INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized RESTRICTED Report No. P-739 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF KENYA FOR A THIRD HIGHWAY PROJECT AND ON PROPOSED AMENDMENTS TO DEVELOPMENT CREDIT 104 KE TO THE REPUBLIC OF KENYA September 10, 1969

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMEINT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECO1'GENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK LOAN TO THE

2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMEINT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECO1'GENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED BANK LOAN TO THE REPUBLIC OF KENYA FOR A THIRD HIGHWiAY PROJECT AND ON PROPOSED A1iENDNENTS TO DEVELOPMENT CREDIT 104 KE 1. I submit the following report and recommendations on a proposed loan in an amount in various currencies equivalent to US $23.5 million to the Republic of Kenya, and on proposed amendments to the Development Credit 104 KE. PART I - HISTORICAL 2. The present project has growm out of a preliminary loan application largely for feeder roads, received in April 1968, at the time the last road project in Kenya, Credit 120-KE, was being negotiated. Other components of the Government's road building program for have subsequently been added, at the initiative of the Bank or the Government. 3. The proposed project has been prepared by the Government, for certain elements with the assistance of consultants. The Bank's Permanent Hiission in East Africa provided general guidance and, for the settlement roads component, more detailed assistance. Appraisal took place in January 1969, and negotiations were held in Washington in July. Kenya was represented by 1Mr. R. J. Ouko, Permanent Secretary of the Miinistry of Works, Mr. S. Mbugia, Engineer-in-Chief, Mr. G. 14anners, Supernumerary, Chief Engineer (Roads), Mr. D. Powrie, Senior Superintending Engineer (Road Planning), and Ir. J. Gatuiria, Senior Finance Officer in the Ministry of Finance. 4. The proposed loan would be the first Bank loan to Kenya since it became an independent republic in December Two loans were extended prior to independence, with the guarantee of the United Kingdom, and subsequently nine IDA credits have been granted. All loans and credits have been made to the Government. The position as of August 31, 1969 was as follows:

3 Amounts in US $ ni-llion No. Year Purpose Bank IDA Undisbursed 256 KE 1960 Agriculture and Roads KE 1961 Land Settlement KE 1964 Tea Development IKE 1964 Highways KE 1965 Tea Roads KE 1966 Education KE 1967 Agricultural Roads KE 1967 Agricultural Credit KE 1968 Tea Development KE 1968 Highways KE 1968 Livestock Development Total (less cancellations) 9.5 of which has been repaid 42.6 to Bank and others 4.8 Total now outstanding 4.7 Amount sold 4.3 of which has been repaid 4.0 Total now held by.3 Bank and IDA Total undisbursed.9 20, The 1961 loan for land settlement (303-KE), reduced by $3.8 million from the original $8.4 million in June 1967 after a revision of the project, was reduced further by cancellation of $665,000 in May A land settlement project is, by nature, a particularly difficult undertaking and the difficulties in this case have been enhanced by administrative problems. The present closing date is September 30, 1969, and any balance undisbursed on that date will be cancelled. 6. The Agricultural Credit Project, 105-KE, has been hampered by management and staffing problems, which now are being tackled with energy by the Government, and there has been a sharp increase in loan approvals since the middle of The Smallholder Tea development project, 64-KE, is nearing complet-on,andthe lag in disbursement is due to the fact that deficits of the KTDA, against which disbursements are made, have been smaller than estimated. The Livestock Development project, Credit 129-KE, encountered difficulty in recruiting management officers; this problem has now been resolved and the Credit was declared effective May 1, A forest plantations loan in the amount of $2.6 million has been negotiated and will be presented to the Executive Directors in the near iature. A Second Education project has been appraised and should follow..ater in the year. In addition a number of other projects are under consideration, including a water supply project for Nairobi, an electric power project and an airport project.

4 -3- S. During negotiations, the Kenya Delegation informed the Bank of the Government's intention to file a request for financing purchases of road maintenance equipment. The role of the Bank Group in developing Kenya's road system lends importance to such a project, which also would provide for a thorough overhaul of maintenance administration. 10. In addition to the above loans and credits, the Bank has made four loans for cormon services in East Africa, three of them for railways and/or harbors and one for telecommunications. All four loans are guaranteed jointly and severally by Kenya, Tanzania and Uganda, with the United Kingdom also being a guarantor for the first loan for railways. Below is a summary statement of these loans as of August 31, Amounts in US $ million No. Year Borrower Purpose Bank Undisbursed 110-EA 1955 East African Railways Corporation 1/ 3/ Railways BAk 1966 East African Railwxays Corporation 2/ 4/ Railways East African Harbours Corporation 2/ 4/ Harbors 5.6 2,5 483-EA 1967 East African Posts and Telecommunica- Teleconmmunitions Corp. 2/ 4/ cations EA 1969 East African Harbours Corporation 4/ _/ Harbors Total (less cancellations) of which has been repaid to Bank and others 14.8 Total now outstanding 95.2 Amount sold: 23.8 of which has been repaid: Total now held by Bank Total undisbursed / Loan made originally to East Africa High Commission 2/ Loan made originally to East African Cormon Services Authority 3/ Guaranteed jointly and severally by the United Kingdom, Kenya, Tanzania and Uganda. / Guaranteed jointly and severally by Kenya, Tanzania and Uganda. 5/ This loan was signed on August 25, 1969, but is not yet effective.

5 11. TEo more Community projects are being processed, one for railways and another for teleconmunications in which Sweden may participate. 12. IFC has invested US $3.1 million in loans and shares in Kenya Hotel Properties Ltd. for hotels and game park lodges. Currently, the IFC is considering particip±i.ng writh the Government and other interested parties, in a pulp and paper mill which eventually would use pulpwood from plantations included in the forest plantations project proposed for Bank financing. PART II - DESCRIPTION OF THE PROPOSED LOAII 13. BCRROWER: The Republic of Kenya A1OUNIT: PURPCSE: AM4ORTIZATION: INTEREST RATE: CCI24ITMENT CHARGE: US $23.5 million equivalent in various currencies To finance the foreign exchange component of a high priority portion, costing $35.1 million, of the Government's road construction program for years including 10 years of grace, in semi-annual payments, beginning September 1, 1979 and ending September 1, % per annum 3/4 of 1% per annum ESTIMATED ECONOMIC RETURN: 15-18% on the four major categories of roads PART III - THE PROJECT 14. An appraisal report entitled "Appraisal of a Third Highway Project, Kenya,, (PTR-24a) on the proposed project is attached. The total cost of the project is $36.3 million. For the purpose of financing it is proposed to divide the project in two parts, Part I costing $35.1 million against which the proposed loan of $23.5 million would be made, and Part II costing $1.2 million, described in paragraph 15 below.

6 Fart I of the proposed project consists of: A. construction or reconstruction of: (i) (ii) (iii) (iv) five sections of trunk roads, totalling about 85 miles eighteen sections of feeder roads, totalling about 288 miles about 218 miles of roads in Phase II of the agricultural road program in the sugar-growing area of Miwani-Chemelil-Yuhoroni-Koru about 366 miles of tertiary roads in settlement areas B. engineering services in respect of: (i) detailed engineering of one trunk road included in A(i) and two feeder roads included in A(ii) (ii) investigation and engineering of required road improvements in settlement areas, including those in A(iv) (iii) (iv) supervision of all works listed under A above a study of the organization of the Ministry of Works and the implementation of its recommendations. 15. Part II of the proposed project consists of the portion of Phase II of the Government's agricultural road program for sugar-growing areas, which is not included in item A(iii) above. The Government requested that this portion be separated from the Third Highway Project and added to the project financed under Credit 10h-KE in order to enable the Government to util:ize a balance of $800,000 of Credit 104-KE not needed for completion of the original project. The Government expects that Part II would be completed by end May 1970, but that another 12 months would be needed to allow for the disbursement of the usual retention funds. The closing date of Credit 104-KE would, accordingly, be postponed from the present December 31, 1969 until May 31, Disbursements would be in respect of foreign expenditures. 16. The project as a whole will bring major benefits to agriculture and tourism. The various road sections in the project are widely dispersed, and in some cases sections constructed under earlier Bank/IDA projects will 'be improved to talce care of subsequent traffic growth; thus the project 'epresents a logical extension to the Bank Group's road financing in Kenya.

7 - 6 - I7. The Roads Branch of the Ministry of Works would have overall responsibility for executing the project. The Ministry has the capacity to undertake this task assuming continued reliance on expatriate engineers and the planned use of contractors. With Kenya's existing bilateral aid agreements, replacement of engineers whose contracts expire should not be difficult. Tertiary roads in settlement areas ($1.6 million of proposed loan) would be constructed by the Ministry's own forces since the nature of the work is not suited for execution on contract; two feeder roads ($0.4 million of proposed loan) would be constructed by extension of contracts awarded under Credit 120-KE, and the remaining work would be awarded to contractors on the basis of international competitive bidding. 18. The proposed loan would cover the foreign exchange component of Part I of the project, while the Government would provide the local currency. The loan proposed includes about $300,000 for financing of engineering services contracted to prepare the project and paid for by the time the loan is expected to be signed. Part I of the project would be physically completed by the end of 1972 and the closing date is set 12 months thereafter to provide time for payment of retention money. PART IV - LEGAL fistrumyents AND AUTHORITY 19. The Draft Loan Agreement between the Bank and the Republic of Kenya, and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreemient and a Draft Resolution are being distributed to the Executive Directors separately. The Draft Loan Agreement conforms generally to the pattern of existing Bank and IDA Agreements for road development projects. There is only one exception, the requirement in Section 5.15 that "the Borrower shall take all necessary action to improve the operational efficiency of the sugar industry..." Tnis provision is directed at problems, largely of management, which fall outside the immediate scope of the proposed project but which could affect the economic return of the agricultural roads included in it. 20. In addition to the documents mentioned above, a draft amended Schedule (Description of Project) to Development Credit Agreement No. 104-KE, dated May 11, 1967, is distributed to the Executive Directors of the International Deve].opment Association. The amendment adds to the project description the roads colstituting Part II of the project described in paragraph 15 above.

8 - 7 - PART V - THE ECONOMY 21. An Economic Report entitled "Prospects for Economic Development in Kenya,, (Vol. II of AF-58b, dated August 31, 1967) was distributed to the Executive Directors early in September, 1967 (R67-148) and updating memorandum, "Recent Developments in the East African Community, Kenya, Tanzania and Uganda" (AF-74), was distributed to the Executive Directors in April 1968 (R68-52). 22. An economic mission visited Kenya in April/May this year to appraise the new Development Plan and its report was discussed with the Kenya Government at the end of August. The report will form the basic documentation for a meeting of the Consultative Group on East Africa which will be held in December. It will be distributed to the Executive Directors before the end of October. 23. The real growth of the Kenyan economy over the past five years has been high - just over 6 percent a year. This is a remarkable achievement in the face of falling export prices for its major export commodities, unfavorable weather conditions, disease afflicting certain crops, and restrictions imposed on Kenya's exports by Tanzania and Uganda. Thus, even when account is taken of Kenya's rapidly rising population (about 3 percent a year), there has been a significant increase in real income per capita since Other indicators of Kenya's recent economic development have been an increasing investmant rate (rising from 13.7 percent of GDP at market prices in 1964 to 19.5 percent in 1968) and a savings rate of around 20 percent. The balance of payments on current account has moved from surplus to deficit, but there has been an overall surplus despite losses resulting from the devaluation of sterling in Hence, Kenya's foreign exchange reserves have increased and in April 1969 they amounted to the equivalent of five months' imports. 25. Kenya's successful economic growfth in recent years has been due in considerable part to a pragmatic and well-directed development policy and this can be expected to continue. It has been assisted, however, by an "early start" in the development of manufacturing and of a range of services (banking, insurance, etc.) particularly when compared to the other countries in the East African Common Market. The uncertainty over the inplementation of the Common Market system has restrained investment in this sector and is one of the causes of the present high degree of liquidity in the economy. At the present time Kenya's problem is less one of finding resources for needed development projects than of following policies, internally and in relation to its Common Market partner states, which will encourage the maintenance of a high level of investment, particularly private investment.

9 The Development Plan incorporates a public expenditure program for the financial years 1969/70 through 1973/74 amounting to KE 180 millions, of which half will be financed from internal sources. The plan projects a growth rate of 7 percent a year at constant prices, wrhich is probably a little higher than is likely to be achieved. Gross fixed capital formation over the period is expected to amount to about K' 670 million at constant prices, of which about 60 percent would be generated in the private sector. This implies that investment would increase at an average rate of some 10 percent a year from 1968, compared with an annual growth rate of 14 percent between 1964 and In its draft report the economic mission estimated that the total foreign exchange gap over the plan would be slightly over KL 180 million which, allowing for the undisbursed part of loans already approved (KL 30 million) would leave some Kb 150 million to be financed. It is estimated that about Kb 80 million of this could be met by inflows of private capital, including both equity capital and suppliers' credits. At the end of 1968 Kenya's external public debt stood at $343.2 million. If Kenya's notional one-third share of the East African Community's external debt is included, the total amount is increased to $408 million, giving a debt service ratio of a little under 7 percent. The net overseas borrowing required to meet the foreign exchange gap projected in the new development plan would mean that the debt service ratio would increase to between 10 and 12 percent by 1974, depending upon the terms of assistance made available. 28. The assassination of the Minister of Economic Planning and Development in July, 1969 constituted a severe challenge to political stability and tribal balance in Kenya. General elections must be held, by mid 1970 and as the time draws near political differences can be expected to become sharper. However, the demonstration of the Government's ability to maintain order in recent months provides a basis for optimism regarding Kenya's political stability. In view of both political and economic prospects, Kenya can be considered creditworthy for the proposed loan. PART VI - COMPLIAiNCE WITH ARTICLES OF AGREEMENT 29. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.

10 PART VII - RECCIvYIENDATION 30. I recommend a) that the Executive Directors of the Bank approve the proposed loan; and b) that the Executive Directors of the Association approve: i) the proposed amendment to the Description of Project for Development Credit Agreement 104-KE, and ii) the postponement of the closing date for this Credit to May 31, Robert S. McNamara President Attachments

11 Basic Data Area: Total - 225,000 sq. miles = 582,750 square kilometres Land area - 219,800 sq. miles = 569,252 square kilometres Population: (mid-1968 estimate): million Rate of growth: 3.0 percent Population density: Total land area per sq. mile Arable land area - about 450 per sq. mile Literacy Rate 1968: 30 percent estimated Political Status: Republic since Independence on December 12, 1963 Member of the British Commonwealth & the Sterling Area * Gross Nifational Product at Factor Cost (1968): K 420 million - ($1,176 million) GNP per capita (l968) Ki 41.1 ($115.1) GDP (at factor cost) Growth Rate: Constant 1964 prices 6.3% 6.6% Current prices 6.8% 5.9% Investment & Savings: K MillJon * Gross Fixed Capital Formation Change in Stocks Gross Capital Formation 47.7i Balance of Goods and Non-Factor Services Gross Domestic Saving Net Factor Income Payments Gross National Saving 5544 _7960 Capital Formation as percentage of GDP at factor cost 15.5% 22.2% Gross Domestic Saving percentage of GDP at factor cost 20.4% 21.0% Gross National Saving percentage of GNP at factor cost 17.1% 19.0% * provisional figures

12 Balance of Payments: KX Million * Exports of Good & Non-Factor Services Imports of Goods & Non-Factor Services Balance of Goods & Non-Factor Services Net Factor Payments Net Transfers Balance of Payments on Current Account Net Private Long-Term Capital Inflow Net Public Long-Term Capital Inflow Net Short-Term Capital Movements Change in Reserves - Increase (-)/Decrease (+) Budget: K Million 1966/67 Current Revenue Current Expenditure Current Surplus 3.77 Capital Revenue 4.55 Balance 8.32 Capital Expenditure Overall Deficit -1 Financed by: Internal Grants & Loans 7.85 External Grants & Loans 7.98 Increase in Cash Balance 0.65 Foreign Exchange Reserves (April, 1969): Total: K 52 million ($146 million) Equivalent to: 5 months' imports External Debt (31 December 1968): $ thousand Including Disbursed Undisbursed Total Debt Outstanding 254, Kenya: Notional 1/3 share of East African Community Debt: 58,706 64,864 TOTAL 313, ,016 Total Debt Service Kenya: 17,799 Notional 1/3 share of East African Community Debt: 10,935 TOTAL DEBT SERVICE 28,734 Debt Service Ratio: 6.9%

COPY FILE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION. September 23, 1969 REPORT AND RECOMMENDATION

COPY FILE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION. September 23, 1969 REPORT AND RECOMMENDATION Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized FILE COPY RESTRICTED Report No. P-742 This report was prepared for use within the Bank