The World Bank FOR OMCLAL USE ONLY. Report No Public Disclosure Authorized. Document of. Public Disclosure Authorized

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OMCLAL USE ONLY PROJECT COMPLETION REPORT KENYA FOURTH INDUSTRIAL DEVELOPMENT BANK (IDB IV) PROJECT (LOAN 1817-KE) DECEMBER 31, 1992 Public and Private Enterprise Division Eastern Africa Department Africa Region Report No This document has a restricted distribution and may be used bv recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EOUIVALENTS Currency Unit - Kenya Shilling (KSh) = 100 cents FY79: US $ - KSh 7.33 FY80: US $ - KSh 7.42 FY81: US $ - KSh 9.05 FY82: US $ - KSh FY83: US $ - KSh FY84: US $ - KSh FY85: US $ - KSh FY86: US $ - KSh FY87: US $ - KSh FY88: US $ - KSh FY89: US $ - KSh FY90: IJS $ - KSh FY91: US $ - KSh FY92: US $ - KSh ABBREVIATIONS AND ACRONYMS USED DFC - Development Finance Corporation DFI - Development Finance Institution EADB - East African Development Bank GOK - Government of Kenya ICDC - Industrial and Commercial Development Corporation IDB - Industrial Development Bank ISAC - Industrial Sector Adjustment Credit NBFI - Non-bank Financial Institution PRPC - Parastatal Reform Programme Committee FISCAL YEAR (1DB) January 1 - December 31 (until FY86) June 30 - July 1 (starting FY87)

3 THE WORLD BANK Washington, D.C U.SA FOR OFFICIAL USE ONLY Office of DIrector-General Oporatlons Evaluation December 31, 1992 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Kenya - Fourth Industrial Development Bank Project (IDB IV) (Loan 1817-KE) Attached is a copy of the report entitled "Project Completion Report on Kenya - Fourth Industrial Development Bank Project (IDB IV) (Loan 1817-KE)" prepared by the Africa Regional Office, with Part II contributed by the Borrower. The main objectives of the loan - institution building and promotion of viable and exportoriented investments - were not met. IDB has failed to develop an appropriate organizational structure, systems and procedures. It has not been able to operate on sound banking principles and financial discipline. Its project selection has not been rational, due to perfunctory economic analyses and external interventions in its decision-making process. Unable to extricate itself from past investment decisions, idb now faces intractable portfolio problems. Sustainability is unlikely. The overall outcome of the project is rated as unsatisfactory. The Bank's performance has left much to be desired. Having been involved in successive operations, it exercised poor judgment in going ahead with IDB IV and, having done so, it remained an inactive bystander in the face of IDB's slow disintegration. The PCR is comprehensive and of good quality. It provides reasons for the poor operational results, and points out deficiencies in both IDB's and the Bank's performance. Attachment This document has a retrkted distnbution and may be used by recpieutts oly in the perfonnance of their official dutie. Its coutents may not otherwise be disclosed without World Bank authorization.

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5 FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT KENYA FOURTH INDUSTRIAL DEVELOPMENT BANK (tdb IV) PROJECT (LOAN 1817-KE) TABLE OF CONTENTS Page No. PREFACE... EVALUATION SUMMARY.....iii PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE Project Identity Background and Sectoral Context Project Objectives and Description Project Design and Organization Project Implementation Major Results of the Project Project Sustainability Bank Performance Borrower Performance Project Relationship... 9 PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE Project Design and Organization Project Implementation Sub-Loans Major Results Project Sustainability Reform and Restructure Lessons Learnt Action Programme for Restructuring/Divestiture of Industrial Parastatals and Financial Restructuring of Industrial Development Bank Limited This document has a restricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization.

6 TABLE OF CONTENTS (cont'd.) PART III: STATISTICAL INFORMATION Page No. 1. Related Bank Loans Project Timetable Loan Disbursements Mission Data Resource Mobilization (Foreign Exchange) by IDB Sub-projects Financed under IDB IV Lending Operations, FY80-FY IDB Analysis of Loans in Arrears, IDB Sectoral Distribution of Loan Portfolio IDB Balance Sheets, FY80-FY IDB Income Statements, FY80-FY IDB Source and Use of Funds Statements, FY80-FY IDB Financial Ratios, FY80-FY IDB Evolution of Staffing, IDB Equity Portfolio and Categorization by the Parastatal Reform Programme Committee.34

7 PROJECT COMPLETION REPORT KENYA FOURTH INDUSTRIAL DEVELOPMENT BANK (IDB IV) PROJECT (LOAN 1817-KE) PREFACE 1. This is a Project Completion Report (PCR) for the Industrial Development Bank (IDB) Project of Kenya. This was the fourth IDB Project financed by the Bank. The loan was approved by the Board on March 27, The loan was closed on December 31, 1988, after making three extensions at the request of the Government of Kenya (GOK) and the Borrower (IDB). US$1.45 million of the loan amount was undisbursed and canceled. The final loan amount, US$28.55 million, was fully disbursed and the last disbursement was made on September 13, This PCR was prepared by the Public and Private Enterprise Division of the Eastern Africa Department, Africa Region. It is based on the Staff Appraisal Report, the Loan and Project Agreements, Supervision Reports, correspondence between the Bank and the GOK and the Borrower, and internal Bank memoranda.

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9 - iii - PROJECT COMPLETION REPORT KENYA FOURTH INDUSTRIAL DEVELOPMENT BANK (tdb IV) PROJECT (LOAN 1817-KE) EVALUATION SUMMARY Objectives 1. This project was implemented by the Industrial Development Bank (IDB) which had previously been involved with three Bank/IDA lending operations. The objectives of the project, which were to be achieved through IDB's financing industrial development sub-projects were threefold. First, the project would support industrial development in Kenya in line with the Government's Fourth Development Plan ( ). Second, specific emphasis would be provided to expansion of public and private investment in export-oriented or import-substituting industries, particularly in areas outside Nairobi and Mombasa. Third, the project would support strengthening of IDB's internal procedures and improvement in its profitability. Implementation Experience 2. The project implementation experience was reviewed from two perspectives. (a) The status of the various sub-projects funded under the project was reviewed (para 5.3); IDB's performance against the above three goals was not satisfactory. First, though loan funds were utilized to provide term financing for medium- and large-scale manufacturing enterprises it was at a much slower pace than estimated at appraisal; three extensions of the closing date were required before IDB was able to disburse 95% of the loan amount. This was attributable primarily the world recession and the sluggish economy in Kenya which reduced demand for industrial loans. Second, of the companies to which loans were disbursed, 12 were put into receivership. Third, about 45% of the disbursements were for import substitution sub-projects and 49% of the disbursements were to sub-projects based in rural areas. Fourth, the slower pace of lending was accompanied by reduced portfolio quality as subprojects were affected by time and cost overruns. (b) Second, the performance of the overall portfolio of the institution was also reviewed (para 5.4 and 5.5); there was a decline in approvals, a high level of arrears in the portfolio and distress in all major sectors of the portfolio. These in turn led to liquidity problems which required high, yet inadequate, levels of provisioning that eroded IDB's profitability and viability. Results 3. In summary, 95% of the total amount of the loan (US$30 million) was disbursed (although three years beyond the programmed horizon), 49% of disbursements were to projects in rural locations and 45% was committed for import substitution subprojects. The results were unsatisfactory since of the companies to whom the 29 subloans were disbursed, 12 have been put under receivership (leading to sale or liquidation), 11 have fully repaid their loans or refinanced them through local borrowing, 1 did not start production due to lack of working capital resulting from cost overruns during

10 - iv - implementation and 5 are still active (a majority of these having had their loans rescheduled). Given the unsatisfactory operating performance of the firms, the impact on the real sectors of the economy-industrial value added, exports and employment was probably limited as well. Sustainability 4. The majority of the funds disbursed under the project went to enterprises which themselves became non-viable; sustainability of economic and social benefits is low. Further, this non-viability and consequent non-repayment of loans led to deterioration in IDB's overall portfolio. In 1989, GOK and the Bank included funding for a consultants study of parastatal restructuring under the Industrial Sector Adjustment Credit (Credit 1927-K(E). A broad restructuring plan for financial parastatals covering revised mandates, funding, strategy, organization and the lending/investment process within these institutions was completed in October In 1990, further funding was provided through the Financial Parastatals Technical Assistance Project (Credit 2147-KE) for technical support for the implementation of restructuring plans for IDB (and another DFI, ICDC), design of corporate workouts for client firms and training for staff of the two DFIs. Findings and Lessons Learned 5. The project was not successful in achieving its objectives. The following lessons have been learned from IDB's performance, and from the Bank's performance in monitoring IDB: (a) The macro economic environment in which the project was to be undertaken was an important variable meriting explicit consideration as was the absorptive capacity of the nascent entrepreneurial class. (b) (c) An institutional development program that would have strengthened the management and organizational structures, procedures and staff skills of the financial institution should have been implemented prior to or simultaneously with the project. IDB was unable to manage many of the internal and marketing processes that are critical to the successful commercial operation. This was demonstrated by the fact that IDB was unable to mobilize domestic currency, keep and attract old clients and retain its staff. In the initial stages of IDB's distress, the Bank may not have been proactive enough at problem solving though it did closely monitor the situation through regular supervision missions. Though the project had been classified a "problem-project" almost since its effective date (Table 4), insufficient corrective measures seem to have been taken to stabilize the situation. The Bank did, however, begin the process of restructuring IDB through an active dialogue with the Government of Kenya and through funding under the Industrial Sector Adjustment Credit (Credit 1927-KE) and the Financial Parastatals Technical Assistance Project (Credit 2147-KE).

11 PROJECT COMPLETION REPORT KENYA FOURTH INDUSTRIAL DEVELOPMENT BANK (IDB IV) PROJECT (LOAN 1817-KE) PART 1: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE 1. Prooect Identity: Project Name Loan Number RVP Unit Country Sector Industrial Development Bank (IDB Project) 1817-KE Africa Region, Country Department II Kenya Finance; DFC 2. Backeround and Sectoral Context 2.1 Since independence in 1963, Kenya has given high priority to industrial development. Kenya created an environment conducive to attract predominantly import-substitution industries, especially those producing final consumer goods. Remarkable achievements were registered in industry, particularly during the first decade after independence. Despite this success, there was growing concern in the mid 80s that: (i) import-substitution industrialization might be reaching the limits of efficiency, (ii) the economy might be becoming highly import dependent, and (iii) employment was not expanding rapidly enough. 2.2 The Fourth Development Plan ( ) recognized the need for a change in the main thrust of industrialization strategy and to this effect the following objectives were set: (a) (b) to encourage greater efficiency in local industrial production and to improve international competitiveness of Kenyan manufactured goods; and to promote the development of export oriented industries. To achieve these objectives, the Government of Kenya (GOK) needed to restructure the trade regime over the Plan period, including (a) rationalization of tariffs, (b) elimination of quantitative restrictions and "no objection certificates," (c) phasing out of duty concessions to new industries, and (d) expansion of promotional and incentive schemes for exports. It was envisaged that implementation of these measures would be gradual. 2.3 Consistent with the GOK's industrial development objectives presented in the Fourth Development Plan, IDB's overall lending strategy aimed at financing medium to large projects generally, and included proposed sectoral distribution objectives for private, public, foreign and Kenyan ownership, regionally balanced industrialization, and export-oriented and efficient import-substitution industries. This strategy was also expected to lead to improved income distribution and employment generation.

12 Project Objectives and DescriRtion 3.1 Project Objectives. The project concept was based on previous IDB projects (Loans 946-KE, 1148-KE, and 1438-KE) (Table 1). Its main objectives were to (i) support the GOK in realizing its industrial development policies by encouraging new industrial investment, Kenyan ownership of industry, industrial efficiency and greater export orientation, (ii) develop IDB as a vehicle for the provision of term and equity financing in Kenya, particularly for foreign exchange requirements, to medium and large scale enterprises, and (iii) strengthen IDB's internal organization and procedures, and improve profitability. To support these objectives, the Bank provided a loan of US$30 million. 3.2 Project Components. The project had one component: US$30 million to help finance the foreign exchange component of IDB's investments in medium and large scale industrial projects in Kenya. Subsequently, in January 1984, the Bank agreed to reserve US$5 million of the total US$30 million loan for financing imported raw material subloans to subprojects meeting minimum new foreign exchange benefit criteria. 4. Project Design and Organization 4.1 Based on the subproject pipeline at appraisal, and new subprojects coming into the pipeline, IDB's total approvals were expected to grow at an annual average of 12% over the period. On this basis, IDB's resource gap during the period between mid-1980 to the end of 1982, was estimated at about US$46.3 million, of which US$30 million, representing 65% of IDB's needs in foreign exchange, was to be financed under this project. The balance of US$16.3 million was expected to be secured by IDB through additional lines of credit from other donors. While the project design methodology reflected substantial demand for investment funds, actual demand turned out to be much lower. More consideration should have been given to the following factors: (a) The Kenyan economy, and the manufacturing sector in particular, underwent significant expansion during the 1970s. At the time of this loan, the "boom" was losing steam. (b) (c) (d) Starting from the latter part of the 1970s, oil price increases contributed significantly to bring about a period of global recession. World economic conditions started affecting Kenya. Moreover, the country was experiencing prolonged drought, a continuing decline of coffee prices and rising petroleum prices; and balance of payments appeared likely to be major constraints on Kenyan growth over the next few years. The prevailing economic environment, therefore, was not conducive to credit demand. Thus, the economic reality in which IDB was operating was not sufficiently recognized and attempts were not satisfactorily made to scale down the amount of the loan. In designing the project, greater attention should have been paid to the low absorptive capacity of IDB and Kenya's nascent entrepreneurial class. This was a fourth loan with which the Bank financed IDB. Commitments and disbursements for all three loans (US$35 million) proceeded more slowly than anticipated and US$1.8 million was canceled from the third loan (1438-KE). The second loan (1148-KE) required a one-year extension of the closing date for full disbursement. Although IDB's performance in implementing the preceding loans was satisfactory, there were clear signs that the fast pace of historical growth had placed increasing strain on the institution and the quality of its work. Decline in the quality of its appraisal and supervision of subprojects, poor profitability record and a high level of arrears, high

13 - 3 - administrative expenses, low spread on operations and poor collection procedures were of concern. 5. Project Implementation 5.1 The project was a follow-up project and it started on time. Despite this, implementation was not satisfactory. IDB confronted substantial problems, many of which stemmed from the recessionary domestic and international economic climate, and poor quality of appraisal and supervision which resulted in continuing deterioration in IDB's collection performance. The commitment date and the closing date of the loan were extended three times (Table 2), and disbursement under Loan 1817-KE officially ended on December 31, 1988 (Table 3). The undisbursed balance of US$1.449 million was canceled effective January 24, The project implementation experience was reviewed from two perspectives based on the data provided by the borrower. First, the status of the various sub-projects funded under the project was reviewed; the data available for this review is extremely limited and does not allow for an in-depth analysis. Second, the performance of the overall portfolio of the institution was also reviewed; given the lack of the data for the project itself and since the project subloans were an integral part of the overall portfolio, this analysis provides valuable insights into the implementation experience. 5.3 Subloans. Table 6 contains the available data on the subloans and indicates that: (a) (b) (c) Twenty-nine (29) subloans were approved and $ million were disbursed. At appraisal, it had been estimated that IDB was financing on average about 30% of investment cost of all projects; the data does not allow confirmation of this estimate. The eleven subloans which were above free limit (of $0.8 million) ranged between US$ million; the rest ranged from US$0.099 million to US$0.580 million. Four sub-projects, totaling US$2.861 million, were made as short-term imported raw material loans. All subloans had initial maturities of up to ten years although, in some cases, this was extended due to loan rescheduling. Of the companies to whom the 29 subloans were disbursed, 12 have been put under receivership (leading to sale or liquidation), 11 have fully repaid their loans or refinanced them through local borrowing, 1 did not start production due to lack of working capital resulting from cost overruns during implementation and 5 are still active (a majority of these having had their loans rescheduled). Significant cost overruns were experienced during implementation for the majority of the projects on account of delays in completing legal documentation coupled with changes in the exchange rate. Overruns were usually financed with funds intended for meeting working capital requirements (equity and/or short-term loans and over-drafts), thus subjecting projects to liquidity strains before commercial operations could begin. (d) Compliance with loan objectives regarding reduced import dependency was disappointing. 12 projects depended heavily on imports while 15 relied fully or partially on local raw materials. (e) IDB's projects continue to be located in urban areas, particularly Nairobi and Mombasa, with only 49% of the disbursements to projects located in the rural areas. 57% of the amount approved went for new projects, while the remainder of funds have been used for expansion and modernization projects or imported raw material loans.

14 Portfolio Performance (FY80-FY92). The overall portfolio displayed the same problems prevalent in the project-financed subloans. (a) Approvals. As indicated in Table 7, during 1980, when the project commenced foreign currency loans of 190 mm KSh (or US$25.6 million at the then exchange rate) were made. Smaller approvals were made for domestic currency loans (18.7 mm KSh or US$2.5 million) and equity investments (6.9 mm KSh or US$0.9 million). During the next decade, loan and equity approval levels demonstrated great volatility: (i) Foreign currency loan approvals peaked at mm KSh (US$25.0 million) in FY84 and then dropped precipitously to 47.9 mm KSh (US$3.3 million). A recovery up to mm KSh (US$15.1 million) in FY88 was followed by another decline up to 33.4 mm KSh (US$1.5 million) in FY90. (ii) From 1985 to 1988, IDB undertook a moderate volume of lending in imported raw materials including, as mentioned earlier, US$2.86 million from the project. (iii) Domestic currency loans have almost completely stopped since FY82 given IDB's liquidity crisis (para 5.5(a)). (iv) Equity investments over the period FY80-FY92 were minimal with less than 12 mm KSh being invested. Commitments and disbursements tended to lag approvals, as may be expected from the delays in sub-project implementation discussed in para 5.3 (c); from currently available data, the annual percentages of undisbursed approvals cannot be compared. (b) (c) Outstanding Arrears and Collection Performance. By FY81, 49% of the projects were affected by outstanding arrears over 3 months; the amount outstanding over 3 months was, however, lower at 18% of the portfolio (Table 8). This situation deteriorated further; between FY83-92, between 65-85% of the projects had arrears over 3 months. The amounts ranged between 200 mm KSh to 375 mm KSh between FY83-89 and ranged between 20-35% of total outstanding. In FY90, arrears over 3 months increased substantially to over 956 mm KSh (93% of outstanding. By FY92, the situation had improved somewhat with about 69% of total outstanding being for arrears over 3 months and 57% of the projects still affected by arrears. Collection performance on outstanding falling due within the fiscal year improved from around 75% in FY83-84 up to 90% and above in all FYs up to FY92 (except for a one-year decline in FY91) due to more intensive project monitoring and arrears follow-up efforts. IDB found, however, that many of its strongest projects were prepaying their loans (in order to avoid foreign exchange risk), thus leaving IDB weaker projects that were uncollectible. As a percentage of total outstanding due, the collection performance was not very high ranging between 20-35% between FY83-90 before declining to 12-14% in FY Sectoral Distribution of Loan Portfolio is presented in Table 9. The data provided by the borrower should be viewed with two caveats. First, there are some discrepancies between the number of projects presented in Table 8 (83) and Table 9 (50). Second, outstanding amounts in Table 9 include principal and interest in arrears. IDB's portfolio shows a wide range of subsectors including: tourism (35% of portfolio), textiles (13%), leather and agro-industries (9% each). All these sub-sectors have many troubled projects; in tourism, outstanding account for 83% of portfolio and for textiles and leather it encompasses 100% of the portfolio.

15 The impact of the portfolio problems on IDB's viability during FY80-92 are discussed further below based on the data presented in the Tables on: Balance Sheets (Table 10), Income Statements (Table 11), Sources and Uses of Funds (Table 12) and Summary of Financial Ratios (Table 13): (a) (b) (c) The primary problem for IDB has been illiquidity arising out of inability to collect back the funds onlent. This has made it difficult to fund ongoing expenses as well as to repay its debts. This was not readily apparent from its financial statements in the early 1980s. IDB did not suspend accrual of interest income on any debt, even if no payment had been received. Starting in 1983, the suspension of income commenced only on debt outstanding for more than 24 months. The appraisal report does not make any reference to requiring IDB to implement a policy in this regard; under current Bank guidelines for financial institutions (OD 8.30), accrual of interest income must cease on non-performing assets (assets on which amounts due remain unpaid for between 90 to 180 days). Implementation of such a policy would have considerably reduced income shown in IDB's books; in FY92, interest arrears receivable are mm KSh. Being unable to collect its debts, IDB commenced building up its provision for bad debts. The appraisal report contains a requirement that by December 31, 1982, the provision should be at least 3% of the portfolio. However, given the magnitude of the problem, this was extremely inadequate. By the end of FY92, IDB's provision for bad debts stood at almost 600 mm Ksh or over 50% of loan and equity portfolio and loan repayments in arrears. Of this amount, 222 mm KSh were provisions on the current portfolio (about 40% of portfolio) and 378 mm KSh were provisions against loan repayments in arrears (60% of arrears). IDB's problems are reflected in many of its financial ratios: liquidity problems show up in the current ratio (which hovered around 1 throughout the period), earnings performance shows in the low net profit/total average assets ratio which went over 1 % only in three FYs and was largely negative otherwise (this despite the recording of uncollectible income) and its inability to raise equity funds shows in the increasing long-term debt to equity ratio which increased from 1.4 in FY80 to 4.7 in FY Risk Assessment. There were no particular risks identified in the SAR other than those normally associated with DFC lending. However, IDB was going to implement a consolidation program in order to improve its internal quality control and supervision of existing projects. This program would result in a better selection of projects through a more critical review of the risks associated with them and requiring that a larger portion of equity investment be raised by sponsors. The risk of not implementing the consolidation program was not considered serious. A major project risk that was not considered was the impact of a devaluation on the borrowers to whom the foreign exchange risk had been passed on and who were also largely dependent on imports for production of their outputs. 6. Major Results of the Project 6.1 In summary, 95% of the total amount of the loan (US$30 million) was disbursed (although three years beyond the programmed horizon), 49% of disbursements were to projects in rural locations and 45% was committed for import substitution subprojects. The results were unsatisfactory since of the companies to whom the 29 subloans were disbursed, 12 have been put under receivership (leading to sale or liquidation), 11 have fully repaid their loans or refinanced them through local borrowing, 1 did not start production due to lack of working capital resulting from cost overruns during implementation and 5 are still active (a majority of these having had their loans rescheduled). The

16 unsatisfactory operating performance of the firms also indicates that impact on the real sectors of the economy-industrial value added, exports and employment were limited. 6.2 The results of the project on IDB were not positive either. Though, as shown in Table 5, IDB had been relatively successful in mobilizing external resources from official sources for its foreign currency lending requirements, it was unable to deploy these resources to effective use since the majority of the portfolio was invested in companies that became unviable. Further, due to the availability of foreign currency resources, a lesser focus was adopted on mobilizing local currency resources except for some additional share subscriptions from its existing shareholders. This situation was further exacerbated once the portfolio began to deteriorate since, in light of IDB's profitability and portfolio, such resources were even less readily available. 6.3 Finally, from an institutional development standpoint too, the project was not very successful. At the time of project appraisal ( ), the process of increasing emphasis on accelerating the flow of approvals and consequent decline in the quality of appraisal had commenced. The project was, hence, also designed to provide Bank support for IDB which entaied encouraging IDB to embark on a concolidation period which would strengthen appraisal standards in order to improve its future lending. Consolidation was not properly implemented, and as a result, limited success was achieved at making IDB an efficient and financially viable DFI. 7. Project Sustainability 7.1 As discussed in para 5.3 (b), the majority of the funds disbursed under the project went to enterprises which themselves became non-viable. Further, this non-viability and consequent nonrepayment of loans led to deterioration in IDB's overall portfolio, outstanding and collection performance (para 5.4) and to a situation where IDB's viability itself became a major issue (para 5.5). 7.2 Another critical element in IDB's sustainability is its staff. As shown in Table 14, as the institution's financial situation deteriorated, there was an increasing number of resignations as many of the senior and experienced professionals had left the institution either for better remuneration or dissatisfaction with the way the institution was managed. Senior staff members were very few and were overstretched. Junior staff whose number was not that significant were required to do the appraisal and monitoring of the projects. The outcome was poor job performance. 7.3 It was with serious concern regarding the viability of IDB and related development finance institutions in Kenya that, in 1989, GOK and the Bank included funding for a consultants study of the sector under the Industrial Sector Adjustment Credit (Credit 1927-KE). This study and complementary information from sector studies came to many of the same conclusions as have already been discussed : policy related and strategic deficiencies in their roles, financing arrangements that incorporate asset/liability mismatches, internal structural flaws and inadequate information, control and analytical processes which circumscribed their effectiveness. A broad restructuring plan covering revised mandates, funding, strategy, organization and the lending/investment process within these institutions was completed in October 1989 in compliance with conditions for the release of the second tranche of the ISAC. Recognizing the critical nature of the restructuring plan in terms of restoring financial viability to the DFIs, in 1990, the Government and IDA developed the Financial Parastatals Technical Assistance Project (Credit 2147-KE). The three components of this project are: to provide technical support for the implementation of restructuring plans for IDB (and another DFI), design of corporate workouts for client firms and training for staff of the two DFIs.

17 The status of work funded through the TA credit is that consultants have been hired and submitted a draft report which is being reviewed by the Government, the DFIs and IDA. The restructuring plan is well underway and the following major activities and their status are provided below: (a) Revision of DFI mandate. Implementation was completed but treatment of Social Projects (i.e. projects undertaken on non-commerical grounds) has not yet been defined; (b) (c) Restructuring of IDB. Implementation is in an advanced stage and standard policies and operating procedures have been developed by the consultants in consultation with IDB and have been sent to the Government for review and approval; and Financial Restructuring. i) Management of Exchange risk is in an advanced stage of implementation; ii) Implementation of sub-project loan rescheduling was inadequate because of the mismatch between IDB receipts and payment; iii) Little action has been taken to carry out the corporate restructuring plan; iv) Implementation of parastatal divestiture and non-parastatal companies was unsatisfactory. Out of 22 parastatals, only 7 have been approved by PRPC for divestiture and only 1 was sold and none of the 19 non-parastatal companies under receivership has been completely liquidated or sold; and v) Financial restructuring of IDB needs to be undertaken. Since its equity is currently negative, IDB needs to be recapitalized. Hence, even though restructuring has commenced, tough decisions lie ahead (i.e. liquidation of companies, unveiling of hidden losses, drastic recapitalization and/or reduction of staff/activity, etc.) which will require substantial political will to take and implement. 8. Bank Performance 8.1 Despite the project's deficient financial and investment performance, IDB has been an essential institution, and the Bank's contribution to IDB's establishment and growth, both in an advisory capacity and as a lender, was commendable. However, the Bank's endeavor on institutional development has not been fully effective to address the weaknesses in IDB's operations and to have any impact on the overall financial environment. The magnitude of IDB's arrears, bad debt losses and low collection ratios demonstrate weaknesses resulted from lack of taking heed to the lending environment and the deficient appraisal processes. 8.2 The Bank's supervision of the project was not effective. Between 1980 and 1988, 12 supervision missions, almost one every six months, visited IDB (Table 4) and held discussions with GOK and other relevant institutions on IDB's performance and problems; nevertheless, the Bank was unable to institute significant change in the deteriorating operating and financial performance of IDB. These missions kept close track of IDB's overall performance and especially of its collections, supervision and appraisal. Based on the supervision missions' findings, IDB (directly) and GOK (by

18 - 8 - copies of the letters sent to IDB) were cautioned about the continually deteriorating operating performances of IDB. As there was no sign of significant improvement, the project continued to be classified as a problem project until it was closed in 1988 (Table 4). With the benefit of hindsight we may be led to think that the Bank was concerned only with consideration of a possible fifth line of credit for IDB. However, the Bank had already begun to move on the issues of restructuring IDB (and other DFIs) in the context of the ISAC and, in 1989, a Restructuring Plan was being implemented as part of the tranche release conditionality for that project. By 1990, the Bank was even more closely involved in the restructuring process for IDB by funding a Financial Parastatals Technical Assistance Project. 8.3 Lessons Learned. Although 95.2% of the total amount of the Loan was disbursed, from the Bank's perspective, the project did not meet its objectives. The following important lessons have been learned from IDB's performance and from the Bank's performance in monitoring IDB: (a) The macro economic environment in which the project was to be undertaken was an important variable meriting explicit consideration as was the absorptive capacity of the nascent entrepreneurial class. (b) (c) An institutional development program that would have strengthened the management and organizational structures, procedures and staff skills of the financial institution should have been implemented prior to or simultaneously with the project. This is especially important for state-owned enterprises which are required to compete in markets if they have not previously been exposed to commercial principles. In IDB's case, it was unable to manage many of the internal and marketing processes that are critical to the successful commercial operation. This was demonstrated by the fact that IDB was unable to mobilize domestic currency, keep and attract old clients and retain its staff. In the initial stages of IDB's distress, the Bank may not have been proactive enough at problem solving though it did closely monitor the situation through regular supervision missions. TMough the project had been classified a "problem-project" almost since its effective date (Table 4), insufficient corrective measures seem to have been taken to stabilize the situation. The Bank did, however, begin the process of restructuring IDB (and other distressed DFIs in Kenya) by funding a consultant study under the Industrial Sector Adjustment Credit (Credit 1927-KE) and requiring implementation of a restructuring plan prior to release of second tranche of that loan in In 1990, further funding for the restructuring process for IDB (and ICDC, another DFI) was provided under a Financial Parastatals Technical Assistance Project (Credit 2147-KE). 9. Borrower Performance 9.1 IDB was successful in mobilizing resources, particularly foreign currency, and invested in term loans and equity portfolios in medium- and large-scale sub-projects and generated social and economic benefits (Table 5). However, (i) sub-projects were affected by cost and time overruns which reduced the economic benefits; (ii) the reliance of most sub-projects selected was on using imported raw materials, and this would not stimulate production and using locally produced raw materials; and (iii) location of sub-projects did not produce balanced growth and distribute the social and economic benefits because over 50% of disbursements were to sub-projects in Nairobi/Mombasa. 9.2 An important deficiency in IDB's performance was the search for a greater business volume that took precedence over selectivity in lending. The quality of subloan appraisals had been declining over the years. Appraisals were done without paying adequate attention to the competitiveness of

19 - 9 - projects, market, pricing and risk assessment. Following the effectiveness of the Loan Agreement it was agreed that IDB would use the first two to three years for embarking on a period of consolidation. The consolidation program was not implemented as expected, contributing to the continuing deterioration of the operational performance of IDB. 10. Project Relationship 10.1 The relationship between GOK and the Bank was satisfactory. The same can be said about the relationship between the Bank and IDB. IDB was cooperative and willing to accept the Bank's recommendations. Overall, it had satisfactory rapport, but it was structurally unable to implement the Bank's recommendations.

20 - 10- PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE 1. As stated in the Project Review by the World Bank, the main objectives of the project were: a) To support the Government of Kenya in realizing its industrial development policies by encouraging new industrial investment, Kenyan ownership of industry, industrial efficiency and greater export orientation; b) To develop IDB as a vehicle for the provision of term and equity financing, particularly for foreign exchange requirements, to medium and large scale enterprises; and c) To strengthen IDB's internal organization and procedures, and improve profitability. It is against these broad objectives that the evolution and implementation of the project has to be evaluated. Project Design and Organization: 2. As stated in the Report, IDB's credit requirement was based on projected requirements for subprojects in the pipeline and those new ones which were expected to come into the pipeline. It was then projected that IDB would fully commit the US$30 million credit from the World Bank by the end of However, as it turned out only US$17,303, had been committed by this date to 14 subprojects. This was as a result of much lower demand than projected for. The report has highlighted some of the major causes of this slack demand as being: a) Global recession and world economic conditions prevailing in the latter part of 1970s which also affected Kenya. b) The country experienced prolonged drought. c) The prices of coffee continued to decline while those of oil were rising. These conditions resulted in severe balance of payment problems which constrained the growth of the economy and hence credit demand. On hindsight, the observation made in the Report that the economic reality in which IDB was operating was not sufficiently recognized and (that) attempts were not satisfactorily made to scale down the amount of loan is fairly accurate. GDP growth had continued to decline from 8.6% in 1977 to 5.7% in 1978, 4.1 % in 1979 and 2.4% in Similarly, growth in the manufacturing sector declined from 7.9% in 1979 to 4.6% in If this trend in the economy had been adequately considered, it would have been realized that IDB would not possibly commit the US$30 million within the projected period. Although there were, say, 23 loan approvals in 1981 alone, most of these were local currency financed under the Medium-Scale Enterprises Scheme (MSES). Indeed the level of approvals declined to 10 in 1982 and further to five each in 1983 and It should, however be noted that IDB was also trying to consolidate its portfolio during this period, and that a number of prospective clients were put away by the high rate at which the Kenya Shilling was depreciating against major convertible currencies. In 1981, the Kenya Shilling was devalued by 22% and further by 15% in 1982.

21 Project Implementation: 4. The Report notes that as a result of necessary domestic and international climate, poor quality of appraisal and supervision, the implementation of the project was not satisfactory. It is true that commitment and closing dates were extended three times with the last disbursement date officially ending on December 31st Even then, there was still an undisbursed amount of US$1,448, which was eventually canceled on January 24th This long period that it took to commit the loan fully may also be attributed to IDB's over-enthusiasm already alluded to above when estimating total requirements over the initial project period, and latter attempts to consolidate the existing portfolio. As already mentioned above, unfavourable foreign exchange fluctuation put away viable projects. Huge balance of payment deficit, excess capacities and accumulation of stocks called for extreme caution over investment decision by prospective investors resulting in IDB approving fewer projects than anticipated. A number of approvals also ended up being cancelled. Sub-Loans: 5. The information on sub-projects given in the Report is generally correct and the figures therein fairly accurate. The following are some of the observations on the sub-loans: a) The total subloans financed through the Project were 29 benefiting 28 different companies. b) Total disbursements amounted to US$28,551, leaving a balance of US$1,448, which was cancelled (see Table 6). Most of this balance had originally been committed but was either not fully disbursed or the sub-projects were cancelled altogether. Of the 29 subloans, eleven were above free limit ranging in size from US$988, to US$4,535, The rest which were below free limit ranged from US$99, to US$580, Four sub-projects amounting to US$2,860, were raw material short term loans. Except for cases of loan rescheduling, the maximum maturity period was 10 years including a maximum moratorium of two years. c) Of the 28 sub-projects for which disbursements were made, 12 have been put under receivership and have since either been sold or being liquidated at a great loss to IDB. Eleven have fully paid their loan through either normal loan servicing as per original amortization programme or refinancing from local borrowing. One sub-project has not started operations due to lack of working capital resulting from cost overruns during implementation. Only five projects are still active, a majority of which have had their loans rescheduled. d) Almost all projects experienced cost overruns during implementation precisely for the various reasons given in the Report, i.e. (i) changes in project scope (ii) delays in securing equity capital (iii) delays in completion of legal documentation, and (iv) changes in exchange rates. Cost overruns were also experienced due to delays in getting approval by the external lenders, and unrealistic original cost estimates. e) Of the 28 sub-projects, 12 relied heavily on imported raw materials while 15 relied fully or partially on local raw materials. Two sub-projects in the hotel industry are high class hotels

22 catering mainly for foreign tourist clientele. One sub-project based on local raw material was designed for the export market. f) Of the 28 sub-projects, 17 i.e. 61 % are located in the urban areas with 14 of them located in Nairobi and Mombasa. g) Of the total disbursements 56.6% went to new projects while the remainder were utilized for expansions or raw material imports. h) During IDB approved a total of 53 sub-projects amounting to KSh million net of deletions. This was below projection for reasons given in the Report and already cited above. The accuracy of the figures in the Report on this section cannot be ascertained as the relevant annex is missing. Annex 6 referred to does not seem to be relevant. i) As of December 1985, IDB's total portfolio, i.e., both loan and equity was KSh. 874 million. The arrears as a percentage of total portfolio were 28.24% or 30.6% of loan portfolio. The corresponding levels in 1981 were 17.88% and 22.22%. The arrears affected portfolio in 1981 and 1985 were 51 % and 827% respectively. This clearly confirms a deteriorating trend in debt collection, and that of the IDB portfolio. Once again, it is not possible to ascertain the accuracy of some of the figures in this section of the Report as the table referred to do not seem to be relevant. Instead Table 7 and 8 have been used to arrive at some of the above information. j) IDB's equity investment as of December 31st, 1985 is given in the Report as KSh million which is fairly correct. This however, appears to represent the entire equity investments over the years from 1974 but does not take into account equity write-offs in projects which were either in receivership or those from which IDB had already divested (either voluntarily or through project liquidations). Otherwise, the total number of projects in which IDB had equity investments as of December 31st, 1985 is correctly indicated as 27 with original equity investment totalling KSh. 63 million. Of the 27 projects, 13 were profitable while 5 of the remaining 14 have since been placed under receivership and are at various stages of liquidation. Dividend yield figures given in the Report are somewhat distorted due to the way equity has been presented. Otherwise, they are generally quite dismal. Major Results: 6. Table 6 which is attached hereto gives a list of sub-projects financed under the Project, together with specific aspects of the individual sub-projects. Of the US$30 million which was available under the Project, 95% was disbursed by the closing date. Forty-nine percent of this arnount was disbursed to sub-projects in rural/semi-urban areas whereas 44.6% was disbursed to sub-projects in either Nairobi or Mombasa percent was disbursed to import substitution sub-projects. 7. Table 6 may also give an indication as to the general performance of individual sub-projects. Of the 28 sub-projects that benefitted from the project, 2 were not fully implemented while 11 ended being placed under receivership for unsatisfactory loan servicing. Some have already been sold at heavy losses to IDB while the rest are at various stages of liquidation. Ten sub-projects have either repaid or refinanced their loans. Only five are still servicing IDB loans, some of which have been rescheduled for several years. Collections from these sub-projects cannot adequately service the entire loans provided under the Project as a result of which IDB is experiencing a lot of financial strain in servicing

23 the loans. It is therefore correct, as stated in the Report that the Project had a negative financial impact on IDB. Project Sustainability: 8. The general observations concerning arrears position, collection ratios, shareholders' support and staff morale are correct. The following are some specific comments we would like to make: a) Arrears: Tables which are referred to in connection with arrears are not available to us. However, from Tables 8 and 10 which present an analysis of loans, and Balance sheets respectively, it is shown that in June 1986, arrears of over three months as a percentage of the total portfolio outstanding were 33% but declined to 23.5% in b) Liquidity: Tables which are referred to in connection with liquidity indicators are not available. However, it is true, as stated in the report, that arrears increased and IDB was forced to place a number of projects in receivership, the Banks best clients prepaid loans through refinancing and the portfolio was considerably weakened resulting in difficulties in meeting external obligations. c) Equity Investments: The views expressed in the report on equity investments are quite correct. IDB's decision to use the domestic currency resources for equity investment had not been fruitful in terms of dividend yields or through capital gains. The funds would certainly have had greater chance of being recycled if they had been put into local currency loans. It is however, important to consider some of the original guiding factors such as promotion of indigenous industrial entrepreneurship or local ownership in some of the international companies which was somewhat achieved. d) Government support: Tables which refer to arrears of GovernmentlParastatal-owned subjects are not available. It is however true that if the Government would pay arrears or debts of public-owned sub-projects, IDB's liquidity would have improved. It is estimated that the total debt in these sub-projects which are referred to as "Social Projects" together with those whereby the Bank cannot take action because of Government instruction is about KSh. 510 million. e) IDB Staff: The comment on staff turnover especially that of senior and experienced professionals is fairly correct. Senior staff members were very few and overstretched. Many, however, left for better remuneration rather than because of dissatisfaction with the way the institution was managed. Reform and Restructure: 9. We are in agreement with the Report's observation that an institution can only sustain itself and fulfill its objectives if the organizational set-up and procedures are responsive to the changing environment, and therefore that the sustainability of IDB would be doubtful if existing organization and procedures are let to continue. It is in this recognition that a restructuring programme for the Bank was approved by the Government and is now being implemented with the assistance of the World Bank and International Development Ireland Limited consultants. Some details on the restructuring are given in our reply to the third paragraph of your letter.

24 Lessons Learnt: 10. Credit Assessment: A number of lessons have been learnt through this Project which will be of great benefit to IDB's future credit assessment and performance. As observed in the Report, the environment in which the credit is expected to perform as well as the absorptive capacity of the entrepreneurial class are important. As already stated above, the assessment of IDB's credit requirement was based on projected requirements for sub-projects in the pipeline and those new ones which were expected to come into the pipeline. However, as it turned out, a number of those subprojects in the pipeline at the time of credit assessment were not financed through the Project mainly because they were at very preliminary stages of project development and were therefore dropped at later stages. It is therefore necessary that credit assessment be based on projects that are at an advanced stage of the project development cycle. Some of the sub-projects were also delayed because of the prevailing economic environment whereupon prospective clients became more cautious and delayed investment decisions. In all, the absorptive capacity of the economy turned out to be less than projected by IDB thus necessitating several extensions of the credit. 11. Project Selection: Another major lesson that has been learnt from the Project is the subproject selection criteria. For instance, most of the sub-projects financed through the project were not capable of absorbing the high financial costs related to a highly depreciating Kenya Shilling against major convertible currencies in which the loans were disbursed. Sub-projects which were considered viable at the time of approval were rendered unviable in the face of a depreciating Kenya Shilling as they could not adequately service their financial obligations. In the end, a number of them prepaid their loans through refinancing or were placed in receivership and sold at a high loss to IDB. Perhaps it may not have been possible to anticipate a situation whereby say, the US Dollar exchange rate would have increased from KShs in 1980 to KShs in 1988 and further to KShs in The issue has now been acknowledged and corrective measures undertaken through the establishment of Exchange Risk Assumption Fund whereby the Treasury will bear much of the exchange risk. 12. Cost Overruns: In assessing the failure of some of the sub-projects, it has been confirmed that a number of them were heavily undercapitalized especially because of cost overruns which necessitated additional borrowing and/or use of funds originally meant for working capital. It is therefore necessary that adequate contingency be provided for in project costing and that sponsors be capable of meeting cost overruns through equity contributions rather than loans. 13. Project Monitoring: There is also a need for close monitoring during project implementation and financial contribution by project sponsors. This will help in detecting problems at an early stage and appropriate corrective measures taken in time. It is hoped that the active portfolio managementhat has been adopted by IDB will effect this close monitoring. Action Programme for restructuring/divestiture of industrial parastatals and financial restructuring of IDB 14. As for the status of the implementation of the proposed action programme for restructuring/divestiture of industrial parastatals in IDB's portfolio, and IDB's own financial restructuring, we wish to state that these were part of a wider restructuring programme which should be addressed in its full perspective. To start with, we would like to note that the issue of restructuring of IDB portfolio arose out of a study carried out under the Industrial Sector Reform Programme by RBC Dominion Securities Inc. on the Kenyan Development Finance Institutions (DFIs) which was presented to the Government in August The study set out a series of activities that were necessary in implementing a proposed action plan whose major objectives were:

25 - 15- (a) (b) (c) Revision of DFIs mandates to improve their effectiveness and implement financial self sustainablity. Restructuring of DFIs' management to implement an organization structure that provided for the autonomy of the Chief Executives and accountability for management decisions among others, and Strengthening financial conditions of DFIs to implement their new mandates effectively. 15. Revision of DFIs Mandates: The main activities that had to be undertaken in the implementation of the first objective included obtaining a cabinet clearance on new DFI policy and restructuring, outlining objectives of restructuring DFIs and the approach selected to implement restructuring, and isolation of "Social Projects" requiring budgetary support. All these activities which culminated in the appointment of International Development Ireland Limited (IDI) consultants to assist in the implementation of IDB restructuring have already been undertaken. The only issue outstanding is on the treatment of social projects especially on reimbursement of costs to IDB from the Treasury. 16. Restructuring of EDB Management: Restructuring of IDB Management entails the restructuring of the Board, defining the Chief Executive Officer's powers and responsibilities, and implementation of a new organization structure reflecting portfolio management approach. Guidelines on the composition of the Board, criteria for selection of Board members, and duties, responsibilities and authority have been established. It has been recommended that government representation be limited to only one director and that more members be drawn from the financial sector and professionals with management, legal and manufacturing bias. These guidelines have yet to be agreed and acted upon by the Government. One area where significant progress has been made is in the implementation of a new organization structure. A new organization chart developed by IDI consultants and IDB Management reflecting the revised mandate of the Bank and reporting system has been implemented. Of particular significance is the establishment of the portfolio management approach. All the projects in the Bank's portfolio have been distributed among for portfolio teams headed by portfolio managers reporting to the Chief of Operations who in turn reports to the Deputy Managing Director. This has resulted in more active portfolio management. However, the full objectives of portfolio management which presumes accountability will be achieved when a concise set of rules as to what decision can be made at each level of the hierarchy are established. At the moment, IDI consultants in conjunction with IDB Management are working on a system that will bring about new arrangements related to delegation of authority and profit centre accounting. 17. Financial Restructuring: The third objective of the restructuring, i.e., strengthening financial conditions of IDB is perhaps more specific to the subject of your letter. The activities related to this part of the action plan may be broadly described as those involving management of foreign exchange risks of the Bank, restructuring/divestiture of IDB's portfolio and financial restructuring of the Bank. 18. Management of Exchange Risk: The implementation of management of exchange risks of the Bank started with the establishment of the Exchange Risk Assumption Fund by the Government under the Exchequer and Audit Regulations in January 1991 and the appointment of a Liabilities Manager stationed at the Treasury. The purpose of the Fund is to provide funds required to meet the exchange risk relating to obligations contracted by IDB, ICDC, and DFCK. Under these regulations, IDB is required to pay to the Fund a fee of 2.5% p.a. on the principal amounts outstanding and in return IDB will be cushioned against losses resulting from foreign exchange fluctuations. The Regulations which were backdated to July 1st, 1989, however, require that IDB first meet the external obligations and claim any loss if the amount so paid is more than it should have paid using the exchange rates of

26 July 1st, Otherwise, IDB shall pay to the government as a credit to the Fund, the amount of exchange gains. IDB would however, prefer that it only meets its part and Treasury tops-up the difference instead of meeting the full amount and then seek reimbursement from the Treasury. As the Fund is meant to benefit the projects financed through foreign currency borrowing from IDB, the Bank has in turn converted such borrowings to Kenya Shillings with effect from the above date or date of disbursement, whichever is the later. Int he process of these conversions, the Bank has also increased the rate of interest charged on the converted loans so as to reflect the market rate of interests in the domestic market. 19. Sub-Project Loan Rescheduling: Apart from the conversions to local currency, the Bank has also rescheduled the original loan repayment programmes so as to accommodate the individual project's debt servicing ability. In the process, interest arrears were capitalized and in a number of cases, the new repayment programmes go beyond the repayment period agreed between IDB and the external lenders of the specific line of credit through which the projects were financed. This has tended to create a mismatch between IDB receipts and payments to external lenders, a situation that may call for negotiations for extension or rescheduling of IDB repayment programme with the external lenders. 20. Corporate Restructuring: One of the components of the Restructuring Project for the Development Finance Institutions being undertaken by IDB involves restructuring potentially viable but currently under-performing projects. This component involves undertaking of financial, managerial and technical analysis to assist in the restructuring of such projects through short term consultants. The above loan conversions, capitalization of interest and rescheduling of repayment programmes are part and parcel of restructuring of projects. There are, however, other forms of restructuring which may be project or enterprise specific, such as strengthening of equity base, management, marketing and production processes. The RBC Dominion Securities study identified 13 projects in the Bank's portfolio which were considered potentially successful but were for various reasons, under-performing and could, therefore, be turned around if certain measures including financial, operational, and management restructuring were instituted. Some of these projects have, however, since prepaid their loans or gone under receivership, thus technically removing them from the potential list to be restructured under the exercise. The Bank, together with the Corporate Restructuring Consultants from IDI have drawn a new list of potential projects to be assisted in the exercise, i.e. preliminary financial, managerial, and technical analysis has already been undertaken on the selected list and appropriate recommendations made on areas requiring detailed analyses for which specialised assistance, may be required. These recommendations are being evaluated before the next phase of the exercise is embarked upon. 21. Divestiture of Industrial Parastatals: The action plan on the divestiture of industrial parastatals in IDB's portfolio is being undertaken under the wider Government Public Enterprise Reform and Privatization programme whose aims include enhancing the role of the private sector in the economy, and reducing the role and rationalizing the operations of the public enterprise sector. The instrument that is being used to undertake the privatization programme is the Parastatal Reform Programme Committee (PRPC) assisted by its Executive Secretariat and Technical Unit (ESTU). The Department of Government Investments and Public Enterprises (DGIPE) is responsible for those aspects of the reform programme that are related to strategic parastatals which are to remain in state hands. These are defined as those that provide essential services or are considered to play a key role from the view point of national security, health and environmental protection. 22. As at 30th June 1992, IDB had equity investments in 23 companies. Out of these, only one, i.e. Rehabilitation Advisory Services Ltd. (RAS) has been designated as a strategic commercially oriented state enterprise which will be retained in the public domain. In order to facilitate the divestiture programme through the PRPC, the Bank has prepared and forwarded project briefs on all

27 the 22 companies which have been considered as non-strategic commercially oriented state enterprises, covering the statement of the company's objectives, ownership, Government exposure, performance, estimated value of assets, and recommended method of divestiture and time table. Additional papers have also been prepared as a guide in estimating the share values of individual companies. 23. Of the 22 companies, only seven have been approved for the first phase of divestiture by the PRPC (Table 15). IDB has already successfully negotiated and sold its shares in Highland Paper Mills Ltd. at a total of KShs. 875,000 compared to the original investment of KShs. 500,000. The shares were sold to some of the company's existing shareholders under pre-emptive rights. The PRPC has also approved sale of IDB shares in the East African Oxygen (K) Ltd. through the Nairobi Stock Exchange as this is a public quoted company. However, efforts to sell through the Nairobi Stock Exchange (NSE) at a reserve price have, for various reasons, not been successful. Apart from the above two companies, the PRPC has not approved modalities of divestiture and timing for the sale of the rest of the companies that have been selected for the first phase of the divestiture programme. 24. Divestiture of Non-Parastatal Companies: Apart from the projects in which IDB has equity investment and is therefore divesting through the PRPC, the Bank is also divesting its investment in a number of companies through sale of projects and/or liquidation of assets. Currently, there are nineteen projects in the Bank's portfolio which are under receivership and at various stages of sale or assets liquidation (Table 6). Every effort is being made to conclude the exercise so that the Bank's portfolio is appropriately restructured. 25. Financial Restructuring of IDB: Finally, as to the financial restructuring of IDB, this focuses mainly on the Bank's assets and liabilities restructuring including that of share capital. The Bank's major assets are loan investments both long term and arrears, and equity investments. As already mentioned above, a decision has already been made to divest equity investments in non-strategic companies. However, the process of divestiture through the PRPC is likely to drag for a long time. In the meantime, the immediate equity restructuring that is available for the Bank is valuation or shares, an estimate of which has been made. 26. As for the loan investment, a provision of KShs. 198,589 million was made for the year 1990/1991 and the Bank is currently assessing any additional provision for the year 1991/1992 which will then be incorporated in the accounts. There is also an ongoing assets liquidation through receiverships or poor debt servicing companies. Perhaps the major achievement in the area of loan restructuring is the conversion of foreign currency to Kenya Shillings debt. Similarly, restructuring of liabilities has partly been effected through the establishment of the Exchange Risk Assumption fund which have already been discussed above. 27. Other Bank liabilities include liabilities to the Government of Kenya in respect of payments made to the external lenders by the Government on behalf of IDB. The Bank has, on a number of occasions, requested the Government to either convert these to equity so as to improve IDB's equity base or write them off against claims on social projects which stand at about KShs. 510 million. The relevant papers to support the claim have been prepared and forwarded to the Government. It should be noted that out of the authorized share capital of KShs. 400 million for the Bank, only KShs million is actually issued and paid up. It is now necessary to not only pay-up this balance but actually enhance the equity base so as to improve on the Bank's ability to borrow both locally and externally, especially in the face of the highly depreciated Kenya Shilling.