducing GHG emissions and adapting to the impacts of climate change.

• In The Netherlands, the Advisory Division of the Council of State assesses the adequacy of the climate goals, administrative and executive aspects, economic and budgetary considerations, and legal aspects of the climate plans of the Dutch government considering the climate targets stipulated in the Climate Act.⁴¹

Legal Framework

With clearly established rules, procedures, and responsibilities, a comprehensive, well-defined, and transparent legal framework guides PFM practices at each stage of the budget cycle. The PFM legal framework is therefore a key tool to translate climate objectives into actions in a transparent and accountable manner.

Environmental-related rights and protections have been enshrined in national constitutions since the 1970s and given statutory meaning through environmental laws over the past few decades.⁴² These traditional environmental laws set the foundation for early green PFM practices, such as requiring environmental impact assessments to be carried out for individual infrastructure projects. However, with the growing importance of climate change, countries started to strengthen their legal frameworks to address specific challenges posed by climate change and implement commitments under the Paris Agreement. Several countries articulated climate considerations in their constitutions, which usually provide a broad promise to tackle climate change. For instance, Tailand, Vietnam, and Zambia included dedicated climate-relevant provisions in their constitutions.⁴³

• Ecuador’s constitution includes a more specific climate-related provision. It has a dedicated section on biosphere, urban ecology, and alternative sources of energy, which lists a set of climate actions to be adopted.⁴⁴

To translate their international obligations into national legal frameworks, countries have also started to enact dedicated climate laws. Climate laws usually include climate targets that are often the translation of international agreements embedded in the legal framework. They also outline mitigation and adaptation objectives, mechanisms to achieve and monitor these objectives, and institutional duties and powers to this effect, including establishing an independent body to give advice on setting and meeting carbon budgets.⁴⁵

• The UK’s Climate Change Act of 2008,⁴⁶ the Philippines’ Climate Change Act of 2009, The Netherlands’ Climate Act of 2019, and Kenya’s Climate Change Act of 2016 are examples of comprehensive national climate laws.

• Also, several EU countries recently enacted climate action laws to comply with European targets and fulfill obligations under the Paris Agreement, such as Germany’s Federal Climate Change Act of 2019.

Although the evolving legal framework that supports climate action offers guidance to kickstart green PFM reforms, green PFM practices are still relatively new on countries’ legal agendas. The legal foundation and design of existing green PFM practices vary across countries, reflecting differences in both legal and political traditions. Countries tend to introduce green PFM practices in their specific climate laws (for example, Sweden) or through amending their existing public finance law (for example, New Zealand, Mexico), or a combination of those (for example, Uganda). In some countries, like Austria, green PFM practices were embedded in the law during the budget law reform,⁴⁷ while in others, like Italy, the practice was built on the existing legal provisions on environmental focus with-out any further legislative amendments.⁴⁸ Countries also applied green PFM practices through government decrees or directives (for example, Finland and Canada).

Although countries took a range of approaches in introducing legal requirements for green PFM elements, in most cases the law mandates incorporating green goals during budget formulation, producing green budget documents at the budget submission, and controlling and monitoring the implementation of green policies at the audit stage. Box 3 illustrates the breadth of green PFM approaches in legal reforms.

As seen in the following examples, providing a legal basis for green PFM throughout the whole budget cycle, including the strategy setting stage, has yet to be developed. Some good examples of more comprehensive approaches in integrating green practices into the PFM legal framework are still evolving:

• New Zealand’s Public Finance (Wellbeing) Amendment Act of 2020 amended the Public Finance Act of 1989 to introduce well-being objectives in its PFM framework.⁴⁹ The Amendment Act introduced several new requirements for the government to report on how their well-being objectives (including environmental well-being), together with their fiscal objectives, guide its budget and fiscal policy. The act requires an explanation in the Budget Policy Statement (presented before the budget) and the Fiscal Strategy Report (presented with the budget) on how these objectives have guided the government’s budget decisions. The latter should also state if there have been any changes in the well-being objectives since the Budget Policy Statement. Additionally, the Minister of Finance is required to present to parliament a report on New Zealand’s well-being indicators at least every four years.

• Beyond the update of the Fiscal Responsibility Law in 2012 to include a cross-cutting budget of climate change into the budget documents, Mexico also reformed its National Planning Law in 2018 to integrate SDGs (including climate-related ones) into national development plans. Through its connection to the budget programs in a performance budgeting framework, the National Planning Law also links SDGs with budget funding.⁵⁰

Although the choice of legal design is largely based on individual country circumstances, including legal and institutional context, countries should consider a strong legal basis (that is, binding legislation) for green PFM practices. The effectiveness and continued application of the green PFM practices usually depend on their being grounded in law, and they benefit from supportive regulations and administrative practices. Having a binding legislative requirement to implement green PFM would reduce the risk of arbitrary decisions arising from changes in the economic or political environment (in particular, in times of crises) and achieve more efficient resource allocation and sustainability.

Countries should carefully evaluate the existing PFM legal framework to assess whether it provides a legal basis for green PFM practices and whether a new law or revision of existing laws (or both) would be more efficient to ensure harmonized development of green considerations in a country’s legal framework. Particularly, when enacting a new climate framework law, the consistency of the new provisions with existing PFM laws should be examined—and overlaps and ambiguity should be avoided.⁵¹ This can be done, for example, by providing cross-references to PFM laws as well as subsequent amendments to PFM laws, when needed.

Adjustments may be needed to countries’ legal frameworks to integrate the green approach in all stages of the budget cycle and for PFM functions beyond the budget cycle. This integration would not require developing a parallel legal framework but rather adjusting the PFM laws and secondary legislation to provide a legal basis for green PFM tools and supplementing existing procedures.

Particularly, it would be important that key elements be backed by primary PFM legislation. These elements would include (1) defining the legal mandate of the MoF to promote and implement green PFM practices; (2) giving legal powers to the Minister of Finance to carry out this mandate (such as collecting information and taking actions for monitoring); (3) imposing obligations on public sector entities; (4) defining key terms (such as “green,” “mitigation,” “adaptation,” “climate-relevant revenue” and “expenditure”); (5) outlining key objectives and institutional roles (such as the specific role of the Ministry of Environment in setting standards, for example, for assessing the climate impact of new budget proposals or for identifying climate risks); and (6) prescribing budget principles and key stages to implement green practices (such as key dates and minimum content of green PFM deliverables).⁵²

The overall PFM legal framework should be flexible enough to afford the executive the possibility to amend procedural requirements as circumstances change, such as in the case of climate-related emergencies. This could be ensured by delegating to the secondary legislation details—such as operational processes, roles, and responsibilities of internal units—and a comprehensive description of the contents of green reports and documents.

Whatever approach countries adopt, a clear ex ante underlying legal framework is important to guide the operation of PFM systems while supporting green practices. The preexistence of a sound PFM law with broad coverage, clear definitions, well-defined institutional roles and procedures, and a robust sanction regime for the enforceability of such provisions can help in the design and implementation of green PFM practices in a transparent and accountable manner. Also, the legal framework should be the link between the fiscal framework, the national development plan, sectoral plans, and annual budgets, and ensure coherence with other budget initiatives, such as gender budgeting.⁵³ The existence of a sound legal frame-work should be accompanied by other factors such as political and institutional setting and enforceability mechanisms.

Fiscal Transparency

Credible green budgeting requires that green commitments, targets, forecasts, costs, outputs, and outcomes be transparently reported and available in a clear and timely fashion to the civil society and the public while giving the public an opportunity to participate in shaping the budget choices.

Transparency refers to the comprehensiveness, clarity, reliability, timeliness, and relevance of public reporting on the state of public finances. It is critical for effective fiscal management and accountability. This helps to strengthen the credibility of the effort to mainstream green elements into the budget—by ensuring that legislatures, markets, and citizens have the information they need to hold the government accountable for the announced commitments and targets and that these stakeholders understand the climate impact of fiscal policies.

Numerous entry points exist for green elements in budget and fiscal reporting, which have been highlighted in earlier sections on each stage of the budget cycle. Some overarching principles from these sections emerge; they are summarized here:

• Budget documentation should include evidence on the climate impacts of fiscal policies and the link between fiscal policy and climate change. For instance, documentation can highlight the link between NDCs, GHG emissions targets, the economy, and fiscal policy. Documentation should also identify where fiscal policies might improve climate and/or wider environmental outcomes.

• Budget documentation should include elements on fiscal risks related to environmental degradation and climate change (see next section).

• The positive and negative climate impacts of the forthcoming budget should be clear and readily available in the budget documentation. In the first instance, documentation can highlight where expenditure is expected to have an impact on climate or wider environmental outcomes, notably through a “tagging” system. Estimates of the carbon emissions resulting from the budget could also be provided.

  • For instance, the Italian Eco-Budget provides an annual breakdown of government spending by environmental objective. More advanced budget reporting can document the impact of budget decisions on the environment.

  • In the Philippines, a National Climate Budget Brief is published annually, based on the climate tagged expenditure data. A government website⁵⁴ also allows monitoring of data generated by the tagging system.

  • In Honduras, detailed tables on climate-relevant expenditure have been presented in a dedicated analytical report (most recent iteration dates to 2019).

Public participation should be encouraged at all stages of the budget cycle. Public participation is increasingly recognized as a key element of fiscal transparency because it helps to strengthen the link between the budget and outcomes for citizens, improves the quality of policy advice and its legitimacy, and acts as an accountability mechanism. Public participation in green budgeting can build on existing mechanisms, including (1) the inclusion or elevation of green outcomes in participatory national planning mechanisms and prebudgeting consultations; (2) the empowerment of independent fiscal councils or climate change commissions to independently assess, report, and consult on green budgeting targets and outcomes; and (3) public consultation on social, environmental, and climate impacts of the budget.

• Each year Canada holds pre-budget consultations as part of its budget process, for which the ministers select different policies to discuss and receive inputs from the public. In the consultation of 2020, one of the policies selected was climate change and protection of the environment.⁵⁵ Additionally, in 2021 the Department of Finance of Canada opened a public consultation, “Tax Reduction for Zero-Emission Technology Manufacturing.”⁵⁶ • A different approach can be found in South Korea, which opens a yearly form of participatory budget.⁵⁷ The public can send project proposals, which are then analyzed to assess their eligibility for integration in the budget by the related thematic ministries. When proposals are deemed eligible, they go through a project maturation process and are integrated in the budget proposal that is sent to the parliament. Although this example is not focused on environmental projects per se, several projects do relate to environmental issues.

Fiscal Risk Management

Climate change creates fiscal risks through the costs of adaptation and mitigation; it also poses transition risks.⁵⁸ The costs of adapting to climate change are incurred to prevent the likely increased incidence and severity of natural disasters and the increased exposure of assets to disasters particularly in middle- and low-income countries.⁵⁹ These costs include preventive costs (such as building infrastructure to higher standards)⁶⁰ and recovery costs (such as replacing damaged infrastructure). With respect to mitigation, building new clean infrastructure generally entails higher capital expenses, although the cost of renewables has fallen, and operating costs may be lower. Transition risks are the risks arising from the shift to a low-carbon economy due to policy, technological, and other changes such as loss of value of public coal-fired power stations (“stranded assets”) as carbon prices increase; from the failure of a country to meet its GHG-reduction commitments, which might create reputational costs or lead to sanctions; or from side effects for a given country of measures adopted by other countries (for example, impact of a possible carbon border tax on exports to important trade partners, or of restrictions on air travel on the tourism sector).

Significant fiscal risks also arise from loss of biodiversity and other environmental risks, including increased threat of pandemics. Destruction of biodiversity, one of the leading causes of infectious disease outbreaks and pandemics, poses a significant risk to supply chains, business, and the global economy.⁶¹ Other environmental risks that can create fiscal costs include pollution, site degradation associated with natural resource extraction or nuclear power production, pest infestation and animal diseases, and the storage or transportation of hazardous substances.

A range of methodologies exist for estimating economic and fiscal costs from environmental and climate-related fiscal risks. A starting point is to conduct an analysis of historical economic losses from disasters and, as data allow, of the associated fiscal costs.⁶² Forward-looking hazard assessments must be linked to the location of assets and networks to estimate exposure to risks and vulnerability to damage in a changing climate. The government’s explicit obligations to give fiscal support after a disaster should then be assessed and its implicit exposures estimated.⁶³ A variety of modeling, assessment, and qualitative risk classification tools can be used to estimate and communicate the economic and fiscal impacts of disasters.⁶⁴ In cases where quantification is too difficult, risk classification such as “probable,” “possible,” and “remote” may be used.⁶⁵

Country examples of estimating the economic and fiscal costs of climate change and natural disasters include ex post assessments and forward-looking estimates of exposures. Ex post assessments include the Post-Disaster Needs Assessment methodology developed by the EU, World Bank, and the UN,⁶⁶ estimation of past fiscal costs from one-of analysis of selected programs,⁶⁷ and information on fiscal losses compiled from government financial statements.⁶⁸ Forward-looking estimates include the following: • An estimate by the government of Colombia of the value of its implicit contingent liability from disaster damages to private property.⁶⁹

• The Philippines’ 2015 fiscal risk statement, which included a debt sustainability analysis, incorporating a scenario involving the occurrence of large natural disasters.⁷⁰

• The 2015–2017 Multiannual Macroeconomic Framework in Peru, which considered the macroeconomic and fiscal consequences arising from a severe weather episode (El Niño).⁷¹

• The UK 2021 Fiscal Risks Report, which contains a chapter on the fiscal risks from climate change, including the economic and fiscal implications of alternative paths to meeting the government’s legislated goal to reduce net GHG emission to zero by 2050 and alternative scenarios and sensitivities.⁷²

• Ireland’s 2021 Budget Economic and Fiscal Outlook document, which rates climate change and renewable energy targets as presenting a high fiscal risk for the government, because failure to meet the state’s climate change obligations could result in significant financial costs or sanctions.⁷³

Governments should have strategies in place to mitigate the expected increase in fiscal risks from climate change. A risk management strategy should address climate-related fiscal risks and can include enhancing disaster preparedness, creating fiscal buffers, ensuring budget flexibilities (for example, contingencies for natural disasters, provisioning), and using risk transfer instruments (for example, insurance). With respect to fiscal risks from climate change, governments need to integrate climate change issues in their public investment management systems, as outlined supra. The UN Sendai Framework for Disaster Risk Reduction 2015–2030 sets out a widely adopted framework for mitigating risks. Elements include (1) understanding disaster risk, (2) strengthening disaster risk governance, (3) investing in disaster risk reduction, and (4) enhancing disaster preparedness.

• Côte d’Ivoire publishes an annual fiscal risk statement as part of budget documentation. A section on specific risks presents a qualitative analysis of the fiscal consequences of the materialization of natural disaster risks, followed by information on the mitigation measures envisaged by the government to tackle these risks.⁷⁴ • Turks and Caicos identifies in its Fiscal and Strategic Policy Statement 2022–2026 natural disasters resulting from climate change as a primary source of fiscal risks and describes risk reduction measures (for example, improving building codes, strengthening reefs), risk financing (catastrophic risk insurance and mandatory private insurance), and possible post-disaster responses.

Governments should identify other potential fiscal risks from non-climate-related sources, such as biodiversity loss and pollution, and invest as appropriate in risk analysis and mitigation.

Coordination with Other Public Sector Entities

Within the public sector, the central government is not the sole contributor to achieving green and climate objectives. Depending on the institutional setting, sub-national governments (SNGs) and state-owned enterprises (SOEs) can play a major part in the delivery of public services and in the construction or financing of infrastructure. Hence, it is important that their actions also be harnessed toward meeting green objectives.

Many of the entry points in the national budget cycle covered in the previous section are also valid for the SNGs’ own budget cycles. A critical hurdle is the often-weaker PFM capacity at the subnational level, especially in emerging markets and developing economies. Central governments have a responsibility to support local-level capacity development, including through training, study tours, and financial support for hiring.

Further, the central government can create incentives for SNGs to deliver their share of the green strategy while not infringing on their degree of financial autonomy.⁷⁵ Although SNGs enjoy varying degrees of autonomy (both institutional and financial), the central (or federal) government can encourage or sometimes even require SNGs to follow national green or climate objectives. Conversely, the central government may also need to adapt fiscal transfers to compensate local governments, which bear a disproportionate burden because of climate change. The burden may include heightened exposure to natural disasters and impact of climate mitigation policies on specific economic sectors such as fossil fuel production or other “brown” industries.

• For instance, part of budget transfers to SNGs can be explicitly targeted at low-carbon investments or green policies, as piloted by the Indonesian government or in India (through a variable in the equalization grant that promotes forest conservation).

• In China, the central government imposes on provincial governments environmental requirements via reporting obligations and monitoring of performance indicators.

• Softer mechanisms used to foster compliance with fiscal objectives, such as France’s partnership contracts with local governments, could also be effective vehicles for green objectives, as shown by the Danish Partnership for Green Public Procurement between the Ministry of the Environment and municipalities and regions.

The role of SOEs makes them highly relevant in achieving green objectives. SOEs can be among the largest companies, especially in emerging markets and in climate-relevant sectors such as electricity, oil, and gas (for instance, China’s PetroChina, Russia’s Gazprom, Brazil’s Petrobras). And financial public corporations can be significant providers of financing for development. The central government, through its regulatory powers and financial relationship with these entities (as a shareholder or provider of transfers and subsidies), has a key role in ensuring their full commitment to green and climate objectives. As a start, all entities of the public sector—SNGs, public corporations (both central or local)—should be involved in the preparation of national and sectoral strategies to ensure a common understanding of their role in implementing them. And there should be regular reporting to the central government so that performance against overall strategic green objectives can be measured.

A range of PFM practices by the central government can influence SOEs (both financial and nonfinancial) in taking green priorities and climate change into account in their strategies and activities. Here are a few examples of such PFM practices that may act as influence channels. These channels are more effective if there is a strong centralized financial oversight and control function, either at the MoF or at a specialized agency. These are complementary to existing regulations applicable to all companies, for instance in environmental, social, and corporate governance.

• The government’s ownership policy⁷⁶ document, the publication of which is considered good practice according to the IMF’s Fiscal Transparency Code, is a useful vehicle for the central government to convey the cross-cutting importance of green objectives in the way the state portfolio is managed.

  • For instance, in its State Ownership Policy, Norway explicitly expects SOEs to act as “exemplary corporate citizens” regarding climate and the environment, on top of delivering on financial targets.

• As a shareholder, the government can in theory directly affect the strategic choices of its SOEs and the way they operate.⁷⁷ In practice, SOEs may still enjoy a high level of operational independence and influence, depending on their size, their strategic importance, and their market share. The transparent issuance of resolutions or directives to the board of directors (for example, on requiring a commitment to lower emissions) may be an important first step. The central government can impose transparency and reporting practices for all SOEs, such as the publication of a climate and/or wider environmental strategy or the regular assessment of the potential financial impact of climate risks. Green or climate efficiency can also be explicitly set as a criterion in the technical and financial appraisal of SOE investment plans, to be reviewed by the central government, for example through the establishment of a shadow carbon price for cost-benefit analyses of investment projects submitted by SOEs.

The fight against climate change could be part of the SOE’s quasi-fiscal activities. Contrary to private firms, SOEs may not be driven solely by profit making, and their activities may include operations pursuing a public policy objective that may worsen their financial position. If green objectives influence SOE pricing policies, that effect should be made explicit, and the SOE should be appropriately compensated.

Principle 1. Several prerequisites should be in place for successful green PFM reforms.

Greening PFM systems makes sense only if the elements of a functional PFM system are in place. Priorities in this respect are ensuring basic financial compliance, with sound budget preparation and budget execution processes, ideally underpinned by a functional FMIS. Such fundamental PFM features are also required to access climate finance (such as the Green Climate Fund; see Fouad and others 2021). It is important that countries ensure these prerequisites are in place or in the process of being implemented, especially in LIDCs that are particularly vulnerable to climate change. Further, it could be counterproductive to strive to implement sophisticated green PFM practices in countries where basic standards of PFM performance are not met or where the capacity to absorb new PFM practices and system is limited. There are, however, opportunities to incorporate some green PFM practices as the core systems are developed (see Principle 3).

Strong political backing and ownership are even more necessary than for a standard PFM reform agenda. To some extent, improving the overall PFM framework to enhance its effectiveness and efficiency is the “core business” of the central budget authority within the MoF. Political buy-in is necessary both to overcome resistance from other stakeholders and to induce them to spend some time and energy on designing and implementing reforms rather than on current activities. However, the MoF has a direct stake in the changes, and the reform impetus may be to some extent self-sustaining.⁷⁸ This is not the case with respect to green PFM reforms, since incorporating green concerns into the PFM system is not a natural part of the mandate of the MoF. Hence, the MoF will move only if there is a clear political signal. Political leadership is important, particularly at the beginning of the reforms, to embed green PFM tools in the legal framework and successfully implement them. In some countries, policy documents reflecting green commitments are instrumental in aligning green PFM with existing PFM frameworks or ongoing PFM reforms.

• In France the first green budget appended to the 2021 budget law resulted from a clear political commitment at the level of the Minister during the 2020 budget discussion one year earlier. It built on the momentum generated by France’s participation in the OECD’s Paris Collaborative on Green Budgeting.

• In Bangladesh the MoF published the Climate Fiscal Framework, which sets out the principles and tools for integrating climate finance into the country’s PFM system and provides the foundation for pursuing the agenda of a climate-inclusive PFM reform agenda.⁷⁹

Some degree of green expertise must be developed for key actors in the PFM processes. Staff in the MoF are, by definition, not climate experts; however, these staff members cannot rely solely on outside expertise from the Ministry of Environment, which will have little if any grasp of the constraints of PFM processes. A nucleus of staff with some degree of expertise on climate change needs to be set up within the MoF. This will require either additional training for existing MoF staff (whose background is mostly in accounting, law, general economics, or public administration) or hiring staff from the outside, or a mix of both. Creation of this core expertise resource must be complemented with a strategy to build capacity and explain the new tools to other stakeholders both within the MoF and in other line ministries and agencies. This effort also includes putting in place elements for collecting and monitoring environmental data that can inform and feed into this green expertise and making sure that other actors—in particular, the ministry and agencies in charge of climate and/or environment policies—are adequately equipped to perform environmental monitoring and reporting, engage in policy analysis, and interface with fiscal policies and budgeting.

• Nepal set up in its MoF a Climate Change Finance Unit, mandated to deal with all climate finance issues with line ministries; staff from this unit received specific training in climate change and climate finance coordination, including analyzing reports on expenditure from a climate change standpoint.

• Fiji embedded into the Ministry of Economy a Climate Change Unit as a focal point of expertise on this topic, notably to support macroeconomic and fiscal processes.

Principle 2. Although green PFM reforms constitute a whole-of-government undertaking, the MoF, as the custodian of public resources, should be the primary driver.

At the central level, green PFM reforms involve an array of stakeholders:

• The Ministry of Environment, which oversees the overall green or climate change agenda—noting that adaptation and mitigation policies might be split across ministries and agencies.

• Line ministries, which would have to integrate green PFM reforms in their own processes and build capacity for monitoring and evaluating their own activities and programs.

• Parliament and independent fiscal institutions, which need to adapt their scrutiny of fiscal strategy setting and budget matters to account for green PFM concerns.

• Climate change committees, which are usually mandated to coordinate, advise on, and evaluate government climate change policies and monitor progress toward their achievement.

• The Supreme Audit Institution, whose working methods must be adjusted to assess the effectiveness of green PFM practices.

However, against this diverse backdrop, the MoF must be solidly in the driver’s seat. Only the MoF has the requisite knowledge and skills to instill green practices into PFM processes and the overall vision of the tools (budget legislation and regulation, manuals and guidance documents, IT tools such as FMIS) that may need to be adjusted for this purpose. The MoF also has the institutional leverage required to have line ministries and agencies implement such green practices and achieve sound coordination, contrary to the Ministry of Environment.

• In the Philippines, while the Climate Change Commission participates in the technical budget hearings (discussions with line ministries on budget preparation), leadership is held by the Department of Budget and Management (in charge of fiscal issues) and the National Economic and Development Authority (in charge of the overall development strategy).

This central role of the MoF also means that it can assess what changes are realistic without hampering the effectiveness of PFM processes. The budget preparation process, in particular, is bound by tight (often constitutional) constraints and involves multiple stakeholders with competing interests. There is often a tendency by all actors to make the budget preparation process more complex, in an attempt to reach more informed decisions. This can definitely be one of the risks of green budgeting—contributing to a “Christmas Tree” approach whereby the budget preparation process becomes more complex (and even unmanageable) in an effort to incorporate more information. The MoF is best placed to avoid falling into this “complexity trap” and keeping PFM processes manageable.

Principle 3. Green PFM reforms should be integrated with the existing PFM reform agenda.

Green PFM reforms and the overall PFM reform agenda can be mutually reinforcing. For example, introducing program budgeting or a targeted program budgeting approach focused on climate policies can provide an avenue to improve assessment of climate outputs and outcomes. Likewise, strengthening fiscal risk management and disclosure can enable an increased coverage of climate risks. In more advanced systems, adopting an overall public sector balance sheet approach may similarly improve the ability to track changes in asset values linked to climate developments.

Moreover, developing and steering green PFM reforms draw on the same skill set as the design and implementation of an overall PFM reform agenda. It requires intimate knowledge of PFM processes, good project management skills, change management capabilities, and a capacity to prioritize. These are all skills that are relatively scarce and usually located in a dedicated project management office within the central budget authority or the broader MoF. Lodging responsibility for green PFM reforms at the same place ensures consistency with the PFM reform agenda and helps leverage project management skills that have already been put to good use.

Principle 4. Countries should look for an appropriate sequencing of green PFM reforms.

Countries should prepare sequenced action plans for the implementation of green PFM reforms. These action plans should identify the key stakeholders in charge of each action and a timeline for reform implementation, including adaptation of the legal framework where relevant. The sequencing of the legal reform usually depends on different legal traditions as well as political willingness and capacity level. Although legal changes may be required early in the reform process to pilot the green PFM practices in some countries, in other jurisdictions, laws may be changed later in the process to codify the new practices. The timeline should be updated on a regular basis by the body in charge of coordinating the reform, based on actual progress and on discussions with said stakeholders.

It is logical for governments to start with green PFM reforms affecting the upstream portion of the budget cycle before moving downstream. Developing the capacity to assess and analyze green or climate impacts of fiscal policies (notably through an explicit link with NDCs) should be the immediate priority to kickstart a green PFM reform process. Similar to gender budgeting reforms (PEFA 2020), green PFM reforms should ideally first focus on actions fostering awareness among agencies and institutions and on the development of methodologies for the production of ex ante green impact assessments and analyses. As a next phase, governments can move to the downstream part of the cycle—measuring actual results and effects and comparing them to ex ante assessments. Once confidence in the new tools and processes has been sufficiently built up, governments can gradually be made accountable for their performances relative to their initial assessments. From there, the green dimension can become fully mainstreamed, with the emergence of a culture of green PFM. This general process does not preclude the possibility for governments to take advantage of opportunities opened by existing PFM practices or ongoing PFM reforms, to focus on low-hanging fruit at first, or to prioritize practices that could attract climate financing. Countries with experience in other types of priority-based budgeting, such as gender budgeting, may be able to fast-track the implementation of certain practices (see Box 1).

It can be beneficial to roll out green PFM reforms gradually, starting with a few pilot ministries or agencies, or with reduced forms of the target practices. Rollout strategies include the following:

• Test runs. Taking the time to test operability of new processes and frameworks allows for course correction before fully rolling them out.

  • In France, the preparation of the first green budget in 2020, as part of the 2021 budget process, was preceded by a test run in 2019, led by the internal audit body of the MoF, covering only four policy areas, and a second test run in early 2020, co-led by the MoF and the ministry in charge of the environment, applied this time to the whole budget.

• Pilot institutions. In countries with across-the-board capacity constraints or with large differences in capacity between ministries, opting for a gradual rollout, starting with a few pilot ministries or agencies with the most negative environmental footprints or with the most capacity and senior management buy-in, allows to build up skill sets over time. In countries with weak capacity and limited resources, implementing a reform in only the most relevant ministries could be a cost- and skill-effective solution. COVID-19 recovery packages can also constitute a good opportunity to kick-start or test new green PFM practices (see Box 2).

  • Countries such as Bangladesh, Indonesia, and Nepal have started implementing green budget tagging in a few green-intensive pilot ministries before a wider rollout.

• Central versus subnational governments. Implementation of green PFM reforms commonly starts at the national level before being piloted at the subnational level. There are even instances of large federal systems where green PFM practices have been spearheaded by subnational levels first (state of California in the US, state of Punjab in India). A substantial training effort is often required, making the rollout to the subnational level longer.

  • In the Philippines, local government units started experimenting with climate investment tagging in 2014, a year after the process started at the central level.

Principle 5. Communicating on the progress of green PFM reforms is important to ensure buy-in from all stakeholders and manage expectations.

Communicating on green PFM reforms and gathering feedback early on are important to gradually build awareness among internal and external parties. Initial consultation meetings and workshops can be helpful to engage internal as well as external stakeholders in the design of the reform strategy—while training them on its basic objectives. There is also value in consulting with parliament and the civil society while designing the reform strategy to understand their needs—especially from the standpoint of fiscal transparency.

• In 2014, a brainstorming workshop on green budgeting took place in the Indian state of Punjab, which brought together civil servants, civil society, and private sector experts.

• In France, the National Assembly adopted an amendment to the 2019 budget law requesting the government to merge all existing budget documents on environment-friendly expenditure into a single document. The “bundle” document was finally replaced by the first green budget document in 2021.

The authorities can make use of a broad spectrum of communication devices to provide updates on the reform.

• Internally, the entity in charge of steering the reform should regularly update the various stakeholders on the reform efforts. Useful practices for the dissemination and exchange of information internally include the organization of ad hoc steering committee or working group meetings on the reform itself as well as meetings, seminars, and conferences held as part of the budget process itself.

  • Orientation meetings on climate expenditure tagging are held annually in the Philippines.

• Externally, governments may choose to leverage existing documents to communicate on the progress of the green PFM strategy. Progress reports on the overall PFM reform strategy can also be complemented by a section on green PFM. Green strategies and budget documents may also include a section on the green PFM strategy itself. Alternatively, the entity in charge of steering the reform can produce ad hoc progress reports on green PFM reforms.