B U S I N E S S

Financing environmental protection

Despite the fact that the EU promised to allocate $60 million for investment in environmental projects in Central and Eastern Europe, the message from the Sofia conference was crystal clear: Central and Eastern Europeans are going to have to dig deep into their own pockets to pay the growing price of environmental protection.

And the price tag is enormous. The EBRD estimates it will cost upwards of $80 billion for the Visegrad countries alone to harmonize the performance of industry and municipal infrastructure with the EU. While foreign governments and international financial institutions have been helping cover these costs with loans and grants, the frequency of Western handouts is sure to fall.

That leaves CEE governments with the less-than-pleasant task of finding the funds themselves. Of course, governments alone cannot shoulder the burden, nor should they: Industry, and ultimately the consumer, is going to have to bear the lion's share of the cost of cleaning up. What governments in the Region can do is provide a stable political and economic climate that will encourage foreign and domestic investment in profitable environment-related projects. Here are some of the mechanisms, outside of national budgets, governments are using to finance environmental protection in Central and Eastern Europe.

Grants

These are subsidies used to finance certain aspects of a project. They have an important leveraging effect, encouraging recipients and other co-financiers to commit further resources. Grants have low administrative costs and can be used for projects that are not financially viable, like cleaning up a hazardous waste site that is contaminating groundwater. They are the primary financing mechanism used during the early stages of transition, but will eventually disappear.

Loans

Loans are the most important financing instrument for CEE environmental investment. Unfortunately, the banking sector in CEE is underdeveloped and undercapitalized, making domestic banks hesitant to assume medium- or long-term risk. In the long term the domestic banking system must be willing to provide project financing if environmental improvements are to be realized. At the moment, international financing institutions (IFIs) provide the bulk of long-term, low-risk financing, often offered on more attractive terms than loans available from the commercial banking sector for countries in transition. Loans are demand-driven and applications must meet established banking criteria, but at present they only cover a small percentage of CEE countries' required environmental expenditures.

Interest rate subsidies

Also known as "soft" financing, this mechanism allows projects which are not financially viable to borrow domestically at a lower-than-prime interest rate. Subsidized loans combine the effects of a "regular" loan with a grant that covers a portion of the interest. The closer to financial viability a project is, the lower the level of subsidy. A good mechanism for use in CEE countries in transition because soft loans develop fiscal discipline and a good credit-rating for the borrower.

Environmental equity funds

Investors put money into a fund which then invests in companies without a specific claim for direct repayment; over time, the value of these companies increases, providing investors with a significant return on their original investment. For use with financially viable and revenue-generating projects only. Unfortunately, many environmental projects don't fall into this category.

However, the recent announcement of two such schemes in the Region has proven that investor confidence in CEE environmental projects is increasing. EBRD, NEFCO and the three Baltic countries have joined forces to develop a Baltic Green Equity scheme provisionally budgeted at ECU 20 million. EBRD is also involved in a "green" venture capital fund that will invest capital in companies undertaking environment-related projects in the Visegrad countries and the Baltics. These funds will encourage other sources to provide private equity, grants and loans to companies working on environmental projects.

Debt-for-environment swaps

BULGARIA AND SWITZERLAND consummate their debt-for-environment swap, signed at the Sofia "Environment for Europe" Conference, with a champagne toast.


Debtor countries trade a reduction in their external debt burden against a commitment to spend the local-currency equivalent on environmental protection activities. This is a good way to solve two problems at once: reducing external debt and generating expenditures for high-priority environmental problems in recipient countries. Unfortunately, because of the significant fiscal considerations, most CEE countries don't meet the criteria for such arrangements. To date, only two countries have made use of swaps: Bulgaria just signed an agreement with Switzerland worth SF 20 million ($17.5 million); in 1991, Poland embarked on a deal with Paris Club creditors that has since generated almost half a billion dollars in environmental expenditures. Swaps are good ideas, but they are not long-term solutions.

Environmental funds

Revenues collected from green taxes and pollution charges are amalgamated into national environmental protection funds and then redistributed as grants and loans to finance activities with environmental objectives. Several CEE countries have such funds, which should support the development of the most sustainable and effective form of financing: the market-based mechanisms which feed them.

Market-based tools

Market-based tools, such as green taxes, and pollution and product charges, internalize the cost of environmental protection, making the issue of "how to pay" irrelevant: We all will. Some CEE countries, especially the Visegrad Four, already use these instruments. Based on the polluter-pays-principle, they are far more progressive than the command and control mechanisms we see in the West. After all, it is the market, and not governments and IFIs, that will eventually have to pick up the tab for maintaining a clean and healthy environment.

This article is based on a report prepared by the UN Economic Council of Europe Working Group of Senior Government Officials, the group responsible for preparing the recent Sofia conference.

THE BULLETIN * AUTUMN 1995