Contributions from
the Column
Focus

The EU’s performance-driven aid

There is no substitute for ownership

Reviewing conditionality

“We will not accept aid at any terms”

Relationships matter, procedures do not


07/2005 		 

EU adopts
performance-based conditionality

The European Commission promotes budget support and has radically reformed its policy on aid conditionality. Since 1999, EU support has been results-oriented, rather than linked to policy changes, as it had been previously. Europe has introduced a variable tranche in budget support, in the sense of ex post conditionality (based on performance in terms of ultimate objectives) replacing conventional ex ante conditionality (based on intermediate targets). The concept’s success will depend on reliable monitoring in the target countries.


[ By Petra Schmidt ]

There is an international consensus that development efforts must become more results-orientated and more efficient. National budgets – and supporting them from outside – figure prominently in the expert debate. The guiding notion is that funding budgets in support of sensible policies is likely to achieve more than individual projects ever will. Transferring money directly into budgets could promote policy strategies in the recipient countries, strengthen national ownership and existing administrative bodies, and reduce transaction costs.

The European Commission is one of the most important advocates of budget support – along with the World Bank, Britain and the Netherlands. EU funds for budget support have markedly risen, particularly so in cooperation with the African, Caribbean and Pacific countries (ACP) which, as former colonies of Member States, have development agreements with the EU. Disbursements more than doubled to almost ¤ 656 million from 2000 to 2004. In 2004, they amounted to almost 21 per cent of new commitments. The Commission has announced that it will further increase the volume for budget support or at least keep the figures stable.

The Commission sees budget support as a particularly promising instrument for contributing substantially to poverty reduction with scarce resources. To determine goals and reduce risks, however, the Commission wants to see four pre-conditions in place.
– There must be macroeconomic stability in the recipient country. As evidence the country must have adopted and be implementing a macroeconomic programme supported by the Bretton Woods institutions. Generally speaking, this will be linked to a loan from the International Monetary Fund’s (IMF) Poverty Reduction and Growth Facility (PRGF).
– There must be a clear political will in the partner country to reduce poverty. Implementation of a Poverty Reduction Strategy Paper (PRSP) within the framework of the debt relief initiative or a comparable strategy for poverty reduction are deemed reasonable proof.
– Sufficiently transparent, efficient and effective budget management in the recipient country is required. The Commission relies on analyses by the World Bank and the IMF when assessing budget management systems.
– The recipient country must accept that progress will increasingly be measured through performance indicators.

The first three conditions are basically the same as those taken into account by other budget support donors. They reflect the over-riding objectives, namely to contribute to macroeconomic stability and to implement poverty reduction strategies. Donor contributions are meant to correspond with national PRSPs as well as budget cycles, with the goal of helping to make national budgets core instruments of PRSP implementation. At the same time, ongoing reviews are geared towards improving the quality of budget management and building efficient management structures.

The fourth condition, in contrast, signifies a new understanding of conditionality. It shifts the focus onto how effective policy measures are. In this respect, the EU differs from other donors.


Multi-annual
donor programmes

The EU’s budget support programmes are normally designed for three years so as to make aid easier to calculate. Two requirements force the recipient countries to carry out realistic and anticipatory budgeting: PRSPs should define priorities for all essential policy areas and resource use should be guaranteed correspondingly. Multi-annual donor programmes contribute to enabling the partners to assess their fiscal options early on and to react fast in the case of undesirable developments.

EU budget support is paid out in several tranches, with a distinction made between fixed and variable tranches. Normally, one fixed and one variable tranche will be released each financial year (Fig. 1).

Fixed tranches form the basis of EU budget support. They are intended to improve the economic and financial equilibrium in the affected countries and are coordinated with the IMF. As a rule, the release of the fixed tranche is linked to the release of the IMF’s PRGF funds. It is an “all or nothing” pay-out: either the full amount originally intended is disbursed or it is deferred. There is no option to reduce the fixed tranche if, for example, difficulties show up in the implementation of the macroeconomic strategy.

The variable tranches, in turn, are meant to support policy areas such as education, health and public finance management, which the Commission believes to be particularly important for poverty reduction. The release of variable tranches depends on outcome indicators, which are defined in agreement with the recipient government. If the goals are not achieved in full, the tranches are reduced accordingly.

The new approach is a reaction to the disappointing experiences made with conventional conditionality in the context of structural adjustment.
– In the past, conditionalities were often too detailed. Generally, they were about enforcing macroeconomic measures, which hardly resulted in improving social services for the poor.
– The omnipresent pressure to disburse funds led to a high degree of leniency on the part of the donors, which undermined the credibility of conditionality.
– The “stop and go” nature of the system, in which tranches are either disbursed in full or else completely deferred, disrupted the budget process in the partner countries.
– Conventional conditionality dispended with a sufficient ownership by the host countries for the reforms, since the conditions were specified from outside. Sufficient ownership and commitment are especially essential, however, for the success of reforms. .

Against this background, the new EU approach is meant to strengthen the result-orientation of both donors and recipients. Furthermore, the idea is to ensure that the government in question has scope for policy choices, with donors taking a back seat in matters of programme implementation. National accounting systems are to be encouraged and successful policy to be rewarded, while conditionalities are supposed to be derived from the PRSPs.

In determining the particular conditions for budget support, the Commission identified four stages of Development Cooperation: input, output, outcome and impact. Indicators have been defined in a manner to make evaluation possible at the various levels.
– Input indicators measure the resources and activities which are put into the development process, such as seminars, workshops, law enactments or the amount of time spent.
– Output indicators measure what was produced with the inputs, for example, the number of schools built or teachers trained.
– Outcome indicators include the benefits enjoyed by the target group, such as school enrolment levels or the proportion of girls among schoolchildren. Alternatively, the expression “result/performance indicator” is used.
– Impact indicators describe intended effects of an intervention, for instance literacy or employment. These effects, as a rule, depend on several outcomes.

In its budget support programmes, the Commission focuses on outcome indicators (Fig.2).

Conventional conditionality focussed on the implementation of policy measures and their direct effects, but hardly resulted in better social services for the poor. It has become evident, however, that increases in health budgets or the construction of new health centres do not necessarily go along with increases in the number of patients treated. In Burkina Faso, the client numbers even decreased in spite of additional health centres.

It therefore makes sense to deal with result/outcome indicators. Furthermore, results-based conditions increase the partner countries’ autonomy by safeguarding their scope in regard to means and methods applied. Many result indicators reflect changes in the provision of social services, which can be assessed by the population. Accordingly, they also lend themselves to foster national accountability. The EU typically uses elementary school enrolment rates, vaccination levels or the percentage of births attended by skilled professionals as indicators for budget support. While impact indicators would be preferable in the sense of dealing with the overarching goals of development, they are difficult to define and their use only makes sense over the long-term. Therefore, they are rarely applied.


Determining the variable tranche

An innovative aspect of the EU approach to budget support is the gradual payments reduction when recipient countries’ performance remains unsatisfactory. Generally, the situation in the partner countries is neither completely satisfying nor completely disappointing. The Commission has changed from a binary (“yes/no”) allocation system to a continuous (“more or less”) system. The idea is to assess sectors in a more differentiated manner and to set specific incentives next.

Allocations are calculated as follows. First, a certain share of the tranche is assigned to each indicator. If the expected objective is achieved, this partial amount is paid out in full. If there has been progress but not, however, as much as expected, only half of it is paid. If the results are unsatisfactory, the money is withheld (Fig. 3). Each indicator thus contributes to determining the total amount of the variable tranche that is to be disbursed.

There is no point in trying to make a conclusive assessment of how well this approach works before having gained several years of experience. Many programmes along these lines are still in their early stages. Nevertheless, some results are already emerging clearly. An analysis of 30 budget support programmes launched since 2000 revealed the following:
– There is a clear trend towards long-term programmes. All budget support programmes of 2004 cover three years.
– The model of combining fixed and variable tranches has caught on. For the first time, all budget support proposals included fixed and variable tranches in 2003. In that year, almost 50% of the funds were part of the variable “performance premium”.
– There is scope to further develop the performance-driven ex post conditionality. So far, the introduction of such elements in the variable tranche does not mean that all indicators used are indeed result-based. The transition to performance-related conditionality is most obvious in the education sector. 73.4 per cent of the education indicators applied relate to outcomes. In contrast, output indicators still prevail for assessing public budgets. Only two per cent of the conditions for this sector are result-oriented. Nonetheless, it is unlikely that input indicators will be completely abandoned – nor is it recommendable. There are, after all, difficulties in defining outcome-indicators in budget matters.
– Linking pay-outs to performance in a gradual disbursement scheme has proved worthwhile. It has been possible to determine balanced objectives, which neither place excessive demands on the capacity of the partner countries, nor leave them unchallenged. On average, 71 per cent of the maximum variable amount has been disbursed so far. Initial experience shows that the variable tranches contribute to making partners more results-oriented.
– Generally speaking, budget support does not convincingly relate to PRSPs yet. Currently, EU conditions are not coordinated well with national objects. An important reason is that it is difficult to define useful PRSP-indicators.


Conclusion

In spite of slight divergences of concept and implementation, which ought to be further reduced, the following points emerge as crucial for the success of EU budget support programmes:
– The Commission’s performance-oriented concept of budget support needs the basis of sound data and indicators for evaluating the progress made in the fight against poverty and the provision of social services. Even after two or three years of implementing the PRSPs, the monitoring systems in many countries are still being developed. Specific efforts should be made to ensure meaningful PRSP monitoring, for instance with the assistance of the statistics departments of ministries and administrative bodies. Only reliable monitoring ensures systematic identification of weaknesses and makes it possible to consistently align budget support with partners’ programmes.
– Donor coordination still poses a challenge in the context of budget support, even though there has been noticeable progress. This is particularly true for conditions set by various donors. Initial experience proves that the Commission is ready to dispense with its own claims in favour of a more harmonised procedure. Nevertheless, with its result-oriented conditionality, the EU is pursuing a new approach which is not applied by all donors. It is essential to avoid excessive transaction costs for the recipient countries and to coordinate the conditionalities, for example, by integrating the various concepts into a joint policy matrix.




Petra Schmidt
is a staff researcher at the German Development Institute in Bonn. Her study “Budgethilfe in der
Entwicklungszusammenarbeit der EU” (“Budget support in EU development cooperation”) will be published this year in the institute’s “DIE studies” series.
petra.schmidt@die-gdi.de