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Sustainable Development in Practice: A Guide to Integrating Environment, Climate and Poverty Reduction

Chapter 5 Finance for poverty-environment objectives

Draft, Steve Bass. Rev 6th September 2022

Overview
Purpose

Public finance and fiscal regimes are needed to mobilize finance towards sustaining productive natural assets and tackling environmental problems in ways that benefit poor people. While analysis, dialogue and planning (chapters 2–4) do much to integrate poverty-environment issues, finance and fiscal processes have their own requirements and limitations for supporting poverty-environment outcomes, which we address here.

 

Coverage

This chapter offers guidance on integrating poverty-environment objectives into national budgets and public and private investment. We draw on the experience of the United Nations Development Programme–United Nations Environment Programme (UNDP-UNEP) Poverty-Environment Initiative (PEI) and its successor, Poverty-Environment Action (PEA). The scope of finance is large, and the field is highly dynamic. In this chapter, we aim to address an audience of environment and development professionals, helping them to understand enough about budget and financial processes to approach finance professionals on poverty-environment issues. But we do not address wider public financial management, or the technical financial tasks which finance professionals will bring to poverty-environment integration. We touch on:

  • The importance of sustainable finance – to meet the joint investment needs of poverty elimination and environmental sustainability
  • Sustainable finance policy frameworks and opportunities – the proliferation of international initiatives but also gaps, notably for investment in nature and not only climate mitigation
  • Budget methodologies and tools that can integrate poverty-environment issues in budget planning, approval, expenditure, tracking and review
  • Fiscal and other means to align public finance with poverty-environment objectives – poverty-environment safeguards and sustainable public procurement that benefits poor producers and consumers
  • Attracting and managing quality foreign and domestic private investment for poverty-environment outcomes – enabling conditions, green private finance, investment treaties and compliance

We do not detail the rapidly evolving international green finance agendas, but note the work done by the United Nations (UN), international financial institutions and others to ensure coherence and interoperability of sustainable finance approaches. The online handbook will cover proven approaches in updates, when evaluations have provided the evidence and guidance.

5.1 Poverty, environment and finance

This section highlights experience, and offers guidance, on integrating poverty, climate and environment objectives into national budgets and public and private investment.

5.1.1 Why public finance is important for achieving poverty-environment objectives

The national budget is highly significant. On the one hand, it can represent the highest level of government commitment to poverty-environment outcomes. On the other, it can present risks of bankrolling activities that harm people and nature.

Poverty, environment, climate and finance interact in complex and often unstable ways. This is especially true in times of economic crisis, as we have seen with the COVID pandemic when debt has escalated, government budgets have been cut, and entire business sectors have failed. These developments in turn have led to increasing insecurity of food, health, sanitation and education services – leading people back into poverty. Land degradation has increased as people seek new sources of livelihood, even if some environmental challenges such as air pollution and greenhouse gas emissions temporarily abate.

The post-COVID recovery stimulus packages represent government budget decisions on an unprecedented scale but– risk a return to the “old normal” by simply reviving economic growth patterns that lock in poverty creation and environmental damage. So far, only a minority of post-COVID recovery packages (18 per cent; UNEP 2021) support net-zero, nature-positive poverty elimination – and almost none is accessible to poor groups. In the face of mounting government and private debt, it is an urgent task to ensure any financial decision is sustainable and does not place burdens unduly on the poor or create ecological debt. This is where new patterns of sustainable financing are needed, with an integrated and longer-term perspective on their economic, social and environmental consequences.

Sustainable finance is critically important to meet the joint needs of poverty elimination and environmental sustainability. A growing body of evidence demonstrates that the costs associated with poverty and poor environmental management – the social protection costs, the health costs, the lost production costs and the loss of natural capital – can be more than offset by gains made by shifting finance towards sustainable investment – for example, creating long-term green jobs, installing low-cost green infrastructure, and shifting food and energy production systems to sustainability. Yet, poverty and environment issues have been persistently neglected by public finance and financial markets. At best, they were treated as risks to achieving financial goals and do no harm safeguards were deployed to mitigate them. Any plans to tackle them in more constructive ways – to do more good – were too often seen as ideals with no systematic links to finance. Even if the sustainability case was well made, decision-makers often balked, assuming that the capital needed to achieve poverty-environment objectives is scarce. Thus investment in poverty-environment issues has remained marginal – until recently.

From a very low base, sustainable finance has recently seen huge increases. For example, green and social bonds are being issued by both countries and companies (box 5.1), new financial innovations are being created and applied that de-risk investments connected to global public goods such as climate, and more energy investments are favouring renewables rather than fossil fuels. The market is picking up on opportunities where government enabling conditions and consumer signals may be conducive. There is potentially no shortage of capital to cover even the boldest of ambitions: it just needs to be attracted and mobilized. The first challenge is to identify and remove the constraints that stand in the way.

Box 5.1 Green/blue bonds

Government agencies are increasingly issuing green bonds. These debt securities are identical to traditional bonds, but with an additional step that tracks, monitors and reports on the use of proceeds for dedicated green projects. These projects can be related to climate (e.g. renewable energy or energy efficiency), sustainable waste management, land use, biodiversity, clean transportation, clean water, etc. They have become a favoured approach to promoting capital-raising for green investments. The bonds are supported by a number of standards, certification models and institutions, and active promotion by governments and regulators. Over $1.5 trillion worth of green bonds and similar instruments had been issued cumulatively by June 2021. Projects related to energy, buildings and transport make up the majority of green bonds globally; land use projects make up far less. Those related to marine assets (blue bonds) are beginning to proliferate.

Voluntary best practice guidelines for sustainable bond issuances – the Green Bond Principles – were established in 2014 by a consortium of investment banks and are monitored and managed by the International Capital Market Association. However, as of January 2022, there were no universally agreed-upon definitions of green, social or sustainable bonds; and the Green Bond Principles do not provide details on what qualifies as such bonds– leaving those definitions largely up to the issuers.

PEA’s handbook on green bonds, (Technical Handbook on Issuing Municipal Sustainable Bonds in South Africa), summarizes the prerequisites and processes for developing and implementing green bonds that support poverty reduction as well as good environmental outcomes.

Source: World Bank (2022).

 

5.1.2 Constraints to public finance supporting poverty-environment objectives

Several barriers need to be understood and tackled to help ensure that public finance and fiscal regimes will deliver on poverty-environment objectives and incentivize private finance:

  • Weak coordination mechanisms between the planning and budgeting processes
  • The predominance of siloed, sector-based approaches to budgeting
  • Inadequate understanding of sustainable finance sources
  • Inadequate integration of poverty-environment objectives, targets or indicators into public financial rules for budgeting, expenditure management and financing instruments
  • Entrenched past expenditure patterns – e.g. in fossil fuels or land use that exclude the poor
  • Lack of performance tracking to improve the poverty-environment effectiveness of public resource use

A system-wide shift towards integrating poverty-environment objectives demands clarity as to how poverty-environment outcomes can be supported by the main fiscal processes of spending, taxing, and borrowing – the fiscal triangle illustrated in figure 5.1.

Figure 5.1: The fiscal triangle

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Source: Agarwala et al. (2020).

 

5.1.3 Understanding how public finance works
Opportunity and risk

The national budget process is both a major opportunity for poverty-environment considerations and a major risk.

The national budget is the single most important public policy for resource allocation to meet development priorities, providing access to the national expenditure and revenue framework. It enables all government spending units to (where relevant) recognize, link to and directly plan for poverty-environment objectives. It offers the opportunity to ensure that taxation, fees and charges mainstream poverty-environment objectives, as do sources of financing such as domestic borrowing and donor partner loans and grants.

In terms of risk, the budget is subject to many political and other context changes. If there are weak links between planning and budget processes, budget allocations may not be consistent with planning document priorities. Some development partners choose to by-pass the government budgeting process entirely instead providing support for poverty-environment programmes through non-governmental organizations, with little resulting influence on government resource allocation. Encouraging all resources to be on-budget can help ensure a rounded, comprehensive view of initiatives that are contributing to poverty-environment objectives.

The process

It is important to understand the budget process, because it has its own dynamics relevant to poverty-environment – it does not simply fund agreed plans. The basic characteristics of a typical national budget and how the regular budget process works are illustrated in figure 5.2 and detailed below, based on IIED (2016).

Figure 5.2 The national budget process

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Source: Ramkumar, 2005

 

The national budget is a financial plan that covers all government functions.1 Government budgeting uses a budget classification system that clarifies the economic, administrative and/or functional commitments and responsibilities of all ministries, departments and agencies.

The ministry of finance has a legally mandated responsibility to compile, present, implement and oversee the government’s annual budget. Subnational institutions play roles, and may also often supplement the national budget with locally raised revenues within the limitations and powers of their mandates.

The national budget cycle is a legal or statutory process that typically has four stages (figure 5.2 above):

  • Budget formulation – the executive branch puts together the budget plan
  • Budget approval – the legislature debates, alters and approves the budget plan
  • Budget execution – the government implements the policies in the budget, reports on progress and achievement, and maintains a system of national accounts
  • Budget oversight – through auditing and legislative assessment, a national audit institution and the legislature account for and assess the expenditures made under the executed budget

Different documents convey the budget specifics. The annual budget incorporates sources of funding and planned expenditure on an annual basis; whereas the medium-term expenditure framework (MTEF) sets out expenditure plans linked to policy priorities, typically for a three-year period. In many countries, the MTEF is the main link between national plan implementation and planning for public expenditure on a multi-year basis. Administered by the ministry of finance, the MTEF brings together development and non-development (recurrent) budgets into a single resource envelope and aims to match government policy priorities with resource allocation.

Different stakeholders play roles in the budget process, and there are diverse access points to influence budget resources, allocations and outcomes within this process. Within institutions, budget committees are often formed to manage the process for the sector side.

If planning systems have a close link to the budgeting and public financial management systems, then they have a stronger potential to direct public and donor financial resources to achieve results. If the planning link to budgets (or to realpolitik) is weak, it is likely that budget allocations will not be consistent with planning document priorities.

The budget process is usually subject to context changes and reforms; it is not a static cycle. Budget process changes are often promoted by external organizations as part of wider public financial reforms, sometimes supported by technical assistance. Many of these public financial reforms can also be used as a vehicle to integrate poverty-environment issues e.g. increasing domestic resource mobilization, managing for results, and improving efficiency of state enterprises.

 

5.1.4 PEI/PEA experience with public finance

PEI has bridged the gap between plans that integrate poverty-environment objectives and the budgets to deliver them by:

  • Making ministries of finance, and budget departments where relevant, the key partner. Following its earlier phase which had focused more on environmental authorities, PEI/PEA’s work aimed at being decision centred, influencing ministries of finance but also engaging with other key stakeholders, many of whom compete for funds and so potentially welcome good evidence and equitable budget processes.
  • Conducting economic analyses that show the costs of (in)action on poverty-environment issues and the benefits of investment, both in macro terms (e.g. as a percentage of gross domestic product [GDP]) and micro terms (household income) – see 5.2.
  • Fine-tuning and mainstreaming key budgeting tools, notably: (i) public expenditure reviews on environment (and later climate) to provide benchmarks and to compare spending with benefits; and (ii) budget circular instructions, checklists, and coding for poverty-environment objectives – both of which have now been mainstreamed in several countries with PEI support – see 5.2.
  • Capacity building for ministries of finance, environment, and others in the above, to embed poverty-environment objectives in relevant financial systems – see chapter 6.
  • Strengthening the links between public and private investment, e.g. using public finance to leverage and de-risk private investment – see 5.5.
5.2 Poverty-environment integration in the budget process
5.2.1 Establishing budgetary aims for poverty, environment and climate

Budget planning involves projecting and forecasting revenues and expenses, setting revenue and expenditure targets and allocations for a specific period, and financial resource planning. It is guided by well-established procedures which may make it too easy to simply repeat what has happened in previous budget cycles. It is therefore often difficult to integrate poverty-environment issues in the absence of precedent, unless a good strategy has been thought out beforehand.

Budgetary aims for poverty, environment and climate will depend on context, but typically include the following:

  • Increase poverty-environment–positive expenditures – such as for pro-poor sustainable land management, watershed and forestry management, water supply and sanitation, disaster risk reduction, soil erosion control, climate-proofing infrastructure, and increased access to clean energy
  • Reduce expenditures that undermine poverty-environment objectives – such as for government-funded fossil fuel extraction and power generation, fossil fuel subsidies, or land clearance that displaces poor people and their livelihoods
  • Increase sustainable revenues – through higher rates and more effective collection of forestry, fishery and minerals taxes and charges; and reinvesting revenues in both sustainable natural resource management and equitable diversification of the economy
  • Attract international funds – notably those aimed at climate adaptation, disaster risk reduction, and forest and biodiversity conservation

 

5.2.2 Opportunities to integrate poverty-environment objectives into budgets

Fifteen typical opportunities for integrating poverty-environment objectives throughout the budget cycle are summarized below. Extensive guidance on these and other entry points is given in IIED (2016). PEI/PEA had significant experience with many of these, discussed in 5.2.3.

  • Official budget instructions: Influencing the preparation or revision of guidelines produced by the finance ministry on budget envelopes and priorities – such as budget call circulars and budget instructions to include poverty-environment issue
  • Budget classification and coding: Including pro-poor environment and natural resources and climate change in categorizing and tracking budget/expenditure classifications
  • Budget committees: Introducing pro-poor environment and natural resources and climate evidence and expert advice into ministry/department/agency budget committees
  • Budget rationale and narrative: Contributing to meaningful MTEF policy narrative requirements in budget submissions
  • Poverty-environment contacts in each authority: Ensuring environment and natural resources desk officers are in place in each ministry/department/agency during the budget cycle (chapter 6)
  • Poverty-environment central financial liaison: Ensuring environment and natural resources liaison points are in place within the Ministry of Finance (chapter 6)
  • Parliamentary oversight: Informing the budget review process by Parliamentary committees. Parliament, the apex democratic and legal authority, approves both the budget and legislation on poverty-environment issues – and can thus ensure coherence
  • High-level budget communications: Budget speech passages and references can offer opportunities to communicate government poverty-environment commitments
  • Value for money: Making finance available, on a competitive bid basis, to encourage innovation for pro-poor environment and natural resources and climate actions
  • Public procurement: Introducing standards to ensure pro-poor environment and natural resources requirements are reflected in significant procurements
  • Investment appraisal: Ensuring capital project appraisal and approval include compulsory pro-poor environment and natural resources and climate standards
  • Budget reporting: Contributing to in-year financial management reports (and mid-year statutory and non-statutory reports) to highlight progress in poverty-environment spending and its achievements
  • Expenditure review: Assessing the quantity and quality (efficiency, effectiveness, and equity) of spending allocations in the context of poverty-environment objectives
  • Audit: Contributing to audits of expenditure by the Auditor General, including to audit committees relevant to pro-poor environment and natural resources and climate outcomes
  • Aid: Negotiations with international development cooperation partners on programmes as well as budget support, and notably donor coordination committees on poverty-environment issues

In addition, Agenda 2030’s Integrated National Financing Frameworks (INFFs) are intended to be a tool to operationalize the Addis Ababa Agenda Agreement at the national level. A country’s national development plan or sustainable development strategy lays out what needs to be financed. INFFs spell out how the national strategy will be financed and implemented. The development and operationalization of INFFs provides an entry point for initiating and implementing public financing and planning tools. Guidance is available to Member States that intend to design and implement INFFs. It covers four building blocks: (i) assessments and diagnostics; (ii) design of the financing strategy; (iii) mechanisms for monitoring, review and accountability; and (iv) governance and coordination mechanisms. More than 70 countries are preparing or have already prepared INFFs. https://inff.org/resource/inff-country-progress-or-april-2021-update

The tasks for integrating poverty-environment objectives across the budget cycle will clearly depend on context and on which of the above opportunities are available. IIED (2016) offers detailed guidance on the typical poverty-environment integration tasks around the four stages of the budget cycle. Box 5.2 offers a simple checklist developed from this and PEI/PEA experience.

Box 5.2 Checklist of key requirements for integrating poverty-environment objectives across the budget cycle

Budget formulation

  • Has the ministry of finance included environmental and/or climate sustainability as a priority for public expenditure in its budget call, circulars or instructions to line ministries?
  • Is the budget classification system (e.g. by economic, administrative and/or functional responsibilities of ministries, departments and agencies) conducive to capturing relevant poverty-environment expenditure, or adapted to suit?
  • Are budgets coded and tagged to identify (and later to track and manage) expenditure on poverty-environment issues?
  • Have responsive budgeting approaches that embrace poverty-environment issues been used, e.g. participatory budgeting, gender-responsive budgeting?
  • Have projects undergone some form of screening to assess their costs and benefits?
  • Have line agencies provided prioritized and costed programmes on the environment and climate change in submitting their expenditure plans to the ministry of finance?
  • Is donor support to poverty-environment objectives strategically on-budget as well as off-budget?
  • Can any ongoing public financial reforms also be used as a vehicle to integrate poverty-environment issues, e.g. increasing domestic resource mobilization, managing for results, improving state enterprise efficiency?

Budget execution

  • Are actual expenditures below the planned expenditures, contributing to low delivery rates by the ministries?
  • Do sectors have the capacity to deliver on work in areas outside their traditional scope, such as environmental sustainability, climate change and gender?
  • Have budgets been delivered to line ministries on time, as some environmental expenditures may be time-sensitive, e.g. afforestation, watershed management and disaster prevention?

Budget approval

  • Have parliamentary committees been provided with enough information to ensure coherence between the budget and relevant policy and legislation on poverty-environment objectives?

Budget monitoring and oversight

  • Is the government tracking its expenditures on the environment and climate through public environmental expenditure reviews (PEERs) and climate public expenditure and institutional reviews (CPEIRs)?
  • Is the government tracking the quality of expenditures in terms of impacts, in addition to tracking the quantity?

 

5.2.3 Tools for poverty-environment integration into budgets

PEI/PEA have helped develop and extend useful tools that have proven to be of value in the poverty-environment toolkit, notably public expenditure reviews, budget circulars, budget coding and tagging, gender-responsive and similar budgeting, environmental economic studies and cost-benefit analysis. While these tools have individual utility, when used together, they have been able to (i) establish a baseline for environmental and climate budget allocations and expenditures; (ii) assess budget allocations in relation to poverty-environment policy and planning priorities; (iii) identify significant gaps between budget allocations and actual expenditure; and (iv) improve the overall efficiency, transparency and accountability of budgeting and expenditure processes. We outline each tool below. Supplementary and updated explanations of these and other tools are provided in PEA’s 2021 Overview of Public Financing and Planning Tools.

 

Public environment and climate expenditure reviews

Public environmental expenditure reviews (PEERs) explore how public funds are spent by government. They can help to identify:

  • What money was spent in support of environmental and natural resource management across sectors, activities or localities, or through which ministry/department/agency
  • What was achieved as a result
  • Whether the results achieved meet pro-poor and environmental and natural resource sustainability objectives
  • How well the institutional mechanisms that govern expenditure and its reporting performed
  • The potential for strengthening social and economic benefits and institutional efficiencies by making changes to public budgeting and expenditure

The process can yield other benefits, too:

  • Align budgets and expenditures with national environmental and climate policy priorities and targets, establishing more relevant expenditure classification and tagging
  • Provide a baseline against which future expenditures can be measured and monitored
  • Strengthen ties between the ministries of finance, planning, environment and other sectors responsible for expenditure areas key to poverty-environment objectives
  • Improve government’s accountability for the direction of public investments

PEERs are typically divided into two categories: capital expenditure (public investment programmes) and current expenditure (operations and maintenance). Particularly in difficult financial times, reviews should focus on operations and maintenance; if such expenditures are not made a priority, much larger expenditures may be needed in the future on environmental rehabilitation or replacement.

Climate public expenditure and institutional reviews (CPEIRs) are a more recent variant of PEERs with a focus on climate adaptation and mitigation–related expenditures across budgets, as well as institutional coherence in climate financing against pro-poor and environmental sustainability objectives. The CPEIR undertaken in Bangladesh, for example, has led to climate change becoming a new priority in the country’s budget system (box 5.3).

Other PEER variants include reviews of expenditure on disaster risk reduction – another area where poverty and environmental objectives are strongly linked – such as in PEI’s work in Vietnam.

 Box 5.3 CPEIR in Bangladesh leads to new focus on climate change in the budget system

The 2012 CPEIR in Bangladesh influenced a significant shift in government thinking, as its findings showed that the majority of the country’s climate funding is embedded in multidimensional programmes across several government departments, and is not limited to the environment sector (Bangladesh General Economics Division 2012). Altogether, Bangladesh was spending $1 billion of public funds each year – about 6–7 per cent of its annual budget – on climate change adaptation. Although a substantial sum, this represents only a fifth of the World Bank’s recent estimate of Bangladesh’s annual expenditure needs for climate change by 2050, three-quarters of which was to come directly from public funds.

Bangladesh’s minister for the environment cited the CPEIR findings in statements made to the Parliament and at international climate change negotiations to leverage the kinds of funds needed to fill the development gap as a result of climate change. Led by its Ministry of Finance, the government then developed a climate change–responsive budget at the national and local levels.

The recommendations of the CPEIR also enabled the government to propose the introduction of a climate budget code with indicators for use in future budgets, so that it can track spending continuously across all government departments. It can thus draw a much clearer picture of how local authorities are grappling with the practical dimensions of protecting communities and livelihoods. Large-scale public investments have begun to be screened using poverty-environment and climate change criteria; consequently, investments are being targeted to those projects that better address the concerns of the poor. All ministries that submit projects for funding must specify the percentage of poor people who will benefit, what the impact on natural resources will be and the extent of resilience of new infrastructure to climate change.

Source: UNDP-UNEP PEI (2014a).

 

PEI/PEA have found that PEERs and CPEIRs are a useful early task in integrating poverty-environment issues into budgets, because few people know what the actual budgets, investments and levels of spending are on environmental issues related to poverty. Putting all this information on the same page has improved benchmarks for future budgeting and encouraged rethinking of some plans. The results have often made the case for increased expenditure on pro-poor environmental management and climate change adaptation, since they reveal any inadequacy of funding in relation to the significance of environmental assets or climate change threats to national development.

Combined with economic analysis, the results of the public expenditure reviews are very useful in persuading governments to strengthen the inclusion of environmental and natural resource sustainability objectives in budget processes, such as the annual budget call circular and in sector budget checklists, and to increase budgets for poverty-environment issues.

Climate expenditure reviews in Africa have shown that environmental and climate expenditures range from 1–15 per cent of government expenditure and 0.2–1.8 per cent of GDP. Although those percentages have been growing, climate-negative expenditure also continues – e.g. incentives for clearing forests, subsidies for fossil fuels and building infrastructure on climate-vulnerable flood plains (IIED, 2016).

Expenditure reviews are typically prepared by economists and public finance professionals, with technical assistance from environmental professionals. The reviews require detailed budget and expenditure data, which may be lacking, particularly for environmental themes where spending classifications are not always relevant to poverty-environment objectives. Because periodic expenditure reviews can be time-consuming and costly, and are not generally institutionalized, improving budget tracking through the introduction of environmental and climate budget codes (below) should be a high priority. So too should be the establishment of routine data collection and synthesis mechanisms that link data on critical aspects of the environment with relevant economic and social indicators. Regular natural capital accounts and wealth accounts can provide such data and directly support decisions on where investment in nature and its maintenance is most needed.

For detailed guidance, see:

  • A Methodological Guidebook: Climate Public Expenditure and Institutional Review (CPEIR) (2015), developed by PEI and UNDP Governance of Climate Change Finance.
  • The Poverty-Environment Expenditure Accounting Framework (PEAF): Application to Inform Public Investments in Environment, Climate Change and Poverty (2017)

 

Budget circulars

A budget call circular – or instructions or guidelines – is the standard way to match the financial needs claimed by sectors and districts with nationally determined budget ceilings and priorities. Typically, the budget office in the ministry of finance coordinates budget call circulars, requesting information from each ministry on its financial needs for the given year(s) within a budget ceiling and against criteria for public expenditure. Resultant “bids” invariably exceed the resources available, so the definition of priorities matters greatly. Clearly, the poverty-environment objectives in the national development plan or other relevant plans should be reflected in the priority criteria in budget circulars. Guiding principles at least should be set out in the first call circulars, perhaps with checklists as illustrated by the Rwanda example presented in box 5.4, even if subsequent circulars will seek more detail (IIED, 2016).

Box 5.4 – The budget call circular as a catalyst for achieving integrated poverty-environment objectives in Rwanda

In Rwanda, an environmental and climate checklist is included as an annex to the budget call circular issued annually by the Ministry of Finance and Economic Planning. All sectors and districts must not only plan for environmentally sustainable and climate change–resilient actions but, critically, also budget for their implementation. Rwanda, like many countries, found that mainstreaming poverty-environment issues into the planning process was not enough: the budget machinery also needed to go through a similar process. As the acting Director General for National Budget in the Ministry of Finance and Economic Planning noted “If the budget call circular does not consider environment and climate change, then most probably environment and climate change are not going to be taken into consideration by any sector or district. But now it is a requirement, it is the role and responsibility of everyone.”

In 2013, Rwanda’s budget statement emphasized five environmental priorities, identified the total cost of the activities budgeted for each, made a commitment for government to finance them, and called for additional (international) financing. In 2017, Rwanda’s Parliament adopted a resolution calling for all sectors and districts to include an environmental and climate change budget statement when submitting their annual plans and budgets; the intent was to reinforce application of the guidelines in the budget call circular.

Rwanda’s experience has confirmed the importance of having tools that are easily used by sector specialists (i.e. budget and planning checklists, and environmental and climate change budget statements) and of building sector and district staff capacities for applying such tools. Having the Ministry of Finance and Economic Planning lead and guide the process – with support from environmental specialists – was significant to its success. By 2018, the national investment guidelines also included a section on environmental and social safeguards. Before a government institution can receive internal or external finances to implement a project, it must demonstrate that environmental and social safeguards are in place, the potential impacts and mitigation activities. The Public Investment Committee uses compliance with these guidelines as a criterion for selecting public projects that are to be funded through the national budget or with external finance sources.

Source: Poverty-Environment Initiative Africa: Achievements and Lessons Learned 2005–2018.

 

Budget coding and tagging

Environmental and climate budget coding can help improve both budget allocations and subsequent tracking of actual expenditures. Tracking makes any discrepancies between allocation and spending more transparent, which can then justify the need for higher (or indeed lower) investments. Once a time series is built up, budget codes can help improve the efficiency of expenditure allocation between national, sectoral and subnational levels and to different institutions and projects, depending on their poverty-environment performance.

Development of budget codes that capture relevant poverty-environment issues takes considerable discussion and some technical skill: they may be derived from plan targets and indicators used in monitoring poverty and environment; alternatively, they may be guided by international standard classifications such as the (Classification of environmental protection activities, CEPA). Developing and correctly assigning environmental and climate budget codes has often required capacity building for the staff responsible for budget preparation, as well as for sector environmental units/focal points (PEA, 2021).

Work on budget circulars, budget codes, PEERs and economic analysis can be mutually reinforcing in achieving poverty-environment outcomes, as illustrated by Mozambique’s experience (box 5.5). Budget tagging can also lay the groundwork for green/climate funds, bonds and other instruments. In Indonesia, the budget tagging supported by PEI and UNDP helped in issuing Indonesia’s first sovereign green bond.

Box 5.5 Environmental and climate budget codes in Mozambique

Mozambique’s expenditures on the environment and climate change more than doubled between 2010 and 2012, with the most significant increase being for investments in sanitation. Environmental expenditure was thereafter maintained at 0.45 per cent of the state budget. Given that the country experienced a severe financial crisis in 2015, with many government priority areas consequently suffering severe budget cuts, the sustained level of expenditure for the environment is an encouraging achievement. The ease with which the Government of Mozambique can now track and analyse public expenditure on the environment and climate derives from a commitment to transparency and budget coherence across sectors.

In 2012, PEI and Mozambique’s ministry of environment took a close look at how the economy was treating natural resources. It carried out two studies: an environmental economic analysis of natural resource management; and a public environment expenditure review (PEER). These assessments identified a huge annual loss – the equivalent of 17 per cent of GDP – from environmental degradation and the inefficient use of natural resources. Furthermore, while 9 per cent of GDP would be needed to remediate these damages, the average environmental expenditure for the period 2007–2010 was just 1.4 per cent of GDP. The study concluded that neglecting to budget adequately for enforcing environmental legislation (such as environmental impact assessment and management plans for natural resources) can be a deferred cost to the economy, with far-reaching consequences in the medium and long term.

The review findings led to a dialogue between the ministries of finance and environment. They decided to establish a budget classification sub-code in the public financial management system to enable tracking expenditure on climate change. The ministry of finance appointed two environmental focal points in its budget department to take the lead in introducing and operationalizing the new budget code. The ministry of environment also decided to test the feasibility of a wider range of environmental budget codes. As of 2018, 21 government institutions were using the new budget codes. Thus, for the first time, the Government of Mozambique can readily assess its environment and climate budget allocations and expenditures.

“I believe that our introduction of budget codes for cross-cutting issues (like climate) was brilliant – transparently responding to the new five-year development plan priorities. With a single click, it is possible to verify allocated resources and who specifically responded to environmental and climate change objectives.”

Official in the National Directorate for Planning and Budget.

Source: Poverty-Environment Initiative Africa: Achievements and Lessons Learned 2005–2018

 

Responsive budgeting for gender, biodiversity and other issues

Methods can be used to make the budgeting process more responsive to certain issues:

  • Gender-responsive budgeting is a methodology that analyses the impact of actual government expenditures and revenues on women and girls as compared to men and boys. UN Women’s Gender-Responsive Budgeting web portal features articles, research papers and training tools for specific themes, countries and languages. PEI and the Government of Indonesia analysed the amount and composition of climate change–tagged budget in five ministries (environment, agriculture, energy, transport and public works) over 2016–2018 for gender relationships. Through extensive stakeholder interviews, the research identified what works and barriers to gender integration in climate change budgeting.
  • For an integrated approach to biodiversity budgeting and finance, the UN’s BIOFIN methodology offers a highly comprehensive and proven approach. It enables countries to measure biodiversity expenditures, assess biodiversity finance needs, identify finance solutions and sources that can fill gaps in financial resources for biodiversity, build partnerships for biodiversity finance and develop biodiversity finance plans. The Protected Areas Benefits Assessment Tool may also assist, offering a way to assess economic values – e.g. of national parks –and the benefits brought to stakeholders at global to local levels.
  • Results-based or performance-based budgeting, whereby financial flows are linked to results achieved, can be greatly helped by poverty-environment budget tagging. It brings clarity to two critical but often marginalized areas of performance – improvements to environmental conditions and poor people’s well-being. Laying out the expected poverty-environment results – e.g. numbers of green jobs created, soil erosion avoided, water supplies secured – can have a profound effect on the quality and efficiency of public service delivery (IIED, 2016).

 

Environmental economic studies, including cost-benefit analysis

PEI/PEA have found that economic analyses are perhaps the most powerful form of evidence to influence plans and budgets. Economic analyses speak the language of officials in ministries of finance and economic planning, who are often economists, and in key economic sectors such as agriculture. Such players are often gatekeepers to budgets, and it is vital to demonstrate the economic rationale for better environmental and natural resource and climate change expenditure. Such expenditure generates economic benefits for local communities, local government, and national government and underpins poverty reduction. Further, it cuts the risk that unsustainable environmental and natural resource use will damage economic and social benefit streams.

However, ministries of environment have often been reluctant to use economic analysis themselves, despite its proven power to influence planning/finance and sector ministries. Rwanda’s success– where the environment ministry supports and commissions economic analysis and closely engages with planning/finance ministries – demonstrates the benefits of doing so and offers the foundation for building a regular system of environment-economy analysis.

Economic analysis should consider covering at least one of three dimensions:

  • Estimating the annual costs of neglecting pro-poor environmental and natural resources management on livelihoods and the economy. This cost estimation requires careful data collection and the use of valuation techniques that require expert environmental economics skills – inputs that may be limited in some developing countries. However, this kind of evidence can play into the hands of those who perceive the environment as being only about bad news and costs rather than valuable benefits.
  • Assessing the direct and indirect benefits of better environmental and natural resource management to livelihoods and the economy. The indirect benefits can be quite broad: for example, expenditure on providing clean water will reduce health sector costs. Here again valuing benefits requires data and valuation techniques require expert environmental economics inputs, which may be in limited supply.
  • Measuring the amount of expenditure on the environment and climate by non-environment sectors or government agencies, and not limited to the ministry of environment. This analysis would look at the operations and maintenance costs for environmental assets that are mission-critical for jobs and national industries. For instance, the agricultural sector, including livestock and fisheries, may fund programmes and projects that have a direct link to pro-poor environmental and natural resource management. This kind of measurement shows how environmental expenditures span many ministries and are the responsibility of many ministries beyond the environment ministry. Its techniques are intuitively more straightforward than the preceding two types of analysis, requiring accounting skills combined with some environmental expertise, and avoiding the need for complex valuation techniques (IIED, 2016).

Other economic assessments can be tailored to key sectors. For example, the Mining Financial Modelling Tool, developed by PEI and the Department of Mines of Myanmar, is an easy to-read cash-flow forecast for the life of a mine that is responsive to changes in economic variables (e.g. commodity price changes, exchange rate fluctuation, delays in construction or ore deposit depletion) and includes estimates of the required costs of environmental management and social development. It allows governments to see if a developer has sufficiently considered the poverty-environment cost-benefit of its mining operations in developing its financial model.

Box 5.6 Environmental cost-benefit analysis

Cost−benefit analysis is a systematic process for identifying, valuing and comparing costs and benefits of a proposal or ongoing project. Cost-benefit analysis helps determine whether the benefits of a project outweigh its costs, and by how much relative to other alternatives. This can help to (i) determine whether the proposed project is (or was) a sound decision or investment; and/or (ii) compare alternative project options, to make a decision on the preferred option. In a cost-benefit analysis:

  • All related costs (losses) and benefits (gains) of a project are considered, including potential impacts on human lives and the environment.
  • Costs and benefits are assessed from a whole-of-society perspective, rather than from the point of view of a particular individual or interest group (i.e. a public and not a private perspective is taken).
  • Costs and benefits are expressed to the extent possible in monetary terms as the basis for comparison.
  • Costs and benefits that are realized in different time periods in the future are aggregated to a single time dimension (discounting).

Environmental costs include the regulatory costs to the government of implementing and enforcing environmental laws and regulations and the compliance costs of meeting them. Environmental benefits are more challenging to quantify in monetary terms since they do not necessarily have a market value and may not be tangible, in which case valuation exercises are required. The Organisation for Economic Co-operation and Development has produced guidance on Cost-Benefit Analysis and the Environment: Recent Developments (OECD, 2006) and Cost-Benefit Analysis and the Environment Further Developments and Policy Use (OECD, 2018), which explore recent developments in environmental cost-benefit analysis, including ecosystem services valuation. See also ADB/UNEP (2019).

Cost-benefit analysis may be used at a number of points during the project cycle. An ex ante cost-benefit analysis is undertaken while a project is still under consideration, typically before a decision is made (by a government or external donors) to support it. Ex ante cost-benefit analyses are primarily done to assess whether a project is worthwhile or feasible, which project option out of several is best, and to inform adjustments to project design. A mid-term cost-benefit analysis is carried out midway through a project to check that the project is on track and to inform any design refinements or adjustments for the remainder of the project period. An ex post cost-benefit analysis is undertaken at the end of the project period to evaluate project performance. This can support transparency and accountability in reporting on how well public funds have been spent.

A cost-benefit analysis involves several steps that are not necessarily linear:

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Source: UNDP-UNEP PEI (2015).

5.3 Poverty-environment integration in public expenditure

The justification of government expenditure is to produce public goods – notably social and environmental protection in support of healthy societies and economies. This involves both direct government capital expenditure (public investment programmes) and government current expenditure (operations and maintenance ). PEI/PEA have focused on two approaches to ensure that both investment and operations expenditure effectively integrate poverty-environment outcomes: safeguard systems and sustainable public procurement.

 

5.3.1 Poverty-environment safeguards in public investment

Integrating poverty-environment objectives into direct public investment is generally assured by the screening, safeguards and budgeting activities described in chapter 4 and section 5.2. This is where environment and natural resource and climate specialists have an opportunity to make sure their required investments are included. Screening and safeguards are needed that suit the country context and fit into mandated investment processes – from initial notification of investment opportunities to selection, approval and monitoring. Much can be learned from other countries’ experience. For example:

  • Malawi reviewed the ways to integrate poverty and environment into its Public Investment Programme, and used this work to revise the relevant Public Investment Manual and Guidelines; Tanzania followed a similar process (IIED, 2016).
  • Bangladesh’s Planning Commission uses a template to appraise all publicly funded capital projects. With UN support, this project proforma now mainstreams issues of poverty, gender, climate, environment and disaster management.
  • Bhutan has screened investments against a Gross National Happiness screening tool, drawing on the nine domains of happiness and applied by a multidisciplinary group.
  • Lao PDR has developed a Green Growth Technical Guideline and Criteria for Public Investment Projects for governmental organizations and staff involved in assessing and selecting inclusive green growth public investment projects for the National Socioeconomic Development Plan and associated provincial plans.

The development of screening criteria can galvanize stakeholders. Safeguards work through screening activities in or out, in this case depending upon their poverty-environment implications. Recent work on green economy has been advancing the kinds of criteria that might be used. For example, the international Partners for Inclusive Green Economy propose measures that cover not only conventional cost-benefit criteria but also more advanced criteria covering the following, among others:

  • Impact on critical (irreplaceable) natural capital and planetary boundaries
  • Security of food, energy and water
  • Pandemic prevention
  • Sustainable use of all capital assets
  • Avoidance of stranded assets
  • Production of environmental, social and economic co-benefits
  • Intergenerational impact

 

5.3.2 Sustainable public procurement

Governments spend a considerable proportion of their budget on public procurement of goods and services. Sustainable procurement means ensuring that any goods and services bought will achieve value for money on a life-cycle cost basis, and generate benefits not only for the organization but also for the environment, society and the economy.

Public procurement can be a politically high-profile way to encourage innovation for better poverty-environment outcomes. A performance-based procurement specification describes the performance to be achieved by the procured good or service – which can include poverty-environment outcomes. Rather than specifying the exact product or technology that will achieve this, it focuses on needs, and encourages innovation as to the best way in which these needs may be met. Malawi has placed considerable emphasis on public procurement favouring local labour and sustainably produced goods which benefits both poor producers and poor consumers, as well as society at large.

Typical poverty-environment issues to reflect in a sustainable procurement specification are illustrated in box 5.7.

Box 5.7 Illustrative poverty-environment specifications in sustainable public procurement

For a goods supply contract:

  • Origin of materials used – e.g. timber from sustainably managed forests, food from organic agriculture, use of recycled material
  • Production methods – e.g. electricity from certified renewable sources
  • Performance of the product in use – e.g. carbon dioxide and harmful pollutant emissions from vehicles
  • Disposal/recyclability of the product – e.g. whether products contain mercury or are separable into easily recyclable components

For a service contract:

  • Consumption of resources in service performance – e.g. energy, water
  • Waste/emissions generated – e.g. carbon dioxide emissions from transportation requirements or type of vehicle used, non-recyclable waste generated
  • Use of products – e.g. use of organic/fair trade produce for a catering service, use of non-toxic products for a cleaning service, use of energy-/water-efficient equipment
  • Working conditions – e.g. employment of disadvantaged groups, payment of minimum wage rates

For an infrastructure contract:

  • Materials used in construction – e.g. use of renewable and/or recycled materials, restriction of harmful or unrecyclable materials, efficient use of material
  • How works are constructed – e.g. minimizing waste and noise from construction sites, energy/water efficiency of machinery
  • Infrastructure performance – e.g. energy use of a building, accessibility for people with disabilities, indoor climate

Source ICLEI– Local Governments for Sustainability and the European Secretariat (2016).

 

Several initiatives offer advice and support on sustainable public procurement:

  • The International Council for Local Environmental Initiatives (ICLEI)– Local Governments for Sustainability and European Secretariat 2016 Procura+ Manual: A Guide to Implementing Sustainable Procurement guides public authorities and others in developing a sustainable procurement policy and implementing it. The manual lays out the costs and benefits of sustainable procurement in different sectors; describes the tendering process; and offers guidance on how to take environmental, social and innovation aspects into account.
  • UNEP’s Comparative Analysis of Green Public Procurement and Eco-labelling Programmes in China, Japan, Thailand and the Republic of Korea (2017) compares green public procurement programs from four Asian countries. It covers challenges and good practices in the legal framework governing the procurement of environmentally preferred products; national eco-labelling programs, guidelines and procedures; priority product categories; and enforcement and monitoring of green public procurement.
5.4 Poverty-environment integration in fiscal policy

Fiscal policy has particular resonance in a post-pandemic era that has seen large increases in national debt, reductions in government budgets, business failures and lost jobs. Governments are seeking ways to develop new revenue sources, to protect and increase resource rents, and to ensure that all subsidies and government spending produce real value for money – and not simply political capital. In the aftermath of the pandemic, with public spending under review and heightened societal expectations for changing priorities, governments have a unique opportunity for significant financial reform. Government’s fiscal role is to create the enabling conditions (taxes, subsidies, information etc.) to encourage private investors (and individuals) to deliver public goods and halt poverty and environmental damage – and thereby secure the long-term reliability of the fiscal base. For example, energy taxes and subsidies influence renewable energy investments; forestry taxes and subsidies influence levels of afforestation and deforestation. Environmental fiscal reform may not always be the most effective way to raise revenues or necessarily the best approach to protect the environment. However, its value lies in its ability to simultaneously raise revenues and protect the environment.

Fiscal policy is a highly technical subject with extensive implications. A full treatment is beyond the scope of this handbook.2 Rather, here we highlight viable options towards good poverty-environment outcomes, and some fiscal risks that have poverty-environment implications.

 

5.4.1 Fiscal options supporting good poverty-environment outcomes

The following are proven approaches that should be explored in country. As this handbook evolves, material on some options will be developed and/or links made to specialized resources.

  • Removal of negative subsidies, e.g. subsidies for extractive rather than restorative forestry and mining management, or for fossil fuels. Subsidy removal will raise net revenue and thus increase the fiscal space, allowing for other types of (potentially poverty-environment-positive) expenditure.
  • Introduction of positive subsidies, e.g. for renewable energy or energy-efficient technology. However, this requires increased revenue and is consequently prone to being reduced in times of fiscal constraint, and so must be planned carefully.
  • Taxing negative environmental externalities (such as fossil fuel production and use) while at the same time raising revenue, i.e. introduction of Pigouvian taxes.
  • Applying environmental charges rather than taxes. Charges may be levied without complex legal changes, earmarked for local or sector use, and more readily accepted than taxes.
  • Revenue recycling, i.e. levying an environmental tax at the same time as reducing taxes on labour, business or income. This can increase economic efficiency and improve employment effects.
  • Using the tax code to incentivize pro-poor green investments through e.g. capital allowances and exemption from income and capital gains taxes.
  • Phasing out preferential tax, auditing and regulatory treatment for unsustainable industries.
  • Mandating risk disclosures and higher risk provisioning for loans to entities engaged in unsustainable activities that contribute to poverty-environment and climate risks.
  • Ecological fiscal transfers that include environmental performance in fiscal allocation formulas to different localities or sectors. These transfers should be conditional e.g. upon additional income being invested in conservation or restoration, or on engaging communities in management and benefit sharing.
  • Linking taxation and government budgets concerning social and environmental protection so synergies and efficiencies are realized, e.g. by creating jobs for nature schemes.
  • Emissions trading and other tradable permit schemes.
  • Innovations in sovereign debt financing that link sovereign debt to climate and nature outcomes, e.g. debt swaps for nature or climate improvements.3
  • Building coalitions for tax reform among poverty stakeholders and environment stakeholders, and managing perceptions to ensure that the losers are compensated (often by using the revenues from the fiscal measures) or that there is public consensus that any losses are fair.

While these options have broad application, each country should generate its own options and generate its own evidence. An ongoing PEER system, natural capital accounts and specific environmental cost-benefit analysis, as described above, will be invaluable in this regard.

 

5.4.2 Handling distributional impacts

The most striking feature of the economic losses occasioned by the COVID-19 pandemic was that global poverty and inequality both increased for the first time in a generation. Economic “trickle up” has been more evident than “trickle down.” To ensure good poverty-environment outcomes, the distributional impacts of any fiscal changes must be anticipated and addressed.

Environmental fiscal reform contributes to poverty reduction when it is ensured that poor households benefit either from the revenues raised (e.g. using increased revenues to improve service delivery of water and energy or other environmental improvements), or from the environmental impacts (e.g. health gains from the pollution reductions associated with the reform). But environmental fiscal reform may also increase poverty, especially through changing subsidy levels for critical livelihood inputs such as water, energy and fertilizers. While such subsidies are defended on the grounds of their social benefits, there are often only limited benefits for poor people who cannot access the subsidies. On the other hand, some poor households will be harmed by any price increases – for example, increased electricity costs or fertilizer costs. Subsidies can be reformed in ways that do not harm poor people. One such method is targeted compensation, such as reducing the prices of other goods and services to offset the price increases related to environmental fiscal reform. (See IIED 2016 for more detail.)

The checklist in box 5.8 can be used to make an initial rough assessment of the impacts of subsidies and wider tax reforms on poor people as producers and consumers. This should be followed by a more thorough assessment where critical issues are specifically identified.

Box 5.8 Assessing the impacts of environmental subsidies on poverty

Production

The subsidies should not affect the ability of people living in poverty to be economically active. Will the planned policy affect:

  • Agriculture or the informal sector (sectors with an above-average share of people living in poverty)?
  • Poor groups’ labour, land and natural resources, financial capital, and human capital – health and education (production factors that people living in poverty require for their livelihoods)?
  • Net employment effects especially for low-skilled or informal labour (employment opportunities on which people living in poverty depend) – notably the green employment opportunities created, and the brown employment opportunities lost.

Consumption

The subsidies should not prejudice against poor groups’ consumption especially of basic needs. Will the planned policy affect:

  • Access to basic goods or services by people living in poverty (e.g. shelter, food, energy or water)?
  • Affordability of key goods and services (e.g. shelter, food, energy or water)?

Where negative effects are found, mitigating options can be identified and assessed, e.g. creating alternative employment opportunities, re-training , or price subsidies such as electricity lifeline tariffs.

Source: Pegels (2015)

5.5 Poverty-environment integration in private investment
5.5.1 Why private finance is important for achieving poverty-environment outcomes

Private investment flows are principal drivers of sectors’ poverty-environment outcomes. Most investment in sectors critical to both poverty reduction and environmental management comes from private sources, rather than from government. Private capital sources include commercial banks, other specialized lenders (leasing, credit cards), private equity and credit funds, infrastructure funds, venture capital funds, start-up incubators and accelerators as well as corporations. Private capital is particularly important for mining, commercial agriculture and other land sectors with major poverty-environment implications.

Foreign direct investment volumes are significant in developing countries. In developing countries, foreign direct investment totalled $11.3 trillion in 2020, according to the United Nations Conference on Trade and Development’s World Investment Report 2020, with recent growth mostly in large emerging economies with sophisticated financial markets – especially China but also Brazil, India and South Africa. Foreign direct investment has many implications. It can help create green jobs and value chains involving nature-based and climate-friendly small enterprises and supply chains, and support integrated land use models that meet institutional investors’ long-term needs for predictable revenues. It can provide much of the volume of investment required: McKinsey & Company (Kumra and Woetzel, 2022) estimate that achieving net zero emissions by 2050 requires global investments of $9.2 trillion a year – equivalent to half of annual global corporate profits. But there are also risks, such as land grabbing or carbon grabbing, which may displace local people and reduces food security. Investment treaties and standards are therefore required to make the most of foreign direct investment.

The requirement to realize commercial rates of return means that green private finance sources are not suitable for public goods projects that do not generate a revenue stream. For example, only 14 per cent of investment in nature-based solutions comes from private sources. And there is still much that falls through the gaps: the sustainable investment agenda must be broadened from carbon-siloed solutions, for example, to also investing in nature and poverty reduction.4

It is therefore important to understand what motivates private finance to invest in poverty reduction and environmental sustainability. Private interest motivations will differ from those of government or the general public, emphasizing:

  • Risk to the company – exposure of future cash flows to climate, environmental and social risks
  • Business dependencies – on natural and human assets to sustain production and markets, including dependence on local producers for supply chain inputs
  • Business opportunities – to access funds and markets that discriminate in favour of good poverty-environment outcomes
  • Time – both seeking returns in a shorter term than would government, and seeking long-term security of access to supplies and markets
  • Real prices – the full cost of inputs and waste, including shadow prices of carbon

 

5.5.2 Green private finance

An increasing proportion of private finance can be defined as green private finance – the financing (through equity or debt) or de-risking (through insurance products, re-insurers and credit guarantors), at commercial rates, of green investments made by companies or individuals. Pension funds and other sources of “patient capital” seek the kinds of long-term, predictable returns that can arise from investing in the environment and those who manage it well, including IPLCs. For example, pension funds have been investing in forests and their sustainable management.

Sustainable finance policy frameworks and opportunities are proliferating. Many global bodies now seek to support investment in the implementation of international climate, biodiversity and sustainable development goals. This has driven a growth in sustainable finance tools, mechanisms and initiatives. Environmental, social and governance (ESG) and sustainability indices have become established in many stock and bond markets. While multiple initiatives enable innovation, their increasing numbers and inconsistencies also risk market fragmentation, higher transaction costs (from duplicate verifications, data inconsistencies and diverse interpretations) and green-washing. Across the UN system at the regional and global levels, too, sustainable finance initiatives are being delivered in ad hoc and uncoordinated ways. The G20 Sustainable Finance Working Group is consequently seeking to improve consistency and take-up. In such a dynamic context, readers are encouraged to keep up to date with the sources listed in box 5.9.

Box 5.9 International initiatives in support of sustainable finance

The United Nations Environment Programme Finance Initiative (UNEP FI) is a partnership between UNEP and the global financial sector – including more than 450 banks, insurers and investors and over 100 supporting institutions – to mobilize private sector finance for sustainable development. It aims to leverage the UN’s unique roles to accelerate sustainable finance. Its website is a rich source of information, such as its Reporting on nature-related risks, impacts and dependencies with UNDP (2021) for the G20 Working Group. UNEP FI is also perhaps the most credible source of global principles for catalysing the integration of sustainability into financial market practice. The frameworks it has established or co-created include:

The Sustainable Stock Exchanges Initiative (SSEI) today involves 90 stock exchanges, accounting for almost all publicly listed capital markets. It is also supported by UNEP FI.

The International Platform on Sustainable Finance (IPSF) offers a forum to exchange and spread information on best practices in sustainable finance, to compare the different initiatives and identify barriers and opportunities to help scale-up, and to enhance international coordination. It involves governments of countries rich and poor that comprise half the world’s population and over half the world’s GDP and greenhouse gas emissions.

The G20 Sustainable Finance Working Group was launched in 2016 to identify institutional and market barriers to green finance and options to mobilize private capital for green investment. It was later mandated to prepare a G20 sustainable finance roadmap, improving the comparability and interoperability of approaches to align investments to sustainability goals, improving sustainability reporting and disclosure in terms of completeness and consistency across companies and jurisdictions, identifying sustainable investments, and aligning international financial institutions’ efforts with the Paris Agreement – thereby providing stable, long-term and countercyclical lending at affordable rates.

 

5.5.3 Attracting quality investment for good poverty-environment outcomes

Having had major influences on government investment in many developing countries, PEI/PEA supported much work to attract private investment into poverty-environment outcomes (box 5.10). The PEI/PEA experience is valuable for highlighting the challenges that must be faced to mainstream poverty-environment issues in private investment, and especially for innovations that overcame these challenges.

Box 5.10 PEI/PEA encouragement of private finance to invest in poverty-environment outcomes

PEI/PEA played a catalytic role in accelerating private sector investment towards poverty-environment outcomes. This work has had two primary objectives: (i) effective regulation and management of investments to minimize adverse impacts on the environment and local communities, and (ii) incentivizing the private sector to invest in activities supporting poverty-environment objectives. PEI focused on the first objective, primarily in Asia, and PEA picked up the second, with:

  • Investment proposal screening, appraisal and approval – using pro-poor environmental and social sustainability criteria and guidelines
  • Investment tracking tools and web-based database tools – improving the transparency of the approval process and supporting investment monitoring and compliance on poverty-environment issues
  • Annual investment reporting templates – covering key sectors such as agriculture, hydropower and mining

PEA latterly worked more closely on a third objective: attracting and mobilizing private finance given its potential to have significant poverty-environment impacts, both positive and negative.

 

While many countries work hard to attract private finance and foreign direct investment, country-specific challenges often stand in the way of mobilizing it for poverty-environment objectives. These challenges include investment risk aversion in the critical smallholder farming sector; lack of access by poor groups to formal finance; poor governance in many sectors including unclear laws and high levels of corruption; high levels of subsidies which create a disincentive to private initiative; and the oligopolistic nature of some sectors with a heavy presence of parastatal companies (UNDP-UNEP PEA, 2021a). A strategic approach to a country’s investment strategy is needed to attract higher quality investment that favours poverty-environment outcomes, and not simply larger quantities of investment. Options to consider for attracting poverty-environment quality investment, validated by PEI/PEA’s and others’ experience, include the following:

Establishing an enabling economic and institutional environment to attract and manage foreign and domestic private investment. Several standard elements are invariably needed to attract investment – macroeconomic stability, realistic and predictable exchange rates, adequate and reliable infrastructure, security of rights over assets, and coherent and clear investment legislation. Ensuring these foundations are in place can be a preferable alternative to the often-excessive tax breaks proffered to incentivize investors. Some other options include:

  • Subsidizing establishment of special economic zones in poorer and/or ecologically important regions to provide quality infrastructure and services
  • Investing in education, skills training and transport infrastructure in poorer regions
  • Training civil servants in effective administration of investment regulations, notably environmental and social provisions
  • Improving investment marketing of sectors with potential to achieve good poverty-environment outcomes

Developing integrated financing frameworks that support poverty-environment objectives. For example, PEA supports governments in producing blue financing strategic documents to serve as a foundation for shaping a credible blue bond framework. These strategic documents offer an agreed-upon definition of what sectors can be classified as blue and financed by blue-labelled bonds to ensure a healthy and productive ocean economy. They identify the types of projects in each sector that could be prioritized based on their poverty-environment relevance. Sample indicators are provided to aid in the development of clear and measurable targets for projects in line with the Sustainable Development Goals, particularly SDG 14, Life Below Water. Stakeholders are identified whose involvement would be expected in the development and management of the blue bond framework (PEA, 2021).

Negotiating investment treaties and investment contracts between governments and investors. International investment agreements aim to incentivize foreign investment by protecting it from host country political risk. By binding themselves to such agreements, however, host countries could find their policy options for regulating foreign investment are constrained. For example, international investment agreement provisions on expropriation and “fair and equitable treatment” could enable investors to challenge the adoption of more stringent environmental and social regulations by the host government, as these may be seen to adversely affect the economics of an investment project. The prospect of then having to compensate investors may discourage host governments from stricter environmental regulations. To avoid investor-state disputes, governments should explore policies that help achieve their poverty-environment and other development objectives without violating existing commitments ; and identify rule changes needed to attract quality investment – including model contracts and transparency requirements before signing new agreements – and should actively put forward their views during negotiations (IIED, 2016).

Voluntary third-party certification as a credible alternative to government poverty-environment monitoring. Where credible from a poverty-environment perspective, and acceptable to markets, certification avoids the need for countries to develop and enforce their own standards. This approach has emerged in several primary industries. Well-established international initiatives include the Forest Stewardship Council and the Programme for Endorsement of Forest Certification Schemes, the Roundtable on Sustainable Palm Oil and the Marine Stewardship Council for fisheries. Certification has primarily been driven by nongovernmental organizations and consumers in developed countries in response to what they perceive to be inadequate labour and environmental regulation in producer countries. The standards are usually high and cover most poverty-environment issues; their prominence has driven debate and progress in upgrading government policy. Certification has been embraced by corporations seeking to ensure credible green and socially responsible branding for their products and has consequently improved market access. But compliance with the social and environmental standards stipulated by certification schemes – and indeed the costs of the certification process itself – have been prohibitive for many small producers. As a result, many certification schemes such as the Forest Stewardship Council have provisions that allow small producers to be certified as a group.

Blending public and private finance to de-risk private investment. Finance originating from governments, development banks and vertical funds such as the Green Climate Fund can leverage private capital through blended finance solutions. Concessional public capital in the form of grants, soft loans and guarantees can de-risk investments that may otherwise be considered too risky for private lenders and investors. Private sector projects that have been enabled by blended finance solutions can have a demonstration effect and open the path for future private investment in the same sectors and countries.

Mechanisms for reviewing individual investment proposals, feasibility studies and plans. Requirements must be clear and capacities available to support investment treaties and contracts, covering screening, appraisal, approval and monitoring. (See chapter 4 for technical social and environmental assessments and requirements for consultation.) The case study in box 5.11 shows how environmental and social impact assessment has promoted quality investment in Lao PDR.

Box 5.11 Environmental and social impact assessment to promote quality investments in Lao PDR

Lao PDR has risen from a low- to a lower-middle-income economy, with per capita income doubling since 1990. The rapid inflow of foreign direct investment was key to this growth, especially in natural resource sectors such as plantation agriculture, forestry, mining, hydropower and tourism. For decades, the merits of prospective investors’ plans were assessed solely on technical and financial criteria, and their impact on environmental protection or poverty alleviation was largely overlooked. Many projects therefore led to some destruction of the environment, land grabs from local communities, and inequitable distribution of profits with very little compensation for local communities.

As the government became more aware of how such investments could and should reduce poverty, they strengthened their commitment to protect communities and their rights, to preserve the environment, and to improve local communities’ technical skills came to the fore. PEI worked with the Ministry of Natural Resources and Environment to develop new ministerial instructions for procedures that investors and government authorities must follow for initial environmental examinations, and for subsequent environmental and social impact assessments for proposed projects. In Oudomxay province, the increased scrutiny exposed 20 projects that were not complying with the law. Four projects were made to halt all operations, 4 received warnings, and 12 were obliged to make improvements.

PEI worked to strengthen bottom-up development measures, especially by shining a spotlight on citizen involvement in environmental and social impact assessment procedures. The welfare of grassroots communities, which are most directly affected by mining, dam construction and plantations, is often compromised in the push and pull between governments and private investors. Taking definitive steps to redress this, PEI trained over 200 central and provincial environment officials on human rights issues, legal frameworks for involving people, conflict resolution and communication initiatives to open dialogues with host communities.

A model contract/template for investments in the agriculture, forestry and hotel sectors has now been consistently used by the Investment Promotion Department in contract negotiations, with staff trained in the use of the model contracts. Four provincial investment strategies have conceptualized the poverty-environment needs of the specific province, identified realistic development goals and the systems and tools necessary to achieve them, and aligned them with the National Investment Strategy.

Source: UNDP-UNEP PEI (2014a).

 

Supporting microfinance institutions. In low-income countries, the formal banking sector primarily serves wealthier, more resilient households and larger, more established businesses. Low-income households and small businesses are thus less likely to have access to formal bank credit and tend to be more reliant on non-bank to lenders such as non-governmental organizations, credit unions and shops (World Bank, 2022). Governments and central banks could consider providing financing to such lenders on preferential terms, conditional on meeting specific poverty, environment or other sustainability targets.

Devolving finance to local levels, thus getting money to where it matters. Governments need to identify and nurture accountable and technically proficient local organizations in addition to microfinance institutions. Less than 10 per cent of global climate fund finance is dedicated to local action and less than 2.5 per cent of humanitarian aid goes to local organizations. But in both cases it is usually local organizations that know how, where, to whom and when to deliver funds, and that are in a position to scrutinize implementation closely. The LDC Initiative for Effective Adaptation and Resilience (LIFE-AR) and the Global Commission on Adaptation’s Locally Led Action Track (LLAT) are leading the way to increase funding for and recognition of locally led adaptation. The Local Climate Adaptive Living (LoCAL) Facility designed and hosted by the UN Capital Development Fund serves as a mechanism to integrate climate change adaptation into local governments’ planning and budgeting systems, and increase the amount of finance available to local governments for climate change adaptation. A recent study concludes that international funders will gain much if they follow the lead of such initiatives in getting ‘money where it matters’ to local organisations, authorities and small businesses (IIED, 2020).

5.6 References

ADB/UNEP (2019) Strengthening the Environmental Dimensions of the Sustainable Development Goals in Asia and the Pacific: Tool Compendium

Agarwala, M. and D. Zenghelis (2020) Natural Capital Accounting for Sustainable Macroeconomic Strategies. United Nations, New York, 2020

IIED (2020) Calling for business unusual: why local leadership matters IIED Briefing

IIED (2016) Budgeting for Sustainability in Africa: Integration of Pro-Poor Environment, Natural Resources and Climate Change to achieve the Sustainable Development Goals – Guidance Manual

Kumra, G. and J. Woetzel (2022). What it will cost to get to net-zero. The Business Times. 29 January.

OECD and GGKP Policy Instruments for the Environment (PINE) database

Pegels, A. (2015). Synergies and trade-offs between green growth policies and inclusiveness. Eschborn, GIZ.

Poverty Environment Action (2021) Overview of Public Financing and Planning Tools

Poverty Environment Action (2021a) Overview of UNDP, UNEP and PEA’s Green Private Finance Tools

Poverty-Environment Initiative Africa (2018) Achievements and Lessons Learned 2005–2018

PEI and UNDP Governance of Climate Change Finance (2015) A Methodological Guidebook: Climate Public Expenditure and Institutional Review (CPEIR)

Ramkumar V (2005), A Citizens’ Guide to Monitoring Government Expenditures, Open Budget Initiative

World Bank (2022) 2022 World Development Report: Finance for an Equitable Recovery

UNEP and Tongji University (2019) Inclusive Green Economy: Policies and Practices, Chapter 8: Fiscal policy for inclusive green economies.