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How effective is budget support in supporting policy reform? Conventional evaluation metrics demonstrate that budget support has performed as well as project financing. A review of empirical evidence and quantitative analysis at the country level indicates that supporting economic policy reform has been more effective than certain areas of public sector governance and social policy. The country context, policy dialogue, project design, analytical work and the timing of support matter for programme success. There is evidence of decreasing returns to policy lending over time. Budget support can be effective even in fragile and conflicted-affected states and helps support policy reform in times of economic crisis, when its impact may be particularly great. In the right context, budget support can be effective in putting the Paris Principles of aid effectiveness into practice. If country ownership is lacking, however, providing conditional financing generally does not lead to sustained reform.

Over the last decade, the demand for, and contribution of, budget support has been shaped by major trends in global financial architecture, and by a sequence of large adverse shocks to the global economy: food and fuel crisis (2006–7), global financial and capital markets crisis (2008–9), collapse of commodity prices (2014–15), COVID-19 pandemic (2020–22), and the Russian invasion of Ukraine in early 2022. A sharp drop in capital flows to developing countries, or a protracted sudden stop in capital flows, can and does cause widespread solvency problem in developing countries. Understanding complex capital flows, the role of the private sector, public sector, and foreign aid is important for understanding how budget support fits into the current aid architecture, and it can help to mitigate financial risks. The global financial landscape has evolved in important ways since the policy-based lending instrument was first introduced, resulting in a reduced role in some respects, but new opportunities in others that are critical to addressing constraints on growth and resilience in the face of global challenge. Despite the potential importance for mobilizing private funds for investments, guarantees issued by MDBs have remained a relatively small portion of their portfolios. Except for International Finance Corporation (IFC) and Multilateral Investment Guarantee Agency (MIGA), the share of guarantees in MDBs’ portfolios remained well below 5 per cent. Although net financial flows associated with budget support are small compared with private flows, budget support has been punching well above its weight. It plays a key role in addressing critical economic reforms and supporting structural transformation in debt-stressed and other vulnerable countries, and in facilitating implementation of important reforms that help leverage private capital. Going forward, budget support could play an even bigger and more central role in supporting low-income and fragile countries; advancing reforms during periods of crisis, including improved debt management; crowd in private capital to finance green infrastructure, through greater use of policy-based guarantees and insurance.

This chapter traces how different donors and multilateral agencies embraced and approached budget support over several different phases including the design, use, and content of conditionality as integral features of budget support as a cornerstone of a new aid architecture that emerged at the beginning of the Millennium. Through policy dialogue, predictable financing, and coordinated donor engagement, budget support was supposed to bring the donor community and government together around the country’s own measures and targets to meet the Millennium Development Goals (MDGs), especially the goal of eradicating extreme poverty. Budget support promised to increase country ownership, build country capacity, and strengthen country systems rather than use the parallel structures set up to satisfy donor requirements. Expectations also included improved donor coordination rather than aid fragmentation, the leveraging of results by scaling up funding and influencing overall government expenditure programmes, greater predictability of resource flows, and greater accountability. Budget support was expected to be more efficient and cost-effective per dollar transferred, thanks to lower transactions and preparation costs promoted by donor harmonization.

Confidence in budget support eventually turned to disenchantment following the initial years after the Paris Declaration. Despite credible evidence of its effectiveness, this shift in perception was driven by a combination of a stronger results orientation, a preference for traditional tangible ‘bricks and mortar’ projects, high-profile episodes of political repression or corruption; the erosion of the Poverty Reduction Strategy Papers (PRSPs) approach; and an overloading of budget support programmes with non-critical conditionality measures. Expectations of sharply increased aid flows turned out to be unrealistic and new donors emerged. Reshaping budget support as an instrument that retains public support would require (i) understanding recipient countries’ political economy and specific development conditions; (ii) addressing fiduciary concerns by donors; (iii) designing realistic and mutually agreed programmes focused on critical reforms that are recognizably significant and relevant to longer term development outcomes and the creation of public goods; (iv) establishing a clearer division of labour among donors; and (v) providing more realistic projections of likely development financing from domestic and international sources, including from the private sector.

Global threats such as pandemics, climate change, inequality, and conflict have made it increasingly difficult to achieve the Sustainable Development Goals. Modalities for aid need to adjust to new priorities. This volume examines the critical role of budget support in effectively responding to the new realities developing countries face, by providing fast-disbursing finance in support of critical, recipient country-owned reforms. Set against the background of a dramatically changing international financial architecture, the volume examines how budget support has evolved from its controversial past, debates over externally imposed conditionality, and unmet expectations from the 2005 Paris Declaration on Aid Effectiveness. With the global financial crisis and the Covid pandemic, and the food and fuel crisis unleashed by the Russia’s invasion of Ukraine, budget support has reemerged as a key financing instrument to support policy reforms and catalyse private capital. The volume proposes a retooling of budget support as a versatile instrument to address development challenges of the next decade.

Chapter 6 examines future challenges to budget support as a tool for development. Budget support is the main development instrument to support broad policy and institutional reform for resilience and growth. When used selectively it is a valuable tool for development assistance in a highly interdependent world facing mounting global challenges. Effectiveness depends on the quality of dialogue, broad ownership of reform, and joint problem-solving between committed partners. Evidence shows the impact of budget support through advance reform objectives, improving public services, and supporting economic performance, although not in all countries and circumstances. Continued learning about context-specific drivers remains a priority. The chapter addresses the concerns of critics and advances three priorities: 1) to provide fast-disbursing support during fiscal crises; 2) support medium-term programmes to accelerate inclusive growth in low-income and fragile countries; and 3) support the global commons against mounting risks posed by climate change, pandemics, and economic interdependence.

This study examines the relationship between public financial management (PFM), the financing of health interventions and health outcomes. Specifically, the paper econometrically tests whether the effect of PFM on under-five mortality depends on the relevance of public sector health financing. Employing OLS on a sample of 215 observations indicates that a one unit increase in PFM quality reduces the U5 mortality rate with about 14 deaths per 1,000 live births. For countries that channel at least, 75 percent of health expenditures through the government system this rate increases to 17 deaths per 1,000 child births. Results are robust to using an alternative dependent variable, adding year fixed effects, a sensitivity test where the health financing threshold is varied and a falsification test that verifies whether findings are driven by unobserved governance aspects. Furthermore, the paper provides a comparative analysis for Latin America and Caribbean (LAC), a region which remains mostly overlooked in the literature. The findings for LAC are broadly consistent with the global sample, though less pronounced and without a differential effect for countries across the financing threshold. Overall, the evidence indicates that the pursuit of universal health coverage and the progress toward related SDGs will be more costly if enabling systems are not in place.

Progress toward universal health care (UHC) in Africa will require sustained increases in public spending on health and reduced reliance on out-of-pocket financing. This article reviews trends and patterns of government spending in the East and Southern Africa regions and points out methodological challenges with interpreting data from the World Health Organization’s (WHO) Global Health Expenditure Database (GHED) and other sources. Government expenditure for health has increased for most countries, albeit at a slower rate than gross domestic product (GDP). In most countries there has been a prioritization away from health in government budgets, putting the onus on the private sector and donors to fill the gap. Donor support is important in the region but reliance on external spending is not consistent with countries’ stated ambitions of universal health coverage. A number of methodological challenges with estimating health expenditures are identified. Capturing health expenditures adequately across agencies and levels of decentralization can be challenging, and off-budget funds and arrears are evasive. Measurement error can be significant because actual expenditure information can be hard to come by and is often dated and unreliable. Furthermore, how external financing is captured will affect government health expenditure estimates. These factors have contributed to differences in expenditure estimates between the WHO GHED and country-specific public expenditure reviews and complicate interpretation. The article concludes that it is critical to strengthen national data capacity and international efforts to promote quality and consistency of data. The GHED is an invaluable resource for monitoring and benchmarking health expenditures. It is best used in combination with deep dive country expenditure assessments.