We report the isolation and characterization of a new inhibitory Smad inXenopus,which we have designated asXenopusSmad7. Smad7 is present at fairly constant levels throughout early development and at blastula stages enriched in the ventral side of the animal hemisphere. The induction of mesoderm by TGF-β-like signals is mediated by receptor ALK-4 and we show that Smad7 blocks signaling of ALK-4 in a graded fashion: lower levels of Smad7 block activation of dorsal mesoderm genes and higher levels block all mesoderm genes expression. Smad7 is able to directly activate neural markers in explants in the absence of mesoderm or endoderm. This neural-inducing activity of Smad7 may be due to inhibition of BMP-4 signaling because Smad7 can also block BMP-4-mediated mesoderm induction. Thus, Smad7 acts as a potent inhibitor of mesoderm formation and also activates the default neural induction pathway.