Budget Support & Effective Public Financial Management

Published on : 19.03.24

By: Moritz Piatti-Fünfkirchen,  Srinivas Gurazada,

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Strengthening the development compact through budget support and effective public financial management

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By Moritz Piatti-Fünfkirchen

SENIOR Economist, World Bank

& Srinivas Gurazada

Global Lead, Public Financial Management, World Bank

It is time to revisit the development compact with a greater focus on Public Financial Management (PFM).

The Paris Principles on aid effectiveness – ownership, harmonization, management for results, and accountability -- remain more relevant than ever as the global community plans to scale up development assistance to support developing countries in their climate transition. Moreover, the multiplicity of crises, compounded with fiscal stress, is making the efficient use of resources more crucial than ever. It is hard to imagine how these principles can be pursued without embracing budget support as an aid instrument.

In this blog post, we find that in recent years:

  • Budget support has remained relevant to broad-based development and has also become used for stabilization purposes.
  • As a result, it has become increasingly used in countries with weak institutional and public financial management capacity.
  • At the same time, there has been a trend away from conditionality aiming to strengthen public sector management reform.
  • Even tough evidence suggests that public financial management reform actions work and that these remain particularly relevant in countries with weak institutional capacity.

1. Budget support (also called Policy-based finance) remains an important aid modality.

In recent years, development partners have committed to an average of about US$ 30bn per year in budget support. Budget support provides unearmarked contributions to government budget, primarily to support the implementation of policy reforms. As such, it is an important vehicle for the implementation of the Paris Declaration of Aid Effectiveness (and iterations thereof) as it utilizes country systems and supports ownership, predictability, focus on results and harmonization of Overseas Development Assistance (ODA).

But recipient countries also increase their demand for budget support during times of crisis, as its quick disbursement nature helps maintain expenditures when the economy is hit by negative shocks.  As a result, interest in budget support also fluctuates with the economic cycle. Its size thus has spiked during times of crisis when developing countries have come under increased fiscal pressure. In particular, following the global financial crisis and the COVID-19 pandemic, budget support increased from 13% to around 20% of total ODA.[1]

2. The importance of Adequate PFM for receiving budget support.

Alongside the macro-fiscal framework, good public financial management (PFM) of recipient countries has been a sine qua non-eligibility condition over several decades. This was raised in the 2006 volume ‘Budget support as more effective aid’ and has subsequently been introduced in various policy and operational guidance documents of MDBs and other partners. This is because it is not possible to track the end use of budget support funds, which go through the Treasury to finance the general budget. Some earmarking can be done if sector budget support is provided. Therefore, there needs to be consensus on broad policy directions and budget priorities, underpinned by joint analytical work with mutual ownership. Good PFM supports this process. It ensures transparency, efficiency and accountability and helps ensure that budget support resources are put to good use. This became the foundation of the new development compact: partners provide unearmarked budget support but have input on the broad policy direction, budget priorities and confidence in the PFM system to deliver (figure 1). Without adequate PFM systems, donors often lack confidence that their financing will be used toward jointly agreed development priorities, thereby undermining this development compact. It becomes particularly concerning when there is evidence of misuse of funds potentially tainting the reputation of the instrument.

Figure 1: Operationalizing the development compact requires increased fiscal space and adequate PFM systems

Source: Authors
Source: Authors

Has the narrative been lost? In our recent book ‘Retooling development aid in the 21st century: the importance of budget support’, we present evidence that budget support is increasingly provided to countries with poor PFM capacity and institutional performance. The average country policy and institutional assessment (CPIA) score of a budget support recipient country from the World Bank lending program today is almost a half-point below what it was 15 years ago. Similarly, the budget reliability[2] of current budget support recipient countries today is significantly lower than it used to be (figure 2). It is a crucial PFM metric as it shows the extent to which the original budget – for which there should be consensus under budget support - is also being implemented as planned.

Increasingly, fragile and conflict-affected countries have become beneficiaries of budget support despite their limited institutional and public financial management capacity. This raises questions on whether the above-mentioned development compact is at risk. On the flip side, it may be for good reason that these countries receive this type of support because many of them are severely impacted by crises and unable to raise critical funds from capital markets. In these cases, the narrative shifts from the development compact to using budget support as leverage for specific policy reforms. This may be useful, but it is fundamentally different and requires a different analytical lens to evaluate the performance of the instrument in these circumstances.

Figure 2: Trend in CPIA and PFM performance of budget support recipients.

Fig 2

3. A trend to reduce PFM conditionality

Budget support often involves commitments by countries to policy or institutional reforms. Public sector management continues to be amongst the most prominent areas for prior actions at the World Bank, but this trend has been declining over time. Instead, other priority areas such as human development, finance or social development and protection are increasingly used as prior actions in budget support. (Figure 3). Since 2011, there has been a decline from about 40% of public sector policy actions to about 25% (see World Bank 2021 DPF retrospective).

Figure 3 World Bank budget support by policy area

Source: World Bank 2021
Source: World Bank 2021

There has been an emphasis on public expenditure management, but this trend is also notably declining. Between 2006 and 2009, 36% of public administration conditions focused on public expenditure management, but this has dropped to 15% in the 2018–21 period. Similarly, there has been a declining pattern in conditions for administrative and civil service reform, which has reduced from about 11% to just over 5% in 2018–21. Additionally, there has not been much focus on information communication technology reforms, including the important area of financial management information systems (FMIS).

4. PFM policy engagement works and countries benefit from scale-up

There is, however, good evidence that conditionality related to public sector governance policies works. Smets and Knack (2018) have investigated this relationship and shown that budget support can improve the quality of budgetary and financial management. However, they have difficulty supporting anti-corruption or civil service reform. This is consistent with Fardoust et al (2023), who found that World Bank policy lending has improved economic management and public sector governance in low-income countries but not in fragile states. For public sector governance, both studies suggest a negative marginal return at some point. A recent review of MDB experience with budget support by the Evaluation Cooperation Group (2023) notes that ‘PFM vastly improved as evidenced by repeat PEFA assessments' and that ‘budget support played an important role in these improvements’.

So, where does this take us from here?

Budget support instruments are not homogenous. Depending on a country's specific circumstances, there seem to be two distinct uses of the instrument: as a programmatic instrument and as a countercyclical instrument. It is important to choose the right goal for the instrument for the right context, as supporting a crisis is different from supporting a broader development compact. Therefore, the success of budget support should also be evaluated differently based on the objectives of the engagement.

While we recommend differentiating more carefully amongst the objectives that budget support aims to achieve, we believe that more efforts to retain the original purpose of improving financial governance should be made. And when appropriate, budget support should be centered on strong institutional and public financial management foundations. But in all cases, more emphasis can be put on strengthening financial governance – not least because evidence suggests that it works. The Global Report on Public Financial Management issued by the PEFA Secretariat identifies several opportunities where quick progress with PFM reforms can be achieved.

[1] Source: Fardoust et al. (2023).

[2] This is measured by PEFA as a composite metric that captures aggregate expenditure outturn, expenditure composition outturn, and revenue outturn. More information is available at www.pefa.org/resources.