Retinoic acid (RA) metabolizing enzymes play important roles in RA signaling during vertebrate embryogenesis. We have previously reported on a RA degrading enzyme, XCYP26, which appears to be critical for the anteroposterior patterning of the central nervous system (EMBO J. 17 (1998) 7361). Here, we report on the sequence, expression and function of its counterpart, XRALDH2, a RA generating enzyme in Xenopus. During gastrulation and neurulation, XRALDH2 and XCYP26 show non-overlapping, complementary expression domains. Upon misexpression, XRALDH2 is found to reduce the forebrain territory and to posteriorize the molecular identity of midbrain and individual hindbrain rhombomeres in Xenopus embryos. Furthermore, ectopic XRALDH2, in combination with its substrate, all-trans-retinal (ATR), can mimic the RA phenotype to result in microcephalic embryos. Taken together, our data support the notion that XRALDH2 plays an important role in RA homeostasis by the creation of a critical RA concentration gradient along the anteroposterior axis of early embryos, which is essential for proper patterning of the central nervous system in Xenopus.