In response to the large inherited environmental liabilities as well as the experienced political instability, the macro-economic stabilisation process and the numerous imperfections in the capital market virtually all CEE countries have by now created earmarked environmental funds (EFs) to generate financing for environmental improvements.

If properly designed, the environmental funds offer a number of advantages:

In a situation where public budgets are volatile and public investments often cut from year to year, due to the need of macro-economic stabilisation, an EF can provide sustained financing for environmental programs.

An EF may, in addition to the supply of funds, assist in leverage of financial resources from domestic sources as well as from foreign donors.

An EF may if properly designed and equipped be able to identify, select and implement cost-effective environmental projects.

An EF can expedite and catalyse national environmental priorities, specified by the government in, for example, a national and/or regional Environmental Action Plan.

An EF may help strengthen domestic capacity for investment project preparation and environmental policy implementation.

However, there are also potential dangers connected with the creation of EFs. The most important ones are, from an environmental perspective, that the provision of subsidies can undermine the Polluter-Pays-Principle, and that earmarking of revenues creates problems for the efficient use of resources. In addition, it is important that the EFs are managed cost- effectively, with sound and transparent project cycle management, and with full accountability to the government and to the general public. Without a careful design of EFs operations and management the abovementioned advantages of will be substantially reduced.

The purpose of the proposed paper is to analyse to what extent EFs in the CEE countries have been a success. EFs share of total domestic environmental investment expenditure is highlighted, major strengths and weaknesses of existing project cycle management are identified, and lessons learned from attempts to strengthen EFs are dealt with. The paper is based on the authors' project work and case studies carried out in, among others, Russia, Hungary, and Poland within the last couple of years on behalf of, among others, Ministries of Environment, EFs and OECD. The aim of this work has been twofold: (1) estimating levels and trends in environmental expenditure and (2) strengthening the management and operational performance of selected EFs.