Last week the European Commission (EC) set out its ‘future approach to EU budget support to third countries’. This was the product of a year-long consultation process and will eventually shape policy with Council Conclusions.

As one of the biggest providers of budget support, any policy changes by the EC will not only affect the budget support landscape but may also drive changes in many of its Member States. The EC has been a great champion of budget support, but some States are increasingly critical about the merits of budget support and want to see a greater results focus.

There are many laudable features of the EC’s new approach. These are not particularly contentious and involve either reinstating commitment for current action or implementing new activities where a considerable consensus already exists. 

1. The Communication reconfirms the EC’s commitment to the aid effectiveness principles, such as support to government owned development strategies, predictability of funding, increased transparency and accountability, and a greater results focus. Transparency and oversight of the budget has been introduced as a fourth eligibility criteria (the others relate to macro-economic stability, public financial management and national and sector policies). This reflects DFID’s additional partnership commitment concerning strengthening domestic accountability, which includes transparency of the budget. A more coordinated donor approach is advocated, with the proposal of a single EU development contract, and the Communication recognises that budget support is not just a ‘blank cheque’ but a package of support (financial transfer, performance assessment and capacity-building based on a partnership approach) necessary to ensure that systems are strengthened and money is spent efficiently and effectively.
2. It will allow flexibility, by continuing to apply dynamic criteria to eligibility and refraining from establishing global targets for EU budget support. The latter can be seen through two lenses: flexibility to allow for the development of an optimal portfolio of aid instruments that reflect country needs rather than specific instrument requirements, versus the loss of a credible commitment to prioritise budget support (the EC has dropped its commitment to provide 50% of its government-to-government assistance through country systems) and the incentives that lock in.
3. The EC will strengthen its risk management framework for EU budget support, in response to calls from the Court of Auditors and parts of the development community that are increasingly aware that risks have often been inadequately measured, managed or mitigated in budget support operations to-date.
4. The Communication responds to growing concerns about establishing appropriate exit strategies, by explicitly building in a stronger focus on domestic resource mobilisation (including from natural resources).  It will continue to support the strengthening of technocratic governance, such as public financial management and administration – including the fight against corruption and fraud, macroeconomic stability and fiscal sustainability, the conditions for growth and development of a ‘green economy’.

However there are two significant changes that have considerable implications for the EC’s future approach to budget support – the first could be a real ‘game changer’ and the second simply a ‘name changer’.   

First, the EC proposes that budget support becomes a political instrument – ‘The new approach should strengthen the contractual partnership ... between the EU and partner countries in order to build and consolidate democracies, pursue sustainable economic growth and eradicate poverty’. This is the first time that western models of political governance have become an explicit objective of EU budget support and included in general policy guidance. Although historically budget support has been vulnerable to deterioration in political relations, with many examples of disbursements being withheld for such reasons, this formalisation of political conditionality is new.

It’s not difficult to see where the momentum for this reform has come from. Donors seem to be increasingly sensitive to the reputational risk of giving budget support to countries that don’t appear to mirror what the EC defines as fundamental principles – democracy, human rights and rule of law. This is illustrated by Andris Piebalg’s comments at a recent Oxfam/ODI event, and positive responses from Member States about tying EU budget support to fundamental principles.

Many may welcome this as a positive step forward. Yet, there are several reasons governments should be cautious about approving such an approach:

1. Budget support already serves many purposes and this overburdening has hindered performance to date. Adding another overarching aim will undoubtedly spread the instrument even more thinly.
2. Analysis of the EC’s Governance Incentive Tranche illustrates that political governance conditionality is unlikely to be more effective than policy conditionality, and, if anything could demonstrate the contrary. Unless conditions are mutually agreed by both the recipient government and donor(s) (as well as amongst themselves), conditionality will do little to facilitate performance; so, will budget support really be able to drive political reform?
3. How will deviations from good performance be measured? Donors differ in how they define and categorise governance, so if the benefits of greater EU donor coordination (as laid out in the Communication) are to be realised, an agreed set of principles as well as examples of deviations from them will need to be agreed in advance. Positively, the EC proposes to set up senior regional teams to navigate these complex terrains.
4. Do we know that adhering to fundamental principles will in fact facilitate greater improvements in growth and poverty? Historically there are only a few cases where democracy clearly preceded growth. What is the credible theory of change that underlies this shift? 

Second, as with DFID, the EC will change the name of their budget support instruments to better reflect their objectives. General Budget Support will become ‘Good Governance and Development Contracts’ – promoting human rights and democratic values, improving domestic resource mobilisation, and improving financial management, macroeconomic stability, inclusive growth and the fight against corruption and fraud. Sector budget support will become ‘Sector Reform Contracts’, and support to fragile states, small island developing states and overseas countries and territories will be coined ‘State Building Contracts’. The term ‘budget support’ will be no more. According to the Communication this will ‘enable greater differentiation of budget support operations, allowing the EU to respond better to the political, economic and social context of the partner country’. Yet, put crudely, the EC has moved from two budget support instruments to three, and introduced additional conditions to one of them. It is difficult to see how this equals greater differentiation.

For the first time EU budget support operations will be formally tied to political governance processes. Yet, it remains to be seen whether this approach will sufficiently shield donors from perceived reputational risks – a force that appears to be driving this change – whilst at the same time support the underserved. This can be better achieved if the EC formally implements a portfolio-based approach, with the flexibility to adapt aid modalities to reflect changes in risk.  The building blocks for this approach already exist, e.g. ‘Sector Reform Contracts’ can be used even where the political governance conditions do not permit the use of ‘Good Governance and Development Contracts’, so, to a degree, the former can be protected from deteriorations in political governance. In order for this portfolio approach to work effectively, guidance is needed at the portfolio level not just the instrument level. In addition, it is likely that a greater differentiation of budget support operations will be needed, and the EC’s new risk management framework for EU budget support should explicitly lay out which instruments will be affected by performance changes associated with different risks.

Arguably, another preferable solution would be to unbundle reputation issues from development assistance, so that deterioration of political governance would not affect the provision of aid in the short run. However, is this really ‘sellable’ to Member States?

For further information on the latest thinking on budget support please see ODI’s expert meeting series on budget support (March to October 2011).