Baltic 21 Series No 10/98
Financing the Baltic 21 - An Overview
The publication of this report in the Baltic 21 Series does not imply an endorsement of the report by the Senior Officials Group. The responsibility for the contents and opinions expressed in this report lies solely with the authors.
FOREWORD
The mandate to develop an Agenda 21 for the Baltic Sea Region, with the objective of Sustainable Development, stems from the Heads of Government of the region and the meeting of Ministers for Foreign Affairs of the Baltic Sea Region, within the framework of the Council of the Baltic Sea States, including the European Union. Because of this, Baltic 21 comprises all Nordic countries and all other countries around the Baltic Sea, as well as the northwestern part of the Russian Federation. The European Union is also a participant in the elaboration of Baltic 21.
Baltic 21 was officially launched by the Ministers of Environment in October 1996 in Saltsjöbaden and the Saltsjöbaden Declaration provides the terms of reference for the Baltic 21 set-up and process. In their back-to-back meeting, the Ministers responsible for spatial planning in the Baltic Sea Region also decided to concentrate work on sustainable development, and in particular to integrate relevant activities with the Baltic 21 process.
Baltic 21 is a democratic, open and transparent process. It is steered by the Senior Officials Group (SOG), with members from the Governments of the Council of Baltic Sea States and the European Commission, NGOs, intergovernmental organisations such as HELCOM, VASAB, International Baltic Sea Fisheries Commission (IBSFC), Nordic Council of Ministers and international financial institutions (EBRD, EIB, NEFCO, NIB, World Bank). All Baltic 21 documentation; background documents, SOG meeting reports, workshop reports, draft texts, are published on the Baltic 21 website (http://www.ee/baltic21).
The emphasis of Baltic 21 is on regional cooperation and on the environment and its bearing on economic and social aspects of sustainable development. The work focuses on seven sectors of crucial economic and environmental importance in the region. For each sector, goals and scenarios for sustainable development have been elaborated, as well as a sector action programme including timeframes, actors and financing. The responsibility for the sector work is distributed among the SOG members. The seven sectors and their lead parties are: Agriculture (HELCOM and Sweden), Energy (Denmark and Estonia), Fisheries (IBSFC), Forestry (Finland and Lithuania), Industry (Russia and Sweden), Tourism (Estonia, Finland and Baltic Sea Tourism Commission) and Transports (Germany and Latvia). Work on the Baltic 21 initiative has involved some 300 persons in the region.
All sectors have presented their work in a sector report. The following report has been prepared by representatives of the IFIs that are most active in the region. The sector reports, and other working papers produced by VASAB, the IFIs, the European Commission and Baltic Local Agenda 21 Forum, among others, constitute the background for the integrated and comprehensive Agenda 21 for the Baltic Sea Region. These reports are however not an integral part of the Agenda 21 for the Baltic Sea Region. The Agendahas been adopted by the Council of the Baltic Sea States and will be reported to the Prime Ministers of the region.
FINANCING THE BALTIC 21: AN OVERVIEW
ROLE OF INTERNATIONAL FINANCIAL INSTITUTIONS
Common Commitment to Environment. The five cooperating international financial institutions (IFIs) participating in the Baltic 21 process share a common commitment to environment as a central element of their policies, lending operations, and non-lending services. The cooperating IFIs include: the European Bank for Reconstruction and Development (EBRD); the European Investment Bank (EIB); the Nordic Investment Bank (NIB); the Nordic Environment Finance Corporation (NEFCO) and the World Bank (see Box 1). All actively support the mainstreaming of environmental concerns into their business practices. They are also assisting efforts to strengthen the institutional capacities of counterpart organisations in countries in economic transition to more effectively integrate environmental issues into their work. All five IFIs have environmental impact assessment procedures which are used as an integral element of the project identification, preparation and implementation process. They have made environment a priority for lending operations and provided loans for a variety of environmental investment and management projects.
Role in Regional Environmental Issues. Since the Prime Ministerial level Baltic Sea Environment Conference held in Ronneby, Sweden in 1990, the cooperating IFIs have taken an active role in regional environmental issues in both traditional market economies and in countries in economic transition. This has included direct participation in development of the Baltic Sea Joint Comprehensive Environmental Action Programme (JCP) and Updating of the JCP in support of the Helsinki Commission (HELCOM), as well as active involvement in the HELCOM Programme Implementation Task Force (PITF). All the IFIs have provided significant funding to support implementation of the Baltic Sea Environment Programme, especially to upgrade municipal water and wastewater services. They have also made major investments in support of improved energy efficiency andmeasures to reduce air pollution; assisted in upgrading district heating systems; promoted improved environmental performance in industries; worked on environmental issues in agriculture; and participated in programmes for the management of coastal lagoons and wetlands. In addition, the IFIs have supported the strengthening of environmental management capacities of national and local governments in countries in economic transition and upgraded air and water quality monitoring systems.
Beyond the Baltic Sea Region. At the pan-European level, the IFIs have been involved in the development and evolution of the "Environment for Europe" process and have had a role in the work of the Environmental Action Plan (EAP) Task Force. They have participated in the Project Preparation Committee (PPC), a complementary activity to the work of the EAP Task Force, which focuses on donor coordination and matching resources to accelerate development and implementation of environmental projects. EBRD, EIB and the World Bank have also shared experiences gained from the Baltic Sea Environment Programme and individual projects with other parts of Europe, the Mediterranean and other regions. The progress achieved in the Baltic Sea region provides an excellent example of the range of environmental activities which can be undertaken by countries that share a common vision and have a long-term commitment to cooperation.
COOPERATING INTERNATIONAL FINANCIAL INSTITUTIONS
Complementary Institutions. Although the cooperating IFIs have many features in common, particularly the focus on loans for financially viable projects, they should be viewed as a network of complementary institutions which can support the Baltic 21 process in European Union member countries and non-member countries. Based on their diverse mandates, the IFIs are able to undertake a wide variety of activities and provide support to the full range of countries in the Baltic Sea region. They are also able to draw upon specialist staff members with significant practical experience in legal, administrative, economic, financial and technical aspects of programme and project preparation and implementation. An important feature of these institutions is their well established commitment and record of being able to work together applying the unique resources of each organisation to achieve common objectives. It is important to note that IFI programmes in the Baltic Sea region continuously evolve to meet the rapidly changing needs of both the public and private sector. Table 1 indicates the Baltic Sea region countries in which each IFI is active, and a review of the types of activities each institution undertakes is provided as Table 2.
Key Functions of IFIs. IFIs provide only a small percentage of total public and private investments in the Baltic Sea region. However, they have an important catalytic role through their special relationship with the cooperating governments in the Baltic 21 process; their extensive global, regional and national experience; participation in a wide variety of sectors; the high leverage value of their funds; and broad knowledge of project design and implementation. The IFIs have a demonstrated record of serving as a catalyst through their ability to work with regional organisations, governments, municipalities and the private sector in moving from sound concepts to the realisation of projects on the ground. Often, they are involved in projects which are innovative, establish new ways of undertaking investments, and provide for development of new financial mechanisms. All the cooperating IFIs have supported direct environmental investments or environmental components in investments. They require environmental review in both direct and intermediary lending operations. The IFIs also are able to develop lessons learned and to transfer this experience between and within regions, countries and sectors.
Use of Banking Principles. It is important to recognise that IFIs are structured and operate on "banking principles" since they provide loans which must be repaid with interest by the cooperating party over a fixed period of time. In this sense they differ significantly from bilateral donors who provide important resources in the form of "soft" money, including grants and subsidised loans. In addition, it should be noted that cooperating national governments have absolute limits for both official and commercial borrowing, determined by their creditworthiness. Similar limits on borrowing also exist for municipal governments and private enterprises.
Common IFI Lending Instruments. The IFIs use a variety of financial instruments to support their work. These instruments vary from institution to institution and can include:
Direct Financing Instruments
- Loans. The IFIs primarily provide medium and long-term credits, often with considerably longer maturities than those provided by other lending institutions. Some IFIs exclusively or primarily provide sovereign loans, that is loans to governments, governmental bodies or with a payment guarantee from the government. Others specialise in providing loans to the private sector or work with both.
- Equity. Equity as a financial instrument is commonly understood as the resources provided to an enterprise by owners or investors carrying the highest risk, meaning that in the case of liquidation of an enterprise or sale of its assets, the equity holders get paid only after all other claims (including loans).
- Guarantees. Guarantees are a mechanism for transferring risk, primarily of loans, to the guarantor, who through better creditworthiness than the borrower, makes it possible for lenders to extend loans to otherwise non eligible counterparts.
Financing Through Intermediaries
- Credit lines. Credit lines are a means of providing IFI loans to borrowers who otherwise would be ineligible because of small loan amounts, excessive transaction costs or other comparable reasons. Providing a global amount to a financial intermediary institution which is in a position to extend smaller, local credits will make IFI funds accessible to small and medium sized enterprises, for example.
- Equity Participation. Equity participation in banks and investment funds is an alternative way of channelling IFI funds to otherwise inaccessible borrowers while at the same time contributing to the development of financial markets.
- Cofinancing Facilities. Cofinancing facilities comprise various instruments intended to attract the participation of other financiers alongside an IFI in a financial package, for example through extending partial guarantees, selling loan participation, and other types of facilities.
- Trade Facilities. To some extent IFIs also facilitate trade financing by helping to set up specialised credit lines, leasing operations, factoring mechanisms, etc. in countries where the availability of such facilities is insufficient.
Public and Private Financing. The IFIs, in spite of their wide range of activities and substantial resource mobilisation capacity, can only play a limited, complementary role in the total picture. International and domestic financial and capital markets are the main sources of financing. The IFIs therefore seek to interact with these markets so as to promote resource mobilisation and channelling. In recent years the role of the private sector has been constantly growing. In this context some IFIs, in addition to cofinancing activities and equity participation in financial institutions, are also engaging in investment banking activities to help project sponsors raise financing. All cooperating IFIs view the expanded role of the private sector in environmental infrastructure, especially in water supply and wastewater management, as a significant long-term trend in the Baltic Sea region and seek to support this process through the use of a variety of financial instruments. They also anticipate that the private sector will take an expanded role in management and investments in energy and transportation infrastructure within the region.
Increasing Importance of Non-Lending Services. The cooperating IFIs often provide members and borrowers a variety of "non-lending services" which include preparation of specialised analyses, advisory support, technical assistance and institutional strengthening activities. A number of the IFIs have provided support for development of the financial sector in many countries in transition. This has been a growing area of cooperation, especially by the EBRD and World Bank, in the Baltic Sea region.
LESSONS FROM IFI WORK ON BALTIC REGION ENVIRONMENTAL ISSUES
Sustained Political Commitment and Broad Based Public Support. The success achieved to date in implementation of the Baltic Sea Environment Programme is directly related to the sustained political commitment and broad based public support that the Programme has received. The long-term success of the Baltic 21 initiative will require the same type of support. This mandates the development of a clear and achievable objective for the Baltic 21 process which can be politically endorsed and adopted by all political interests. Political acceptance needs to be fully complemented by a public commitment to undertake the wide variety of actions required to fulfil the goals of Baltic 21 over a long period of time. Effective measures to explain the objectives of the process to the public will be critical in all portions of the Baltic Sea drainage basin and should be anticipated to require significant expenditures by all cooperating countries. While it is clear that public support is critical to the success of Baltic 21, it should be noted that to date, activities to support this element of the Baltic Sea Environment Programme have had difficulty in obtaining adequate funding.
Importance of Partnerships. The partnerships established through the work of the Baltic Sea Environment Programme should be expanded to meet the needs of Baltic 21. The significant progress in implementation of the HELCOM coordinated Baltic Sea Environment Programme can be attributed to the exceptionally effective development of a strong series of partnerships between HELCOM, the European Union, regional organisations, cooperating countries, local governments, international financial institutions, bilateral donor organisations, academic and applied research institutions, nongovernmental organisations, private sector interests, and a large number of individual citizens. The role played by these partnerships has been critical, providing the basis for sustained political interest and strong public support, and greatly facilitating major resource mobilisation efforts. This framework of partnerships has been important in the development of strategies, identification of priorities, development of practical actions and implementation of a range of activities. The types of partnerships have been diverse, including formal and informal relationships between IFIs, cities, and nongovernmental organisations. The Baltic Sea region provides an outstanding example where partnerships, including joint implementation, twinning arrangements and nongovernmental organisation cooperative activities may find their expression in many forms and at various levels. This wide range of partnerships should be key elements of Baltic 21.
Preventive and Curative Measures. One of the most important challenges of the Baltic 21 process is the need to identify and undertake both preventive and curative measures to address environmental management concerns in the Baltic Sea region. The experience gained from the Baltic Sea Environment Programme reinforces the view that the design and implementation of Baltic 21 should pay careful attention to maintaining a balance between "preventive" and "curative" measures. Preventive measures, by far the most cost-effective type of intervention, can be complemented by curative actions to remediate existing problems. Baltic 21 provides an important opportunity to broadly integrate the environmental dimension into the regional development process to assure that it is sustainable. While curative measures will remain important in all key development sectors to be addressed under Baltic 21, significant action needs to be taken to prevent new problems from occurring that create considerable management and financial demands for their resolution.
Importance of Integration of Environmental Priorities into Investment Plans. Development and financing by the cooperating IFIs of "free standing" environmental projects and projects that have major environmental components in the Baltic Sea region has demonstrated the critical importance of integration of environmental priorities into national investment plans. It is clear that the countries which have had the highest rates of investment under the Baltic Sea Environment Programme are those which have built these priorities into their formal investment strategy. Where this has been done both domestic and international sources of funding, including loans and grants, have been more readily available and project development has proceeded in a much more efficient and timely manner. Integration of priorities into investment plans has had the added advantage of bringing parties responsible for planning, finance, environment, and cooperating sectoral ministries and municipalities together to reach a consensus on priorities in a formally structured manner. This experience should be factored into the Baltic 21 process in all cooperating countries, to facilitate the transition from planning to implementation of the long-term objectives of this initiative.
Cofinancing is a Critical Tool. In the countries in economic transition, where affordability is a critical constraint to investments, the use of cofinancing that blends loans from IFIs and grants from the European Union and bilateral donors has proven to be a critical tool. The process of project design used by the IFIs has provided a sound framework for evaluation of potential projects and allowed for careful assessment of the ability of national governments, municipalities and private sector parties to borrow on a medium and long-term basis. When combined with grants, the size of the projects can be larger, allowing for greater impacts and reducing the effective cost to the cooperating government or investors. The linking of grants to loans has provided an important incentive for governments to undertake environmental investments on an accelerated basis for both national and region benefits. Cofinancing has also reduced project preparation and supervision costs, allowed for more effective sharing of experience and supported efficient use of limited management, technical and financial resources by all parties.
Project Planning and Management. Implementation of the Baltic 21 initiative requires that special attention be given to improvement of the project planning and management skills required to make many municipalities, utilities and industries creditworthy and able to effectively use loan and grant funding from domestic and international sources. A priority area is the development, in both traditional market economies and countries in economic transition, of improved skills in strategic planning, financial management and accounting. For projects to be sustainable, it is important that the institutions responsible for their planning, implementation and operation have sufficient managerial skills and a solid financial situation. Improvement of skills in contract management, competitively based procurement, and disbursement continue to be consistently identified as a major area for institutional strengthening in the countries in economic transition. Development of these skills in the countries often requires the use of qualified international expertise and is often not possible without external grant financing for these services and related training activities.
Investment is Not the Only Answer. It is extremely clear from the experience of the IFIs working in the Baltic Sea region that investments are not the only answer to the issue of environment and development. Reviews of relevant experience indicate that complementary measures are required in three areas:
- Well Defined Objectives and Priorities. At the programme and project level it is necessary to have well defined objectives and clearly established priorities which have been developed in a transparent manner, reviewed and accepted by the cooperating parties and which provide a realistic basis for actions. Objectives should be described in a manner easily understood by decision makers and the public. Priorities should be developed against clear criteria, including assessment of human health risks, ecological damage and economic impacts. Priorities should be established for both preventive and curative actions and used to direct the use of scarce domestic and international resources to achieve maximum environmental benefits. In the Baltic 21 process, priority should be given to the broad integration of environmental concerns into the policies and programmes of the major investment sectors at the regional, national and local level.
- Clear Policy Frameworks. Development and implementation of effective policy frameworks is critical to the success of Baltic 21. It should be recognised that policies have a strong influence on the identification and mobilisation of support for the preventive measures required to address long-term environmental challenges in the region. Policies are also needed to create an atmosphere which encourages both public and private sector interests to undertake curative interventions. In all cases it is important that clear legislation exist, which can be realistically implemented and for which consistent measures can be taken to support enforcement at the national and local levels. Adoption of policies which support the proper pricing of natural resources, including water, energy and raw materials, is critical for effective environmental management programmes at all levels. In addition, measures need to be taken in some countries to address distortions to tax and social legislation which indirectly result in adverse environmental impacts. The expanded role of the European Union within the region will make policy review and revisions necessary in many countries and require that additional resources be applied in the short and medium-term to address this process.
- Institutional Strengthening. The strengthening of institutional capacity at national and local levels is needed in all countries participating in the Baltic 21 process. Especially important is the capacity within national financial institutions, sectoral ministries, and the private sector to more fully integrate environment into planning, implementation and management processes. The strong emphasis given in many countries in the region to decentralisation leads to considerable need for strengthening institutions and human resources at the local level. All investment projects should include a careful evaluation of institutional strengthening requirements and make provisions for these to be an integral element of the project. It should be expected that grant funds will continue to play an important role over the short and medium-term in supporting institutional strengthening efforts in the countries in economic transition in the context of Baltic 21.
Well Targeted Investments. The cooperating IFIs all recognise the important role that well targeted and properly designed investments can play in the realisation of the objectives of Baltic 21. These investments must continue to be supportive of policy measures and institutional strengthening and they must address priority actions at the regional, national and/or local level. Projects in the countries in economic transition should continue to focus on the use of least cost solutions which are both affordable and promote environmental improvement. Investments should be balanced to support improved productive performance of an enterprise or utility and to address environmental aspects. Environmental improvements can only be made and implemented by public and private enterprises that are well managed and financially sound. Given the complexity of developing high quality projects, it is strongly recommended that when IFI financing is potentially being considered for Baltic 21 related initiatives, these institutions be contacted and asked to review their potential cooperation at the earliest stage of project preparation.
REVIEW OF AVAILABLE FINANCING MECHANISMS TO SUPPORT SECTORAL CONCERNS OF BALTIC 21
Financing Baltic 21. Meeting the long-term objectives of the Baltic 21 initiative requires public and private funds to be spent on an incremental and phased basis. Financing should include the use of the full range of instruments outlined above, complemented by new financial instruments developed during the course of Baltic 21 implementation. It should be noted that the countries participating in the Baltic 21 process are considered from an international perspective to be high or middle income countries and are therefore not eligible for many types of concessional international assistance that is targeted for lower income countries. At the same time, the countries in economic transition have very limited financial resources for investments and the affordability of loans remains an important issue of economic and social significance. This mandates careful use of available resources for activities which address key economic, social and environmental priorities. It also emphasises the need for preventive actions to avoid development of situations that would require these limited resources to be applied to an expanded series of issues.
Critical Role of Domestic Resources. It should be recognised that the mobilisation of financial resources by national governments, municipalities and the domestic private sector is a key element for the success of regional environmental initiatives such as Baltic 21. The commitment and ownership by direct beneficiaries has been consistently demonstrated in ongoing programmes and projects in many parts of Europe to be the most important factor for success. Development of government and public support for programmes is critical for sustained mobilisation of national and local resources. Local generation of resources is required for both the investment and operational phases of projects. Once domestic resources are mobilised and available, they need to be effectively used to maintain the creditability of the programme. This requires programme related projects to be properly designed, meeting both regional and national needs. In the case of investments, special attention should be given to construction supervision, commissioning, operation and maintenance of facilities.
Complementary Role of International Resources. International sources of funding, including those provided by the European Union, IFIs, bilateral donors and the foreign private sector, should be viewed as complementary to the domestic resources of cooperating countries. In order to achieve the objective of the cooperating parties in the Baltic 21 process to institutionalise sustainable development and accelerate environmental management measures, significant financial resource transfers to the countries in economic transition will be required in the form of loans, "soft" loans and grants from these parties over the short and medium-term. In this context it is anticipated that the financial programmes of the European Union, including EU (Phare), EU (Tacis) and EU (Life), will be an increasingly important set of instruments to support environmental improvements in the Baltic Sea region (see Box 2). The considerable resources anticipated to be required for Baltic 21, and in many countries the large investments required for European Union accession process, are beyond the ability of some countries to fully mobilise within the proposed time frames for either activity without the transfer and effective use of financial resources from international sources. This should be clearly recognised as a key concern for high level discussion in the review of Baltic 21, given its broad implications for many aspects of the proposed actions and schedule of the initiative.
Available Financial Instruments. Types of available financial instruments will vary with time and place. Currently, the Baltic Sea region can be seen as divided into two groups of countries: the traditional market economies with well developed financial and capital markets on one hand, and the countries in economic transition with more limited access to financial instruments on the other. The encouraging progress in the transition process is, however, narrowing this gap. Generally, international as well as domestic financing can be based on market terms or have public sector support. Financing can be provided on loan, equity or grant terms. Loans can be with or without guarantees. The principal domestic sources of funds, in particular for environmental projects, include user charges, pollution fees and fines, budgetary allocations and non-budgetary incentives, domestic loans and local private sector investment.
External Financial Resources. The principal types of external financial resources available for countries in transition include the programmes of the European Union, IFIs, bilateral donor organisations, export credit agencies and commercial banks, and direct investment by foreign companies. Among international financing possibilities, different constraints apply to market based, bilateral donor and multilateral financing. Grants and concessional funding from the European Union and bilateral donors, both from within and outside the region, have in recent years been an important source of support for environmental activities and should be anticipated to play an important, though decreasing, role in Baltic 21. The loans provided from IFIs should be viewed as a combination of domestic and international financing, since they are repaid by the country while it benefits from the longer repayment periods, more favourable terms and advisory support provided by resources from these institutions. It should be noted that the use of loans from IFIs is conditioned by the willingness of the concerned party to assume debt through formal borrowing; this has been a problem for some countries involved in the Baltic 21 process.
Effective Use of Soft Loans and Grants. "Soft" financing instruments, usually signifying a grant element used to mitigate pure market based financing, are one way of enabling investments which otherwise would not be implemented because of financing constraints. Such a grant element is mainly provided by the public sector. There are a number of options to soften pure market based financing, such as providing a direct investment subsidy in the form of a non-reimbursable grant; an interest subsidy whereby the interest rate for a loan to be paid by a borrower is reduced; a credit risk enhancement for a lender through a non market based guarantee, which normally would have a public sector budgetary back-up and/or imply future non-recoverable cash transfers; grace and repayment periods for a loan which is beyond a market based loan maturity; and financing with equity features, allowing for a lower yield prospective, a longer investment repayment period and/or higher risks than pure market based equity or venture capital financing.
Constraints to Soft Financing. Soft financing is limited by, among other things, public sector budgetary constraints; public sector policies to refrain from market distortion activities; management constraints; and sometimes also by private sector investors' reluctance to become exposed to the interference normally associated with financial support from the public sector. For external financing, the Organisation for Economic Cooperation and Development (OECD) guidelines for officially supported export credits restrain the use of mixed credits. Effective use of these scarce, but frequently critical, resources is of paramount importance. Coordination at an early stage with other financiers, beneficiaries and project sponsors has proven valuable in this respect.
Expanding Role of the Private Sector. The participation of private sector investors and specialised development finance institutions will be of critical importance. A substantial part of the activities called for in Baltic 21 are linked to the private sector. Throughout the world, local governments, including many in the Baltic Sea region, are turning to the private sector for management of a widening range of services, such as water supply and wastewater systems, waste management and energy supply. In doing so, they seek efficiency gains in management and operation and in mobilisation of private investment capital. Several options for private sector involvement in utility management and operation, through full privatisation or in public/private partnerships such as service or lease contract arrangements, should be explored as part of the Baltic 21 process. As a parallel development, financing needs should increasingly be satisfied from private sources. The present reliance on subsidies from government or government guaranteed loans should be reduced. Already private financing for certain investments through "Build-Operate-Transfer" (BOT) schemes or similar arrangements have become viable options. In such cases, the viability of the project will also be an essential precondition, in that the financiers must feel confident that the project will provide an acceptable level of risk and a return on their investment.
Potential New Financial Instruments. The Sofia Conference pointed to some potential new instruments which could encourage implementation of environmental investments in the Central and East European countries. These recommendations remain appropriate for consideration in the context of the Baltic 21 process and include:
- Environmental Loan Guarantees. This instrument would enhance direct project lending, making loans more accessible and improving lending terms for environmental projects.
- Environmental Supplementary Equity (Green Equity). This would complement loans and marked based risk capital in direct project financing. It has a soft feature as it would be extended with lower return requirements and/or with higher risks than market based equity financing.
- Increased Availability of Soft Financing. Investment in environmental projects would be enhanced by making soft financing more readily available.
Strengthening National Environmental Funds. Strengthening these funds in the Central and Eastern European countries would facilitate financing of environmental projects. Poland provides an outstanding example of how the use of a National Environmental Fund and the special EcoFund can make major contributions to the generation and application of domestic resources both independently and through cofinanced investments. In Poland, the contribution of such funds covered close to 40 percent of domestic environmental expenditures. Although the figure is lower in other countries, a number of new funds have been established in recent years and the capacities of some existing funds strengthened, improving their revenue base and developing financing mechanisms. Some funds have also been established with external support from donor grants and/or IFI loans, such as the National Pollution Abatement Fund in Russia and the Environmental Investment Funds in Latvia and Lithuania. Still, however, substantial additional efforts will be needed for these funds to reach their full potential throughout the region.
Although financing from domestic sources will remain a limiting factor in the countries in transition in the short term, it is important to recognise that the fundamental questions linked to resource mobilisation in support of sustainable development are universal in character. In all countries of the Baltic Sea region, financial mechanisms such as capital markets and banks will have to reconsider operating policies, if the goals of the Baltic 21 initiative are to realised.
REGIONAL TRENDS OF SIGNIFICANCE TO BALTIC 21
Dynamic Nature of the Region. The Baltic Sea region is a highly dynamic region which is driven by rapid and diverse economic, social and environmental developments. The Baltic 21 process should expect sometimes unanticipated changes within the region which may require significant adjustments to the objectives of the initiative, and adoption of measures to address new issues which emerge over time. It should provide a clear mechanism for adjustments to the scope and objective of the initiative to meet these changing conditions. The recent work of the Helsinki Commission (HELCOM) in updating the Baltic Sea Environment Programme provides an excellent example of the importance of adjusting the design of regional programmes to effectively address new issues which have emerged in the region.
Key Role of European Union and Government Polices. It should be emphasised that while the IFIs have an important role in the development process and in mainstreaming environment into investment planning and operations, it is the policies of the European Union and national governments which provide the framework that drives the use of both international and domestic resources. The rapidly expanding role of the European Union in the Baltic Sea region is a major factor for environmental issues given the important role of its policies and directives in establishing goals for regional and national programmes, its broad interest in environmental issues in all major development sectors and the impact of the current European Union accession process in many of the countries in economic transition within the region. Concern with compliance with the "acquis communautaire," the laws of the European Union, is a major force behind many policy, management and investment strategies. In the Baltic Sea region four countries are today members of the European Union whilefour others have applied for membership.
European Union Directives. In member and applicant countries, activities related to addressing current and planned directives have a major impact on the approaches adopted by the concerned governments and in turn their requests to the IFIs for support. European Union actions related to the definition of collective approaches to environmental assessment procedures, water resources, solid waste management and integrated pollution prevention and control should be anticipated to have a significant influence on both Baltic 21 and the establishment of national and local investment priorities. In the applicant countries, the accession process will in the next few years be a key factor in determining policy and priorities, as the countries will be required to harmonise their legislation with European Union directives and to show compliance with European Union norms, standards and requirements. Specialised support will be required for the transposition, implementation and enforcement of the European Union directives in environment and other fields.
Emerging Regional Trends. The Baltic 21 process will be implemented in a dynamic setting in which many regional trends will have an important influence on the realisation of the objectives of the initiative. Key regional trends which should be considered are as follows:
Environmental Trends
- Mainstreaming Environment. Environment and natural resources management concerns will continue to be mainstreamed within the Baltic Sea region by the public and private sector. This will have a major influence in "building-in" rather than "adding-on" environment in the planning process and increase the attention given to environment in operations. This will include greater interest in environmental aspects of investment by commercial banks and insurance organisations and should lead to significant reductions in environmental risks posed by many types of investments. The mainstreaming process, in combination with ongoing efforts to support a wide range of curative interventions, should allow for a shift in the focus of interventions from "point sources" which largely involve the municipal, energy and industrial sectors, to the management of "non-point" or diffuse sources which involve agriculture and transportation.
- Greater Use of "Economic Instruments" in Environmental Management. The expansion of market economies in the region will result in greater use of economic instruments in environmental management. One of the first instruments to be used will be the pricing of water and raw materials; this is already playing a role in the "internalising of externalities" for environmental degradation related to inefficient use of natural resources. The use of the "Polluter Pays Principle (PPP)" will continue to broaden in the region, stimulating municipalities and industries to make more cost-effective investments in waste minimisation, improved process supervision and well planned control measures. In addition, trends in the reduction of subsidies for inputs to agriculture and industry are anticipated to continue.
- Environmental Challenges from Increased Privatisation. The expanded role of the private sector, especially in the countries in economic transition, presents the Baltic 21 process with significant opportunities to create an effective partnership with international and domestic business interests. Addressing the issues related to increased private sector participation, especially in energy, industry and infrastructure, will require use of many new environmental management tools, including environmental audits and environmental due diligence guidelines for small and medium investments. This is an area in which incentives—especially for adoption of clean technologies, use of waste minimisation strategies, and improved process supervision—could have a major positive impact. Baltic 21 should give special attention to outreach measures which could support the development of "corporate environmental partnerships" within the region.
- Broader Financial Base for Environmental Investments. Increased understanding of the mechanisms for environmental investments—especially those for municipal water and wastewater services and solid waste management services—which can be undertaken on a commercial or semi-commercial basis may expand the range of parties prepared to invest in these types of activities. An important party which might consider making such investments, subject to adequate guarantees against risks, would be pension funds. In addition, provided conditions are right and the nature of investments well understood by the public, it may be possible to mobilise large numbers of individual investors. Given the need to mobilise a wide array of resources for the Baltic 21 process, special attention should be given to assessment of the opportunities and constraints in developing a broader base for participation in environmental investments overt the medium and long-term.
- Increased Importance of International and Regional Environmental Conventions. It should be anticipated that the wide range of current and proposed international and regional environmental conventions will become a much more important force for change during the course of the Baltic 21 process and will have an increased influence on the establishment of financial priorities at a number of levels. At the global level, conventions will provide a framework which defines many types of actions that could have a significant influence on Baltic 21 initiatives concerning the energy and transport sectors. At the regional level, the existing conventions of the United Nations Economic Commission for Europe (UN/ECE), the Helsinki Convention on the Baltic Sea Environment and the Warsaw Convention on Baltic Sea Fisheries all provide critical frameworks which support the objective and concepts of Baltic 21 through complementary structures with their own work programmes and projects.
Administrative and Socio-Economic Trends
- Increased Decentralisation. In the Baltic Sea region an increased decentralisation of governmental authority in both traditional market economies and countries in economic transition is a trend which will have a major impact on the success of the Baltic 21 process. Decentralisation brings decision making to the local level and allows for more active involvement of the concerned population; however, it also creates demands for far more sophisticated local skills in planning and management of all types of activities. This is especially the case in environmental management where new skills need to be developed on many levels of local government to address administrative, planning, financial and technical demands. In addition, support often needs to be provided to national authorities in redefining their role and functions in a decentralised system. This support often includes assistance in the adjustment of programmes, retraining of personnel and development of new planning, budgeting and administrative procedures.
- Expanded Role of Civil Society. Throughout the Baltic Sea region the "civil society" is playing an expanded role and is taking an active part in public debate concerning environment and development issues. The change in the role of the civil society in the countries in economic transition is dramatic, with the rise of a vast array of new religious, political, social and voluntary institutions which provide for a strong nongovernmental base. This expansion of civil society has resulted in an increased emphasis on transparency in public decision making and greater demands for accountability in the use of public funds. Public consultation with elected officials, public interest groups, nongovernmental organisations and potentially affected parties should be anticipated to be an element of the Baltic 21 process and activities included under the initiative.
- Importance of the Consumer. With expanded environmental awareness, the consumer will become an increasingly important party in environmental management in all sectors. Green certification and labeling schemes have already had a significant impact on some types of goods and industries. Concerns over environmental standards used by the airline industry, food products, paper products and hotels in the region provide current examples of the expanding influence of the informed public. It should be anticipated that the informed and mobilised consumer will be among the major advocates of Baltic 21.
- Increased Recognition of Affordability Issues. Effective development and implementation of Baltic 21 will require increased recognition that the traditional market economies and those in economic transition will continue during the short and medium-term to have significantly different income levels. This has a considerable impact on the ability to provide resources for "curative" actions to address current environmental issues. Affordability has a very human dimension. Many individuals, especially the elderly and others on fixed incomes, are not able to pay the significant increases which are required for technically and environmentally acceptable services in many sectors. They require support from the emerging "social safety net," and the potential impacts of proposed policies and projects on these vulnerable populations needs to be carefully evaluated.
- Demographic and Settlement Patterns. Unlike most areas of the world, the Baltic Sea region has nearly stable population growth; this means that most environmental infrastructure investments have a long functional life once they are brought up to the desired standard. This is an important factor in the success of Baltic 21, as well as the work of HELCOM, in that it is possible for a limited level of investment to close the "investment gap" where it may exist and not be "overrun" by population growth. In addition, the region has a relatively stable settlement pattern which also reduces the impacts of "rural to urban" migration trends or "coastalisation" of population, a major trend in southern Europe. While from an investment viewpoint these trends are very positive, from an economic and financial viewpoint the demographic trends have a serious implication since the region has an ageing population which will increase over the period of the initiative, resulting in greater demand for expenditures for social services. This will in turn reduce the availability of investment funding, make it difficult to adjust utility rates due to affordability issues and place increased financial burdens on the working population which will be reduced in proportion to those dependent on its productivity.
Emerging Sectoral Trends. The cooperating IFIs have reviewed the key sectors being evaluated as part of the Baltic 21 process—agriculture, energy, fisheries, forestry, industry, municipal environmental infrastructure, tourism and transportation—and have prepared a brief overview of the key issues in these areas which is provided as Attachment A. It should be noted that the role of the IFIs in these sectors varies greatly, from significant involvement in policy, investment and institutional development through historically minimal involvement. Many of the key policy decisions in these sectors are beyond the scope of the IFIs since they involve complex issues related to the competencies of the European Union. The points noted in this presentation focus on trends and their relation to the work of the IFIs.
Coordination with HELCOM Activities. The evaluation by Baltic 21 of these sectors complements the ongoing work of HELCOM which has been mandated by the Prime Ministers to coordinate implementation of the Helsinki Convention and undertake the Baltic Sea Environment Programme to restore the ecological balance of the Baltic Sea. Since these activities are undertaken in the context of the Helsinki Commission, they focus on the key requirements for management of the Baltic Sea drainage basin consistent with the provisions of the Helsinki Convention and its associated agreements. Ideally, Baltic 21 and the Baltic Sea Environment Programme, both of which involve the participation of the IFIs, could be effectively coordinated to provide two powerful complementary mechanisms that promote regional environmental management and sustainable development.
Table 1: International Financial Institutions
Countries of Operation
