Climate Budgeting powered by Climate Budget Tagging: An Effective PFM Tool in the Fight Against Climate Change
“Without doubt, climate change is the largest crisis facing humanity till date. Each of us has witnessed some form of visible damage that climate change is causing – extreme weather patterns being one of the common signs. Recognizing the need for bold and quick action, governments worldwide have taken the pledge to transition to less carbon-intensive economies and have committed to timelines to reach “net zero.” India has set 2070 as the target year to achieve net zero emissions. Furthermore, the union government has announced stiff climate goals for the nation to achieve by 2030¹.”
Climate investment needs
The Synthesis Report (Sixth Assessment Report) of the Intergovernmental Panel on Climate Change (IPCC), released in March 2023, states that the pace and scale of current climate action are insufficient1. Huge investments are needed to achieve the transition, and countries don’t have the luxury of time to mobilize them. The Report states that the climate investment need is 3 to 6 times the current investment level.
There is a silver lining though amongst the dark clouds - the Report states that sufficient global finance and financing options are available to rapidly reduce emissions. Appropriate policies and financing products are needed to direct the capital to eligible climate projects. ‘Greenwashing’ – the practice of posing investments as climate-friendly when they are not so actually, poses a serious threat in efforts to mainstream climate finance. To counter this threat, public finance management (PFM) tools, that can ensure accountability of end-use of capital deployed for climate action, are required.
Climate Budgeting
One such effective PFM tool is Climate Budgeting. Climate Budgeting attempts to quantify and track government budgets directed towards furthering climate objectives. Regardless of the level at which it is applied – national, state, or local – Climate Budgeting helps the government understand the quantum of its budget that is oriented towards policies and programs that further its climate agenda2.
At the core of Climate Budgeting, is the technique of Climate Budget Tagging (CBT). Just like how a baggage tag of every piece of baggage at the airport mentions details of its owner, flight and so on, CBT entails attaching a ‘climate tag’ to every line item of the government budget.
The Annual Budget is an important policy document in government. In addition to its inherent function of ensuring fiscal prudence, the budget operates as a tool of administrative control as well. The budget tagging technique has been in use in government for many years now. National and State Governments in India prepare thematic budgets (covering themes like gender, child, nutrition, pro-poor and so on). Thematic budgeting is getting more attention as governments increasingly align their policies and strategies to the Sustainable Development Goals (SDG) 2030 agenda3. Although CBT presents certain unique challenges, in several ways, it is an extension of the budget tagging technique to climate action.
Benefits
Climate budgeting promises several benefits:
- Mainstreaming: It helps mainstream climate concerns into economic policy making, multi-year and annual planning, and budgeting.
- Impact Assessment: It allows government to assess the climate relevance and/or climate impact of development spending.
- Sustainability Perspective: It helps imbibe the sustainability and climate perspective into budget proposals submitted by line departments to the finance department.
- Transparent Communication: It helps government in communicating its policy intentions and budget allocations towards the fight against climate change, and reporting performance against climate action plans.
- Credibility for Capital Raising: Clearly defined climate goals backed by budget intent impart credibility to the government’s fund-raising pitch to the investment community.
- Traceability of Climate Finance: Currently tracked ‘green finance’ is less than one fourth of India’s climate investment requirements. CBT is an effective technique to introduce traceability into climate investments.
“Climate Budgeting is gaining popularity in recent years, thanks to increased attention being given to climate change - globally as well as in India.”
Adoption
Climate Budgeting is gaining popularity in recent years, thanks to increased attention being given to climate change - globally as well as in India. In India, the union government does not prepare a climate budget.
Odisha (Pioneer State)
First State to formulate a Climate Budget for fiscal year 2020-21 and has been doing it every year thereafter4. Covers 11 departments using a nuanced methodology based on Climate Change Relevance Share and Sensitivity Share.
Assam (‘Green Budget’)
Introduced its first ever ‘Green Budget’ for fiscal 2023-245, covering 14 departments and tagging schemes across vulnerable sectors and three broad domains of climate action.
Bihar (‘Green Budget’)
Presented a ‘Green Budget’ for 2021-22 and 2022-236, covering 19 departments using a linear rating scale aligned with national and state climate action plans.
While a ‘Green Budget’ and ‘Climate Budget’ are different in the true sense, their objectives and methodology intersect, since both rely on variants of the CBT methodology. Internationally, several countries have adopted Climate Budgeting including Bangladesh, Nepal, Pakistan, Indonesia, Thailand, and some African countries.
Methodology
CBT essentially involves tagging the climate-relevance of government programs, schemes, or budget lines, and determining the budget allocated towards climate, using a defined weightage system. Governments may choose to build different levels of complexity into their CBT system:
1. Categorical Tagging
Tags programs as Directly (green tag), Partially (orange/yellow tag), or Not at all (brown tag) relevant. Discloses allocations under each category (e.g., Assam Green Budget 2023-24). Presumption is to maximize green and avoid brown tags.
2. Linear Scale Rating
Rates programs/schemes on a linear numerical scale depending on their extent of alignment to national, state, and local climate action plans (e.g., Bihar Green Budget 2022-23).
3. Advanced Multidimensional
Evaluates Climate Change Relevance Share and Sensitivity Share via Impact Appraisal (e.g., Odisha). Extends to adverse climate impacts with negative weights (e.g., France).
Most governments would opt to start with a basic tagging methodology and progressively move to more sophisticated ones. Variants also exist in the breadth of coverage. Governments may decide to limit the CBT exercise to key departments considered strategically important from a climate action standpoint or extend it to the entire budget. Here again, governments are most likely to prefer to start with few departments and cover all departments over time.
For instance, the Assam Green Budget 2023-24, Bihar Green Budget 2022-23, and Odisha Climate Budget 2023-24 cover 14, 19, and 11 departments respectively. A Government may decide to introduce additional dimensions into its CBT system for a finer analysis of climate actions and budgets. For instance, the Assam Green Budget 2023-24 tags schemes to vulnerable sectors as well as three broad domains of climate action; the Odisha Climate Budget 2023-24 uses a more nuanced methodology to classify sectors based on Climate Change Relevance Share and a Climate Change Sensitivity Share determined through a Climate Change Impact Appraisal. Internationally, France is the only country to tag budgets on activities that have an adverse climate impact by assigning them negative weights.
Pre-requisites
For successfully implementing CBT, and to be able to produce climate budgets, the following enabling factors must be in place:
1. Climate budgeting mandate
This is best achieved by ensuring that the climate budget exercise is initiated in the annual budget circular7 itself.
2. CBT Guidelines
Presently, there are no CBT standards in place in India8. It is, therefore, important to develop a Guideline document that prescribes the tagging methodology, and the weightage system along with climate budget templates. This can ensure that the CBT system is uniformly followed and attempts at greenwashing are discouraged.
3. Project team
Developing the CBT system initially and producing the climate budgets for each year would require climate experts, PFM experts, and IT experts to collaborate. The government should constitute a multi-disciplinary team for this purpose, if required drawing upon external experts to plug internal capacity gaps.
4. Sensitization and training
CBT requires estimates and subjective assessments to be made on the climate impact of programs. To ensure that CBT is implemented uniformly, there is a need to sensitize officials of the Finance Department as well as line departments. Additionally, it is important to impart training to staff on procedural and documentation aspects of CBT.
5. CBT functionality in IFMIS
The IFMIS9 must be customized to enable climate-tagging of programs, schemes, and budget lines. Necessary modifications in the Chart of Accounts need to be incorporated. Climate budget reports also need to be developed. Although CBT requirements from IFMIS are not complex, the customization exercise must start in advance so that the CBT system is tested and ready for rollout during the annual budget exercise.
6. CBT must track actual expenditure as well
Restricting CBT to budget allocations only would render the entire climate budgeting exercise academic. It must extend to tagging actual expenditure incurred during budget execution. Only then it becomes a powerful climate accountability and performance monitoring tool. This is best achieved by introducing climate tags in the Chart of Accounts itself.
Where does one begin?
Governments planning to introduce climate budgeting can start by first listing all budget lines along with their allocations that are directly oriented towards furthering the state’s climate goals. This list should form part of the annual budget publication.
Compile and publish all budget lines and allocations directly oriented towards furthering state climate goals in the annual budget.
Categorize schemes based on CBT Guidelines, apply defined weights, and compile an independent climate budget document.
Full CBT rollout capturing positive and negative climate impacts, integrated into Chart of Accounts for budget execution tracking.
“Governments planning to introduce climate budgeting can start by first listing all budget lines along with their allocations that are directly oriented towards furthering the state’s climate goals.”
Conclusion
It pays to keep the Climate Budgeting exercise simple to begin with. More important than the sophistication of the CBT technique, and the resources devoted to the exercise, is the intention of the government to embrace Climate Budgeting and its attempt to produce a climate budget. This is where the front-runners - Assam, Bihar, and Odisha - have shown the path to other Indian states.
“With the help of climate experts and finance professionals, and necessary enhancements in the IFMIS, implementing Climate Budgeting is not difficult. Chartered Accountants (CAs) are well-positioned to help governments in embarking upon this initiative.”
With the help of climate experts and finance professionals, and necessary enhancements in the IFMIS, implementing Climate Budgeting is not difficult. Chartered Accountants (CAs) are well-positioned to help governments in embarking upon this initiative. Knowledge of PFM systems (government budgeting in particular) and IFMIS systems would be essential. The post-qualification Certificate course of ICAI on Public Finance & Government Accounting equips CAs with such knowledge. In addition, CAs would be expected to possess a reasonable understanding of climate change and climate action topics to be able to meaningfully engage with climate experts and appreciate the nuances of the CBT methodology.