Sustaining the regular flow of water from mountain forests is important for downstream stakeholders in seasonally dry tropical countries, and a watershed payment for ecosystem services (PES) scheme that links rural ecosystem service providers to urban water users through economic transfers may help to maintain water supply and forest habitat. A CARE/WWF project in the Uluguru Mountains of Tanzania has established a pilot watershed PES scheme. We trace the development of this scheme and outline its initial impacts. Memoranda of Understanding between companies in Dar es Salaam (the downstream water users) and farmers in the mountains provide the framework to deliver tangible financial benefits to local people, help change patterns of land use and potentially improve water quality. A number of lessons learned from this project are relevant for similar schemes elsewhere in the region. Overcoming the various challenges is essential for expanding the current pilot project to a scale where it delivers measurable changes in water quality for downstream users.

The Uluguru Mountains in eastern Tanzania contain at least 16 endemic vertebrate and 135 endemic plant taxa, with hundreds of more taxa shared only with forests in eastern Tanzania and Kenya. This degree of endemism is exceptional in tropical Africa, and the Uluguru Mountains are one of the 10 most important tropical forest sites for conservation on the continent. Surveys carried out during 1999–2001 updated information on the status of forests and biodiversity across the Uluguru Mountains. Forest area has declined from c. 300 km2 in 1955 to 230 km2 in 2001. Forest loss has been greatest over altitudes of 600–1,600 m, and concentrated in submontane forest. During the recent surveys most of the endemic and near-endemic vertebrate species known from the Uluguru Mountains were re-recorded, but three endemic snake species and two near-endemic bird species were not found. These species were previously known from the elevations where deforestation has been greatest. More than 50 plant species are also known only from the altitude range that has been heavily deforested. The primary cause of forest loss has been clearance for new farmland. The forest that does remain is largely confined to Catchment Forest Reserves managed for water by the Tanzanian Government. Without these reserves the loss of forest, and hence the loss of biodiversity, in the Uluguru Mountains would most likely have been much greater.