This chapter highlights key challenges and progress made to better use, redirect and mobilise further public and private financing to support environmentally sustainable and socially inclusive development in Eastern Europe, the Caucasus and Central Asia (EECCA) countries. It discusses how energy and fossil-fuel subsidies can be reformed to support green growth and address social implications of subsidy reforms in the region. It also highlights approaches to make public financial management more supportive of a green economy transition, including the use of environmental funds. Finally, it discusses recent developments in some EECCA countries on making domestic financial systems consistent with the Paris Agreement and the Sustainable Development Goals.
Green Economy Transition in Eastern Europe, the Caucasus and Central Asia
5. A focus on finance for green growth in EECCA
Abstract
Finance is a crucial enabler for implementing action on a green economy transition in the Eastern Europe, the Caucasus and Central Asia (EECCA) countries1. Some EECCA countries increasingly recognise the scale of investment needs for their green economy transition, and have the technical understanding to estimate them. There has been an increasing awareness of the importance of better using scarce public funding to mobilise private-sector investments to support green growth in the countries over the past decade. In recent years, several EECCA countries have been advancing their policy agenda on finance mobilisation for green economic growth using private, public, domestic and international sources.
Despite the progress, several key barriers still exist to scaling up investments in green economy transition. These comprise large up-front costs of such investments, prohibitive cost of capital, unconducive policy environments for finance mobilisation and difficulties in accessing international financing.
This chapter focuses on financing issues on which the OECD and the EECCA countries have collaborated over the past two decades. It highlights several issues from fossil-fuel subsidy reform, public financial management and catalysation of private-sector investment.
Reforming fossil-fuel subsidies to promote transition towards a green economy in EECCA countries
Phasing out fossil-fuel subsidies is a key policy instrument to tackle climate change, reduce pollution and contribute to long-term energy security in the EECCA region and beyond. Subsidies for fossil-fuel production and consumption distort costs and prices, leading to inefficiencies in the economy. This also often hinders investments in e.g. energy efficiency and renewable energy development. Such subsidies also increase fossil-fuel use, resulting in higher levels of greenhouse gas (GHG) emissions, air pollution and related health problems. These can inflict a high cost on society.
The governments of EECCA countries have historically used fossil-fuel subsidies to advance development by addressing “market failures” (OECD, 2021[1]; IEA, 2021[2]). These policy objectives include rural development and poverty alleviation, promotion of particular industries, and greater energy access, energy security and independence. These issues can be, unsurprisingly, politically sensitive. In Kazakhstan, for example, the government’s drastic cut of subsidies for liquefied petroleum gas and the resulting price hike for consumers triggered the largest protest since the country’s independence (Watters, 2022[3]).
Obtaining robust evidence to support reforms of fossil-fuel subsidies is an essential building block of energy transition policies but remains a challenge in the region. Under the GREEN Action Task Force, the OECD prepared an inventory of energy subsidies in Armenia, Azerbaijan, Belarus, Georgia, the Republic of Moldova (hereafter “Moldova”) and Ukraine in 2018 – the first comprehensive and consistent record of energy subsidies in the region (OECD, 2018[4]). The study has provided enhanced transparency and a solid analytical basis that can help build the case for energy subsidy reforms in the Eastern Europe and the Caucasus countries. In 2021, the OECD conducted a new round of analysis entitled “Fossil-Fuel Subsidies in the EU’s Eastern Partner Countries: Estimates and Recent Policy Developments” as part of the “European Union for Environment” programme (OECD, 2021[1]). These reports provide a clear overview of multiple types of fossil-fuel subsidies provided over the past decade in the Eastern Europe and Caucasus countries. Such subsidies include direct transfers of funds to producers and consumers of fossil fuels; and tax expenditure and other government revenue forgone.
It is worth noting that the data from these analyses are now available in the OECD database on government support to fossil-fuel production and consumption (https://www.oecd.org/fossil-fuels/data/). The inclusion of the Eastern Europe and Caucasus countries in this database is an important milestone in increasing transparency and improving disclosure of information on government support allocated to the energy sector in this region.
Key findings and data on fossil fuel subsidies in EECCA
Fossil-fuel subsidies in the Eastern Europe and Caucasus markedly fluctuated during the period 2010-2020 but in general remained at the same level in 2020 as in 2010 (Figure 5.1). The COVID-19 crisis made the Eastern Europe and Caucasus countries painfully aware of the need to mobilise significant additional funds to support their health systems and economies. Despite reduced economic activity and low energy prices in 2019 and 2020, total government support to producers and consumers of fossil fuels in the Eastern Europe and Caucasus region increased by more than 6% from 2019 to 2020.
Figure 5.1. Quantified fossil-fuel subsidies in the countries of Eastern Europe and the Caucasus (USD million)
Note: Inventory records tax expenditures as estimates of revenue that is forgone due to a particular feature of the tax system that reduces or postpones tax relative to a jurisdiction’s benchmark tax system, to the benefit of fossil fuels. Hence, tax expenditure estimates could increase either because of greater concessions, relative to the benchmark tax treatment, or because of an increase in the benchmark itself. In addition, international comparison of tax expenditures could be misleading, due to country-specific benchmark tax treatments.
Source: OECD Fossil-Fuel Subsidies database, www.oecd.org/fossil-fuels/data/.
The levels of fossil-fuel subsidies also vary markedly across the Eastern Europe and Caucasus countries (Figure 5.2). On a per capita basis, in 2020, with about USD 104, Azerbaijan had the highest subsidies. Ukraine followed at USD 83. Armenia had the lowest support levels of USD 4 per capita in the same year. At the sector level, more than 80% of total support was allocated to natural gas and electricity. Natural gas dominates the energy mix in the Eastern Europe and Caucasus countries and is the main fuel used in generating electricity and heat in the region. Most subsidy measures supported the residential sector in 2020 followed by support to the electricity generation sector. It is notable that Armenia and Moldova provided no support to producers (or importers in the case of Armenia) of fossil fuels.
Figure 5.2. Per capita fossil-fuel subsidies in Eastern European and the Caucasus countries (USD per capita, 2020)
Source: OECD and IISD (n.d.) https://fossilfuelsubsidytracker.org/.
Fossil-fuel subsidies loomed large compared with the COVID-19 recovery packages put in place by the governments in the Eastern Europe and Caucasus region. As presented in chapter 2, rescue and recovery spending in these countries totalled about USD 5 billion in 2020 and 2021.2 Of this amount, longer-term recovery support amounted to USD 1.72 billion. Of the USD 1.72 billion, only USD 0.11 billion is estimated to have a positive environmental impact, while USD 0.84 billion was spent on measures estimated to have a mixed or negative impact on the environment.
In comparison, USD 3.2 billion of subsidies was allocated to support producers and consumers of fossil fuels in the Eastern Europe and Caucasus countries in 2020. With return to economic growth and rising energy prices in the international markets, the International Energy Agency, in its World Energy Outlook 2021, expects that consumer fossil-fuel subsidies may more than double in the coming years (Figure 5.3).
Figure 5.3. Recovery packages (2020-21) vs. fossil-fuel subsidies (2020) in Eastern Europe and the Caucasus countries (USD billion)
Source: (OECD, 2021[5]).
Policy recommendations
Reforming fossil-fuel subsidies and government support is a key policy measure to tackle climate change, reduce pollution and contribute to long-term energy security in the EECCA region. The countries could benefit from further efforts to rationalise energy and fossil fuel subsidies. Possible actions could include the following recommendations:
Embrace a holistic approach to reform of fossil-fuel subsidies:
The governments in the region should build on reforms to date but need to design further reforms more holistically. The reform has to be well designed and its short- and longer-term consequences need to be clearly understood. Experience from many countries shows that targeted support measures (e.g. to vulnerable households) deliver better results and ensure better energy affordability than untargeted subsidies applicable to all. Transparency and stakeholder dialogue are the cornerstone of subsidy reforms.
Review recovery measures put in place in response to COVID-19:
In response to the crisis, governments needed to mobilise significant additional funds to support their health systems and economies. The Eastern Europe and Caucasus governments reacted quickly and sought to protect their citizens and businesses by putting in place crucial rescue and recovery packages.
An OECD analysis shows that most such measures in the energy sector are largely concentrated in the end-use electricity sector. This is where countries and utilities have made commitments to avoid hardship during the crisis (OECD, 2021[1]).
o In order to avoid introducing new subsidy schemes or even turning them into a long-term structural feature of the economy, and with growth starting to recover, the countries should review their COVID-related short-term support arrangements (late fee interest suspensions, additional assistance with bills or bans on disconnecting customers in arrears) and decide if they are still necessary.
Undertake further study on “induced transfers”:
To complete the fossil-fuel subsidy picture, more analysis should be carried out on induced transfers, i.e. regulations that mandate fossil-fuel companies to sell their products to certain categories of consumers (e.g. vulnerable households) at below-market prices.
Improve reporting and transparency:
Improving the transparency and credibility of data on fossil-fuel subsidies, including on tax expenditure in the energy sector, can help decision makers and the public at large design better reforms. Such work can create significant value if undertaken by countries on their own.
Draw on this analysis for international reporting obligations:
The Eastern Europe and Caucasus countries report on fossil-fuel subsidies within the frameworks of the United Nations Sustainable Development Goals (SDGs) and the World Trade Organization. They may wish to consider using data and estimates in this OECD analysis as a starting point for such reporting obligations.
Enhancing public financial management for green finance mobilisation in EECCA
A crucial role for public financial management in promoting green economy transition
Development finance institutions and the private sector are expected to contribute a significant amount of financing to promoting businesses and investment in support of a green economy transition in EECCA countries. Yet, public finance still continues to play a critical role in providing the right incentive framework to stimulate increased demand for investments in support of climate and environmental action in the region. Although scarce, public finance can leverage significant external and private funds. In so doing, it can contribute to the achievement of priority policy objectives on climate, environment and broader development agendas in the region, if used in a cost-effective, transparent and inclusive manner.
There has been growing interest in green budgeting across the world. For instance, at the One Planet Summit in December 2017, the OECD launched the Paris Collaborative on Green Budgeting (OECD, 2017[6]). This initiative works with governments, institutions and experts to embed climate and other environmental goals within national budgeting frameworks. It aims to design effective tools to assess and drive improvements in the alignment of national expenditure and revenue processes with climate and other environmental goals.
OECD work on environment-related public financial management in the EECCA region dates to the mid-2000s. The OECD has developed a number of policy tools to help governments manage their environmental subsidy programmes in a cost-effective way and in line with good international practices. Among the tools is the Handbook for Appraisal of Environmental Projects Financed from Public Funds developed under the EaP Task Force3 (the predecessor of the GREEN Action Task Force) (OECD, 2007[7]). The Appraisal Handbook was based on the Recommendation of the OECD Council on Good Practices for Public Environmental Expenditure Management (PEEM) (OECD, 2006[8]).
The Good Practices for PEEM provide guidance on how to design and implement public environmental expenditure, or subsidy, programmes. These good practices can also be used to evaluate the performance of Environmental Funds in terms of environmental effectiveness, management efficiency, fiscal prudence, transparency and accountability. The Appraisal Handbook complements the Good Practices for PEEM and provides a step-by-step approach to implementing the good practices in real life (OECD, 2007[7]). The OECD also worked on green budgeting and on the integration of public environmental investment programmes into medium-term budgeting processes. This work was largely prompted by new approaches to budgeting adopted by the EECCA countries (including medium-term expenditure frameworks), as well as new approaches to aid delivery by international partners (via national country systems and sectoral and general budget support).
Progress on, and remaining challenges to, developing and financing public investments towards a green economy
Many EECCA countries began introducing medium-term budgeting processes more than a decade ago, which also involve ministries of environment (OECD, 2011[9]). Most of the countries have extensive experience with preparing strategies and policies, as well as actual programmes to support environmental protection and resource management. These interventions, however, were often not properly costed or supported by specific implementation measures, such as financing strategies, market studies or feasibility analysis. Analytical tools, such as costing or cost-benefit and cost-effectiveness evaluation models, were rarely used in the programming process (OECD, 2011[9]). Public investment programmes lacked clear and measurable environmental targets and benefits; performance indicators are not consistent across the years of programme implementation.
To fill these gaps, the OECD has moved a step further in its public finance work. The OECD has assisted the governments of Kazakhstan, Kyrgyz Republic (hereafter “Kyrgyzstan”) and Moldova to design green public transport investment programmes in line with the OECD Council Recommendations on Good Practices (OECD, 2019[10]). As part of these projects, the OECD designed a model that supports the financial analysis of public investment programmes and their development. This model, Optimising Public Transport Investment Costs (OPTIC), allows calculation and optimisation of total programme costs, for both the public financier and private sector investors (see Box 5.1). The model also helps calculate the optimal level of the subsidy and the air pollution and GHG emission reductions that can be achieved through programme implementation. The model is an Excel-based analytical tool that can help the decision-making process become more objective and more transparent. Most recently, the model has been further calibrated to allow to calculate investments needs and design a public investment programme for biodegradable waste management in Georgia, and an investment programme for the water supply sector in Azerbaijan.
Further, credible statistical information on environment-related financial flows is an important basis to plan for, and monitor progress on, public financing for the countries’ transition to a green economy. Kazakhstan and the OECD worked together to further improve the coverage, granularity and quality of statistical information on environment-related financial flows from the national budget and the private sector. The study examined how Kazakhstan’s national statistical system works and how it can be further improved to better measure and understand financial flows that contribute to a green economy transition (OECD, 2020[11]). This work has led to some amendments in Kazakhstan’s statistical forms for investment expenditures and costs of environmental protection. These changes aim to improve granularity of green finance related information to be reported and provide decision-makers with a better understanding of how public finances are spent.
Box 5.1. Good practice example: Designing and implementing green public investment programmes – experience from Poland and the Czech Republic
Since 2012, the OECD has supported countries from the EECCA region in the areas of energy efficiency of the housing sector (Kazakhstan), clean urban public transport (Kazakhstan, Kyrgyzstan and Moldova), biodegradable waste management (Georgia), or water supply sector (Azerbaijan).
The OECD provided technical assistance and capacity building to public authorities in designing and costing green public investment programmes. It also supported complementary activities and requirements needed to launch the implementation of the programme.
One example of such capacity development component under the greening public expenditure work stream were four webinars organised to support designing and implementing green public investment programmes in partner countries in the region. The webinars were organised by the OECD and aimed to:
share knowledge, experience, and approaches in managing similar expenditure programmes and green public investments in general in the EU countries
support the initial stages of the OECD co-operation with the governments of Azerbaijan and Georgia with regard to designing and costing green public expenditure programmes
help Moldova launch the designed green public investment programme targeted at more environment-friendly urban public transport based on the previous work
The first two webinars focused on implementation structures for the programmes and presented experience from the Czech Republic and Poland using environmental funds (February 2021) as well as alternative schemes that are applied in Austria, Switzerland, and the Netherlands (June 2021).
The next two webinars focused on the substantial part of the programmes, i.e., the focus sectors. Experts from Denmark, Italy and the international bioenergy sector presented ways of utilising biodegradable residues for energy purposes (December 2021) and specialists from Austria, Romania and Slovakia conveyed best practices on increasing water supply and wastewater treatment in rural and remote areas in their countries (January 2022).
For more information, see www.eu4environment.org
Increased interest in dedicated public funds for climate and environmental action in EECCA
Environmental policy makers in many EECCA countries have recently expressed renewed interest in public funds to support investments that contribute to the countries’ green economy transition (OECD, 2019[12]). Such funds, or “Environmental Funds”, are generally capitalised by national budgets (and often financing from development co-operation partners). Hence, the debate on these funds can also be framed in the broader context of green public financial management. Environmentally responsive, or green, budgeting means using the tools of budgetary policy making to help achieve the country’s environmental goals.
While Environmental Funds were already common in the EECCA region more than 30 years ago, they have transformed. Due to pressures to improve the efficiency and transparency of public finance systems, some EECCA countries closed down their extra-budgetary (including environmental) funds starting in the early 2000s. The revenues of these funds were consolidated into countries’ state budgets (in Kazakhstan in 2000, in Belarus in 2011 and in Ukraine in 2014).4 The consolidation of traditional Environmental Funds into state budgets has been ongoing. In countries where such Funds still exist, environmental authorities may find it more and more difficult to justify the need to maintain them. Reforming such Funds in line with good international practices may be one direction to go.
At the same time, new financing sources emerged and replaced the Funds, including funding from development finance institutions (DFIs). This is often blended with domestic financial resources, or DFI-supported lending products extended through domestic commercial banks [see for example OECD (2016[13])].
Comparison between “traditional” and “new” Environmental Funds in EECCA
“Traditional” extra-budgetary Environmental Funds were first established in the late 1980s in all former Soviet Union Republics except Armenia, Georgia and Tajikistan.5 “Traditional” Funds have three characteristics. First, they manage earmarked public resources for environmental improvements. Second, they capitalise mostly by the revenue generated by pollution charges and fines. Third, they finance a broad range of environmental protection activities (water, waste, air, biodiversity).
Several EECCA countries continue to maintain their traditional Environmental Funds. These include Azerbaijan, Kyrgyzstan, Moldova and Uzbekistan. These Funds have all been converted from extra-budgetary into national budgets. Their revenues are internally (within the budget) earmarked for environmental activities managed by the Funds. Kyrgyzstan and Uzbekistan have established Environmental Funds both at national and subnational levels, while Moldova closed its subnational-level Environmental Funds in 2017.6
Alongside these “traditional” Environmental Funds, new types of public funds for climate and environmental action have emerged in EECCA countries. Many of the new public funds in the region target investments in energy efficiency and renewable energy. While there is no universally agreed definition of such funds, an OECD document prepared for the 2019 GREEN Action Task Force annual meeting calls them “Specialised Clean Energy Funds” (OECD, 2019[12]). These include, for example, the Renewable Resources and Energy Efficiency Fund in Armenia (established in 2005), the Georgian Energy Development Fund (2010) and the Energy Efficiency Fund in Ukraine (2018) (OECD, 2019[12]).
All these Funds are state-owned and were established through an initial equity injection from the state. Their main source of revenue is also the state budget, but their sources are not linked to the pollution charge system. Instead, the Funds receive budget allocations based on their spending plans. In addition, international DFIs have provided these Funds with received significant finance for investment projects and technical support over the years.
Another important feature that distinguishes these Specialised Clean Energy Funds from the “traditional” ones is their focused mandate and spending strategy. While “traditional” Environmental Funds generally financed projects across all environmental issues, these new Specialised Funds support investments in one or two main sectors, namely renewable energy and energy efficiency. Table 5.1 provides a general typology and evolution of “traditional” and “new and specialised” Environmental Funds provided in OECD (2019[12]).
Emerging good practice in using Specialised Clean Energy Funds in EECCA
These public funds, both “traditional” and “specialised”, have been evolving into a mechanism to support environmental and climate-related projects in many EECCA countries. Table 5.1 and the underlying study (OECD, 2019[12]) also demonstrate the diversity of institutional arrangements that governments use to manage their public environmental spending. The study underscores there is no “one-size-fits-all” solution. Depending on the economic context, the maturity of finance markets and capacities in the countries, each government selects the institutional set-up of its fund, and financial instruments that suit it best.
The recently established new Specialised Clean Energy Funds are usually much better capitalised, better focused and better governed than “traditional” Environment Funds. They also use more sophisticated financial products and can support bigger investments (OECD, 2019[12]). Support from DFIs, both financial and through technical assistance, may have played a role in this better performance.
Institutionally, these new Funds are considerably different from traditional ones. The new funds represent a new model that seems to be better adapted to market needs and more in line with maturing financial markets in some EECCA countries. (OECD, 2019[12]). Box 5.2 provides an overview of three Specialised Clean Energy Funds in Armenia, Georgia and Ukraine. They have a number of different features from the “traditional” Environmental Funds. Apart from being sector-specific with targeted mandates, these Funds have a wider range of revenue sources and relatively high disposable revenues. They also have a clear governance structure and professional staff that work on the day-to-day project cycle management. The Armenian and Ukrainian Funds have also greatly benefited from external development finance, both financially and in terms of capacity building and other types of technical assistance.
Moldova, Ukraine and the OECD have also collaborated under the GREEN Action Task Force to promote the reform of some of their national funds. The work includes reviewing and strengthening domestic public finance mechanisms that can finance green investments and providing support to setting up new ones. This has led to the development of a new operational manual for the National Ecological Fund in Moldova (now renamed National Environmental Fund) to streamline and guide operations. In addition, assistance to adjust the legal base of the fund has led to significant changes to how it functions and is administered, laying the foundations for further reforms. In Ukraine, support has been provided around the feasibility of establishing a new environmental funding entity and to reviewing the landscape of environmental taxes and expenditure.
Box 5.2. Good practice example: Specialised Clean Energy Funds in Armenia, Georgia and Ukraine
Of the three funds in Armenia, Georgia and Ukraine, the Armenian Renewable Resources and Energy Efficiency Fund is the oldest; it has been in operation since 2005. The Georgian Energy Development Fund, established in 2010, promotes investments in renewable energy. The Energy Efficiency Fund of Ukraine, which started operations in 2018, launched its first Call for Projects in mid-2019. An overview of their key features is provided below; further details can be found in OECD (2019[12]).
Armenia’s Renewable Resources and Energy Efficiency Fund
The Armenian Renewable Resources and Energy Efficiency Fund is an independent legal entity with its own governance structure, professional staff and balance sheet. The Fund is governed by a Board of Trustees, which consists of 11 members appointed for two years. Board members are representatives of different government bodies and civil society organisations.
The government of Armenia provided initial equity (approximately AMD 22.4 million/USD 46 000) to the Fund. Its main revenue sources are budget allocations, grants from bilateral and multilateral development partners, financial income, income from different services (energy audit, consulting, energy service company) and project implementation fees. On average, over 2017 to 2019, the Fund’s budget has varied between USD 400 000-500 000 per year.
The Fund supports renewable energy and energy efficiency projects in vulnerable rural communities, social entities, public buildings and innovation fields. Over the past five years, the lion’s share of the Fund’s support, approximately USD 10 million, has gone to energy efficiency projects in public buildings (kindergartens, schools, hospitals). The Fund uses a wide variety of financial instruments to disburse its resources. These include grants, interest rate subsidies on bank loans that families with three or more children have borrowed on the financial market, soft loans to domestic commercial banks and communities and factoring, to name a few. This is an interesting combination of disbursement mechanisms that requires strong in-house capacity. The Fund works closely with four domestic partner banks in the private sector.
Georgian Energy Development Fund
The Georgian Energy Development Fund (GEDF) is a joint stock company set up in 2010 by the government of Georgia through a Government Decree and an Order of the Minister of Economy and Sustainable Development. It mainly supports development of the renewable energy market in Georgia, including investments in hydro, wind and solar energy.
The GEDF functions as a project developer, project promoter, service provider (e.g. engineering consultancy for project scoping, obtaining necessary permits and licences) and project manager. Its staff members carry out extensive research and analysis; identify project opportunities; conduct project pre-feasibility assessment and environmental impact assessment; design projects; look for investors to co-finance projects and raise funding for project implementation; organise public tenders; and manage projects for which funding has been ensured.
The GEDF often enters into partnership with investors (international financial institutions and/or private financial entities) with which the Fund establishes Joint Ventures (Special Purpose Vehicles). The Fund also functions as a public equity fund. The GEDF provides up to 30% equity on an investment project. In addition, it is supposed to always have an exit strategy and can leave the project at various stages of its development. This arrangement allows the Fund to maintain its resource base and function as a revolving Fund as well.
Ukraine’s Energy Efficiency Fund
The Energy Efficiency (EE) Fund emerged from the concept of “Turning Subsidies into Investments” developed by the Ministry of Regional Development, Construction, Housing and Communal Services with support by Germany and the European Union. It sought to provide significant support to investments in energy efficiency in residential buildings as a way of reducing households’ electricity and heat consumption bills. These bills have increased significantly over the past years, leading more and more households turning to the state for support. Improved energy efficiency will lead to lower bills. This, in turn, will help reduce inefficient energy-related social subsidies provided by the state budget. Saved budgetary resources will instead be allocated to a Fund that will manage this revenue stream.
After several years of preparation, a Law on the EE Fund adopted by Parliament in 2018 established the EE Fund. According to its Charter, the Fund is governed by a Supervisory Board of two representatives of the Cabinet of Ministers, two independent members and one representative of donors. The national government provided an initial equity to the Fund and its Charter capital amounts to about EUR 58 million.
The Fund aims to support thermal modernisation, installation of highly efficient heating and cooling systems and equipment, as well as the replacement of existing systems with more efficient ones. It was designed to provide grants only and will work closely with selected private-sector and state-owned banks. The Fund will reimburse a certain amount of the cost of energy efficiency investments for which project owners have obtained loans from partnering banks.
Although the Fund’s operations are at an early stage, the legal and institutional set up is well-designed to ensure its operational integrity, political independence and transparency of the use of its resources. This new funding mechanism shows that Ukraine has recognised that its energy sovereignty depends on significant energy efficiency improvements.
Policy recommendations
EECCA countries could benefit from further efforts to enhance public financial management in support of their transition to a green economy. Possible actions include enhancement and better use of budget-related information, inter-ministerial co-operation, and promotion of green stimulus measures for post-COVID recovery, as highlighted below:
Improve the statistical system to measure public (and possibly private) finance flows directed to environmental protection, resource management and climate action, as well as environmentally harmful subsidies such as fossil-fuel subsidies
EECCA countries’ efforts in this direction could build on existing methodologies such as the System of Environmental-Economic Accounts, the European standard statistical Classification of Environmental Protection Activities and Green Growth Indicators.
Use enhanced information on green finance for more granular policy analysis
More precise, comprehensive and timely measurement of green finance within the budget cycle could help individual EECCA countries promote policy discussion on green economy transition on various fronts.
This would include identifying sectors, sub-sectors or geographical areas where gaps between investment needs and spending are particularly large; providing an evidence base for discussion of factors that promote or inhibit green finance mobilisation; assessing effectiveness of policy or financial interventions; and developing and adopting a variety of financial instruments for green economy transition.
Deepen co-operation among ministries and agencies within each EECCA country
Greater co-operation between the finance ministry and other sectoral ministries and agencies is also of utmost importance. Enhanced collaboration could allow for a greater level of data availability and quality, such as on foreign direct investment directed to activities that can promote the country’s green economy transition.
Enhance capacity to prepare public investment programmes properly costed or supported by specific implementation measures, such as financing strategies, market studies or feasibility analysis
Analytical tools, such as costing or cost-benefit and cost-effectiveness evaluation models, could be a good basis for such public investment programming. The OPTIC model could also help EECCA countries calculate and optimise total programme costs and estimate the fiscal impact and economic implications of such programmes on financial sustainability.
Use scarce public resources to demonstrate the need for public support in meeting national environmental and climate-related goals and priorities
Fiscal support could directly mitigate perceived or potential risks associated with environmental and climate-related activities. This, in turn, could help EECCA countries leverage private-sector investments in such activities. In so doing, efforts to “green” public financial management should also be in line with maturing financial markets in some EECCA countries.
Public financial management could also support governments to manage and reform their environmental subsidy programmes in a cost-effective way and in line with good international practices.
Promote green stimulus measures for post-COVID recovery and addressing socio-economic challenges caused by Russia’s war against Ukraine
Such work could aim at, for instance, improving enabling policy frameworks and public financial support for capacity development for scaling up investment in renewable energy, low-emission transport, energy efficiency and Nature-based solutions for climate action and biodiversity conservation. Many of them could also simultaneously aim to boost employment rates and wider social and ecological benefits and to phase out ageing and polluting means of production.
Catalysing private-sector finance for green economy transition in EECCA
The importance of the private sector for scaling up investments in green economy transition
The achievement of national targets on climate change and wider green growth agendas in EECCA countries requires massive investment from a diverse set of sources, including the private sector. The governments in the EECCA region and their development co-operation partners have provided a considerable amount of funding to climate- and environment-related projects over the past decade (OECD, 2022[14]). Public funding alone, however, would not be sufficient to cover the countries’ financial needs to achieve their climate and environmental goals in the coming decades (EU4Environment, 2021[15]; OECD, 2020[11]; OECD, 2019[16]).
Deeper and more stable banking and financial sectors can greatly contribute to economic growth in the EECCA region (AFI, 2018[17]; EIB, 2012[18]). Domestic financial systems in EECCA countries have been growing steadily over the past years. In general, however, the financial systems of many EECCA countries remain more vulnerable to external shocks than many other regions (IMFBlog, 2022[19]). Access to low-cost, long-term capital remains a major barrier to mobilising finance, including for climate- and environment-related projects. Businesses with financial needs still face relatively high lending interest rates. These ranged from 11.6% in Armenia to 23.55% in Kyrgyzstan in 2019-20 (World Bank, 2022[20]). Borrowers also often face challenges of short repayment periods and high collateral requirements (OECD, 2019[16]; EaP GREEN Programme, 2018[21]; OECD, 2021[22]).
In recent years, EECCA countries such as Armenia, Georgia, Kazakhstan, Kyrgyzstan, Ukraine and Uzbekistan have begun to align their policy directions on financial-sector development with national goals on green economy transition and climate action. The role of finance and economic ministries, central banks and financial regulators in promoting sustainable finance are increasingly recognised (NGFS, 2022[23]). A number of local commercial banks, non-bank financial institutions and associations of financial institutions across the region have joined the effort.
Initiatives in catalysing the private sector investment are increasing in EECCA courtiers
Some EECCA countries have made progress on developing a national roadmap, policy framework and voluntary principles on sustainable finance as part of their development strategies. In Kyrgyzstan, a sustainable finance roadmap forms an integral part of the Green Economy Development Programme. The programme, adopted in 2019, sets out plans for the country’s transition towards a green economy (IFC, 2019[24]). The roadmap was developed by the Ministry of Economy and the OECD through the UN Partnership for Action on Green Economy. They collaborated with the central bank, sectoral ministries and the Union of Banks of Kyrgyzstan, as well as with other development co-operation partners (Government of the Kyrgyz Republic, 2019[25]; IFC, 2019[24]).
The role of central banks in EECCA countries has also been elevated in some EECCA countries. This is encouraging given their crucial responsibility for developing financial sectors and supervising related regulations. The National Bank of Georgia (NBG), for example, adopted its sustainable finance framework that includes the Roadmap for Sustainable Finance in Georgia to outline all the planned and implemented actions under this framework (NBG, n.d.[26]) (see also Figure 5.4). The NBG developed the Environment, Social and Governance (ESG) Reporting and Disclosure Principles with a corresponding template in collaboration with the OECD under the GREEN Action Task Force. It also started publishing the annual Sustainable Finance Report, while developing a Sustainable Finance Taxonomy and the analysis of vulnerabilities to climate risks in the financial sector (NBG and NGFS, 2022[27]).
Figure 5.4. National Bank of Georgia Sustainable Finance Framework
While capital markets in EECCA countries are not yet contributing significantly to financing green investments, green bonds show signs of becoming an asset class in their own right. Kazakhstan was the first country in the EECCA region to issue a green bond, but Armenia, Georgia and Ukraine soon followed. Between the second half of 2020 and early 2022, eight green bonds were issued in the region, two in each of the four countries. This amounted to approximately USD 2 billion in total (OECD, forthcoming[28]). The OECD is conducting a regional study on green bonds in Eastern Europe and the Caucasus countries and Kazakhstan. The study aims to assess the role that EECCA bond markets can realistically play in financing long-term green investments and helping countries achieve their climate-related targets (OECD, forthcoming[28]). Uzbekistan also issued, in collaboration with the United Nations Development Programme and the Citibank Group, the SDG Bond to finance the country’s efforts to achieve the SDGs. The vast majority of projects focus almost exclusively on social development (e.g. construction of schools, hospitals), the SDG bonds also support some water supply and sanitation projects.
Green bonds have begun to gain traction in the region as a complement to bank financing (OECD, forthcoming[28]). The regulations and the market infrastructure supporting the expansion of the local capital markets are being developed and improved to support issuers and investors. However, this issuance is still limited, only nascent and takes part in the corporate sector, with rather little engagement by governments. As evidenced by the experience of other countries, sovereign green bond issuance can send the right signals to market participants and can foster the transformation of bond markets to finance the green transition.
A number of dedicated credit lines have been introduced to support green investment by businesses across the EECCA region over the past decade. However, many still find it challenging to access such green credit lines (EaP GREEN Programme, 2018[21]; OECD, 2019[16]). In the region, small and medium-sized enterprises (SMEs) contribute to most employment and gross value added. Hence, greening SMEs would contribute significantly to making EECCA countries’ economic development both inclusive and environmentally sustainable. A key challenge is the market gap in terms of green credit for SMEs. Many banks providing dedicated green credit lines tend to serve larger customers. Moreover, loan sizes are often more than what an SME might need (e.g. loans larger than EUR 500 000). Demand-side issues have also constrained progress in building a market for green finance for SMEs. The challenges include SMEs’ weak financial literacy, poor record keeping, insufficient business planning and lack of awareness of the economic benefits of green investments (OECD, 2019[16]).
A gap in knowledge among (potential) users about the pros and cons of green investment, and their insufficient understanding on how to access and use banking services, hinder households and businesses from taking out green loans. The OECD conducted a household survey in co-operation with the Union of Banks to provide evidence on this gap (OECD, 2021[22]). It also helped the National Bank of the Kyrgyz Republic further understand the current situations on households’ access to, and use of, green finance in the country. The survey also revealed other barriers to scaling up private-sector finance for actions for green economy. These include lack of bank accounts, lack of information on banking products and insufficient information on the purpose of green financial products (OECD, 2021[22]):
30% of households had taken out a loan or credit to finance one or several activities with a climate mitigation or adaptation purpose in the past five years.
40% did not know whether they had taken out a loan or credit to finance any of these activities, which points to a lack of understanding of green finance.
70% did not know whether they were interested in doing so in the near future.
Use of formal financial services in general was low (more than 80% of respondents did not have a bank account).
There is an emerging use of risk mitigation financial instruments in the EECCA region. Armenia, for example, has developed agricultural insurance in recent years to bring more stable earnings for small farmers and improve their credit standing (KfW Development Bank, 2019[29]). This, in turn, can enable small farmers to invest in their farms through loans to improve their productivity, while better preparing them against external shocks such as droughts and floods (KfW Development Bank, 2019[29]). A mix of domestic funding from the Ministry of Agriculture and finance by bilateral and multilateral institutions (KfW and the Climate Investment Fund) subsidises insurance payments up to 50-60%. The insurance was designed to cover, for instance, fruit orchards and vineyards against hail, fire and spring frost (Badalian, 2019[30]).
Policy recommendations
Policy makers in the governments and financial regulators of EECCA countries can support private-sector actors in further scaling up green finance in many ways, as highlighted below. It is nevertheless important to get the basics right: adopting and reforming relevant environmental and climate legislation (e.g. on energy efficiency and renewable energy) and strengthening their enforcement, ratcheting environmental standards and reducing fossil-fuel subsidies to create market signals.
Elevate the role of central banks and other financial regulators in the EECCA region in ensuring financial sector policies, regulations and guidance are aligned with the country’s national objectives on sustainable development.
Clearer definitions of “green” activities through developing a taxonomy, principles on ESG disclosure, technical assistance for staff of financial institutions in assessing, monitoring and reporting ESG-related risks could provide a basis for advancing policy alignment. Good practices and lessons are already available from the experiences of, for instance, the National Bank of Georgia, the Central Bank of Armenia and the Astana International Financial Centre (AIFC Green Finance Centre, n.d.[31]; SBFN, n.d.[32]) (See also Box 5.3).
Improve access to green financial instruments and services while advancing further efforts to increase use of formal financial instruments:
A functioning financial market where households and businesses actively use financial products and services is in many ways a precondition for introducing elements of green finance.
A comprehensive regulatory and financial framework that promotes financial inclusion, social inclusion and green finance will help implement mutually reinforcing policy actions; create synergies between economic, social and environmental goals; and achieve progress faster (OECD, 2021[22]).
Assess and address broader policy issues to enable access by businesses and households to finance for green action:
Financial regulators of many EECCA countries are responding to higher inflation by raising interest rates. They should, however, continue to work towards a wider range of issues on access to finance for businesses in support of a long-term green economy transition.
Approaches may include strengthening financial literacy, especially among small businesses and households, exploring credit guarantees for lending specifically to activities in support of green economy transition (e.g. energy efficiency and renewable energy), and promoting non-bank financing (e.g. green leasing). Limiting the social impact of higher prices of energy on the most vulnerable would be essential. The European Commission’s proposal for a Social Climate Fund could provide an inspiration for initiatives to help the poorer segment of society without undermining governments’ commitments to reduce GHG emissions [See further information on (European Union, 2021[33]).].
Strengthen awareness raising and capacity development for (potential) users of sustainable finance:
Further insight on the demand side of finance would help governments and financial regulators develop policies to accelerate the up-scaling of private sector financing for green economy transition in the EECCA region. A greater understanding of, for instance, the needs of individuals, households, entrepreneurs and businesses for financial solutions would support the transition to a green and inclusive economy (OECD, 2021[22]).
Support development of dedicated in-house capacity within private-sector financial institutions.
Georgian commercial banks have already been working on various green finance products. They have dedicated significant internal resources to developing and promoting energy efficiency and renewable energy lending products on the Georgian market. This has included building capacity in loan appraisal (e.g. the incorporation of energy savings into cash-flow and payback analysis). It has also included renewable energy product finance; marketing; training for branch staff in promoting products; and environmental reporting (e.g. energy savings, GHG emission calculations) (OECD, 2019[16]).
Use public financial resources for green investments more efficiently and strengthen capacity of public authorities to manage green public expenditure in line with good international practices.
Since existing resources in the public sector allocated for green investments are scarce, they should be used with greater efficiency, transparency and accountability. In order to improve the efficiency of the use of public funding, EECCA governments could make use of the existing OECD toolbox for managing public environmental expenditure (e.g. Good Practices for PEEM, Handbook for Appraisal of Environmental Projects Financed from Public Funds, methodology for designing and costing green public investment programmes). These tools can also be used to reform existing public finance institutions that manage resources for green investments (e.g. Environmental Funds or other similar entities) or to establish new ones. The need for, and the performance of, such institutions should be regularly reviewed by the governments in order to ensure that they meet the high standards of public finance.
Public funding should also be better used to create demand and leverage private domestic and international funds for green investments but also optimise the subsidy support provided to the private sector. The development of public investment programmes and the use of de-risking instruments (e.g. public seed capital, tax credits, insurance) can help incentivise the private sector to use its own resources and invest in green projects. EECCA governments can also use public resources to work with the banking sector (e.g. loan guarantees, currency and interest rate subsidies, collateral support) to ensure access to long-term debt finance at an affordable cost for the enterprise sector. Using scarce public resources to create demand and leverage significant private funds for green investments remains
Box 5.3. Good practice example: Network of Central Banks and Supervisors for Greening the Financial System
As a global initiative, the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) provides a forum for members to develop frameworks for financial policies and regulations in support of assessing climate risks. The focus of NGFS is diverse, including micro-supervision, integration of sustainability and climate risks into monetary policy frameworks, and endorsement of mandatory disclosure, among others. Membership includes the Central Bank of Armenia, the National Bank of Georgia and the National Bank of Ukraine from the EECCA region. The Sustainable Banking Network is another community of financial sector regulators and banking associations from emerging markets committed to work on sustainable finance, including for climate resilience.
Source: Network of Central Banks and Supervisors for Greening the Financial System: Membership www.ngfs.net/en/about-us/membership.
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Notes
← 1. EECCA countries include Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Republic of Moldova, Tajikistan, Turkmenistan, Ukraine and Uzbekistan.
← 2. Data until end of October 2021.
← 3. The EAP Task Force: The Task Force for the Implementation of the Environmental Action Programme of Central and Eastern Europe.
← 4. Until 2014, Ukraine had a national (special budget) Environmental Protection Fund and numerous regional/local Environmental Protection Funds managed by local authorities. In 2014, the National Fund was closed down while the local Funds continue to exist. The resources previously allocated to the National Fund are now split between the local Funds and the general state budget.
← 5. Similar Environmental Funds were also established in several Central European countries, many of which are now members of the European Union. These include, among others, the Czech State Environmental Protection Fund, Estonian Environmental Fund, Polish National Fund for Environmental Protection and Water Management, Slovenian Environmental Development Fund.
← 6. Azerbaijan seems to have a national-level Fund only. However, the public information is not sufficient to state this with certainty.