REC - Sofia Initiatives: Economic Instruments: Green Budget 1: Financing Environmental Protection

EAP TASK FORCE AT OECD: Financing Environmental Protection in CEE and NIS

by Patrick Francis, Environmental Finance Programme Manager, EAP Task Force

As more and more information about the environmental degradation in CEE and NIS countries has emerged in recent years, the need for greater, and more effective, environmental investment in the regions has been more fully appreciated. The "Environmental Action Programme for Central and Eastern Europe" (EAP), endorsed by the 1993 European Environment Ministers' Conference in Lucerne, identifies environmental investments as one of three key priorities (along with policy reform and institutional strengthening) for improving environmental protection in CEE and NIS countries. At the Lucerne Conference, Ministers also established two institutions to support implementation of the EAP: the EAP Task Force and the Project Preparation Committee (PPC). The Task Force Secretariat supports government efforts in the areas of policy reform and institutional strengthening (see Box 1 below), while the PPC (to be featured in a future newsletter article) facilitates the preparation and implementation of environmental investments by improving coordination between donors, international financial institutions and the CEE/NIS countries. The 1995 European Environment Ministers' Conference held in Sofia re-affirmed and amplified the importance of enhanced financing for environmental protection activities in the regions. In response to the challenge, local and national governments have initiated a wide range of actions to expand and make more effective use of domestic environmental financing sources, while many bilateral and multilateral organizations are also engaged in supporting CEE and NIS efforts in this area.

Box 1: Focal Points of the EAP Task Force: Environmental Funds and National Environmental Financing Strategies
Efforts to improve environmental financing in the CEE and NIS countries increasingly focus on maximizing the effective and efficient use of domestically generated resources, rather than the overall supply of resources, (whether domestic or foreign). This emphasis is reflected in the environmental financing component of the EAP Task Force's work program, which includes activities focused on strengthening the operations of environmental funds and the development of a pilot national environmental financing strategy.
Environmental funds are quasi-independent or independent institutions, having been created by the initiative of Ministries of Environment for the purposes of providing additional, ear-marked finance for the support of environmental protection activities. Such funds exist, or are in the process of being formed, in most countries of the regions. The funds typically receive revenues from pollution charges and fines, environmental taxes, product charges and other fees on the use of natural resources and the environment. The funds then use this money to support environmentally beneficial activities, such as investments in pollution control and prevention technology, environmental education, and the establishment of environmental monitoring systems. The financial support provided by the funds is disbursed in various forms, most commonly as grants and soft loans. The EAP Task Force is supporting the strengthening of the funds through the Environmental Funds Network, which it initiated with meetings in 1996 (in Vienna for CEE funds and Almaty for NIS funds). The Network's basic objectives are: to support the dynamic evolution of funds as environmental policy and financing mechanisms in the transition to market-based economies; to help the funds develop and employ tools and procedures enabling more effective and efficient financing of environmental protection activities; to strengthen the management and other human resource capacities of the funds, and; to facilitate dialogue and cooperation between the funds and with donors and international financial institutions. The Task Force's work with CEE funds is being supported by the EU Phare program.
The Task Force has also initiated a pilot study to develop a National Environmental Financing Strategy in cooperation with the Lithuanian Ministry of Environment. The strategy will assess the "demand" and "supply" of financing for priority environmental problems in the country and offer concrete suggestions for policy and institutional reforms over the next 3-5 years. The strategy is intended to assist officials in the Ministry of Environment, other ministries, parliament and other relevant institutions involved in decisions concerning environmental protection and financing. The experience gained from preparing the Lithuanian strategy will enable the EAP Task Force to refine and disseminate a methodology which could be used in subsequent work on environmental finance planning in other countries in the region.

Obstacles to Environmental Financing

Domestic and international efforts to strengthen environmental financing in CEE and NIS countries face a number of serious obstacles, many of which are related to the profound economic, political and social changes presently taking place in the regions. While significant progress has been made in recent years in many countries, the regions' economies remain "in transition" and the financing conditions and mechanisms typical of more mature market economies are still emerging. At the same time, many traditional sources of financing for environmental protection, particularly State budgets, have dwindled or disappeared entirely, while governments are having difficulties in raising new taxes. Decentralization has also created problems for local governments which are increasingly responsible for maintaining and initiating major investments in public services, such as water and waste management, but who often lack the skills and expertise necessary to finance such projects. Local governments are also sometimes prevented from generating the needed financing because of legal and other barriers. The private sector has also felt the pinch. The advent of privatization, "hard" budgets, price liberalization, increased domestic and international competition, and the high price of capital on the commercial markets has induced a strong preference for allocating money to investments which yield immediate profits (not typical of many environmental projects) and an aversion to projects involving net costs or only long-term profits (typical of many environmental projects). The budgets of many households are also under strain, especially as they are increasingly obliged to pay the full costs of many goods and services which were previously subsidized by the State, or simply not provided at all."

Sources of Environmental Financing

In most (if not all) CEE and NIS countries, domestic sources provide the lion's share of financing spent for environmental protection activities. Foreign and international sources generally play a limited, though important role by catalyzing environmental investments and leveraging additional resources for projects, many of which are of special significance because of the human health benefits they yield or demonstration effect they have. The main sources of domestic financing tend to be the central state budgets, the private resources of enterprises and extra-budgetary environmental funds. The significance of the roles being played by these different institutions, however, is changing. As a result of severe fiscal constraints and decentralization, the role of the state budget in environmental financing has decreased in some of the countries since 1990. This trend is expected to continue, though the state budget is likely to remain an important source of environmental financing in some countries, particularly among the NIS, for much of the transition period. With a decline in the role of the state budget, the share of environmental expenditures contributed by local governments and environmental funds (national and sub-national) has increased, and is increasing, in some countries. The role of polluting enterprises in environmental expenditures should also increase as the "polluter pays principle" becomes more fully adopted and implemented in the regions.

Emerging Mechanisms for Financing Environmental Protection

The economies and financing systems of CEE and NIS countries are evolving and so too are the opportunities for them to finance environmental protection activities. Countries which have progressed the furthest in economic transition are beginning to make greater use of financing mechanisms commonly used in western countries for the support of environmental investments, such as loans, bonds, equity investments, public-private partnerships and user fees. While significant obstacles and reluctance still remain, the commercial banking sectors of some countries are becoming more active in the environmental sector by offering loans for commercially viable projects. Municipal bonds have been issued by some cities to finance environmental services. Early steps are being taken with the use of "green" equity to generate financing for environmentally beneficial investments at the enterprise and municipal level. Various types of public-private partnerships, including "build-operate-transfer" schemes are being explored to finance projects. Increasingly, polluter/user fees are being levied to finance environmental protection activities and they underpin many of the public sector investments in this sector. In many cases, however, the "ability to pay" for environmental protection in CEE and NIS countries during the transition period is exceeded by the financing needs. Therefore, for some sorts of projects, and in some countries, subsidized financing from institutions such as the central governments, environmental funds, bilateral donors or international development banks will remain necessary.

Aarhus and Beyond

At the 1998 European Environment Ministers' Conference in Aarhus, the results of work undertaken by institutions such as the Task Force and the PPC will be reviewed, and further needs in the area of environmental financing assessed. The financing needs of the 10 countries preparing for accession to the European Union will increasingly be driven by strategies for compliance with EU environmental directives. In the NIS, there will be a continuing need for strengthening environmental policies and institutions in order to better mobilize and direct scarce financial resources. The continued implementation of investment projects in the NIS should also provide much needed momentum to ongoing environmental protection efforts in the region.

Acknowledgment: This article appeared first in the Newsletter Environment for Europe No.2, October 1997, issued by the Aarhus Conference Secretariat. The article is reproduced with the permission of the author.
For further information on the EAP Task Forces work on environmental financing contact Patrick Francis, EAP Task Force at OECD, Tel.: +33-1-45241385, Fax: +33-1-45249671, e-mail: Patrick.Francis@oecd.org.

REC * PROGRAMS * SOFIA INITIATIVES * ECONOMIC INSTRUMENTS * GREEN BUDGET * NOV. 17, 1997