# **1. Introduction**

Some of the financing mechanisms suggested or anticipated as part of a future climate policy framework (mitigation and adaptation) are likely to lead to substantial net financial inflows to many low-income countries (LICs). First and foremost, this concerns financial transfer schemes related to international agreements on mitigation policy (involving either cap-and-trade or taxation schemes). International transfers may also be generated in response to a need for adaptation to climate change in lower-income countries, or to support energy-sector developments in such countries. The estimates of “necessary” _additional_ financing to meet low-income countries’ needs for adaptation expenditures, costs of mitigation, and energy technology transfers and development, are today highly uncertain, but could easily exceed the current level of Official Development Assistance (ODA), which is about US$100 billion annually. As more specific regional examples that illustrate the possible magnitude of these increased financial flows, calculations made by the IMF indicate that an aggressive global carbon trading scheme, were it instituted and implemented with a set of population-based emissions rights, could easily lead to a financial inflow of up to 10 percent of GDP for Sub-Saharan Africa, and up to 5 percent for India, from around 2020 on.<sup>1</sup> When mitigation in LICs would instead be based on greenhouse gas (GHG) emissions offset programs, lower-income countries are also likely to experience net additional financial inflows, although most likely of smaller magnitudes.

Some part of these additional funds will flow to the public sector, and some part to private-sector recipients. The distribution of flows by these two main categories is likely to depend on type of flow by financing purpose (whether it is related to mitigation, energy development, or adaptation). Any eventual distribution among public- and private-sector recipients is today unclear, but some likely basic principles can be identified. A high flow to the public sector is most likely under aggressive mitigation policies implemented by emissions taxes or cap-and-trade (c-a-t) schemes with widespread quota auctioning to emitters, and population-based distribution of international entitlements to emit GHGs. Under c-a-t with free entitlements, widespread use of offset markets, and widespread reliance on support to private-sector energy sector developments, more of the revenue is likely to flow to the private sector.

Such increased net inflows will create additional policy opportunities for low-income countries, but also challenges. Increased attention to a number of public management issues may be required, for the additional revenue to be put to its best use, and to prevent that disruptions and obstacles are caused to other aspects of the economy. The purpose of this paper is to discuss some of these effects, from a macroeconomic as well as microeconomics/incentives perspective.

The paper raises, and analyzes, a number of related economic and political economy factors.

First, as already stressed, it may matter whether disbursements flow to the _private or to the public sector_ . For some effects (perhaps including exchange rate/interest rate effects) it may matter little whether the private or public sector is the primary beneficiary. For other effects (fiscal space, earmarking, rent seeking and corruption) it may matter much more.

Secondly, the _time frame for scaling-up of financial flows, and the consistency over time of the scaling-up_ are likely to matter. Scaling-up may be problematic if executed quickly, but easier if phased in gradually over time. Very variable flows may also be problematic.

The financing mechanism may impact on these effects. It may matter whether international funds are disbursed as aid, as loans, or as foreign direct investment by outside private-sector parties. It may also matter whether financing is generated in response to a specific need or purpose (say, to finance specific energy-sector or adaptation projects); as part of a particular GHG emissions financing scheme

> 1 See IMF (2008a).

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