The relevance and application of this analysis to increased climate-related financial flows depends on a number of factors. One is the permanence of the flow scale-up. A study by the IMF (see Box 1 below) indicates that most of the low-income African countries covered by this study are very careful about scaling up spending when financial inflows (ODA) are scaled up, in particular when it is not clear that the increase is permanent. This main conclusion was supported in more recent IMF studies. The first is by the Independent Evaluation Office (2007), which found that programmed absorption and spending in Sub-Saharan African countries, with Poverty Reduction and Growth Facility programs sponsored by the IMF, is generally low. The second is by Aiyar and Ruthbah (2008), who found that absorption and spending in Sub-Saharan African countries (with our without a PGRF program) is low in the short run, but somewhat greater in the longer run. Thirdly, Farah et al (2009), studying possible scaled-up aid (from 10 to 15 percent of GDP) to Niger, find that such scale-up appears to be easily manageable and will lead to an acceleration of growth (thus leaving GDP at a level 12.5 percent higher by 2020).

A further factor is that when a large fraction of increased inflows benefits the private sector in the first instance (as is typical for FDI), only the “absorption” (and not the spending) issue is relevant, and perhaps even this not fully as FDI can lead to subsequent counteracting profit expatriation to the investing countries later. Finally, when increased aid or funding is given in kind, as directly imported goods or investments, the “absorption” issue need not be a concern.

A more recent IMF study, Berndt et al (2008), provides additional data on the absorption and spending issues, studying aid disbursement under the IMF-sponsored “Poverty Reduction and Growth Facility” (PRGF) program. They find a generally stronger tendency for low-income countries to absorb and spend additional aid, with tentative long-run absorption and spending ratios of between 0.6 and 0.9. This is however a long-run effect, in the sense that absorption and spending of additional external income is smoothened so as to minimize the negative effects of non-reliable disbursement. This paper also finds that the degrees of absorption and spending do not depend on whether the country in question has a PRGF program or not.

# **3.3 The need for “fiscal space”**

The discussion above has focused on traditional macroeconomic factors, basically assuming that the country in question is in a “normal” situation, with no pressing short-term “needs”. One possible “need”, to be sure, could be a precarious financial or debt situation for the government which may constrain it in international financial markets or in its ability to attract direct foreign investment (FDI). Indeed, we pointed to such needs as one main reason why the standard option of spending-absorbing was not followed by many countries, in particular in the cited IMF study. Another possible “need”, however, is related to “fiscal space”. In its broadest sense, fiscal space can be defined as “the availability of budgetary room that allows a government to provide resources for a desired purpose without any prejudice to the sustainability of a government’s financial position”.<sup>10</sup> In the context of increased financial flows as discussed here, the main idea is that such flows, in particular if they flow to governments (directly, or indirectly e g via increased tax revenue), may create additional “fiscal space” which makes it possible for the government to fulfill fiscal spending targets that would otherwise be difficult to fulfill. In particular, aiming to fulfill the Millennium Development Goals implies that a number of spending targets, otherwise out of reach for the respective governments, may need to be fulfilled. Some of these goals (such as those related to child mortality and infectious diseases) relate to immediate, short-term, spending; others (including educational and environmental sustainability goals) to longer-run spending issues.

A key question here is whether additional, climate-related, financial flows create additional fiscal space for governments. One here again needs to understand that increased international financial inflows imply, essentially, that the _international_ buying power of the respective economy is

> 10 See Heller (2005b), page 3.

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