UK’s budget juggling trick with rainforest loan for bus-fare cap needs transparency

Andy Burnham, the UK’s latest prime minister, has suggested reducing the amount the British government gives as climate finance grants and providing some of its climate finance through loans instead, in a move it anticipates will save £400 million. 

The government plans to use the savings to fund a cap on bus fares in the UK, triggering accusations from the development sector that Burnham’s proposal “throws Global South countries under the bus”. One likely destination for these new loans is the Tropical Forest Forever Facility (TFFF). 

Andy Burnham, the UK’s latest prime minister, has suggested reducing the amount the British government gives as climate finance grants and providing some of its climate finance through loans instead, in a move it anticipates will save £400 million. 

The government plans to use the savings to fund a cap on bus fares in the UK, triggering accusations from the development sector that Burnham’s proposal “throws Global South countries under the bus”. One likely destination for these new loans is the Tropical Forest Forever Facility (TFFF). 

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The TFFF is a new initiative designed to provide payments to countries that protect their rainforests by raising money from governments and private investors, channeling that money into riskier and therefore higher return assets, and using the returns it earns to fund forest protection. But there is a catch. 

The UK has committed to provide around £6 billion in climate finance funded through aid (or official development assistance, ODA) over the next three years. If switching from grants to a loan to the TFFF reduces government spending, it will likely reduce the amount that counts as ODA as well. 

In other words, the government can make the £400 million saving, or meet its £6 billion aid budget-funded climate finance commitment, but it probably cannot do both. The UK cannot have its cake and eat it.

How will it score as ODA?

Whether any loan to the TFFF scores as ODA depends on the OECD’s Development Assistance Committee (DAC) which is currently deliberating on this topic. 

A plain reading of the DAC’s current reporting rules suggests that the TFFF would count as a multilateral organisation: the independent investment arm, the Tropical Forest Investment Fund, would ultimately be a global, official entity (with sovereign governments appointing the board and being sole equity holders), which pools capital from sponsor governments. This would mean that to count as ODA, any loan to it would have to charge less than 5% interest. 

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The current concept note suggests a return for sponsor capital equivalent to US borrowing costs of a similar duration: currently around 5.2%, which would make any such loans ineligible. The UK could choose to charge less, but if the UK charges less than it borrows (also above 5%), the difference will add to the deficit in future years. And ODA accounting is not binary: if the UK charges just under 5%, only a small fraction of the loan would count.

At the same time, the risk profile of TFFF is not the same as your average multilateral, and there is speculation that the DAC could allow higher interest loans to TFFF to partially count (by changing the ‘discount rate’ used to measure how concessional the loan is). The TFFF’s own modelling suggests that the risk of the UK losing money on the loan would be fairly limited: roughly a 1% chance of some capital impairment in the riskiest scenario. But some analysts doubt the accuracy of this model and view the risk as much greater.

Would it really save money?

If the risk really is higher, then it might justify counting more ODA on a loan to the TFFF, but it also undermines the arguments that this would create savings for the government. Loans generally don’t count towards the deficit because they create an asset. But that only works if the loan is expected to be fully repaid. If there is a material risk of losing money, then at least some of the transaction will also count towards the deficit. 

One possibility is that the loan will be ‘partitioned’ into a financial asset (the part which is expected to be repaid and wouldn’t count towards the deficit) and a ‘capital transfer’ (the part not expected to be repaid). The greater the risk, the larger that second component, and the bigger the impact on the deficit.

This would be the ODA and public accounting rules working as intended. ODA is a measure of ‘donor effort’, usually taken to mean fiscal impact. If it counts as ODA, it should have an impact on the deficit. And the fiscal treatment itself is governed by numerous international accounting standards, a key purpose of which is preventing politically motivated obfuscation of how governments spend their money. If it costs money, there should be an impact on the deficit even if it is a loan. If it doesn’t, it shouldn’t count as ODA (even if there have been exceptions in the past).

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We still know too little about the details to be sure how a loan to the TFFF (or a more exotic transaction) would count towards either ODA or the UK’s headline measures of debt and deficit. The key parameter for each is risk: the lower risk, the more likely it is that the transaction will save money, but the greater the chance that the government would have to spend more ODA elsewhere to meet its climate finance target. 

If the UK believes in the TFFF business model and wants to preserve tropical forests, then it should invest. But this decision should not be driven by optimistic accounting tricks. The government cannot expect to reduce the real value of climate finance to partner countries by giving less in grant money, without this having an impact on commitments to spend that money.