Report No. 201-KE E COPY The Second Decade: A Basic Economic Report on Kenya Annex 4: Domestic Savings and Financial Intermediation Annex 5: Prorties for Planning and Project Design Annex 6: Prorities for External Assistance (Vol. V of Five Volumes) January 15, 1974 Not For Public Use Eastern Africa Regional Office Document of the International Bank for Reconstruction and Development International Development Association This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does fiot accept responsibility for the accuracy or completeness of the report. UNITS OF VALUATION The official unit of currency in Kenya is the Kenya Shilling (Sh.) However, in accordance with the practice of the Kenya Government, most large values in the report are expressed in Kenya Pounds (L) L 1 = Sh. 20 Sh 1 = 100 cents Some values have been expressed in terms of constant US dollars for pur- poses of international comparison. CURRENCY EQUIVALENTS From Independence at the end of 1963 until March, 1973, the exchange rate between the Kenya Shilling and the US dollar was retained at $1 = Sh.7.143. This is the exchange rate used throughout the report. Since June 30, 1973, the Kenya Shilling, together with those of Tanzania and Uganda, has been set at a central rate of $1 = Sh.6.9, and all three countries have availed themselves of the wide margins of up to 2¼4 per cent. Exchange Rate Used in the Report Present Rate of Exchange US dollar = Sh. 7.143 Sh. 6.9 Kenya Pound - $ 2.80 $2.8985 THE MISSION This report is based on the findings of an IBRD mission which visited Kenya in March/April, 1973. The main mission consisted of the following Bank staff: John Burrows - Chief of Mission Ramgopal Agarwala - Macro-Economist George Beier - General Economist (Project Planning and External Assistance) Ved Gandhi - Fiscal Economist Randolph Harris - General Economist (Public Services) Martin Wolf - General Economist (Private Sector) Sven Burmester (Education), Andrew Hayman (Tourism) and Frank Stubenitsky (Health) also participated in the work of the Mission and have contributed to the report. Lyle Hansen was adviser to the Mission. A preliminary report was prepared in August and discussed with the Government of Kenya during Octolber 1973. The present report incorporates the comments of Government, and where possible, includes more recent material. PREFACE 1. During the course of 1972, the WZorld Bank decided to embark upon a series of "basic" economic reports on its major member countries. The nature of country economic work has been under review for some time in the Bank, and the decision to undertake these major reviews on a regular basis reflects the general desire to improve both the quality and the usefulness of this work. The basic economic report is intended to provide a periodic Overview of the operations of an economy. From the Bank's point of view, these reports are intended to provide a new perspective of the longer term structural developments in an economy, to assess the extent to which they can be shaped by policy changes, and to identify the country's external assistance requirements. But more than this, a basic economic report is expected to provide a synoptic view of the many facets of the economy, and thus to bring into focus other work being undertaken by the Bank and else- where at a sectoral or project level. From the country's point of view, it is hoped that these policy-oriented reports will be valuable in giving ob- jective and possibly new insights into the dynamics of the economy and the options which may be open to the Government in the future management of the economy. 2. This is the first basic economic report on Kenya. The timing is particularly appropriate as Kenya prepares to enter the second decade of Independence and is about to publish the Third National Development Plan. We feel that it is therefore a suitable time to assess how far Kenya has come during the past ten years, to review her major successes and failures, to assess what prospects lie ahead, and to identify major policy issues. This is the main purpose of the report. Of course, this is not the first Bank report to undertake this task, but the latest in a series. For exam- ple, the Bank published a report on the Kenya economy in 1963 which reviewed the development prospects of the country as it moved towards Independence. In 1967, a major Bank mission reviewed the revised development plan (1966- 70) and again in 1969 another mission reviewed the second (1970-74) plan. Each of these missions and the subsequent reports differed in composition and scope, but all served to make a critical review of Kenya's national plans and to offer constructive comments. At the request of the Government, both the 1969 mission and the recent 1973 mission visited Kenya while the new plan was still in draft forn, so that the comments of the mission could be taken into account before the plans were published. 3. A report of this nature must essentially be the result of a com- promise between comprehensiveness and brevity. The Kenya economy is much too broad and its operations much too complex to allow for complete cover- age, even in a "basic" report. We have therefore deliberately circumscribed the scope of the report in a number of ways which it is important to make clear at the outset. First of all, the report is intended to be a review of the operations of the Kenya economy only, and makes no attempt to review progress or prospects of the wider region to which the Kenyan economy belongs, or even to assess in any comprehensive way how Kenya's development prospects are affected by her membership of the East African Community. Some of these relationships are referred to when they are of particular relevance, but the report has not tried to view the Kenyan economy from an integrated regional perspective. This limitation does not in any sense mean that either the Mission or the Bank feels that regional economic considerations are unimportant. On the contrary, it is clear from its major financial commitment to the EAC corporations and the development bank that the Bank fully supports this unique development in regional cooperation which Kenya, Tanzania and Uganda have pioneered. The report focuses on Kenva and ignores the wider Community simply to keeD the scope of the report within manageable bounds. This narrow focus becomes seriously myopic only in those sections of the report (on trade policies for instance) where Kenya must clearly act in concert with her partners in the Community. Again, while we try to suggest what options might be best for Kenya, viewed in isolation, we are very conscious that these options will have to be reviewed by all three Partner States, and that the decisions will ultimately be taken with the interests of the whole region in mind. 4. The scope of the mission was circumscribed in a second major re- spect. Even in its focus on Kenya, the report will not undertake a detailed review of all sectors of the economy and of all economic problems. The eco- nomic literature on Kenya is prolific, and we have drawn heavily on this. In particular, the recent ILO/UNDP Report on Employment, Incomes and Equal- ity in Kenya has presented a very comprehensive and innovative analysis of unemployment and poverty, and we make no attempt to go over this ground again. Rather, we see this report, with its broader macro-economic focus, as being essentially complementary to the ILO/UNDP Report. We have not attempted to add in any significant way to the existing knowledge on the various sectors; instead, we have tried to consolidate and integrate this knowledge into our overall understanding of the operation of the economy. Similarly, we have not placed great emphasis on reviewing progress under the Second Plan or on describing the objectives of the Third Plan, because these tasks have been done very well by the Government itself. 5. Our report does not therefore try to deal with everything in great depth. On the contrary, it draws heavily from the wide range of studies al- ready available and tries to use this information to provide a synoptic view of the way in which the economy as a whole functions and perhaps some new in- sights into important relationships between variables. Thus, while the re- port tries to be as informative as possible and to present sufficient back- ground data on most aspects of the economy for the general reader, the de- tailed analysis is highly selective and focuses mainly on a number of key issues which we see as critical to the future development of Kenya and the well-being of its people. 6. The report is divided into five volumes. The main report traces the major developments in Kenya's first decade of independence, identifies the emerging issues, and examines the major options open to the Government in the future, as the Mission sees them. The remaining four volumes contain the analytical annexes, which discuss the major issues in detail and extend the technical arguments. 7. An outline of the complete report is shown on the opposite page, and a select bibliography of some of the major sources of information on Kenya is given at the end of Volume I. THE SECOND DECADE A BASIC ECONOMIC REPORT ON KENYA CONTENTS VOL. I THE MAIN REPORT: EMERGING ISSUES AND POLICY OPTIONS VOLS. I-V THE ANALYTICAL ANNEXES 1. The Macro-Economic Model and Projections 2. Fiscal Policy for Development 3. Key Issues in the Private Sector 4. Domestic Savings and Financial Intermediation 5. Priorities for Planning and Project Design 6. Priorities for External Assistance ANNEX 4 DOMESTIC SAVINGS AND FINANCIAL INTERMEDIATION ANNEX 4 DOMESTIC SAVINGS AND FINANCIAL INTERMEDIATION CONTENTS Page No. CHAPTER 1 THE ROLE OF SAVING PROPENSITY IN GROWTH 1 CHAPTER 2 DOMESTIC SAVINGS IN KENYA 3 Movements in Aggregate Saving-Income Ratio 3 Factors Behind the Savings Behavior 4 Prospects of Savings: Projections in the Macro-Model 9 CHAPTER 3 DEVELOPMENT IN FINANCIAL INTERMEDIATION 10 CHAPTER 4 SOME POLICY IMPLICATIONS 12 Interest Rate Policy 12 Financial Intermediaries 16 Impact of Restructured Groowth Strategy 17 Appendix: Effect of Foreign Capital Inflow on Domestic Savings: A Case Study for Kenya Statistical Tables CRAPTER 1: THE ROLE OF SAVING PROPENSITY IN GROWTH 1.01 The process of economic growth is often viewed as one of saving, investing and growing. Actually the historical evidence on the process of economic growth suggests that the causality may often have been the exact opposite. As Kuznets has demonstrated 1/ for the United States, the peri- ods of high growth preceded and not followed increases in saving-income and investment-income ratios. Even in the less developed countries in the post war period, the countries that have attained high rates of growth are pro- bably distinguished more by their efficiency of resource use (indicated, say, by incremental capital output ratios) than by the rate of accumulation. For example, Iran and South Korea which have attained annual GDP growth rates significantly higher than Kenya's (11.3 percent and 11.8 percent, 2/ respec- tively) were characterized by lower ICORs (2.0 and 2.46) and not by higher domestic saving-income ratios (17.3 percent and 17.8 percent). 1.02 Even to the extent that investment increases are important, it seems doubtful whether they are a'Lways stimulated by higher saving Propen- sities; quite often investment increases bring about ex post increases in saving by changes in income or prices. 3/ In this process, saving behavior and savings mobilization are important not because they determine present investment, but because they increase the efficiency of capital formation and determine the process by which ex post equalization of saving and in- vestment is brought about. This in turn has implications for future invest- ment possibilities. The financial institutions which mobilize savings help in allocating funds to productive users, thus raising overall efficiency of investment. 1.03 Similarly, even though an ex post increase in the saving-income ratio can be brought about by an increased investment financed by credit creation, the ex ante propensity to save determines whether the equalization is brought about by inflation or not. If the consumption propensity is high, the equalization is brought about by an increase in consumer prices as well as increase the demand for consumer goods imports which may reduce resources for investment in future. A high saving propensity, on the other hand, will make any given increase in investment more easily sustainable. Without the stimulus of investment, higher saving propensity may merely result in lower income, as is well known from Keynesian economics. 1/ S. Kuznets, "Long-Term Changes in the National Income of the United States of America since 1870," in Income and Wealth of the U.S. (ed. S. Kuznets), Bowes and Bowes, Cambridge, 1952. 2/ For the five-year period ending in 1970. 3/ The effect of inflation on savings is of course complex. In general, a ceteris paribus increase in expected inflation reduces saving pro- pensity, although an actual increase in inflation may bring about an increase in ex post "forced" savings. -2- 1.04 In the light of the above observations, we shall study the saving propensity and savings mobilization in Kenya not simply as ex post ratios but in terms of the processes associated with them. We shall conclude that the ex post saving-income ratio in Kenya over the period under study, namely, 1964-71 was generally very high. Moreover, the relatively low rate of in- flation which prevailed until recently might be an indication that the ex ante propensity to save was also high. The efficiency of investment as indicated by ICORS, was also quite good until recently compared with most other less developed countries. 1.05 In recent years, however, there are indications that saving pro- pensity may be declining and that the ex post high rate of investment can only be maintained by inflation, balance of payments deficits and foreign borrowing -- all of which could create problems in the future. 1/ Even though it is difficult to be definitive, it seems to us that in spite of the good performance of the past, the time has probably come to increases efforts in the direction of checking the incipient fall in saving propensity. We shall also argue that, from an allocational point of view, it may be nec- essary to allocate finance to new directions -- agriculture and small busi- ness -- for both efficiency and distributional reasons. The present system of financial institutions is primarily geared to the "formal" sector and needs some retuning for meeting the newly emerging needs. 1/ In this connection, it is sometimes argued that foreign capital inflows reduce ex ante domestic savings. In our judgment, the causality is often the other way around; when for extraneous reasons, saving propensity de- clines, part of the gap may have to be filled by foreign capital inflow. For a more detailed discussion, see Appendix. ANNEX 4 -3- CHAPTER 2: DOMESTIC SAVINGS IN KENYA Movements in Aggregate Saving-Income Ratio 2.01 The movements in gross domestic savings and the savings-income ratio in Kenya are presented in l'able 1. The ex post saving-income ratio was, except for 1965, around 19-20 percent. This should be regarded as an excellent performance in comparison with most other less developed countries. This looks all the more remarkable when viewed in the light of the slow rate of price inflation in general and in the consumer price index in particular (Table 2). This implies that ex post saving was by and large a reflection of genuine ex ante saving propensity and not in the nature of forced saving through credit creation. 2.02 In Tables 1 and 2, the saving-income ratios do not take into ac- count the effect of international terms of trade. However, to measure the real purchasing power of the goods and services produced in a country, one should adjust the GDP at constant prices by the change in terms of trade. This provides a series of "gross domestic income" 1/ from which, after de- ducting consumption, we obtain a series of gross domestic savings at import prices. This measurement of savings is helpful in computing resource re- quirements at constant prices. 2.03 The estimates of GDS and gross national savings (GNS) 2/ as per- centage of gross domestic income for Kenya and a number of other countries are presented in Table 3. In order to take out fluctuations, these are presented as three year centered moving averages. In the light of these more refined estimates, Kenya's performance again appears to be excellent. 1/ Gross domestic income (GDY), adjusted for changes in terms of trade, is defined as follows: GDY = GDP -X X) where: GDY = gross domestic income at constant prices GDP = gross domestic product at constant prices X X = exports deflated by export price index 7x PM = exports deflated by import price index 2/ (GNS) defined as: GNS = GDS + FSY + NCT where : GNS = gross national savings GDS = gross domestic savings FSY = net factor service income NCT - net current transfer received -4- Even South Korea, whose success in economic growth is generally regarded as spectacular, did not have a higher saving propensity than Kenya. In Africa, Ivory Coast, which has sustained a remarkable rate of growth (7.5% per annum over 1960-70), achieved a savings rate significantly higher than Kenya's. But the expatriate community is even more important in the Ivory Coast than in Kenya and, when allowance is made for factor incomes and transfers, we find that as far as national savings are concerned, Kenya's performance was marginally better than Ivory Coast's. In recent years, Brazil has come to be regarded as the latest miracle in economic growth. But even there, we find that Brazil's saving-income ratio was lower than Kenya's. 2.04 However, while Kenya's long-run performance in savings has been very good, there are, in recent years, some causes for concern. As shown in Table 4, GDS actually declined in 1971 compared with that in 1970. The decline in GNS was even larger because of increase in net factor service payments and a decline in net current transfers received. Factors Behind the Savings Behavior 2.05 It will be interesting to examine the causes behind the good sav- ing performance in Kenya compared with other developing countries. One possible reason could be the high growth rates of income. 1/ Regression of domestic saving-income ratio on growth rate of GDP in Kenya over the period under study does show some association. 2/ In particular, it "lexplains" the 1/ For a detailed discussion, see S.K. Singh, "The Determinants of Aggre- gate Savings", IBRD Economic Staff Working Paper No. 127, March, 1972. 2/ S/Y .1706 + .22 y (19.8) (2.1) (t-statistics) -2 R = .36; D.W. = 2.08' SEE = 0.11 1965 1966 1967 1968 1969 1970 1971 Saving-Income Ratio Actual .166 .202 .182 .173 .194 .202 .185 Estimated .174 .204 .179 .189 .188 .188 .185 ANNEX 4 -5_ dips In the saving-income ratio in 1965 and 1971. However, for a cross- country analysis, it is difficult to be sure if high growth rate causes high saving-income ratio, or the other way round. l/ In order to understand the behavioral relationships better, it is desirable to make an analysis of the disaggregated figures on savings. 2.06 In particular, it is desirable to analyze the saving behavior of households, government and businesses separately. Within business savings again, depreciation allowances accounting for a major part of business sav- ings are determined by past investment pattern and tax laws, and should not be regarded as a function of income. No disaggregated figures on savings are available from published sources of data in Kenya. However, the macro-unit in the Ministry of Finance and Planning has prepared some provisional and as yet unpublished .astimates of the components of savings. These figures are presented in Table 5, from which it can be seen that the major source of sav- ings has been the household sector, whose contribution increased very consid- erably until 1969 (when it was aibout 54%). Since then, however, it has de- clined rapidly to only 25 percent in 1971. There has been a steady increase in the relative importance of depreciation allowances (in proportion to total capital stock), while the relative share of Government savings has increased substantially, especially since 1969. 2.07 Does the structure of savings in Kenya throw any light on the factors behind Kenya's good performance compared with other developing countries? Table 6 presents some figures on the structure of savings in a number of other countries, for comparative purposes. In general, it is difficult to conclude anything definite from these figures because of extreme variations in the structure of savings from country to country, from year to year in the same country and even from one estimate to another in the same coqntry and in the same year. We therefore have to rely on an analysis of the unpublished esti mates of savings referred to above. 1f Since growth rate of GDP is, by definition, I S (1) &y = k(-) > k S + k 'F y y y y where G is GDP growth rate - saving income ratio y ~~~~~~ysaigncerto k inverse of ICOR I investment-income ratio F foreign capital inflows as a y y ratio of income we have (2) - - - . G _ F y k y y Therefore, causal interpretation on regressions of type (2) could be misleading. -6- 2.08 Household Savings. Since it has been the major source of savings, the decline in household savings in recent years must be the cause for some concern. The saving-income ratio of household has fluctuated around 10 per- cent. The lowest ratio was in 1965, when the growth in personal disposable income was virtually nil. Apart from this drop, the ratio was rising steadi- ly until it reached the level of 14.5 percent in 1969. Since then, however, it has dropped sharply and was only 7 percent in 1971. As before, a part of the changes in household saving-income ratio could be explained with reference to changes in growth rates of personal disposable income. 1/ 2.09 The above analysis does not indicate any definite conclusions as to why Kenya's household saving performance was good and why it has deteriorated recently, In fact, it is quite possible that the recent de- cline is only a random fluctuation and the saving-income ratio will improve in the future a! it did after 1965 and 1967. 1/ However, it is also possible that there is some structural change going on in the economy and some ten- tative judgment may be made on the basis of what is known of the Kenyan economy. (a) The expatriate business community has been playing an important role in Kenya's economic life. Thriftiness of this community may well have been an element in good saving performance of Kenya. It is also possible that in recent years, their confidence in the future was badly shaken. One type of reaction was probably to consume more goods and services because of the uncertainties of the future. The same kind of reaction might have led to an apparent increase in consumer expenditure, due to over- invoicing of imports, as a method of repatriation of capital. In other words, even when real consumption was 1/ The regression equation is: S = 8.33 + .26Y (4.17) (1.1) where S = saving income ratio (%) Y = percentage change in personal disposable income 1965 1966 1967 1968 1969 1970 1971 Actual 6.5 10.3 10.5 11.1 14.5 11.4 7.0 Estimated 8.4 12.3 9.6 11.3 10.0 10.5 9.6 t/ Recent information does suggest, in fact, that savings performance in 1972 returned to its level of 1970. ANNEX 4 -7- not increased, over-invoicing resulted in higher recorded consumption in Kenya even though part of it was actually saved and repatriated abroad. 1/ (b) A second contributing factor to decline in household savings could have been the increased rate of inflation in recent years and static interest rate structure. For the first time since Independence, the real interest rates in Kenya are becoming negative. In 1972, for example, the rate of inflation was about 6 percent, or well above any rate of- fered by commercial banks (see Table 11). (c) Apart from the above two factors of recent origin, Kenyaniza- tion and urbanization in general may have been contributing to a reduction in the propensity to save. Because of the ob- ligations of the extended family system, Kenyans who took over expatriate jobs may not have been able to save as much as their predecessors. This system did have desirable income distribu- tion effects but its effects on savings could well have been adverse. Similarly, urban migrants generally tend to save less than their rural counterparts in agriculture. The rea- sons are various: diemonstration effects are stronger in urban areas, agriculturists tend to have a higher saving-income ratio because of greater degree of transient element in their incomes; agriculturist can put their savings into farm improvement and therefore have better investment opportunities than urban workers who can only put their money in banks; 2/ to a farmer 1/ In order to reduce the impact of uncertainty, it may be desirable to consider some scheme for smooth transfer of business from expatriate to Kenyan hands. See Annex 3. 2/ In urban areas, savings for house purchase ie an important encourage- ment to saving. Kenya's past housing policy has offered little oppor- tunity to the lower income groups in the urban areas to own their own houses, and home ownership has been further discouraged by the sub- sidies injected into publiz housing. It is hoped that the increasing emphasis on self-help low-lost urban housing schemes in Kenya will un- lock a new source of savings among the wage-earners. - 8 - a tractor may be as much a status symbol as an automobile is to a city man. 1/ 2.10 Government Savings. Even though Kenya is a predominantly private sector economy, the role of public sector is significant and increasing. The contribution of public sector to saving in the economy is noted in Table 5. In order to analyze further the sources of receipts and the types of ex- penditure, we present the detailed figures in Table 7. In 1964, the tax re- ceipts did not even cover government consumption expenditure. However, there were large international transfer receipts (E 20.7 million) which offset this deficit, and gave rise to positive savings. Over the period 1964 to 1969 there was a decline in government saving, partly because of the decline in interna- tional transfers and partly because of the rapid rise in government consump- tion, which increased by about 17 percent in both 1968 and 1969. In 1970 and 1971 however, there was a significant recovery in government saving, a very welcome offset to the decline in private household savings over this period. 2.11 Corporate Savings. With economic growth, corporate savings, espe- cially depreciation allowances, normally account for an increasing part of total gross savings. 2/ In Kenya, depreciation allowances increased by about 140 percent between 1964 and 1971, an average annual rate of about 14 percent. However, the growth in undistributed profits was disappointing. They actually declined from i 13.5 million in 1964 to E 3.6 million in 1968. Since then, they have recovered to i 13.1 million in 1971, but are still marginally below the 1964 level. Thus even though the recent recovery in this component of saving is encouraging, the overall stagnation over the period is a cause for some concern. 1/ Using the data collected by Central Province Survey (19'63), M. Scott obtained the following regression: 2 S = -299 + 0.198Y (R = .96) where S - savings as indicated by cash surplus Y - income In spite of problems of data and interpretation of cross section equa- tions, the marginal propensity to save of 20% indicated by the above equation is impressive. For details, see M.FG. Scott, "Estimates of Shadow Wages in Kenya," February 1973 (mimeo). 2/ For example in the U.S. in 1971, capital consumption allowances were $93.8 billion which was about 9% of GNP ($1,050.4 billion). Corporate sector capital consumption allowances ($60.3 billion) and undistributed profits ($20.5 billion) together accounted for 53% of total private gross investment ($152.0 billion). ANNEX 4 -9- Prospects of Savings: Projections in the Macro-Model 2.12 Household Savings. The detailed projections on prospects of sav- ings over the Third Plan period and beyond are given in Annex 1, in the con- text of the overall macro-economic scenario. Some relevant figures on savings are reproduced in Table 8. From this table, we note that if the past good performance could be continued the ex ante saving income ratio would be about 20-22 percent. This is a respectable rate although the investment program of the Third Plan which implies a GDP growth rate of 7 1/2 percent will require investment income ratio of about 25 percent. If, however, the average saving propensity of household sector cannot be maintained at 10 percent, the average over the sample, but remains at 7 percent reached in 1971, the overall saving income ratio will be about 19-2-0 percent, which would be insufficient to fi- nance the investment levels required for Plan targets. This would mean infla- tionary pressure and/or balance of payments deficits, over the Plan period and beyond. However, the assumption about the saving-income ratio of households is critical and on the basis of statistical evidence available so far, the 1971 behavior could well be ran,lom. All that one could say is that there is a need for vigilance in this respect and it may be useful to think out the policy alternatives before the problem becomes serious. 2.13 Government Savings. ]n the projections, government savings account for about 24 percent of total savings in 1978, which is the proportion reached in 1971. Thus, if the Government visualizes an increasing relative role for the public sector, it may be necessary to improve Government's saving per- formance. 1/ 2.14 Business Savings. The contribution of depreciation allowances to total savings continues to increase and would amount to 41 percent by 1978 in the projections. The annual growth rate in depreciation allowances of about 14.5 percent (in real terms) is quite reasonable. 2/ However, the contribu- tion of undistributed profits registers a decline from 11.8 percent in 1971 to 6 percent in 1978. As mentioned before, the slow growth in undistributed profits over the past and expected future is worrisome and may deserve more intensive study for discussion of possible reasons and remedial measures. 1/ For more detailed discussion, see Annex 2. 2/ This, however, presupposes that target growth rates and investment rates over the Plan period are feasible which may be doubtful. See Annex 1. - 10 - OUPTER 3: DEVELOPMENT IN FINANCIAL INTERMEDIATION 3.01 As discussed in Chapter 1, we believe that institutions for effec- tive mobilization and allocation are important for achieving efficiency of resource use. However, in spite of the importance of the financial institu- tions, we do not propose to discuss these in this annex because they have been adequately discussed elsewhere. The Bank Economic Report of 1972 1/ pre- sented a broad survey of the developments in this respect. More recently, the Central Bank of Kenya has published a booklet, Money and Banking in Kenya, which gives a historical review of development of financial institutions and their present position. Lastly, the Agricultural Sector Survey report 2/ of the Bank has discussed the rural credit institutions in a comprehensive manner. We therefore confine ourselves to a brief reference to the main highlights in the financial sector in recent years. 3.02 The banking system in Kenya is fairly advanced in comparison with other developing countries at a similar stage of development. There are eleven commercial banks in Kenya, three of which dominate the banking system and account for 80 percent of total bank deposits. The rate of growth of money supply has shown some wide fluctuations in recent years. As shown in Table 9 the rate of growth of money supply accelerated to 23 percent per annum in 1970, This was due to the rise in deposits, particularly the term deposits, which was due partly to the increase in blocked accounts of emi- grants and other non-residents, and partlv to a genuine increase in savings. However, in 1971, there was a decline in the rate of growth of deposits and money supply. In 1972 the money supply expanded by about 14.7 percent. 3.03 The loans and advances to the private sector expanded at an accele- rating rate up to 1971 when the rate of expansion was 36 percent. This was associated with a serious deficit in balance of payments and the Central Bank used for the first time its power of variation in minimum cash balances. It announced that from December 16, 1971, commercial banks were to maintain with it minimum cash balances equivalent to 5 percent of their net deposit liabilities, in addition to the required liquidity ratio of 12-1/2 percent imposed in December 1969 under the Banking Act. However, due to the abrupt- ness of the change, some banks found it difficult to meet the requirement, and the measure had to be withdrawn after six weeks. In 1972, there was a significant slowdown of demand for credit mainly due to the tightening of import controls and the disruption of trade with IJganda. Commercial banks in general seemed to have excess liquidity and the monetary authorities were urging them to expand their lending. 1/ The Mobilization of Private Savings, Annex B, Vol. II, Economic Program and Prospects in Kenya, IBRD, Report No. AE-22, March 1972. See also B. Dillon, Financial Institutions in Kenya, 1964-71: A Preliminarv Analvsis, Wiorking Paper No. 61, IDS, Nairobi, September 1972. 2/ Agriculture Sector Survey Kenya, TBRD Report No. 254-KE. ANNEX 4 -. 11 - 3.04 As regards allocation cf loans, the main problem is to find ways of expanding commercial bank lending to agriculture. As shown in Table 10, the proportion of loans and advances made to agriculture have not been ex- panding at all -- in fact, they have declined from 12.3 percent in 1969 to 10.2 percent in 1971. This is in spite of attempts by the Central Bank and the Government to persuade the banks to expand their loans to agriculture. It seems that unless some way is found by which public institutions can act as intermediaries for channeling funds to agriculture, the share of loans to agriculture is likely to remain inadequate. 3.05 Apart from the commercial banks, Kenya has eleven non-banking fi- nancial institutions in the private sector, under the category of "specified financial institutions". In the last two years their role relative to commer- cial banks has been increasing. At the end of June 1970, their assets amounted to only 8 percent of those of the commercial banks, by the end of September 1972, this ratio has risen to 15 percent. This was due partly to the differ- ential impact of credit controls on banking and non-banking financial insti- tutions; but it was also influenced by the more flexible and aggressive in- terest rate pclicy followed by these institutions in attracting deposits in the face of a rising rate of inflation, in contrast to the static interest rates of commercial banks. 3.06 Apart from the above, there are a number of specialized lending institutions in the public sector providing development finance for industry and commerce, agriculture, housing and tourism. In general, these public sector institutions depend on government loans and grants or on foreign capital. They do not mobilize their own resources and are generally under- capitalized. Nor have they succeeded in attracting the long-term funds available in other financial institutions such as life insurance companies. If the public financial institutions are to play their proper role in sav- ings mobilization for growth, it Ls desirable to think of the ways of broad- ening their capital base. In particular, some of the institutions (such as the AFC) might be able to accept deposits from the households they serve. The growth of the cooperative sav:Lngs movement is especially promising in this respect. - 12 - CHAPTER 4: SOME POLICY IMPLICATIONS 4.01 As suggested in the preceding chapters, the performance of the Kenyan economy in generating and mobilizing domestic savings has been very good and if these trends were likely to continue in the future, policy in- struments for improving saving performance would not be of high priority. There are, however, certain indicators which suggest that, left to itself, saving performance might deteriorate in the future, and it is therefore necessary to think of policy measures to prevent this deterioration. In fact, as is often found in real life, once the situation starts to deterio- rate, destabilizing forces are strengthened and corrective measures become more painful and less effective. It is, therefore, advisable to anticipate the problems and discuss and adopt preventive policy measures before the problems get out of hand. Interest Rate Policy 4.02 The first area in which some review of policy is necessary is interest rate policy. As shown in Table 11, the interest rate level and structure have been almost static in Kenya for as long as systematic data are available, which is since 1967. The rate of interest on savings depos- its in commercial banks and post offices has been 3 percent per annum. The deposit rates in hire purchase companies and building societies are some- what higher, but these are restricted in coverage. The minimum rate on loans and advances has been static at 7 percent, but actual rates may have gone up to a certain extent. The Central Bank rates on advances against Kenya Government securities and under crop finance schemes have also been static at 6.5 and 6.0 percent, respectively. The redemption yield rates on locally registered Kenya Government stocks based on government support prices have actually declined since 1965 particularly in the case of long term (over 10 years) and medium-term (5:-10 years) stocks. The yield on long-term stocks declined from around 8.5 percent in 1965 to around 7 percent in 1972, and that on medium-term stocks from around 7.7 percent to around 6.5 percent. The structure and level of interest rates was not a serious problem as long as the rate of inflation was low and the balance of payments strong. How- ever, in 1972, when the rate of inflation reached about 6 percent, the real rate of interest became negative for the first time since Independence. Similarly, the balance of payments position in 1972, though better than in 1971, was still under strain, and it is likely to come under further pressure as the Third Plan programs create new demands for foreign resources. 4.03 The rate of inflation is, of course, a worldwide phenomenon at present. However, in many countries, the old orthodoxy about low interest rate policy has been given up and interest rates have moved up along with inflation. For example, as shown in Table 12, in Britain and in Euro-dollar markets (the two most important markets for Kenya) the interest rates have gone up dramatically and are now much higher than those in Kenya. For an open economy like Kenya this could cause serious problems. For example, foreign companies and banks which might under better conditions have borrowed ANNEX 4 - 13 - abroad (and thus increased the availability of resources for the economy) are now tempted to borrow domestically. There are, of course, restrictions on domestic borrowing by foreign comwpanies, but the interest differential can still create pressures on domestic resources by tempting the foreign companies to borrow to the limit, and even to find ways of bypassing the legal provi- sions. 1/ Similarly, it creates an incentive for foreign companies to repatri- ate their profits (on which there is no restriction) which could otherwise have been used domestically. It is true that the rate of inflation in Britain is even higher than in Kenya. However, for international financial movement, the relevant consideration is not: the domestic inflation rate but the interest rate difference and exchange risk. On both these counts, the dice are loaded against Kenya. 4.04 In this connection, it is important to emphasize the mutually de- stabilizing effects of inflation and balance of payments deficits under a regime of static interest rates and exchange rates. As inflation gathers momentum, it stimulates demand for investment and by increasing expected rate of inflation, reduces savings propensity. This is associated with and it further stimulates the rise in imports and discourages exports; the con- sequent strain on balance of payments and risk of exchange rate depreciation further reduces foreign capital i-aflow, thus further reducing the total re- sources available and increasing the rate of inflation. Once this set of forces gets going it is possible t:o end up either with a Latin American type of situation, with open inflation and exchange crises, or the Indian type of situation, with repressed inflation and exchange controls. The time for action is before destabilizing expectations get entrenched, and in Kenya's case that time is now. 4.05 It is of course desirable to make some quantitative estimates of the effects of interest rate variation on saving propensity, financializa- tion of savings, on efficiency of investment (through better allocation and through capital-labor substitution), and on balance of payments (through demand for imported capital goods). In Annex I, we do try to work out the implications of variation in interest on macro projections to 1985, on the basis of some assumptions about elasticity of substitution between capital and labor. However, it has not been possible to make any systematic statis- tical analysis in Kenya because interest rates have varied so little in the past. In the absence of relevant empirical material in Kenya, it may be of some value to study the experience of other developing countries which have adopted different interest rate policies. It is, of course, possible that the experience of one country does not apply to another. The problem is further complicated by the fact that, even in those countries where interest rates have changed, it is difficult: to identify the specific influence of changes in interest rates because of the other associated changes going on. All that one can get is a broad feetl of the possible association of interest rate policies and the other relevant economic magnitudes. 1/ See Annex 3. - 14 - 4.06 Among the countries that have made dramatic experiments in interest rate and other financial policies in recent years, the three that are well known are: South Korea (since mid-sixties), and Indonesia and Brazil (since 1967-1968). The initial characteristics of these three were all different. In South Korea the domestic saving rate (three-year centered moving average) was 5 percent in 1963 and the foreign resource balance was two and a half times the level of exports. But the efficiency of investment as indicated by ICOR was quite good (see Table 13). In Indonesia, both domestic savings and ICOR were in bad shape (domestic saving income ratio about 6 percent and ICOR about 5), although the resource balance was only about 25 percent of exports. In Brazil's case, the domestic saving ratio was quite good (about 17%) and the resource balance varied between deficit and surplus, but the efficiency of investment was low (ICOR was about 4). The financial policies adopted by these three countries also differed markedly. 4.07 However, all three countries, although different in circumstance, adopted measures to increase the real rate of interest and, although the mech- anism differed in the three cases, they all accelerated their growth rates by improving the elements in which performance had been weakest. Thus, South Korea improved its domestic saving ratio (which was poor), though not its ICOR (which was good). Brazil accelerated its growth through an improvement in ICOR, but not in its saving-income ratio (which was good). Indonesia had poor performance in both savings and ICORs and it improved its performance in both respects, though its savings performance still has a long way to go. In all these cases, the financial policies were associated with improvement in the degree of financial intermediation, as indicated by the figures of time and savings deposits shown in Table 14. These show that the proportion of money supply held in time and savings deposits increased substantially par- ticularly in Korea and Indonesia. Obviously, one cannot conclude anything definite about the effects of interest rate policy from the above. All one can say that the three countries which have in recent years followed active financial reform policies have accelerated growth. Their experience may not apply to Kenya, but it certainly does not contradict the hypothesis that higher real interest rates may help growth -- through stimulating savings, better allocation, or the more intensive use of capital. If Kenya decides to re- examine its interest rate policy, as the Mission recommends it should, it will be useful for the Government to examine the experience of these coun- tries more closely to see what lessons could be learned for Kenya. 4.08 In the context of a brief review of this kind, it is not possible to suggest any detailed policy reforms. However, in the light of the above discussion, we would like to make some tentative recommendations about the direction in which interest rate policy in Kenya might move. (a) From the point of view of savings mobilization, as well as the allocative efficiency, there is a case for higher in- terest rates for both deposits and loans. (b) The increase in rates should be particularly high at the long-term end of the interest rate structure. This seems ANNEX 4 - 15 - desirable because short-term loans are necessary for work- ing capital which is complementary with employment. It is the longer term rate of interest that may be important for reducing the capital intensity, for example, in building and construction, whicin is particularly high in Kenya. The longer term interest rate may also be a significant instru- ment for changing the import intensity of investment goods, because the imported investment goods generally tend to be of longer life than similar domestic investment goods. It could be argued that, with fungibility of capital, it is dif- ficult to change the structure of rates by government policy. Actually, both the level and structure of interest rates are now largely determined by administrative fiats and not by mar- ket forces. In particular, the low rates that often prevail on long-term lending by official institutions can be changed by government policy. Moreover, even though some amount of fungibility is possible, long-term capital investment cannot be generally financed by short-term loans, due to the costs of roll-overs and the risk of illiquidity. (c) High interest rate policy should not exclude the agricul- tural sector. It seems to us that the real problem is one of access not cost; in other words, it is much better to get credit to small-scale farmers at the market rate, than not to get it to them at subsidized rates. In fact, the cost of credit is not a major item in farm budgets, and we would not expect a moderate increase in lending rates to have any sig- nificant adverse effects on farmers. Quite the reverse, the productivity of credit -- particularly on such inputs as fer- tilizer, improved seed or grade cattle -- should be high enough to make even high cost credit attractive to the progressive farmer. (d) It is true that many agriculturists in Kenya are at present saddled with heavy debts, partly as a result of the terms of settlement schemes. However, the way to tackle the debt problem on old loans as well as the new is to be liberal in amortization schedule and not in lower interest rates. 1/ For example, a settlement farmer with a development loan of I61,000 over 10 years at 6-1/2%, pays L165 a year (I100 redemption + T65 interest). If the interest rate were halved (to 3-1/4%) he would save 633 in an- nual costs. But the same result would be achieved by extending the maturity of the loan from 10 to 15 years. If the maturity were ex- tended to as much as 21 years, the farmer could afford to pay 8-1/2% on his loan, and still save 1633 a year, or 20 percent of his present settlement costs. - 16 - Financial Intermediaries 4.09 Our second set of suggestions relates to financial intermediaries. In general, our feeling is that the financial institutions are well developed in Kenya and a more active interest rate policy should further stimulate the system and enable it to perform its functions on savings mobilization and allocation more effectively. The main areas in which there is, we feel, a need for strengthening institutions are: (a) institutions for channeling financial resources to small African businessmen and farmers, and (b) insti- tutions for mobilizing savings from low income groups in both rural and urban areas. In terms of priority, it seems to us that the agencies for channeling of resources are more important than for saving mobilization. At present it seems that financial institutions are net transferers of funds from rural areas to urban areas. Thus any further development of institutions for mo- bilization of savings, without a prior (or at least concurrent) development of lending functions, will only accelerate the drainage of fund from rural areas to urban areas. 4.10 The development of lending institutions for agriculturists becomes extremely important if the strategy of agriculture-oriented growth is accepted. The problems and possibilities in this field have been examined at length in the Agricultural Sector Survey 1/. Similarly, the institutions for channeling resources to small African businessmen are inadequate and as discussed in Annex 5 special measures are needed for this purpose, possibly in conjunction with a special Kenyanization Fund. Mobilization of savings from small savers will however become more important in the future as policies are adopted for income redistribution. For this purpose, we recommend the following policy measures: (a) The strengthening of the Post Office Savings Bank as a savings institution. In many respects the network of post offices seem very suited as a mobilizer of small savings but over the period 1963 to 1971, the net balances due to depositors have actually slightly declined. The Government has recently taken some steps to improve the administration of post office savings, which may help to increase its popularity. It may be necessary to introduce more reforms later. (b) The Mission feels that the rural cooperatives provide an excellent instrument for savings mobilization as well as for channeling credits to farms. It is hoped that priority will be given to this aspect of cooperative development, rather than unproductive forms, such as consumer cooperatives. (c) It would be useful to explore ways in which the commercial banks could be encouraged to lower their minimum deposit requirements (as the KCB has already done). More practic- able ways than mooal suasion will also have to be found to increase commercial bank lending to small farmers and entrepreneurs. 1/ IBRD Report No. 254-KE, op. cit., Annex 7. ANNEX 4 - 17 - Impact of Restructured Growth Stsategy 4.11 Apart from the above suggestions regarding financial policies, it is important to emphasize that the general policy packages discussed in Volume I and in Annex I have relevance for savings mobilization also. In particular, it seems worth emphasizing that an agriculture-oriented growth strategy, which should help in the matter of balance of payments gap, un- employment and poverty, may also help to stimulate savings. As discussed above, for the same level of income agriculturists tend to save more than urban workers, and the effects of income redistribution on savings will be less serious for growth if the redistribution is from urban rich to rural poor, than from urban rich to urban poor. Because of lack of data on sav- ings in different sectors, it is dlifficult to be more precise about the effects of restructuring growth or redistribution through growth. One point worth noting is that, with restructured growth, investment requirements are brought down to a manageable leveL, and this reduces the savings due to depre- ciation allowances in the future. This however is not a demerit point for restructured growth, because by reducing investment requirements, it i8 actually reducing the gap between investment and saving,.which is what matters from the point of view of internal and external imbalance. APPENDIX Page 1 EFFECT OF FOREIGN CAPITAL INFLOW ON DOMESTIC SAVINGS: A CASE STU1)Y FOR KENYA 1. In recent years it has been argued that foreign capital inflows reduce domestic savings; it is further argued that because of this substi- tution effect, the net benefits of foreign capital may be significantly less than the inflows suggest. In this appendix, we examine this thesis in the light of the Kenya experience. We begin with a brief review of the stages of development in this thesis and examine its validity from general analytical and statistical points of view. We shall then examine the Kenyan data to test the hypothesis and present some results of our analysis of the problem from a different point of view. A Brief Survey of the Literature 2. The literature on this subject has been recently reviewed by Mike- sell and Zinser. 1/ Without going over the same ground, we would like to summarize the main stages of the debate very briefly: (i) T. Haavelmo pointed out the general principle that to the extent that foreign capital inflows increase the permanent income of a country, it would be expected to lead to increase in consumption as well as savings. (ii) Rahman 2/ emphasized the importance of "psychological" factors in inducing the government to relax its saving efforts, when foreign funds are available. Rahman and Enos and Griffin, 3/ tried to test the hypothesis by 1/ Raymond F. Mikesell and James E. Zinser, "The Nature of the Savings Function in Developing Countries: A Survey of the Theoretical and Empirical Literature," The Journal of Economic Literature, March 1973. 2/ M. A. Rahman, "Foreign Capital and Domestic Savings: A Test of Haarelmo's Hypothesis with Cross-Country Data," Review of Economics and Statistics, February 1968. 3/ K. B. Griffin and J. L. Enos, "'Foreign Assistance: Objectives and Consequences," Economic Development and Cultural Change, April 1970. APPENDIX Page 2 estimating cross country regressions of the following type: S F y = a + a F Where S - domestic savings Y gross national product F - foreign capital inflow defined as imports riinus exports They found S to be significantly negative. (iii) Weisskopf 1/ argued that Ra3man, Griffin-Enos results were unsatisfactory because of the econometric problem of iden- tification and are misleading in a trade-constrained situa- tion. He developed a technique for identifying savings contraint cases and tested the hypothesis for the cases where savings constraint was binding and found evidence in support of the hypothesis that foreign capital inflow reduced domestic savings. (iv) Papanek in an interesting article 2/ has attacked this thesis from three angles. He argues, first, that the statistical relationship is in part the result of an accounting conven- tion, not of a behavioral relationship. Second, estimates of savings contain wide margin of errors. Lumping of different types of capital inflow together is wrong. Strikingly dif- ferent results obtained by different authors cast doubt on their reliability. Third, he contends that these authors mistake association for causality. Exogenous factors may casue both high capital inflow and low saving rates. (v) Chenery and Carter 3/ have shown that even if the substitution hypotheses were correct, the implication drawn about the effects of foreign capital are wrong, because the analysis ignores the interdependence between different variables and their dynamic effects. 1/ T. E. Weisskopf, "An Econometric Test of Alternative Constraints on the Growth of Underdeveloped Countries," The Review of Economics and Statistics, February 1972. For a critique of Weisskopf's methodology, see The Review, February 1973. 2/ G. F. Papanek, "The Effect of Aid and other Resources Transfers on Savings and Growth in Less Developed Countries," The Economic Journal, September 1972. 3/ H. Chenery and N. G. Carter, "Internal and External Aspects of Develop- ment Plans and Performance, 1960-1970," IBRD Working Paper No. 141, February 1973. ANNEX 4 APPENDIX Page 3 Some General Criticisms 3. The "substitution hypothesis" and the usual statistical analysis to support it seems to us to be defective for a number of reasons. In the first place, it is difficult to imagine a behavioral saving function for the economy as a whole. The saving behavior of business sector as far as depreciation allowances (which generally account for more than 50 percent of business savings) are concerned depends mainly on tax laws and past invesmtnet pattern. Similarly, the government saving behavior is influenced by different type of factors, political processes, current expenditure requirements of past capital expendi- ture, etc. and should be analyzed separately. Thus, it seems difficult to imagine for purposes of economic analysis, a behavioral entity for the economy as a whole whose "income" is increased as a result of foreign capital inflow and which reacts in such a way as to reduce its domestic savings. 4. Even if one can imagine a behavioral entity for the economy as a whole, should capital inflow lead, a priori, to lower savings? Possibly, but not necessarily. To the extent that foreign aid increases "permanent income" it can be expected to leac to some increase in "permanent consump- tion." However, to the extent that the availability of foreign techniques increases the productivity of capital, foreign capital inflow improves the rate at which the present goods caLn be transformed into the future goods and thus may increase the rate of savings. It is difficult to be sure which way the balance will lie. 5. Even if the a priori thesis had some theoretical validity, its statistical implementation is faulty and fails to test the hypothesis. First of all, the statistical equations use "trade balance" (imports minus exports) as the indicator of foreign aid. Actually the thesis if correctly tested statistically, would require estimates of grant element of foreign capital by examining the terms of lending and sources of finance for the gap; it cannot be approximated by trade balance which might have been financed by drawing down of foreign reserves, workers' remittances, profits from foreign investment, suppliers' credits at exorbitant interest rates, or IDA credits on virtual grant terms. Similarly, if the influence of foreign capital in- flows on savings is to be estimated, both should be measured independently. Actually, savings are generally estimated by deducting trade balance from investment so that if there is any, error in measurement of trade balance it is transmitted, one to one, to savings estimates, which are then being regressed on trade balance (thus violating the statistical assumptions under- lying regression theory). Moreover, the statistical regressions assume that current income and foreign capital inflows are independent, whereas, in practice, in the absence of foreign capital inflows, current domestic income would have been lower due to lack of raw materials and lacking complementary elements for domestic investment. APPENDIX 6. Even if the statistical result of negative association between savings and trade balance were correct, the inference of causal relation will be wrong. This is not the usual caveat applicable to statistical relation. In the first place, the usual growth rate equation gives definitionally an equation where saving-income ratio is negatively associated with foreign capital if, in regression, growth can be assumed to be independent of foreign capital inflow. Thus = k(G) -- y y Y _ = saving income ratio cy = growth rate of GDP k = ICOR F capital inflow as a ration of GDP In this case, the causality is from foreign and domestic savings to growth, not from foreign capital to domestic savings. Secondly, quite often due to extraneous reasons (for example, a transient decline in income due to bad weather), saving may decline leading to emergency imports and balance of trade deficit. However, here both low savings and high trade deficit are caused by other factors, not one by the other. Some such cases have been pointed out by Papanek. As we would notice below, Kenya's case fits in this category rather well. 7. Lastly, even if the causal inference were correct for ex post re- lation between saving and foreign capital inflow, the inference about the efficiency of foreign capital will be wrong. As Chenery and Carter argue, "The proper test of the effectiveness of aid, however, is its effect on growth or other social objectives rather than on savings as conventionally measured ... In cases where there is constraint other than savings, or where the constraints are mixed over time period, the negative association can be expected as a result of ex post savings falling below ex ante as the system is constrained else- where. The association between aid and savings in these cases (the vast majority) is not direct and, in fact, were we to reduce F (current trade balance), savings would rise, but output, investment and consumption would fall." 1/ To take a simple example, suppose that food is imported to pay the workers on a public works project and workers consume the food instantly. In terms of national accounts, output is increased by the value of public works (investment), consumption and investment are also increased by the same amount and saving income ratio is reduced. However, if this food aid has not come in, output, investment and consumption would have been lower and the inference from the regression where output is independent of "food aid" is misleading. The correct way to asses the effects of foreign capital is to work out the alternative scenarios of output, investment, consumption, 1/ Chenery and Carter, op, cit., pp. 27-28. ANNEX 4 APPENDIX Page 5. and so on under alternative assunptions about the levels of capital iR.5low and examine the difference made by changes in capital inflow to the overall picture. This is what we try in our model as presented in Annex I and the basic results are reported below. Statistical Analysis with the Kenyan Data 8. In the light of our colmnents on the usual statistical analysis of the problem, it is clear that this type of analysis has very limited power of discrimination for testing the hypothesis under discussion, and widely different results could be obtained for different countries and different times and different approximations for "foreign capital inflow". Our analysis of Kenyan data confirms our suspicions. Testing the form used by Rahman and Enos and Griffin, we got - =0.1707 - .1852 - y ~~~~y (15.2) (-.57), -2 = -.11; DW 1 .2; SEE - .026 where S - gross national. savings Y= gross domestic income F - resource gap (All figures in constant prices) However, if the same hypothesis is tested in a different form, we get S = -230.5 + .36Y - .77F (-.37) (7.1) (-3.08) -2 R - .89; DW - .89; SEE - 20.0 It is interesting to note that the coefficient of F is not significantly different from unity which may well be the result of defining S as I - F. If this were a genuine behavioral response one would expect some lag in response of saving to movements in F. However, if we introduce a lag of one period to F we get APPENDIX Page 6 S - -114.5 + 0.25Y + 0.422F_ (-1.2) (3.3) (.86) R - .72; DW - 2.2; SEE - 32.8 Similarly if we move away from definitional relationship and use long-term capital inflows (FC) as the indicator of the foreign capital inflow instead of trade balance, we get S - -139.87 + .28Y - .24FC (1.3) (3.1) (-.49) R2G .70; DW 2.74; SEE - 33.3 9. In order to further examine the hypothesis we also made a disaggre- gative analysis. In most cases, foreign capital inflows are not used to finance imports of non-capital goods directly. Therefore, the hypothesis of negative association between F and S implies that due to the fungibility of foreign exchange, the availability of foreign capital either increases imports of consumer goods (MC) or raw materials (MR) or reduces exports (X). In order to test this hypothesis we ran the following regressions: MR = 5.57 + .055 FC + .1399 CDP (.1) (.20) (2.9) R2_ .73; DW - 1.2; SEE - 19.0 MC - 19.50 - .089 FC + .046 GDP (.63) (-.57) (1.75) R2 = .25; DW - 1.54; SEE - 10.4 Government imports (MG) MG - 8.76 + .067 FC + .0031 GDP (.83) (1.256) (.34) R _ .32; DW = 2.0; SEE - 3.6 X - 103.09 + .144 FC + .207 GDP (1.40) (.39) (3.26) R - .79; DW - 3.54; SEE - 25.1 Except in the case of government imports (which include import of capital goods), none of the above equations show any significant evidence in support of the hypothesis under consideration. ANNEX 4 APPENDIX Page 7 10. Apart from regressions, if we examine the figures, we note that only in the last two years, namely, 1970 and 1971 has the current balance (imports minus exports) has been significantly positive. As discussed in the text, these were the years when due to extraneous factors, savings pro- pensity probably did decline leading to balance of payments deficit. Thus, the Kenyan experience will fit, rather well, Papanek's examples where causality does not run from trade balance to savings but the other way round. Moreover, the balance of payments deficits were financed largely by drawing down of foreign reserves and this also illustrates the fallacy of equating trade balance with foreign aid. 11. On the basis of the above results, we conclude that regression equations of ex post aggregate savings on trade balance do not measure the effect of foreign capital inflow on domestic savings propensity. Because of the various conceptual and statistical problems involved, these simple minded regressions given completely misleading (and unstable) results. For more meaningful results, we have to analyze the problem in the framework of a complete model where the savLng functions are treated in a disaggregated fashion and the dynamic effects are studied. This is what we did in our macro-model (Annex I) and some of the main results are reported below. Result of Analysis with the Macro-Model 12. The details of the macrc-model are presented in Annex 1. The model uses slightly modified gap analysis, when the ex post equalization of ex ante and ex post consumption is brought about by changes in relative prices of consumer goods. We note in Annex 1 that if the target growth rates are to be attained, there is a gap in foreign exchange resources, over and above the past and expected future commitments. If this gap could be filled by com- mercial borrowing, the macro economic scenario is as presented in Table 15. If the extra resources are not obtained to fill this gap, and structural and other policy-changes are not adopted, the feasible growth rate would be about half of the plan targets. On the other hand, if the additional foreign capital required to fill the gap is provided, domestic savings are in fact higher by a substantial amount. However, if we run regressions of savings on income and foreign capital, it does not capture this effect, but shows the usual negative association between savings and trade balance. (See Table 15) 13. Our arguments and results should not be interpreted to mean that foreign capital inflow can do no hzarm. In fact we argue in Annex I that foreign capital inflows, indiscriminately used, could create debt servicing problems in the future, and we point out at other places that in the past foreign private investment and external aid have not always been in Kenya's interest. We also find that when faced with the foreign exchange problem, it is advisable to examine structural and policy changes which may reduce the foreign exchange gap. It is quite possible that when apparently easy foreign capital inflows are available, policy makers may ignore the harder alternatives of structural and policy changes and thus harm the long rur objectives of a country. All that we argue here is these types of effectb cannot be assessed by simple minded regressions, but have to be based on case by case country studies. These studies may have to take into account political and institutional factors for analysis of saving behavior in the economy, Particularly that of the government,. STA- TISTICA.L TABLS,S Index Table No. 1 Gross Domestic Savrings 2 Consumer Price Indices in Various Countries (1963 - 100) 3 Gross Domestic Savings (G!DS) and Gross National Savi n½s (sld S) as a Percentage oj' Gross Domestic Income (GDY) 4 Domestic Savings Aldjusted for Terms of Trade Sources of Savings in Kenya 6 Structure of Savings in Various Countries 7 Government Receipts and Expenditures, 1 ')L-1971 S P'rojections of Ex-Ante Savings: 1 974-1 9 S 5 9 Changes in Money uuop ly aznd Related Yaria'b 1 es 10 Loans and Advances by Commercial L.-.anks 11 Princ,pal Interest Rates 12 Selected Interest Rates in Eurepe 1 ITCORs in Selected Countri-es L Strulcture of :Deposits and -,-rrency in Vari.os Countries 1, mparison of Systems D:,),Tami.cs with Different leve'.s of Threigr Capit.lI Inf oi Annex li TABLE 1 GROSS DOJAiESTIC SAVINGS (bn million) GROSS DOGIESTIC GDP SAVING INCOME SAVING ,ATIO (g) 1964 63.92 355.00 18.0 1965 53.57 356.39 15.0 1966 82.49 415 .89 19.8 1967 86.66 437.51L 19.8 1968 87.08 479.7" 18.2 1969 106.55 519.15 20.5 1970 116.4o 577,79 20.1 1971 121.13 630.L6 19.2 1972 1L3.il1 11.21 20.2 Sou-irce: listry of Finance and Plannhng, Kenya. .LL .rI.CL Ivd;l . cl?t S t- ! j O: L , j, CH. ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~Y7L 7~~~~~~~LLt L 17 0~~~~~~~~~~~~~~~ LI L)11 3 LI 6'DI L (I OL t?-d°L ~~~~~~9I ?Ol O-L lllG C- 7l,'i cO 6 0 ~~11 IO CL 6 6 ) I L , ' CO L 0 O co L 0 lOl) l c. ( O1 0C 0 C c IIlL L o t 7'-S '7-c0i) - c*(01 76G LGl 9c9(. 5 t 5, .;~~~~~~~~JLI 1KG :NA oiL:iH Z *Kar0Nc oC (CCL = £.961) 'clVtI-ii-,; ' OC-.LiGAi .... G¶Iij( '7S)TO CWVr L.-iOD.krEl ( , C Table 3: Gross Domustic Savings (GDS) and Gross National 3Avirgs (GNS) as a Percentage of Gros Donrstic Income (GDY) (Three-year crtered mov`.ng average) Ken ya Tanzania | thiopia Ivory Coast Colombia Pihllippines Bra11 ITndonesia South Korea Per Caoita Incorne (1970) in US$ 150 100 80 310 340 210 L20 80 250 Population (000) (mid-1970) 11,250 13.270 214,625 h,941 21,632 36,350 92,7614 115,567 31,793 nrial Growth Rate of GNP T;s) 6.7 6.'. .0 7.5 4.9 5.9 5.1 3.0 9.l (1960-70) GDS GNS GDS GNS GDS G.IS GDS GNS GDS GNS ODS ONS GDS GNS GDS GNS GDS GNS 196l. 10.2 10.5 19.3 17.8 22.11 23.3 18.6 18.0 5.l 4.0 7.6 13J.L 1965 18.6 17.8 17.1 15.6 10.1 10.6 19.h 18.0 22.3 23.3 18.14 17.8 6.5 5A4 10.1 15.1 1966 18.3 16.3 17.L 16.0 10.7 11.1 20.f 16.3 19.3 17.8 21.6 22.7 17.3 16.6 5.8 5.0 12.1 16.8 1067 18.5 16.1 17.6 16.7 11.6 11.8 21.1 16.2 19.2 17.7 90.1 21.0 16 .1 15.3 6.3 5.6 1.h- 18.7 1963 18.h 17.0 11.5 17.6 12.2 12.3 22.2 17.7 19.6 18.1 18.3 19.2 16.6 15.7 5.9 5.0 16.L 20.4 1969 19.1 18.5 17.3 17.9 12.1 12.2 22.7 18.7 20.0 18.L 18.3 18.7 17.L 16.4 7.5 6.1 17.8 20.9 U- 1970 19.5 19.0 18.7 19.2 12.0 12.0 20.0 18.2 13.9 19.3 17.2 16.3 8.5 6.7 17.8 19.9 Smirce: Wojrld sank Atlas and other IBRD Sstimates. TABLE It DOMESTIC SAVITG(' ADJUSTED FOP TFMFIS OF' TI;ADE (Fig,ures in riii -os of Uo at average 196$-69 prices and exchange rates) GROSS GROSS DOMESTIC NAT IONAI DOMF,STIC DOMESTIC SAVINGS SAVIN'GS PRODUCT INC OME (CGDP) (GDY- ) 196 i , 021i.3 1,033.7 1 96 .3 204 1 1965 1,039.2 I ; o.6 172.7 163.6 1 966 1 ,1 9I.6 1,201:.3 2Lf .1 2h.(, 1957 1,241 .9 1,2)46.4 22S .L 190.2 1 96P 1,345.9 1,346.o 2I2 213.7 1 .-c9 1 .L3L.1 1 ,42,'.3 278.6 `7L.7 ,9,o 1$,44L 1,53c.o 311.8 3 .6 1Q71 l ,6L4.1 1,611.8 30o.2 290.7 Source: ITI'D estimates. iAnnex x TABLE SOURCES OF SAVIj%S IT KEWYA aZ 13 US IBU 1ISSS -MOUSEHOIDS GOV&U*tTT - UI4DISTR-IW1 NTE; oDIE;c TTION FROFITS ALLOWANCES Million 196I 2 12.8 13.5 16.B 19(t.5 17.0 9. 6.7 17.18 1966) 31.7 1c.3 12.0 19.2 1967 33.8 1 0. 22.6 1968S 35.8 70.7 ,.6 26.3 1969 5'.4 7.Lj '0.6 30.1 17 70 Li z 2C.1-i 0 33.8 1971 0 ,26.2 .1 L4i .0 Pea rer1 a<.ges 196r 3 .5 19e. 3 ' 1 1h2(11 1 ;1:? 2ti -4 .1 a 26.3 1)6 9i>t, . 7 123.8)L , 320.7 19( 1>< 3 3 .3 1. 32<,- .7 1971 1 ,zig:-es on Gove'ninen.t s vIlng gi-ven r ere :10 trae ¶Eri tncse jr .-r' ex2, ;-iie Go differencese i- deJ i ittor. >oim-ce: Nn>ts.,,ary 1of Finrance and FP 1 caning, TABLE 6 STRUCTURE OF SAVINGS IN VARIOUS COUNTRIES COuTRY YERS | PERCENTAGE CF TOTAL SAVINGS GIKIl.RNi Bl GOVENNENT 1CORPORATIONS HOUSEHOLTS Taiwan 1955-597/ 13.2 56.8 1960-64,/ 20.2 79.8 1965-68- 15.5 80.5 1 9-59371 6.2 56.7 Philippines 1 955-9 LI 24.0 3h.2 41.8 1 960-60-Y 13.0 2l4.0 63.C 1965-6&J 3'.2 20.7 71 .2 1955-592a 12.3 30.9 56.8 Venezuela 1960-64a/ 56.o 10.2 33.6 1965-6W2/ 9.2 13.7 27.0 Brazi 155 - 20.2 75 C 1960-6!4/ 10.2 89 . 1 9f6 57/ 22.6 77.3 651.0 Korec. :,outh 195559_/tlO 3G2 1 960-602' 75.2 3.! -7.o 1965-672! 5,3.2 23>J 1?, 5 kc obmbi 195k491 9.6 20.0 29. 1960-62L 3.2 35./ 26.2 1 965-66' . . 3.7 A~ ~ - 'curces: -Ju n T1 'ai, Finzarnciol Interriec-aies oi_d laion al-vr Y Developing Countries, abae Iir bii.siierE. 1e 7?. r?Se 'earbcok of ti a-!c< Inrcore I co-t,. YU.N. ECAFE, Economic Bulletin for ss a and the Ear East, Decembe.- 1962. lBased on "'I.1irect" xa-n: eti-mates. TABLE 7 GOV';TMi8Ea,:-MT RECLI?TS IDT EX?ENDITU?ES 1964-1971 (v M'illi or) 1 96L 1965 1966 1967 1 968 1 965 1970 1971 IN9-1°7EA1E 1 96LI-1 971 Goverr.ent Irterest .aicd L.- .,'7 .99 -.69 6.'o 7.00 7.70 82 Transfer F. yaents 'ade lnternationa' 5.10 6.20 7.60 6.70 4.10 4.00 ' .70 3.90 -2 _________ ds11 .7J 9.19 8P.12 7.90; 9.'2 8.49 6.29 6.17 -0 C0over=nent Consw mt.-' on 19.35 52.32 '.0'9 62.23 73.52 36,6 HCL .L2 1C5.03 113 Businesa '-bsidies .35 .63 .70 1.5> 2..6S 2.10 1.16 0.97 177 OGovernmen!t Savi ng 12.81 9.'75 1C.31 10.61 10.65 7.36 20.41 26.2L 103 Total Expenditure C,3.58 82.56 88.81 94.27 1o6.l42 113.8 131 .81 152.01 82 Tax Receirts of w'-ich 48.01 52.17 653.89 66.47 '72.78 82.17 95.67 111.17 132 DirecU Income Taxes (10.u7) (10.70) (9.23) (11.60) (11.96) (11.68) (16.6,) (19.90) 90 Indirect Business Taxes (26.91) (29.41) (,5.4P) (35.97) ( 1.C6) (46.62) (56.55) (62.94) 136 Personr.' Taxes 10.6) !12.03) (1..18) (15.90) (17.76) (20.87) 212.47) (23.33) 1$7 ;rofii.s of Gcvernment Cor:,ora- tio!nS -"I.O. Sales of' Service- i/ 37 16.8') 15.12 19.4o 2 C,.3L 20 .4 7L: 27 23 .,43 nlterncationGal Transfer Receicts 20.70 13.O 10.40 8.40 13.30 11.20 12.lO 11.30 -L, Tctal 7erefeots 87.59E 82.56 88.31 91L.27 106.42 113.8 13L.81 152.01 82 nource: Ministry of Finance and PlErring, Kenya TABLE P IROJECTIONS OF EX ANTE SAVINGS: 1974 -19'5 ( 1illion, at Constant 1970 Prices) PERCENTAGE 1976 1975 1976 1977 1978 INCREASE 1966G 1 98r 1 97l-78 Basic Pr_oj_ections GDPat aN.arket Prices 767.2 827.1 692.1 962.9 1039.9 36 1215.2 1°812.7 Gioss Investment 194.0 210.' 2.-;- Ll7.7 2t8.6 33 316.2 478.2 Investment/Income Ratio (5) 25.3 25.r1 25.6 25.7 25.8 26.0 26.L Gross Savings of which 161.6 177.1 19k. 212.5 232.3 44 27L.1 42'.4 Households 51 .9323 .1 ) 25.5 (31 .3) 59.L(30.6) 63.6(29.9) 68.2(29.4) 31 79.0(28.8) 116.9(27.0) (c.rporations Uncistributeci FroC'it 9.3(5-8) 10.2('5.8) 11.2(5.8) 12.3(5.8) 1 1.o(6.0) 51 211.4(7.8) lJ.9(10.3) Depreciatior: ,-llowances 61 . (38.) .3 39 .1 ) 77 .3(39. ) 86,0(40.5) 96.3(40.6) 53 1 06L.2(38.1) 1 7 . 3(3.) acvernmer.t 35.6>(23.1') 62.2(23.8) 6,6.2(23.83) 50.6(23.8) 55.9(24.1) 45 69.5(25.6) 119.3(2'.0) Saving/Income Rabio o6) 21.0 21.4 21.7 2Q0 ?2.4 22.5 23.5 Projected Level of 3Sa.vings (assu2rong household saViIA[s income r-ttio rem3r..s at 7%) Gross S:avin,s 16.1 160.5 176.3 193.5 211.8 65 250.5 391.0 '-ou.seold 36.3 'c.9 61 .6 66.5 67.7 31 553 80.6 Saving/Incoane Ratio () 19.0 19.1 19. 2 20.1 20.6 20.6 21.5 Projected Level of savings ossulrniag resti-cturea groth) GDF at. Narlcet Prices 766.6 92K1 293.1 964.8 1062. 36 1219.9 1320.3 Jross Iim-esstsen-t 176 .3 191.3 206.9 222.6 262.1 67 283.8 42A Crosc Snvl:g- 2 173.6 15?.f 207.1 22 .0 42 26o5.7 60.1 rP,la,ph-orls r9F 2 .1 ( 32 .5;) 5 r: .9( 32 .2) 60.0(31 .) ( .2 ( 1 .1) 69.2(30.) 3? 30.5(30.3) 1 1 7 .(2 . 7) Corpors tions Undistributed. Pi-ofit 10.0(6.3) 11J.(6.6) 12.9(6.8) 1 .5 I7.0) 16.6(7.-) 66 2L 6. -(9?) 60.511 .9) Derreciation 'l10owTnces 599.9(37.7) 5 : .2:r.0) 72 .6(3o.2) 79.6(38.6) )6 . 33.a. Cs c4- i (3. L) 130.6(31 .9) Government ?1 .D(% .) V.6- - . K. '(23.6) V.6(23.5) 53.6223.7) .5 (5.6,25.0) 112.6(27. ) Source: HMission estimates Nte: Figures i.n p Arentheses indicate the 3ercent- ge -'i_stribution of total savings by source. Annex hl TAiBL.E 9 CA.A±4GES Il MICilf-Y SUPPL-Y AND ! LELATEIJ V Ait2L S Imnnual Percentat?.e ':ncre.se H:i\;D ~TOTAL, C -G: ft,,iXc Y T.;9Siu 'L , C)IF 1? t L; SY OUTSfDE :tjC 1rkj Wr' ITS DCL.32XVsupp SUPPLYRL5JK 19-a..Lt-! .Ln9. 13 * 4 . 5 ._ . ri . S , t l CU!rM, 2'aiii Etr,-- Of.L*7 ., Sru.rce: ~ir1m tr>= cf ir i.r.3rceE "!1I1.=]2 !rlii]a .r, a TABLE 10 LOAN ATD ADVANCES BY COIlAI2LZiC7'iC,NT _ZS TA tIN( IN O.R THE YEAR 1 965 a.0c 2.12 5 . o5s 1966 h.07 2.o6 5.82 1967 3.7h 2.09 156 1968 3.33 2.18 3.2 1969 2.83 2.30 2.L1 1 970 3.02 2.45 2 . L6 2.11 1971 Source: IBRD estimates. ,+\.1'-.:_ 1i SThI4CTl'. 01DEP0'-ITS' .fND CTMYr;.I:Y Ii; IOl- 01 C'lnT TE KOlv';E, NW)aE A j ,.R.i i.. -- --_- ...... _ __ (,.lLI.~~~~T-. ;;,,....___(hT,.l gR'."i' -- C ~+,L C'. .7 .- .>IE hE . Kr.- ti r;-oDn!'',j ',i >'\[-J >--1',TX -X,^' -' 2 .'~~~~~~ -t).~T , T7.i , , O'2.;'v5'c,1U9i > v, 11 .'7 is,l.< 670.7 v'7.3 1 59.7! 5'1 .r1 -"2.rG 22.1 17612 29tRc 31r72J T'4-4 11 T~ 70 1>8'-.'7 ;'j3.2 i''Q0. f$.l~~EI ' QXo d.' '21.07T 2.-1 LA:,2 +,3 48'7 1 7-1 2 1 .0st ; i 0 ?.,!-'j'7 1!.O 1 Ln 2 R J7.5 1 .270', Lss, l. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~7 .519 L I I L 7 6L. 2.2--:e.0 1 il6 25 a 3X: 1.6 L.... 2'n-z ttsis 9622 1'?76 16c)2 . Annex 1 T ABL 15 C01ilFAR`ITSON OF SYSTEMS DYNiAMTCS WaITfI DIFiERMEN7T LEVELS OF FOREIGN CAFITAL INFLOW (U'; tMillion, at Constant t 9 iO Prices) GLOVjTiI FOREIGIGE JUIP FIT~~~~rU SAVING CAPITAI -",DP (5) I-IFLOW (GY) k s) (1') LOW LEVEL OF FOREIGN CAPITAL INFLOW 2084i5 4.6 332. 8 27. 7 21 *,' 6 .9 347.L 2297 6.9 361.1 43.2 2412 5.1 372.6 66.7 9C31 5.1 L02 .9 98. 266-. 5.o h6L.. 13., 2805 -3..8 ii. iiP I-EI .EEL Oil' FOIP:1JN CAPITAL PIli 6 1 ., U ~~~~7 . i 17'1. <9 2316 7.3 51 .5 7 2ll92' 7.9 50 . 269(6 7.9 5-2.0 C1 . 2912 b . o510. 10. 1L 1 699.4 3iY. J' -1 760.5 1 ;' I. Aou.rce: ;ission Projectiors ol,te: iT- c rIe-,ression equ a-ion obtaii:ie-d from tlie above diata is: =O + .O2 7 GY - y f7.2) (17.5) (-4.7) ANNEX 5 PRIORITIES FOR PLANNING AND PROJECT DESIGN ANNEX 5: PRIORITIES FOR PLANNING AND PROJECT DESIGN CONTENTS Page No. CHAPTER 1 PRIORITIES FOR PLANNING 1 CHAPTER 2 PLAN ORGANIZATION 6 Int:roduction 6 Central Government Planning 6 Local Authorities 8 Conclusion 9 CHAPTER 3 EXPANDING PLANNING CAPACITY 10 Introduction 10 Supplementation 10 Economies of Scale 16 Encouraging Local Initiative 19 CHAPTER 4 IMP'LICATIONS FOR PROJECT DESIGN AND APPRAISAL 22 The Need for New Types of Investment 22 Metlhodological Problems for Required New Projects 24 Some Difficulties Arising from New 'Project Designs 27 Pac'kaging Projects for the Donors 29 Conclusions: Residual Problems for the Donors 30 APPENDIX 1 STRENGTHENING MANAGEMENT IN THE MINISTRY OF AGRICULTURE APPENDIX 2 SOME EXAMPLES OF REPLICABLE PROJECTS CHAPTER 1: PRIORITIES FOR PLANNING 1.01 Kenya has devoted muLch attention to the preparation of its national development plans, the third of which is to be published shortly. The plans are typically well conceived proposals for the development of the economy, are based on realistic assessments of the revenues likely to be available, and incorporate well balanced public expenditure programs for the financial years covered by the plan period. l4hile setting high targets for growth, Kenya's plans have not been over ambitious in macro-economic terms, and the targets of successive plans have generally been attained. 1.02 Nevertheless, the emphasis in macro-economic planning has tended to be on the production of the published plan, at the expense of the plan as an implementable program of action. The private sector has been incorporated only peripherally, the plans have had little project content, policy proposals are not always previously agreed, and the plan programs have been frequently dis- regarded during the subsequent preparation of the budgets. Commitment to the plans has been weak, both in the active participation of the people, politicians, or even the major operating ministries in their preparation, and in a dis- ciplined monitoring of their implementation. 1.03 These kinds of emphases and weaknesses in national planning are by no means unique to Kenya, and Kenya's plans are certainly much better prepared and more realistic than most. Sector planning and investment management has been adequate in some sectors aind inadequate in others. Historically, invest- ments have been concentrated in the infrastructure sectors, and in these sectors the Government has achieved considerable planning and executing efficiency. Many of the investments were large, productively absorbing investment funds while alternative sectors were not equipped to absorb them. Furthermore, Kenya made use of a large international cadre of consulting experts for infrastruc-- tural investment, for both pro;ject planning and supervision of construction. Tihe expenditures on consultants by the Roads Branch of the Ministry of Works, for example, average about 6-1() per cent of the investment budgets. For major works in the water supply sector, the consultants budget is comparable. As Et result, these ministries now have available to them a local supply of proven expertise to assist in all phasxes of the investment process. Absorptive capacity is not a problem for these sect:ors. 1.04 Modern large scale irLdustry has also had the benefit of a large input of planning in its investments. The entrepreneurship accompanying foreign private investment and technical assistance in industry have supplemented Kenyan planning and implementation skills in this sector. As a result, large scale industry has expanded rapidly and efficiently within the price framework set by government policy 1/. There: is evidence of excess absorptive capacity, for 1/ The framework itself is sub-optimal, and some of the investments are con- sequently uneconomic, but this is a weakness of general policy rather than an absorptive capacity problem (See Annex 3, Chapter 3). - 2 - example, in the waiting list for placement in the expanding industrial estates. In the agricultural sector, on the other hand, and in the small scale indus- trial and commercial sectors, there has been no comparable input of supplemental manpower. Partly for this reason (and partly because these sectors are more difficult to begin with) absorptive capacity problems persist in these sectors. In the social sectors, the problem is mainly to constrain investment within the limits of available resources and to make sure that the highest priority investments are undertaken first. The Harambee movement, 1/ and the naturally strong desire for social services on the part of Kenya's people, require con- stant discipline from Central Government to prevent spending in these sectors from getting far beyond what the country can afford. 1.05 In the light of the strategy put forward in this report, and the uneven capabilities for sector planning, the Mission believes that the priority for future improvement in planning is at the sector level, and that the main concentration of this increased effort should be on all phases of micro- economic planning and development management in the directly productive sectors. Intensive work on sector plans per se is needed to establish the main policy parameters for use in evaluating all of the projects and programs in these sectors, and to establish the links between subsector programs and projects. But sector plans must be practical programs of action, not merely statements of philosophy, and very often sector policy will emerge out of the attempt to identify more projects and programs. 1.06 Increased management effort is required to mobilize the large government organization, particularly in agriculture, and direct it to systematic and disciplined performance of development functions, both in conjunction with new projects and in the execution of ongoing recurrent pro- grams. This will require, in the first instance, detailed planning, programming and budgeting for the use of staff. 1.07 With increased concentration on micro-economic planning within the directly productive sectors, the macro-economic intersectoral planning will acquire more substance because the sectoral investment opportunities will, both in the aggregate, and in each sector, exceed the funds allocable to finance them. Only in this situation is it possible, in principle, to maximize social bene'.t from the investment program by shifting funds, at the margin, between sectors. It seems safe to assume that the other sectors -- infrastructure and the social services -- will continue to be able to absorb more funds than are 1/ To the extent that Harambee projects impose either capital or recurrent costs on the Government, an ideal sector plan for a social sector would allocate Harambee support funds in order of the priority of projects. In practice, Harambee funds are allocated according to the initiative and the persistence of the local sponsors of projects. The misallocation involved in this selection method is generally regarded as a necessary cost of the Harambee system; it is generally felt that the benefits of Harambee -- stimulation of grass roots initiative and cooperation, and mobilization of local savings for social purposes -- outweigh these costs. ANNEX 5 -3- 1.08 The Mission believes planning improvement to be particularly important at this juncture in Kenya's development for four main reasons: (a) As discussed extensively in the main report and in Annex I, sustaining Kenya's good pace of economic growth will probably require a rapid growth of investment in the directly produc- tive sectors at the expense of slower growth of both infrastruc- ture and social services. Because the micro-economic ground- work for an expanded investment program in the productive sectors is not well developed, this shift cannot be accomplished simply by intersectoral reallocations at the macro-economic planning level; it requires also a concerted planning effort. (b) As discussed in Annex 3, the resource use in the private industrial sector has not been optimal from the point of view of generating employment or foreign exchange. Within the present policy framework, which is characterized by underpricing of capital relative to labor and of exports relative to produc- tion for the local market, it is particularly important to exercise great care in the selection of investments to be stimulated; the price system is not encouraging optimal alloca- tion. Furthermore, local small scale industry, agriculture, and trade are discriminated against by present pricing, exchange rate, and other policies so that additional planning effort is needed to stimulate these subsectors. These are the main employment generating subsectors and probably contain the most important under-utilized development potential. (c) Because Kenya will become more dependent on external borrowing to finance development expenditures at a time when the perfor- mance of donors appears to be shifting to directly productive investments, it is increasingly important that a balanced program of investments be presented for external financing. If, for example, the ability to identify, prepare and appraise projects for foreign financing is concentrated in the infrastructure sectors, this may reduce the amount of aid available and at the same time bias matcro-economic allocation in favor of infrastructure. (d) The priorities for future development expenditure are the hard sectors from the point of view of planning and management. Small scale industry, trade, and agriculture can be expected to respond spontaneously to improvements in policy, but they are presently lagging far behirLd the urban formal sector in both fixed capital and human capital, and special programs are needed to stimulate them. Many of these programs will be risky,cor will involve a preponderance of local cost, or will produce results which are hard to evaluate in financial terms. All of these factors will make it more difificult to identify, appraise and package projects -4- in a way that will appeal to foreign suppliers of invest- ment funds or even to Kenya's own project analysts used to dealing with more prestigious projects. Yet it is extremely important that this effort be made, rather than letting these subsectors continue to lag behind the development trend. Programs designed for these subsectors will also require a large management and programming input per shilling invested. Because these programs will involve very large numbers of firms, the administrative mechanism for executing them could become overwhelmingly cumbersone without a sub- stantial improvement in management. 1.09 It was the clear impression of the Mission that within the whole project cycle, from recognition of a development opportunity to the operation of the project, the most glaring lack was at the first stage -- project iden- tification 1/. Ideally, identification of development projects should become a major concern of the entire field staff and management of the productive sectors, as well as of their separate planning units. The task of project identification is simply too vast for a few experts, no matter how keen and competent 2/. Furthermore, a "project" most naturally develops as a response to growth or to overcome a bottleneck in operations, and is first observed by the operators. The more that the eventual operators of the programs contribute to the decision on where to invest-and how to design programs, the less are projects liable to fail at the operating stage. But at the lower field levels, the requisite expertise for project preparation is lacking, which throws the burden of project preparation and identification back on the few planners in the central staff of the ministries or even farther to the macro-economic planners 3/. No conceivable expansion of these central staffs is likely to solve the problem of too few identified projects; unless the field staff can be stimulated to do the bulk of the identification work, a shortage of projects will persist. 1/ For simplicity, we use the term "project" to refer to any special development effort that is undertaken as a separately managed work. This can, and often should, include broadly-based programs identified at the subsector or even sector level of operation. We interpret the term "project identification" to include the demonstration that a profitable investment opportunity exists and that it can be implemented (i.e., designed, "constructed," programmed to operate) within the general policy framework of the Ministry. 2/ The prevalent misconception in many operating ministries that "planning" is a mysterious, and perhaps even dangerous, activity best left to "planners" is a serious obstacle to development in Kenya. 3/ One can observe this process operating in agriculture and it can be anticipated in small scale business if, as planned, the field staff is greatly expanded. ANNEX 5 -5- 1.10 An impottant stimulus to field staff to do the initial work of project preparation would be a very quick response by central ministry planning groups to all project ideas emanating from the field. This response would either: reject the project out of hand; accept the possibility of the project on the condition that certain additional information requirements are filled and specify the additional inforrmation requirements; or accept the proposal as an identified project and commit the Ministry, in principle, to devote resources to the project 1/. Such a quick response would not only serve to reinforce local initiative in cases of government commitment, but would also have a very strong demonstration effect 2/. For this reason, we believe that a higher priority within the project planning machinery of the central minis- tries should be given to this itmediate post-identification phase, and that Kenyan planners particularly should be concentrated here 3/. 1.11 The decision in principle to commit resources to a given project idea, within a clearly identified sectoral strategy, is an essentially Kenyan deci- sion which cannot be taken outside the economic and political decision-making levels of the nation. But the subsequent stages of the project cycle -- the phases of detailed project preparation, appraisal and implementation, and the design of a management system for operating the project and coordinacing it with other activities -- are largely technical and are less concerned with policy decisions. Thus, while Kenya planners should be mainly concerned with the central deotsions about policy and the priorities in resource allocation, there is no apparent reason why foreign expertise (in the form of technical assistance or consultant services) could not do much of the work at these later stages in the cycle. 1.12 Once the Government is committed to a reasonably well-identified project, we believe that there w:Lll generally be little difficulty in lining up external assistance, including where necessary technical assistance in its preparation 4/. Most bilateral donors have expressed a preference for concen- trating technical assistance more heavily in the project cycle, and we believe that this facility -- including t:he activities of the Bank's regional office have not been utilized as much as they might have been. 1/ Initially the commitment need only be to investigate the project in greater depth in the near future with the understanding that further commitment would depend on this investigation. 2/ The immense growth of the Harambee movement in the social sectors illustrates how quickly and widely effective local action can be emulated. 3/ This suggestion differs great:Ly from "bottom up" planning, which has been tried unsuccessfully. Onie of the causes of failure of this planning was that too much work was placed on local authorities of limited planning expertise. The result was a series of generally ill-prepared shopplig lists. Our suggestion is thal: single projects, rather than lists or ill- conceived area plans, be submitted and judged. 4/ The common difficulty of donor A refusing to accept the design or the appraisal of donor B is discussed at some length in Annex 6, Priorities for External Assistance. The Mission considers the problem soluble. -6- CHAPTER 2: PLAN ORGANIZATION Introduction 2.01 The 1969 Bank economic report gave some attention to the planning organization of Government, and examined several areas in which planning capacity was deficient or absent. Since this report, considerable progress has been made in strengthening the planning organization and in achieving more effect:ive coordination. This section will briefly describe some of the more significant developments in planning in Kenya and suggest some areas in which further strengthening is necessary. Central Government Planning 2.02 Central Planning Organization: The Planning Division of the combined Ministry of Finance and Economic Planning is now a fully-established Kenyan unit, under its own Deputy Permanent Secretary who, in view of the size and complexity of his task, is of permanent secretary rank. The Planning Division includes 16 planning posts and six senior planning posts and is overwhelmingly Kenyanized. The Ministry still relies heavily on a high quality team of expatriate advisors, supplied principally by the Ford Foundation and CIDA, particularly in a few key fields such as agriculture, rural development and project planning. In spite of the widening and deepening of indigenous planning capacity, these posts will remain a high priority for external technical assis- tance for the medium term future in view of the requirement for increased absorption of capital in the productive sectors. However, it would be desirable for the Ministry to put less emphasis on the preparation of plan documents and put more emphasis on the management of the economy. The Ministry of Finance and Planning's comparative advantage lies in mobilizing the resources for develop- ment, in the allocation of national priorities, in resolving conflicts, in coordinating the public sector and the private sector and the various levels of Government, and in monitoring the implementation of the Plans and ensuring that the resources are provided through the annual budget for their implementation. 2.03 A Project Identification and Evaluation Un't was established in 1970 by CIDA and is the largest single technical assistance project in planning in Kenya. 'The unit has seven full time expatriate staff working in the central Planning Divisioni and operating ministries, together with a similar number of Kenyarns in Nairobi or on training fellowships in Canada. The work carried out by zhe unit provid.es a systematic r,nethod of codifying projects and monitoring plan implementation. The methodology adopted permits more effective coordina- tion between development expenditure budgeting and recurrent expenditure budgeting, 4rC._ '14ng the provision of manpower. T'he unit is also undertaking a geographical disaggr,gai.ion o' investment expenditure, which is a useful first step in coor- dintation of Central Government investment act:ivitv ut the local level. 2.04 Sectoral Planninig Units: Qne of the more serious problems of planning in Kenya is the inadequate planning capacity of many operating ministries. Des- pite some progress in establishing and staffing sectoral units, the limited planning capacity of some key ministries remains a constraint to sound policy formulation and project preparation and implementation in Kenya. Apart from the scarcity of experienced manpower, three factors seem to have been important in ANNEX 5 -7- restraining the growth of effective planning units in operating ministries. One has been the reluctance of ministries themselves to accept economic plan- ning, presumably because of the fear that their own technical responsibilities might be eroded. A second and more serious factor has been the tendency to favor the central planning unit at the expense of sectoral units, with the result that most of the more senior and experienced Kenyan economists are located in the Ministry of Finance and Planning. This in turn has resulted in a tendency for sectoral development strategy to be evolved by the sectoral specialists in the central Planning Division rather than by planners in the operating ministries. A third related factor has been a reluctance to accept not only the scale of planning input required in sectors such as agriculture and natural resourees, industry and social services, but the variety of dis- ciplines often required to make up a balanced planning team. 2.05 The two ministries with main responsibility for directly productive investments -- Agriculture and Commerce and Industry -- have planning units which in size and composition could be classified as sectoral planning units. The largest planning unit -- with seven permanent posts and 17 expatriates attached to the unit under various schemes of technical assistance -- is the Ministry of Agriculture. Although large compared with other ministries, this unit has a wide spectrum of responsibilities, including price and general agricultural policy, marketing research and intelligence, project preparation and evaluation, water development programs, the agricultural component of the special rural development program, the development of all crops and livestock, and the provision of general economic support services to the nine technical divisions of the Ministry and to the statutory boards. These numerous func- tions have allowed little attenl:ion to be given to the evolution of a long- term strategy for the development of the industry as a whole. The Ministry has also found it difficult to prepare sufficient projects to take advantage of all external aid potentially available for the agricultural sector. A?pendix I to this Annex presents a proposal for increasing the planning capacity of the Ministry of Agriculture. 2.06 In the Ministry of Commerce and Industry, the unit primarily res- ponsible for the project cycle .-- identification, evaluation and granting of protection -- is the Industry Division. This division has an established strength of eight positions, of which only five were filled at the time of the mission. A UNIDO project provides funds for seven expatriate advisers to the division, but only three of these posts were filled. The Ministry has virtually no project identification capacity, but concentrates on preparing evaluations of private sector proposals for the New Projects Committee, which, in turn, approves projects, and recommends to the Ministry of Finance whether Certificates of Approved Enterprise should be issued. These evaluations are very short, and, on the basis of the few examples examined, inadequate. Requests for protection are decided upon by the Industrial Protection Committee on the basis of Industry Division recommendations. Evaluation of requests is -8- ad hoc and based on no agreed methodology. There is no apparent limit to the effective protection granted 1/. The Ministry of Commerce and Industry seems to have played very little part in the preparation of the forthcoming Develop- ment Plan. 2.07 In the ministries responsible for other productive sectors the planning capability is generally rather weak. Perhaps the most serious deficiency in the past has been the inadequate planning and coordination (both in the Ministry of Tourism and Wildlife and in the Kenya Tourist Development Corporation) given to the development of the tourist industry. There is also inadequate planning staff to give as much attention to the development of such sectors or subsectors as wildlife, fisheries, afforestation and mining as their potential surely warrants. 2.08 We have, at several points, referred to the capability of the Ministry of Works, and particularly the Roads Department, to design and imple- ment projects. However, it is clear that their capacity to identify projects has run ahead of the evolution of a strategy for the transport sector as a whole. The weakness lies mainly in the Ministry of Power and Communications (since the Ministry of Works is the implementing agency and not the policy- making ministry) and, in a broader context, with the political constraints to exploiting the potential for greater coordination of transport services and policy within the East African Community. 2.09 A somewhat similar position exists in the social services, and particularly in the Ministry of Education, where the capacity to use an ever- increasing share of the nation's resources has far outstripped the conception of the contribution which education can make to the nationts welfare. Educa- tional planning was first introduced in Kenya in 1970 when a planning unit was established in the Ministry of Education. But so far the unit has dealt primarily with immediate problems on a piece meal basis, and has little influence on policy issues, the definition of objectives, macro-economic planning decisions or inter-agency coordination. It is understood that it is now the intention of Government to make better use of the unit in the future by involving it more closely in the foundation of longer-term plans, possibly as part of a much wider national review of education. This would be a most desirable move. Local Authorities 2.31J,~) We have referred elsewhere in tbis report to the absence of any uefiined D:lcy towards local government in Kenya, This lack of commitment is clearly reflected in the paucity of planning going into the development of local authorities, both in the administrations of the local authorities them- selves and in the Ministry of Local Government. The obvious exception is the 1/ One official, when asked what protection is regarded as reasonable, answered that the reasonable level is that level which ensures "reasonable profitability". ANNEX 5 -9g Nairobi City Council which has attempted an ambitious long-term development plan for the city. But this kind of autonomous planning must inevitably be constrained by the lack of an overall national policy for local government 1/. Conclusion 2.11 This brief summary of planning organization, while focusing on the major inadequacies, is not intended to leave the impression of a generally deficient planning organization. On the contrary, the Mission was impressed by the depth and quality of much of the planning being undertaken in Kenya, and many of the weak points referred to above are now being strengthened, or are at least recognized as weak points. There is no lack of qualified manpower -- both Kenyan and expatriate -- in Kenya, although there will quite obviously nevier be enough experienced planners to do everything. The problems is more a matter of the priorities for their use. We see a need for a relative shift in emphasis from macro-planning to sector planning, with an emphasis on the one hand on increasing the absorptive capacity of the productive sectors, and on the other hand, on the development of a more systematic ordering of priorities in social services and infrastructure. We point out some of the implications of these priorities, and suggest some econDmies of operation in the planning process, in subsequent chapters to this Annex. 1/ The Nairobi Urban Study set out: to prepare a master plan for the develop- ment of the city during the remainder of the century. However laudable this attempt, it was bound to run far ahead of national policy -- even in the short term -- in such critical areas as the overall national policy for urbanization, a workable scilution to the problem of local government financing, the development of rational low cost housing policies, or a strategy of dealing with urban unemployment. - 10 - CHAPTER 3: EXPANDING PLANNING CAPACITY Introduction 3.01 In the judgment of the Mission the capacity of the Government to plan for the needed changes in investment emphasis and to prepare and execute new programs is severely limited. There is apparently no pool of surplus planning talent beyond that needed for business as usual. That is to say that macro-economic planning, and the limited sector planning which exists, absorb all the available manpower. Indeed the planning manpower of important minis- tries concerned -- Agriculture and Commerce and Industry -- is already over- loaded. To make rapid progress in planning and implementing productive programs, therefore, will require improvements in planning efficiency and an innovating approach to project preparation and organization. It is particu- larly important that each trained and capable Kenyan planner have leverage over as wide a range of investment plans as possible. Some possible devices for ga'ning this leverage are supplementation of Kenyan planning skills, economies of scale in project preparation and encouraging local initiative in the identification of projects and programs to relieve trained planners of this task. Supplementation 3.02 Two forms of supplementation have been tried with great success but on too limited a scale: supplementation of manpower and supplementation of the administrative structure itself through the semi-autonomous productive institutions and closer cooperation with the private sector. Both types of supplementation should be expanded, always on the condition that policy formu- lation remains firmly under Central Government control. We believe that policy control will become more effective as the cadre of experienced Kenyans is relieved of much of the burden of technical work: an overworked administration, attempting to do more work than it can do, is likely to lose control of policy through its inability to give due attention to policy issues. 3.03 The Central Government can dispose of part of its burden of detailed project preparation and implementation by making greater use of both the pri- vate sector and specialized ->,arastatals. Compared to the ordinary bureaucracy, these organizations have obvious potential advantages of flexibility and motiva- iori, for example: 1/ (a) A much greater flexibility, in manpower policies and wage rates. (b) A merit system for tenure and advancement of personnel. (c) Relatively small (potential) size, avoiding diseconomies of scale. 1/ We do not mean to imply that parastatals should raid the bureaucracy by offering high wages for skills in inelastic supply. Rather the point is that the parastatals can respond to labor markets (e.g., by hiring surplus school learners at lower wages, by hiring only the labor needed for the development task, by doing their own specific training, etc.). ANNEX 5 - 11 - (d) Profit (in the case of parastatals, reward to management for financial success) as a discipline and a motive. (e) The potential for organizing all supporting services under one administration. The primary disadvantage of these organizations is the possible divergence between private profit (or institutional financial success) and social benefit. The problem for the Government is how to make maximum use of the flexibility of the private sector and parastatals within a framework giving maximum profit and financial incentives for socially useful activities. 3.04 In general, all policies which bring market prices of inputs and outputs closer to their social values will improve the framework for operation of the private sector by making socially useful actions more profitable. These policies -- exchange rate adjustment, more uniformity of effective protection, incomes policies, interest rate policies -- have been discussed at length elsewhere in this report. The only additional point is that the same type of policies are useful in dealing with the production-oriented parastatals; if the prices facing such parastatals conform fairly closely to social values, then the test of profitable operation is sufficient for appraisal cf potential parastatal activities and for judging the performance of operating organiza- tions. On the other hand, projects which depend on very high effective protec- tion for their profitability, or which cannot be profitable at all, are dubious uses of funds, either in parastatals or in the private sector. It is becoming increasingly clear that private foreign investment can be very expensive to the economy in the long run if it is channeled into such activities. 3.05 In addition to the correction of price signals referred to above (and discussed much more extensiveLy in the main report and in Annex 3), the Mission recommends that the Government pursue a more active program to directly promote private investment of the right type, both foreign and domestic. In the industrial sector this would imiply expanding the team of experts in the Industry Division of the Ministry of Commerce and Industry to give it some capacity both for subsectoral planTing and for project identification. To discover what product lines offer potential for development and to do the necessary preappraisal work to attract foreign or domestic firms into these lines, including a systematic presentation of the infant industry protection available and its duration, are probably the minimum terms of reference for this unit 1/. Small-scale African businessmen in established product lines also have clear capacity for improvement in efficiency and subsequent growth, and the Mission endorses the Government's plans for a Small Business Administration, with the reservation that the effort might well be even greater than planned 2/. 1/ We are assuming that the negative function of this unit, to prevent profit- able but uneconomic investments, will be taken care of by policy reform. If not, then expansion of MCI, just to perform this negative role, is necessary. 2/ A discussion of small business opportunities, the Government's proposed response and a type of small business project is included in Appendix 2 to this Annex. - 12 - 3.06 Promotion of agricultural production and the associated processing facilities appears to be one area which could benefit greatly from a policy of active encouragement of private investment. Potential investors are likely to be unnecessarily uncertain about such questions as access to land under long-term leasehold, estates versus outgrowing arrangements, the willingness of Government to provide infrastructural services and extension, the extent and duration of expatriate management that will be permitted, and so forth. Although the details of some of these questions will have to be negotiated on a case-by-case basis with potential investors, general statements of policy, appropriate to the pre-identification stage of investigation, would be helpful for some of them. Such statements are lacking. 3.07 The Government should particularly encourage foreign private invest- ment in those subsectors within agriculture where market connections and high- specialized skills are prerequisites to success. The current development of the pineapple industry illustrates both a successful application of this principle and a weakness in the Government's approach to such investments. The pineapple industry, a single largely foreign-owned and controlled firm, exports about $2.5 million worth of pineapples per year, provides steady employment to about 3,500 Kenyan workers at wage rates ranging from Sh. 225 per month for unskilled field labor (2,000 workers) to Sh. 1,500 per month for the factory mechanics to Sh. 2,000 per month for foremen. The total investment in this project was about $7 million. Production of the fruit is heavily concentrated (97%) on the company's estate. 3.08 This industry illustrates several important points: (a) Given the oligopolistic competition in the product, the entire industry development probably depended upon the foreign firm's market connections and brand name. (b) The industry is very productive of wage employment both in agriculture and processing, with a very low investment cost per worker ($2,000) or per dollar of annual exports (2.8). (c) The industry has done very little to support or encourage Kenyan entrepreneurship. The reason for this is the failure of the outgrower scheme which was initended to produce a high percentage of the fruit. According to most commentators, the outgrower scheme failed because of difficulties in transportation (high cost and too low a reliability to insure the delivery of high quality fruit) and the low priority that the company assigned to outgrower production. It is generally alleged that the company would prefer to produce on its own estates in a completely integrated chain from farming to final product, an altogether understandable, risk- minimizing strategy on the part of the private firm. ANNEX 5 - 13 - Nonetheless, the failure of the outgrowing scheme represents a lost opportunity for real develop- ment of African entrepreneurship -- in farming, in management for agricultural markets demanding high quality, and in transport. The early identification of these opportunities, the stimulation through credits and extension of the required activities, and the assumption of risk on the part of the Govern- ment to guarantee that outgrowers would produce and deliver a certain amount of fruit, 1/ could have confined the foreign firm to its comparative advan- tage -- the international marketing and organiza-- tion of processing. This would have made this particularly good project even better. It is the Mission's opinion that the opportunities to involve foreign private capital in similar ventures can be exploited on a much greater scale with proper iden- tification work and that, by careful design of Kenyan participation, the benefits to the economy can be greater. 3.09 The parastatal form of organization could be more useful for rapid development of commercially profitable activities, such as high valuable crop cultivation. Soma of the existing production-oriented parastatals could be strengthened with this aim in mind, and parastatals with surplus administration capacity might be given developmenit responsibility for a wider range of products. We do not advocate the creation of new institutions; rather that better use be made of existing ones. The advantages of small size and special- ization, relative to the Ministry of Agriculture, and the potential for efficient organization of supporting services have already been pointed out. These advantages seem to outweigh the difficulties inherent in bureaucratic fragmentation. 3.10 Supplementation of the bureaucracy through the addition of production subsidiaries has proven successful, most notably in the tea industry through the Kenya Tea Development Authority but also in the industrial estates program through Kenyan Industrial Estates and the large-scale industrial lending field through the Industrial and Commercial Development Corporation. In the opinion of the Mission, delegation of operating responsibility to productive subsidiaries is a sound procedure, subject only to the condition that the policy framework within which these subsidiaries operate is itself sound 2/. 3.11 Because the tea program has been particularly successful, it is worthwhile comparing this industry with the situation in other major agricul- tural programs where few working projects have emerged. The reasons for the 1/ Although guarantee arrangements could prove costly to the Government in event of default, this mechanism seems the only way to keep risk of non-performance (a "development'" rather than a "business" risk) from being an impediment to development. 2/ Elsewhere in the report we have! commented unfavorably on some of the policy parameters within which these subsidiaries operate. It is not an adverse reflection on the subsidiaries that by efficient management within that framework, sub-optimal results are obtained. - 14 - comparative lack of progress in implanting major programs lie partly in the organization of the bureaucracy. The Ministry of Agriculture, with over 14,000 employees, probably suffers from serious diseconomies of scale, compared, for example, to the compact tea authority (KTDA). Undoubtedly, its extension agents have a much more difficult task -- general extension and farm management advice, rather than the promotion of a single crop. In addition, the Ministry works under the considerable handicap of the civil service system, supporting a large percentage of relatively untrained and incapable extension agents who, in effect, hold tenured positions. KTDA, by contrast, can work on a merit system of tenure and promotion. And finally, the Ministry suffers from fragmentation since, although it probably suffers from diseconomies of scale in extension proper, the logical correlative activities -- marketing, stocking of inputs, irrigation, land settlement, cooperative management -- are often under the control of more or less autonomous marketing agencies, the private sector, or other ministries. 3.12 No single stroke, least of all massive reorganization, is likely to solve all of the problems which impede the planning and implementation of agricultural programs within the Ministry. Rather the transformation of the Ministry into an effective development institution for small farmers is a process which must be begun now and which will yield results only over a number of years. Meanwhile, the Mission suggests a new concentration on planning and implementation of productive programs which can be split off from the slower- moving government machinery. This offers the prospect for effective implemen- tation of these programs even in the short run, and should serve, in general, as a supplement to programs designed to increase Ministerial effectiveness, rather than as a substitute for that effort. 3.13 The example of the KTDA suggests that it is possible to organize a complicated small farmer production and marketing program quite efficiently when the scale of the overall operation is manageable and the management is able to concentrate, with some autonomy, on a single specialized activity which offers high potential returns to croppers. These organizational features of KTDA, combined with the relatively high return in tea, offer the best expla- nation of the apparent anomally of very efficient operation of a complicated production and handling process within a sector which has not succeeded very well in organizing the much simpler and less demanding processes of maize or cotton production by small growers. The Mission suggests, therefore, that in other fields of potentially high return to croppers, the basic organizational structure of KTDA might be duplicated 1/. This would require reorganization or expansion 1/ An obvious objection, that manpower would not be available for duplication of KTDA management and extension teams, is not valid in the opinion of Kenyan specialists in government personnel. Sufficient underutilized talent, particularly in middle management, appears to be available from within the agricultural bureaucracy. The same experts in personnel point out that KTDA has expanded and succeeded under Kenyan manpower, most of it drawn from the agricultural bureaucracy. ANNEX 5 - 15 - of existing parastatals to bring extension, input management, wholesaling, and exporting for a particular crop under the direction of a single agency responsible for its development. The existing Horticultural Crops Develop- ment Authority could, for example, provide the nucleus for several specialized crop development efforts 1/. The Mission does not have the qualifications to determine which parastatals should be upgraded to first class development institutions. (HCDA was cited as an example of a possibility.) Rather, our recommendation is that serious at:tention should be given to upgrading and assigning development responsibiLity to some of the parastatals which now serve only regulatory or marketinig functions or, if necessary, to creating new parastatals for development purposes 2/. 3.14 By delegating a large segment of the implementation and operation of required productive investment: to the private sector and parastatals, the Government reduces its planning task to setting out the correct guidelines and incentives within which these organizations will operate. Control is not lost in this process; it is indeted probable that these organizations will perform more efficiently than the Government since private (institutional) project incentives can be equated to social profit incentives through correct use of policy tools. 3.15 A second form of supplementation that is now underutilized is the direct addition of manpower from outside the Government establishment to work in micro-economic planning. Most of this manpower would have to be recruited from outside the country. This could be accomplished through a redirection of bilateral technical assistance. Kenya could also make greater use of resident consultants from the private sector and such groups as the Institute for Development Studies could be recruited for project work. Local knowledge is of course desirable, but except for initially identifying projects, it is not indispensable for most of the technical project preparation work. Therefore, in our opinion, the Government should be even-handed in its recruit- ment of technical experts 3/. It is worth noting again that in just those areas where supplemental manpower has been most heavily utilized for planning, absorptive capacity has ceased to be a problem. 1/ At present HCDA has neither the staff nor the budget for a major develop- ment effort but important pre-conditions to a development effort -- large productive potential, some experience, a wealth of studies -- already exist. 2/ The recent Agricultural Sector Survey has made various suggestions for the merger or expansion of boards. See IBRD Report No. 254-KE, Volume I, Chapter V. 3/ An exception would be the manpower required at the immediate post-iden- tification stage. Since this initial evaluation is less technical and more a matter of quick judgment of the feasibility of the proposal within the context of the economy and the Government administration, local exper- tise and judgment is a primary requirement. This is why (para. 1.10) we have suggested that Kenyan experts, suitably supplemented with technical subordinates on long-term contract, be concentrated at this level. - 16 - Economies of Scale 3.16 It is a cliche among planners and among donors that the planning work going into a one million dollar project is very similar in extent and difficulty to that of a twenty million dollar project. It follows that the larger the projects are, on the average, the more can be done to increase the rate of growth of investment in the productive sectors with given planning skill. There is no apparent disagreement from Government that large projects should be sought. This section will not therefore discuss the principle of large projects but rather some ways in which larger projects can be identified and implemented 1/. 3.17 The most obvious way to achieve economies of scale is to define projects as broad;y as possible. A "project", subject only to the condition that it retains sufficient clarity to be managed to the production stage in a unified effort, might, at an extreme, embrace an entire subsector program. We have found much support, both in the planning organization, and in the external aid community, for very broadly-defined projects which aim to affect a great numDer of people and to concentrate decisions about sectoral and sub- sectoral alternatives within a given project preparation 2/. Some of the most urgent planning tasks in agriculture could be approached on this basis. For example, the future development of crops such as sugar, oilseeds, tree crops or horticultural commodities probably needs to be planned otn a nation- wide basis, through broadly-based programs designed to integrate all aspects of research, production, marketing and program. On the other hand, other priorities in the agricultural sector - and particularly the design of a major development strategy for the drier arable areas - seem more suited to broadly conceived regional programs. But the broad approach need not be confined to agriculture. We suggest elsewhere that small business assistance and even road planning would benefit from a broader sector or subsector investment program preparation (see Annex 6). This process is virtually automatic in the case of some development oriented parastatals (e.g. the existIng organization of the tea industry), where everything from input supply through extension and processing to final marketing is the function of a single management. Elements of a broad program can be organized, however, without necessarily concentrating all power within a single agency. The Government has already had some successful experience along these lines in such programs as livestock development and industrial forestry; but in general, the device of unified subsector programs is underutilized. Tihe Mission found that some peopie interpret '&rge" projects to mean '"capital intensive" projects or, worse still. that this is the criterion by which a project is judged to be "Bankable". Let it be clear, on the contrary, that our concept of "large" projects are typically programs of low unit cost, which are large mainly because they are designed to benefit a large number of people. 2/ The Mission found a great eagerness on the part of donors to support integrated programs of sectoral or subsectoral development, with greater or less stress on their preparation as identifiable single projects depending on the sector and the donor. It is our impression that the Government underestimw'tes the donors' flexibility in the design of major subsector programs. ANNEX 5 - 17 - 3.18 The preparation of these broad-based projects or programs is any- thing but easy. But they are worth striving for, not only because they can use planning manpower more effic'-ently, but because they should result in more effective planning and a bet:ter allocation of resources. A single nationwide oilseed development program, for example, would be less likely to make allocation errors, or to leave gaps or cause duplication, than a series of smaller and uncoordinated oilseed production projects. Moreover, at a time when Kenya is short on well conceived sector strategies, this subsector or program building can go a long way towards assembling the components of an agriculture sector strategy 11. 3.19 A second scale-increasing device is to expand a production-oriented project to include both indirect benefits and indirect costs. This may simply mean undertaking several separate but related investments concurrently and treating them as a unit. For example, a project to improve husbandry methods of subsistence maize producers in a given locality might be combined with the introductiorn of a high value crop, the provision of required water, transport and processing infrastructure ancL the provision of basic health and technical education services. Not only would this bring many separate fixed investments under one planning exercise, but it would also bring into the project analysis many of the indirect benefits and costs. In our example, the latter would include the increases in Government overheads and recurrent costs caused by the different services required in going from the minimal government support for subsistence maize farmers to the more complex package required for diverse market production. 3.20 There will, of course, be a loss of apparent precision in project evaluation with such broad project definitions. On the plane of pure logic, it is clear that this loss is apparent rather than real; the indirect costs and benefits are the same as those required for the success of a much simpler malze project, but they would typically be covered by fairly imprecise assump- tions about indirect project effects in a narrowly-defined maize project if indeed they were considered at all. The accuracy of the micro-economic analysis is thus seen to improve as the project is broadened, although the pro- ject itself is more difficult to evaluate. As to the planning and financing problems associated with such complex projects, we can only repeat that donors appear anxious to direct technical assistance effort to this kind of work, and that foreign financing of the indirect project components is clearly more likely if they are included in production programs than if they were excluded. 1/ This is another example where the best can be the enemy of the good. To wait for a fully-fledged agricultural development strategy - in which everything is optimized and coordinated - is to wait for a long time. In the meantime, four or five soundly-conceived subsector or commodity programs, with a heavy emphasis on implementation, could have a marked effect on agricultural production and incomes in a relatively short period. 3.21 Program planning and operation would be more difficult than project work because by its nature a program cannot be managed as a unit up to the operating phase. For example, elements of a major maize production program (if one were launched) already exist; the extension agents to service the program are already effectively tenured, a marketing board is already operating, and various public and private input supply agencies (from fertilizer and hybrid seed to credit) are already in the field. Program design would imply a massive coordination effort of agencies only partially suited to a develop- ment effort, rather than the creation of a unit to undertake a specific develop- ment task. Each of the existing units which would have to be incorporated in a maize production program has its own bureaucratic inertia and its own set of operating policies. The Mission suggests that the Government give strong consideration to preparing one or two major crop development plans, complete with required management systems. If such a program or two could be identified, and obtain Government commitment in principle, the technical work of prepara- tion could be delegated to suitably directed technical assistance teams. We believe that financing for such a major crop program could be arranged with little difficulty (see Annex 6). 3.22 Another proven method for achieving economies of scale in investment is to design projects which can be replicated with little or no variation. This method is particularly suitable for use when the target activity is carried out by a number of small enterprises all of whom need a package of project assistance. It overcomes two difficulties in this type of project situation; the ineffectiveness of a single service (e.g. credit) when a number of services are required (e.g. credit, extension, input supply, marketing) and the scarcity of personnel required to plan and implement the package of services 1/. 3.23 The planning economies in replicable projects come from spreading a given planning effort over many project units. Given the fact that it will be reused again and again, the plan for a very small project can economically be given the same attention that would be given a project equal in size to the sum of the many replications of the small project. In other words, a serious project identification, financing plan, detailed preparation and execution can be carried out for a small project. 3.24 Examples of project replicacion are treated in Appendix 2 to this Annex. The Mission believes that this approach is applicable to at least the folLowing: (a) Minimum package programs for small-scale agriculture. Under these programs, a representative unit is identified. The 1/ An important side effect of replicability is that it makes it easier to avoid the use of foreign personnel in actual project implementation. Experts, from whatever source, can do the preliminary design and planning work and the model applications of the project while leaving the replica- tion process to local personnel. Moreover, standardization and simplifica- tion of design can usually allow personnel of limited academic qualifica- tions and experience to be employed in implementation. AN1EX 5 - 19 - required services and other inputs are planned in detail, the representative unit is appraised, and, if economic, the units similar to it are provided with the planned services. (b) Small business credit and extension services. For each of several activities (each containing a large number of small firms) a detailed operations plan (including plans for investment, production, inventory management, sales, accounting and coiatrol) is designed. This package of infor- mation, together with needed technical assistance and credit, are then provided to as many potentially viable firms in the business as can be identified. (c) Site and service programs for agriculture. In each of several regions, a small parcel of land is procured and prepared with all necessary services and inputs to produce a high value crop suitable to the region. Farmers from the immediately surrounding region are invited to rent on a share-crop basis a portion of this land (say, half acre to an acre per farmer) to produce the designated crop under close supervision and guidance of an extension agent whose responsibilities Include looking after input supplies and transport/marketing arrangements. 3.25 A desirable feature of each of these programs is that they attack directly the problem of the small, usually poor, and usually hard to educate Kenyan small businessmen and traditional farmer. Once designed, all of the programs can be staffed by relatively junior personnel because the job of project management is very specialized; it requires far less skill and training to teach several clients the same thing than to give unique assistance to each client. Each of the projects affects a great number of productive units which otherwise might be too small to be assisted. Encouraging Local Initiative 3.26 There is little scope for local initiative in project planning, implementation, or operation within the present vertically-organized ministries. Local governmental units have no development funds of their own and no hope of generating them given their present tax base. The historical pattern has been to increase concentration of revenues, planning, decision-making and adminis- trative control under the Central Government Ministries in Nairobi. Although this centralization was probably necessary because of shortages of trained administrative personnel, it has effectively cut off the flow of productive ideas from the local operating units of the ministries. The coordination of inter-ministerial activities at the local level, which would be necessary for all but the simplest projects, is quite difficult in a situation where each local officer is primarily responsible to his Ministry in Nairobi. There have been some attempts at investment planning from the bottom up, but these have resulted in impossible shopping lists of inadequately analyzed ideas; their effect on the investment program of the ministries has been minimal. - 20 - 3.27 As discussed earlier in this Annex, we believe that local initia- tive in project identification is a necessary condition for an adequate investment pipeline in the productive sectors and that the best way to stimulate this initiative is by central response to the project ideas coming from the field staff of the ministries. To the extent that a project falls within the jurisdiction of a single ministry, this implies nothing more than strengthening the ministry ot provide staff for this function. Inter-ministerial projects, which probably constitute the majority of worthwhile ideas, will require a more cumbersome working group approach, but the sponsorship of the project by an expanded ministerial staff can speed this process. 3.28 The Development Opportunity Team is an experiment in its early stages, hardly more than a concept. The idea of the D.O.T. is that a team of project evaluation specialists based in Nairobi, probably in the Ministry of Finance and Planning with channels into ministerial headquarters, would do field work to help in the preparation and appraisal of projects identified at the local level. In our opinion the D.O.T. could be most useful as an instrument for performing the screening function for projects financed by district development grants. 3.29 District development grants, a device for transfering small alloca- tions of Government funds to the districts for use in approved investments, have potential to become an important stimulant to local initiative. They have, until now, been quantitatively unimportant and their use has not been tightly controlled. Lacking central control, these grants have often been diverted either to projects of doubtful productivity or to projects in the social service sectors which have little to do with the basic development purpose of the grants. If the transfer of resources to-the district were accompanied by a strong screening process, however, the grants could become a useful device for decen- tralizing investment to some extent and thus shifting some of the burden of development planning and execution from the central ministries. 3.30 A project consisting of funding for an expanded district grant program plus a project evaluation team, such as the D.O.T., to screen and improve local project proposals would also introduce some flexibility into the government investment program, which is now too centralized, and would make use of the initiative of the district governmental team in projects of a manage- able scale. In expanding this program, by adding a project team, and increasing allocations, the control mechanisms would be strengthened automatically both by the process of economic evaluation and by the increased visibility of the program. This combination of increased visibility and effectiveness might also have a strong education effect for local politicians. To the extent that these projects produced noticeable increases in employment, incomes, and standards of living in the local area, they should pay political dividends. In the rela- tively short run, it might therefore be possible to attract the kind of political attention to the productive sectors that has so far been monopolized by the social services sectors, which are now under strong direct local pressure to expand through the Harambee device. ANNEX 5 - 21 - 3.31 The emerging practice of disaggregation of the national plan and the investment budget to the district level will also encourage local initiative to the extent that district officers become involved in construc- tive criticism of the plan. Because ministerial plans are prepared indepen- dently, there is ample scope for imbalances and inconsistencies in any single district. To bring these to the attention of the Central Government is a useful bureaucratic function as well as a potentially important learning exercise in planning and coordination. At present, plan disaggregation is concerned only with identified projects. It would probably be useful to expand the exercise to include indicative investment totals that could be financed if well conceived projects were found, disaggregated by district and by economic sector. 3.32 Although attempts have been made at district development planning, ranging from solicitation of investment plans, from general district level ministerial staffs who are inadequately trained to produce them, to the preparation of detailed comprehensive plans for some districts by a team of experts, these attempts have not produced a worthwhile increase in workable investment projects. For the present, the Mission does not expect district planning to be a stimulus to local initiative: district staffs themselves are too inexperienced in the art, and imported experts have not succeeded in stimulating local input into the fancier plans that they have attempted 1/. In the longer run, with growth in the number and quality of planners available, the district planning idea might profitably be reintroduced. For now, what planning talent can be spared for work on the district level, should probably be channeled into work in project identification. 1/ There is an additional problem of effective policy making by foreigners if these development plans are taken seriously. It appears far more advisable to confine the foreigner to a technician's role. - 22 - CHAPTER 4: IMPLICATIONS FOR PROJECT DESIGN AND APPRAISAL The Need for New Types of Investment 4.01 The need to increase investment in the productive sectors has impli- cations for project design as well as for planning. We have already noted some of them in the discussion of Chapter 3 (covering economies of scale in project preparation). Broadly-defined projects and programs were shown to be ways to get more investment per unit of planning effort. More broadly, the situation in the Kenyan economy dictates that any large increase in productive investment will imply movement to new types of investment. Sector by sector we observe: (a) In manufacturing, the scope for efficient import substi- tution - which has been the main engine of industrial growth in the past - is diminishing, and the potential for further export of import substitutes to the EAC market is also limited by the industrialization programs of the other Partner States. The underlying strategy of this report has emphasized the major priorities for industry; to place greater emphasis on resource-based manufactures for export, to promote small-scale enterprises, and to reform the incentives system to improve the efficiency of the private manufacturing sector and avoid the more costly, later phases of import substitution. 1/ We have indicated in the previous chapter that new directions of this kind will require an increased planning capacity. But there is also a clear need for new and better project ideas if the desired new emphases are to be attained without a slackening in the momentum of industrial growth. (b) In the agricultural sector, the potential for productive investment and growth is enormous. But the opportunities as well as the priorities are changing. Some of the export crops (such as coffee and tea) on which Kenya has built up her agricultural industry are facing uncertain market prospects. Investment associated with the transfer of the previous Scheduled Areas to Kenya ownership will dwindle as the remaining foreign farms disappear, and other large programs such as land registration are reaching diminishing returns. A great challenge lies ahead in building on to and extending the firm foundation already laid in the agricultural sector. But like manufacturing industry, 1/ In fact, Kenya has already gone well beyond reasonable exploitation of the import substitution device for industrial growth in several fields. "Deepening" import substitution by producing a wide range of protected intermediate goods is discussed, with strongly negative conclusions, in Annex 3. ANNEX 5 - 23 - agriculture is another case where new sources of growth must be found. The obvious under-exploited resources are the land and labor presently locked up in the agricultural smallholdings, including the subsistence agricultural sector. But as the Bank's recent agricultural sector survey has pointed out, the techniques for developing this potential ara not yet generally available. If a large incremental investment in agriculture is to be achieved, new projects will have to have a new style and a new and greater scope. (c) In the infrastructure sectors, where there is excess absorp- tive capacity in the sense of the capability to identify and implement investment projects, our macro-economic strategy calls forc a stabilized, if not declining, alloca- tion of resources, In some sectors this will also entail a lower growth rai:e, while in others it will hopefully be possible to ma:Lntain past rates of growth, despite a lower investment rate, through the more efficient use of resources. This will demand not only the careful consider- ation of priorities within each sector, but a systematic effort at designing projects which can be made to stretch the available resources further. 1/ (d) In the social sectors, Kenya is faced with the need to clear up distortions in incentives and provide a develop- ment focus to its investment effort (education sector) or to start virtually from the beginning to design whole programs (population control) or to decide on the very highest priority E6ervices in cases where the obviously desirable level of services is beyond the budget capabi- lities (health care, potable water, water supply in general). In none of these s.ectors are there obvious solutions awaiting only the infusion of large amounts of investment funds. Furthermore, clear international as well as Kenyan precedents are lacking; program preparation will be very tough work and innovative approaches are clearly necessary. 31 1/ As pointed out in the main report, we feel that there is considerable scope for lower ICORs (and thus greater output per unit of investment) in the infrastructural sectors, particularly in construction. 2/ The rural water supply system of financing and planning is both an exception to the general rule of inadequate program development and an example of the type of innovative approach that Kenya can and must develop in the social sectors. - 24 - 4.02 Even if there were no absorptive capacity problem as such, other goals (in addition to growth of output) would require innovative approaches to project preparation. Kenya is committed to helping its poor to develop, be they subsistence farmers or small-scale businessmen and their employees, and this commitment would call for direct investment action in support of these groups, even if ample potential for inducing growth existed in the modern industrial sector, the large farm sector and large-scale business. Trickle-down effects have not been reliable in relieving poverty either in Kenya or in many more advanced countries. Direct investment action to improve the productivity of poor persons is probably called for, pursuant to the goal of eliminating the worst excesses of want, whether or not this would maximize growth. However, the macro-economic and sector analyses seem to indicate that there is not much of a trade-off between growth and poverty relief; the more prosperous sectors are not the sectors where rapid growth in investment can be anticipated. The maximum under-utilized potential appears to lie in the resources: land, labor and small business ownership, of the poor. Methodological Problems for Required New Projects 4.03 The stress on new types of projects which must characterize any serious effort to increase investment in the productive sectors will bring with it an accentuation of some common methodological problems and some new ones. In this section we attempt to anticipate some of these problems and suggest solutions. 4.04 Evaluation of Outputs and Inputs at Economic Prices: Many of the required projects would produce outputs which until now have been relatively discriminated against by major Government policies. Thus, for example, the value of foreign exchange earned by agricultural exports, the correct domestic price of foodstuffs, and the value of the output of informal sector manufacturing as compared to domestic industry, would all have to be calculated. Observation of present prices would be misleading, given the distortions in the pricing system. An internationally agreed system (or rather a set of closely related more or less agreed systems) exists for evaluating project outputs and inputs at economic prices even in the presence of serious distortions in observed prices in the market. The problem is a technical one and considerable exper- ience with the solution has been conmpiled by the Institute for Development Studies and various international consultants to Kenya. The problem reduces to one of calculation of the relevant package of shadow prices within the Kenyan ,rowt,' program, factor endowment, and policy f-ramework. 1/ Using all these sources of expertise, there should be enough manpower to subject at least the more important projects to an adequate evaluation.. 4.05 Were it not for the fact that price distortions facing the productive sectors are so many and so large, the risk of error inherent in departure from observable market prices would perhaps outweigh the advantages of a calculated- economic-value approach. The risks are clearly great; for example: the use 1/ See Appendix 1 to Annex 3. ANNEX 5 - 25 - of shadow prices to reflect no more than prejudice, the "justification" of projects with rigged but superfIlcially plausible shadow prices, and the risk of gross error int observation gi:ven the generally weak statistical base. But the solution seems to be to approach shadow prices (particularly those pre- pared ad hoc for a particular project evaluation) with caution and suspicion, checking to determine that they are firmly based on careful calculations of opportunity cost. The shadow price tool is simply too valuable and necessary to throw it out because of its frequent abuse. 4.06 Quantification of Benefits and Costs: Quantification of benefits and costs will become more complex and subject to greater apparent error as projects are defined more broadly or as sector programs are introduced. We have argued earlier that the analysis of broadly defined projects would probably be more nearly correct, and that the apparent increase in error is an illusion created by including more of the errors in the project itself rather than omitting them from consideration altogether by defining projects narrowly. Nonetheless, broadly defined projects do introduce serious quanti- fication problems, for example, if health services are included in a rural development project, quantification of health benefits is necessary. 4.07 The increased complexity of broadly defined projects or subsector programs implies an irreducible effort in their preparation, and the Govern- ment is not yet equipped to prepare and execute many such projects using its own planning and management resources. On the other hand, most of the donor agencies would be more than willLng to undertake a large part of the pre- paratory work and the execution phase of major programs, either by diverting technical assistance or as part of a project loan or grant, if the Government were committed in principle to the project. The Government's input could thus be reduced to project identification and the crucial commitment in principle to undertake the project. An ad(litional problem in connection with financing of a major project may arise if the project is too big for the single donor who does the preparation to undertake alone. However, with early commitment to the project on the part of the Government, international sharing of the financing burden can usually be arranged concurrently with the project prepa- ration. It need not necessarily produce an additional long delay. 4.08 Definition of the Project: The logical limits to an expanded project or program will generally be far less obvious than those of an infrastructure project. To cite only one example, much of the expense of a successful maize production program would be incurred in further training, management, and employment of extension agents and more generally in the overhead activities to set up a machinery for delivering development services to smallholders. The infrastructure for such a program might be very small, the imported in- puts relatively minor, and the expense spread out over many years, so that the inclusion of import costs or infrastructure costs or even of start-up costs misses much of the expense. Another difficult evaluation problem for Govern- ment is caused by the need to allocate shared costs and joint products uetween the programs in question and the ordinary recurrent budget. A counterpart to the evaluation problems caused by the difficulty of defining a project will be the difficulty of agreeing with donors on the reasonable limits to projects. - 26 - As projects shade off into ordinary administrative recurrent cost on the one hand, or into parallel investments out of favor with donors, one the other, the Government can anticipate greater trouble in negotiation for support. 4.09 To the extent that methodological problems arising from logically indefinable limits to a program are mostly due to the institutional rules of donors, they can be solved by pragmatic compromise on a case-by-case basis. The Mission has no solutions to suggest beyond early definition of the Govern- ment's view of the proper limits of the project so that these difficult, often multi-lateral, bargains can be struck during the preparation phase thereby reducing delay to a minimum. In addition, it is the Mission's clear impres- sion that donors are, with few exceptions, prepared to be more flexible than the Government gives them credit for. We would urge the Kenyans to be less restrictive in th.eir own definition of projects. No time is lost in going to a fallback position, if necessary, provided this is done early. 4.10 The more technical problems of project valuation can be relieved, to some extent, by a much greater stress during project preparation on the manage- ment system and the programming of inputs at the operating stage. This concentration is necessary, in any case, if the transition to operations is to be smooth and quick, and the identification of input costs can be considered a by-product of good preparation for management. Joint cost and multiple product problems will, however, persist as "judgement areas" where reasonable men can disagree. This puts a premium on early preliminary identification of the program's limits in order to clear up these disagreements as soon as possible. 4.11 Risk. Risk is an ordinary problem in project evaluation to be handled by careful analysis of the sensitivity of the social return on in- vestment to reasonable probable variations in the benefit and cost elements. If probabilities can be assigned to various possible costs and outputs, risk can be quantified and the social return on the project expressed as a net-of- risk return. For the innovative projects recommended in this annex, risk will not generally be quantifiable because we have no experience with similar projects. Risk is an important problem if the innovation depends upon the cooperation of the private sector. For many activities, ordinary business risk may be minimized by a less innovative approach having less development impact. In such cases the Government should probably intervene as risk taker, isolating the private sector from some of the uncertainties of developmentally motivated processes. 4.12 The example of the pineapple canning industry cited in Chapter 3 is a case in point. Had the Government been prepared to assume the risk of guaranteeing a supply of suitable fruit to be produced by outgrowers, this good project might have been made much more productive of small-scale entre- preneurial incomes and management experience. As it is, the entire production chain is under the central entrepreneurship of a foreign firm. .^7-,;. 5 - 27- Some Difficulties Arising from New Project Designs 4.13 Programs that are large, geographically diffuse, and concentrated in software, rather than infrastructure, present special difficulties of project preparation and financing. This section attempts to anticipate some of these, as well as suggest solutions. 4.14 Loss of Visibilitv. Project visibility may beccme a major issue as programs with a larger scope are introduced. Not many of the new type of investments have built-in monuments, such as large infrastructural or fixed- plant requirements, and even where such requirements are present, a range of much less visible software will usually constitute a greater part of project cost. Very heavy local concerntrations of software effort are proba7Cly not economic, considering the widespread national need, so it is doubtful that visibility problems can be solved by donor identification tith development in an isolated area. I/ 4.15 The problems of visibility will eventually be solved, if at all, mainly by a change in donor attitudes. There is simply no way to make some of the most important projects visible in the sense that infrastructure or fixed capital is visible. However, visibility of a different type can be obtained by skillful packaging and by In unremitting stress on the output of the programs rather than the inputs. 2 If, for example, an investment package could be designed so that donor A can be clearly associated with the increase in sunflower production due to oilseeds project (or better still with the value of that output, or the increased income to the rural poor as a result of that output) a considerably more meaningful visibility could be achieved. 4.16 Critical Mass and Political Constraints. In some instances, opportunities for productive investment will be geographically concentrated. For example, the Nairobi area and the areas surrounding the Mumias sugar project or the Broderick Falls pulp and paper project would be logical locations for projects designed to stimulate small-scale business, because of the existing or emerging conceatration of consumer purchasing power. In other instances, the attempt to bring about any development may require so large a minimum package of Government inputs, that the areas would be getting a disproportionate share of public help. In still other Instances a larger package of Government inputs may be the most efficient way to plan and promote development. In all of these cases, projects face strong political opposition to the geographical concentration of expenditures. 1/ The concentration of great resources in a small area, which has occurred under the Special Rural Development Program, being irreplicable on account of insufficient funds, has generated reasonable jealousy and antagonism from the much more numerous excluded areas. Thus a political problem has arisen in addition to the economic one mentioned here. S.R.D.P. has none- theless, made important contributions. See Agricultural Sector Survey, Kenya, op cit, Annex 8. 2/ When the usual visible project is "rcompleted", after all, the road or the factory is still only an intermediate good. - 28 - 4.17 To the extent that the services provided are social services more or less loosely related to the productive investments, the Mission has no advice other than that the Government attempt to extract payment for services from persons able to pay for them. In the case of directly productive invest- ment, for example, building up consumer-oriented industries to serve the 10,000 newly-emerging middle-income earners at Mumias, the Mission would urge a focus on the income level of the beneficiary of the Government service rather than the income level of the area. If projects are concentrated on the small entre- preneur and the small farmer, and through them aid their wage employaes, they will be directed to the very lowest income groups. And, in the Mission's opinion, the Government should make every effort to overcome the political obstacles to helping these groups in those areas where high concentrations make this aid most efficient. 4.18 It goes without saying, that, in cases where a package of services is required (e.g., improving productivity in subsistence crops), the provision of Government services at sub-minimal levels in order to spread the services geographically is*wasteful of resources. The question is partly technical (how does the marginal return to a third dose of services to one subsistence farmer compare with the marginal return of a first dose to another?) and partly politi- cal (at what level of development should a farmer be left on his own in order to aid less developed farmers, regardless of the comparison of marginal returns?). The Mission feels that the technical choices should be made by carefully weighing the alternative economic benefits against the cost. As to the political problem of just how far the relative economic benefits should deter- mine allocation, we have no suggestion except to note that to the extent a program takes the very poor as a subject for development, even a heavy con- centration of services would tend to improve the overall equity of the system. 4.19 Project and Program Administration. Finally and perhaps most seriously, the details of project and program administration, in broad-gauged projects, will tend to merge with the ordinary workings of the bureaucracy. This is all to the good, if the program is planned well enough so that it continues uninterruptedly from implementation to operation. But the control of processes and procedures very quickly passes out of planners' and donors' hands. Project leverage, as such, just won't amount to very much and the emphasis must shift to improving the ordinary institutions of Government to a point where both Kenya's planners and donor agencies can be confident that the program will be well administered within the bureaucracy. 4.20 The problem of reduced project leverage and control, and the conse- quent uneasiness of donors, can probably best be handled by an additional emphasis during project preparation on the management mechanisms for the operating phase of the project. There is no reason in principle (or apparently, in fact) for donors to prefer separate administration and levers on that administration if they can be assured in advance that the program will be well administered within the ordinary bureaucracy. On the contrary, since the development of an efficient and development-oriented bureaucracy is partly a precondition to and partly a highly desirable result of development, the early ANNEX 5 - 29 - and effective merger of a progr:am into the bulk of the Government programs, while it continues to produce :its development impact, is in a real sense an ideal result. To demonstrate t:hat this result can be achieved -- first by show'ng in careful project preparation how it could be achieved and later by making a success of such a broad-gauged program -- is a clear challenge to the planners, to the cooperating donors, and to the bureaucracy. Packaging Projects for the Donors 4.21 Each of the donors who support Kenya's development effort has special institutional rules and, at least to some extent, unique preferences. The large number of donors involved relieves Kenya of the need to tailor its deve- lopment effort to the investment preferences of any one of them, and donors who might be extremely ill-equipped, institutionally, to handle some develop- ment programs might be ideal for others. 1/ Matching these specialized donor availabilities and insitutional constraints to the requirements of productive investment programs is a high priority planning task which would pay dividends in increased aid, the best available terms, and minimum delays. It is the Mission's clear impression that Kenya is devoting far too few resources to this matching problem. Only about five professionals (including the supervisor) are employed in the unit in charge of coordination of all technical assistance and international aid -- an annual program of commitments in excess of $100 million in total, scattered among a dozen significant donors, and literally hundreds of separate grant, loan, and technical assistance projects. This is not enough personnel to maximize the Government's investment flexibility by. making full use of the insitutional differences between donors. 4.22 Cooperation and coordination of several donors may be required for some of the most important projects. Although necessary, this coordination is an additional project task, and has its costs. An important special case of problems of coordination is the reluctance (or refusal) on the part of some donors to accept each other's identification and appraisal work. The least offensive result of this policy is duplication of work and delay. The most serious result is the (often tacit) refusal to consider projects which are being or have been considered by other donors. This will become a still more important problem to the extent that project identification and pre-appraisal bottlenecks to increased investment must be broken-with the aid of foreign technical assistance. 4.23 International cooperat:ion and coordination, on the program or project level, is a very difficult task given the differing institutionAl limitations of the donors and the varying delegation of responsibility to their Kenya-based representatives. It is the Mission's impression that there is a great potential for vastly improved coordinatiort of this kind. At a minimum it should be possible to decide for each donor the general limits of acceptability, of preliminary project or program work done by other donors. The Mission also suggests for the Government's consideration, that the Bank might provide a useful coordinating service whenever the Government has committed itself to 1/ An interesting case in point: is the general surplus in U.S.A.I.D. of funds, including funds for local procurement and recurrent cost support, earmarked for use in family planning programs. - 30 - carry out a large program which will obviously need help from several donors. Although we can claim no expertise in this role, it appears that an honest broker could solve many of the coordination problems before they delay execution of projects. Conclusions: Residual Problems for the Donors 4.24 This annex has made several suggestions for improvements, and changes in emphasis in Kenya's development planning. Each of them was made in the spirit of expanding the development effort, closing the gap between Govern- ment investment goals and the volume of well-prepared projects, and easing the problems of international cooperation in Kenya's development effort. At the end of the day, however, it must be recognized that greater concentration of Government effort in productive sectors and among the poorer portions of these sectors is inevitably going to put intense strain on the usual practices of donors. To cite only the most obvious examples, large geographically dis- persed programs aimed at aiding the large mass of business or farms are in- evitably going to entail, among other things: a closer coordination between technical assistance and the project cycle, a higher proportion of local costs, much smaller procurement packages requiring more flexible procurement rules, a need (often) to cooperate with other donors or accept their preliminary evaluation results, and (often) an early loss of project control. Because we consider the solution to these problems to be of major importance we devote a large part of the next annex, "Priorities for External Assistance" to a discussion of possible donor responses to them. In conclusion to this annex, we recommend to the Government of Kenya that they be bold, innovative and aggressive in preparing and presenting projects for financing, and that they act on the assumption that sound, well-prepared projects will generally find financing (up to a fairly flexible limit to financial availability) in spite of the institutional limitations of the donors. We reiterate that these limitations are, in general, probably flexible enough to achieve this result. ANNEX 5 APPENDIX 1 Page 1 APPENDIX 1: STRENGTHENING MANAGEMENT IN THE MINISTRY OF AGRICULTURE 1. There is a concensus that the Ministry of Agriculture is weak in its detailed programming of work to be done by its large and scattered field staff, its management of that work and its monitoring of the results. To some extent this has been reflected in the implementation of individual capital projects, leading to dissatisfaction within the Government and complaints among aid donors of a planning-implementat:ion gap. But it is still more noticeable and certainly more serious in the programming, management and monitoring of acti- vities covered by the ordinary recurrent budget. Being about half of total expenditures of the Ministry, recurrent budget activities are clearly important. Furthermore, any agricultural project eventually comes under the ordinary work- ings of the Ministry when, in it:s operating phase, it loses its identity as a project and becomes only one of many facets of the operating program. 1/ The eventual productiveness of any project, therefore, will depend largely on management within the Ministry; "shielding" a project up to the operational stage by isolating it from Ministerial management closes only the planning- implementation gap, and may do very little for the output-effectiveness of the project. 2. A second weakness of the Ministry which has been discussed in this annex is insufficiency of project planning and sector and subsector planning. This is due partly to a shortage of planning personnel and partly to the organi- zational position of the planning staff within the Ministry. As presently organized, the planning staff performs a mixture of macro-economic planning, policy planning and administrative functions, with detailed project and program planning being a residual claimant of time. 3. This annex presents a suggestion for reorganization of the planning staff to include a strong programming, management, and monitoring function (which is at present simply absent), to clarify the responsibilities for micro- economic planning within the Ministry, and to increase the staff for this planning. The suggestion will require substantial increases in manpower and most probably in expatriate manpower. Indeed the entire set of recommendations can be viewed as a proposal for a large bilateral or multilateral technical assistance project, and the Mission strongly commends such a project to those bilateral donors anxious to shift their technical assistance toward directly productive programs. 4. Because the Ministry of Agriculture is responsible for directing the Government's agricultural program in close coordination with several other ministries, for supervising the very large agricultural extension service and for controlling many parastatal agencies, the Permanent Secretary of Agriculture 1/ Exceptions are projects operated as separate entities by parastatals, where the control of the Ministry is indirect and day to day management functions reside in the parastatal. It is this feature of parastatal which prompts the Mission to recommend their expansion during the early phase of the development of the Ministry's management ability. APPENDIX 1 Page 2 probably has the most complex management task in the entire civil service. The single most difficult and most important part of this task is to design and implement a more effective system for delivering development services to smallholders. With the growing emphasis within the Ministry on development of small scale farmers, there is a good opportunity to reinforce the Ministry's efforts to develop such a delivery system. More generally, the management arm of the Ministry for delivering and coordinating all forms of development services needs to be strengthened. Programmir.g and Budgeting 5. Reflecting the Ndegwa Report's recommendations for the systemization of management procedures, the Mission recommends that a Programming and Budget unit (P. and B.) be permanently established in the Ministry. Its exact loca- tion is of less importance than that it be established, but it is essential that it is located where it can perform its true function of supplementing the management function of the Permanent Secretary. The Mission feels, for this reason, that the P. and B. unit and the Planning Division must be closely linked, if not merged, w-tth direct access to the Permanent Secretary. 6. The first major task of P. and B. would be to design and introduce the operation of an integrated delivery system for services to increase the productivity of small scale farmers. The focus of the unit's work would be on detailed management, ensuring that efficient systems were developed for using the skills and the time of ministerial field staff and for coordinating with counterparts in other ministries and the private sector in order to complete the tasks set by policy makers and planners as efficiently and quickly as possible. P. and B. would have no policy-forming functions, and would work entirely through the existing mechanism of the Ministry. 7. Other tasks for P. and B. would arise at intermediate and later stages in the project/program cycle. For any project which would use Minis- terial personnel in its operating phase, P. and B. would design the delivery system for the services, do the necessary financial budgeting and detailed programming of manpower use, and finally monitor the operating phase of the project to enforce and/or correct the plan for use of manpower and other resources. With the extension of detailed programming and monitoring over a wider and wider range, it is natural that P. and B. should be responsible eventually for such overall tasks as the preparation of the annual financial and manpower budget, for preparation of general management systems and for outlining programs of work and manpower use for the Ministry. Thus, we suggest that it should become the primary management tool of the Ministry. 8. The demands that P. and B. would eventually make on qualified Kenyan staff are substantial, reflecting the fact that management is an important and very difficult task in such a large ministry. At the outset, however, the nucleus of the unit sufficient to the task of designing and managing a system for delivery of development services to small farmers might be composed of a few competent Kenyan officers: ANNEX 5 APPENDIX 1 Page 3 Head of Division (Administrative experience) Manpower Programmer (Personnel experience) Financial Planner (Financial experience) supplemented by a team of specialists recruited under technical assistance arrangements from a bilateral donor: Team Leader (Public Alministration) Deputy Leader (Managemnent Systems, P. and B.) Credit Specialist (Financial Economist) Credit Specialist (Agricultural Economist) Marketing Specialist (Farm Management) Marketing Specialist (Marketing Organization) The composition of the unit reflects the main needs of small scale farmers -- extension, credit, provision of inputs and marketing assistance. In order to insure consistent focus on the initial problem of designing and operating a delivery system for smallholders:, the expatriate assistants should have a group identity and a clear group goal. For this reason it is probably desirable that they be recruited from a single bilateral source or that a multilateral institution serve as executing agent reponsible for recruiting a task oriented group. 9. The longer term development of P. and B. would require additions to staff and training would be a priority task. The development and operation of management systems is a relatively new skill in Kenya; this could well be an example of the type of skill which, having proved itself effective, will be raided by the private sector and other government agencies for a long time to come before the general Kenyan market is well supplied. For this reason, technical assistance for the P. and B. should be put under as long a time contract as possible since it might be some time before the unit could be completely Kenyanized. Development Planning 10. A Development Planning unit is needed to serve three main functions: (a) Sector Planning, including the design of major strategies for the Ministry (e.g., national agriculture policy, regional integrated development programs); (b) Commodity programming to determine (for all main commodities) price policies, guidelines for investment and current expenditure in conmodity development, and, in conjunction with P. and B., tc design delivery systems for getting the required development services to farmers; APPENDIX 1 Page 4 (c) Market research, to assemble and analyze information on supply, demand, stocks and prices of major commodities and to seek new market opportunities through promotion activities where appropriate. 1/ 11. The proposed development planning unit is not completely different from the planning unit as now designed. The main innovation in establishing this unit is to give it narrower and deeper terms of reference. For example, a maize program might be designed by this unit, considering every question from land use alternatives, through production and marketing management to rules for pricing inputs and outputs. Whether each of these operating functions is done within the Ministry or in coordination with others, the "package" for maize is best planned and programmed as a whole. Some of the more urgent planning tasks -- such as the preparation of comprehensive programs for maize, oilseed, or cotton, might best be undertaken by relatively small, but highly competent "task forces", recruited for that one purpose. Project Preparation 12. A Project Preparation unit consisting of specialist officers would identify viable projects and prepare them for effective implementation in accordance with the sector guidelines provided by the Development Planning unit and with the assistance of P. and B. in detailed programming and monitoring. This division should be aggressive and innovative and it should be judged primarily on the number of well prepared projects that it brings to the implementation stage. A secondary function of this unit would be to provide on-the-job training for Kenyan entrants into the Development Planning and P. and B. units. Because individual projects lend themselves to practical case- study training techniques, training combined with substantive work might be carried out very effectively by this unit. An additional advantage would accrue if the aggressiveness which should characterize this unit is communicated to new entrants. 13. Strengthening the planning and implementation capacity of the Ministry of Agriculture in this way would require an increase in manpower. In the first instance, this might consist of a few professionals to begin the Commodity Policy work with concentration on one or two commodities, and perhaps two project teams in the Project Preparation unit. Senior and experienced Kenyans should lead both units and qualified expatriates, preferably with Kenya experience, should be recruited under technical assistance agreements to do much of the initial work. A heavy stress on operations, on-the-job training should ensure that expatriates can be phased out of project preparation. Because many com- modities have very special problems, temporary expatriate help on individual commodity problems should be programmed in advance of most new concentrations of effort on particular commodities. 1/ The fact that pyrethrum, a non-polluting insec.ticide,is not yet a recognized retail commodity (under its generic name or any brand name) in the American market is an example of underutilized promotion. ANNEX 5 APPENDIX 2 Page 1 APPENDIX 2: SOME EXAMPLES OF REPLICABLE PROJECTS 1. We have argued in this annex that a shortage of planning, programming and management skills can be expected to constrain absorptive capacity in the productive sectors for the mediuim term future. Although this can to some extent be relieved by expatriate manpower supplementation and by a greater stress on micro-economic planning and programming, it will still be necessary to get maximum output from each planner. Designing replicable projects is one device for multiplying the effect, not only of planning effort, but of efforts to design management systems and manpower-use programs. In addition, project replicability provides a vehicle for learning from past experience; monitoring the operation of a given project is given greater impetus because the results can be incorporated into successive similar projects. 2. In this appendix the development of the small-scale business sub- sector is examined to show how a replicated project could operate there. Secondly, two alternatives are considered for use in the agricultural sector: the minimum package approach and a type of site and services program. Both of these agricultural efforts would be replicable. Small-Scale Business Development 3. There can be little doubt that the development of the small-scale business sector is. extremely important in the overall development of the Kenyan economy. Small-scale firms provide a wide variety of cheap goods and services for the poor. They absorb the surplus labor force which does not find an outlet in slow growing formal employmeni: supplying well over half of the non-farm, non- government employment. They provide an avenue for capital and skill accumula- tion by new migrants. 4. At the same time, labor conditions and real wage rates in the small- scale business sector are probably lower than most in the Kenyan economy, so that any development here would have maximum distributional benefits. It can not be expected, however, to elevate the small-scale sector in isolation, be- cause their position as residual employer or migrants will hold down the wage rate as long as the large gap between formal sector wages and farm earnings induces large migrations in search of formal sector jobs. On the other hand, measures to improve the productivity of labor in the small-scale sector can have an impact on the returns to capital in this sector, on the number of laborers employed and under some conditions, a short run effect on small-scale business wages. 5. Small-scale business can be developed given adequate extension, credit and training, but no one of these services, in isolation, is likely to accomplish much. Hence, the entire literatu.re on small-scale business in Kenya has stressed an integrated approach, aind some of the programs which have provided a full range of services with such an integrated approach (e.g., industrial estates programs and the Partnership for Productivity program) have so far experienced a relatively low failure rate. A serious problem arises, however, APPENDIX 2 Page 2 because in small-scale business the small investment required for each oper- ating firm and the lack of standardization of these investments, combine to make the subsector a very large potential user of extension and training capacity per shilling invested. There can be no thought of an input of expertise, on a firm by firm basis, comparable to the input into a large infra- structure or large industrial project. The low failure rate achieved by both the industrial estates and Partnership for Productivity is based on inputs of expertise which simply cannot be duplicated over a significant number of small- scale firms using present methods. 6. The Government's programs of support to small-scale business are undergoing a transition. Emphasis is apparently shifting from an excessive reliance on concentrated assistance on a few firms at the upper end of the small business scale. This past effort directed toward relatively large firms was quite successful in creating new African firms and maintaining them in profitable operations but the Government has recognized that it did so at a high capital cost and a high cost to the consumers in terts of protection. The new emphasis in government policy is toward assistance over a much broader spectrum of smaller firms. 7. The final form that the Government's program of assistance to small business will take is not yet decided. The recommendations within the Govern- ment, however, are consistent with a shifting emphasis toward very small firms and toward a much greater number of firms. According to the most advanced formulas available to the Mission this would entail the following: (a) Assistance to small business would be centralized under the jurisdiction of the Ministry of Commerce and Industry (MCI). The Industrial and Commercial Development Associa- tior (ICDC) under MCI would be directly responsible for the administration of the program and would create a Small Business Development Agency (SBDA) as a subsidiary to handle this task. (b) The functions of all the present agencies for the support of small business would be subsumed within SBDA. In particular, the Kenya Industrial Estates (KIE) program, the recently inaugurated Rural Industrial Development Center (RIDC) program, the Kenya Industrial Training Institute and the District Joint Loan Boards as well as the present Small Business portfolio of the ICDC itself would all be coordinated by the SBDA. The KIE would continue to function in much the same way as in the past. But the RIDC program, the ICDC lending program and the activities of the District Joint Loan Boards would all be changed rather fundamentally as their activities were coordinated. (c) The SDBA would attempt to provide the full range of necessary services to small businessmen, consisting of business analysis ANNEX 5 APPENDIX 2 Page 3 and feasibility studies, training, credit, and extension services. 8. While the Mission concurs with the new emphasis on small business and with the proposals that a single agency provide a package of development aids to these businessmen, we ieel that there is a serious risk of inefficiency in the new organization. As the Government itself has recognized, it is neces- sary for services to be closely coordinated and tailored to the needs of the individual entrepreneur. Each small businessman needs credit, training and advice in proportions which are unique to his enterprise. But the main loci of these services are the RIDC (to be renamed Small Business Development Centers). The SBDC will, for the next few years, have a relatively small cadre of experts scattered very thinly. One center per province is recom- mended as the near term goal. It is fairly obvious that only with a much larger staff could serious advice and extension unique to the individual firm be given. There is little doubt, on the other hand, that the present program of development of the Small Business Development Centers will place a heavy strain on the supply of manpower of the type required, i.e., highly trained and experienced men with enough general business sense and experience to design unique advice for many firms and enough leadership ability and personal presence to command attention oE businessmen. 9. It is because the task is so large and the available cadre so small that the Mission believes that radical innovations in program design are necessary. Two features of any design that will be efficient, given the extreme scarcity of experts available, will be that the work of experts will be reusable and that the scheme itself will generate additional expertise. As illustrations of contrasting schemes which would fit within the proposed government framework for Small Business assistance, the following paragraphs examine first a scheme supported by Swedish grant aid, which incorporates con- siderable foreign expertise as Et supplement to Kenyan personnel and follows the industrial estates model with some modifications, and second, a more radical project proposal, specifically designed to save expertise, which has received some support from Government during our Mission to Kenya. 10. The Swedish credit is designed to support small-scale manufacturing enterprise in the Kisumu region, roughly coincident with Nyanza Province. It includes financing in the following amounts: (a) An amount of up to Sh 4.7 million for construction of an industrial estate as Kisumu. (b) Up to Sh 1.7 million for equipping a Rural Industrial Development Center and a Technical Service Center. (c) An amount not exceeding Sh 7.7 million for a revolving credit fund. This fund will be used to finance up to 80% of initial capital. cost of entrepreneurs (approximately 25) who will be provided with rental sites by the estate management either within the industrial estate (about 20 firms) or APPENDIX 2 Page 4 elsewhere in the Kisumu region (about 5 firms). The fund may also be used to finance up to 90% of initial capital cost of firms outside the estates, to finance working capital as a lender of last resort or guarantee working capital loans, and to hold equity in new firms to a limited extent. (d) A sum of up to Sh 5.6 million for personnel and a small allowance for contingencies. 11. The portion of the funds going into the industrial estates -- per- haps two-thirds of the total grant on the assumption that just over half of the revolving fund and the personnel grant will be used for the firms in the Industrial Estate -- is not particularly innovative. Very few firms, with high capital cost per firm, will be supported so that this portion of the loan will have little effect on the overall problem of support to a large number of small firms requiring assistance. 1/ But the RIDC segment, the remaining portion of the revolving fund and the remaining personnel assistance give this grant some flexibility. If half of the personnel grant is used to provide technical assistance to small firms outside the industrial estate, either through the RIDC, in conjunction with the administration of the revolv- ing fund, or as a supplement to the government's incipient Small Business Development Authority, this would add 11 man years of expertise spaced over four years. This is a significant supplement to the expertise expected to be available for Kisumu through the normal Small Business Development Authority, but it hardly represents a critical mass for a full scale attempt to develop small business. It is worth emphasizing that the Swedish grant does constitute an advance over the ordinary industrial estates development project. The point of the above description is simply that the bulk of funds of even the most recent industrial development effort is still committed to a very few firms who will be helped very extensively and quite expensively. The remain- ing funds in the program and still more the remaining expertise are too small to affect major technical assistance using conventional methods. 12. In our opinion, it is necessary to supplement such programs as the Kisumu program just described, and the industrial estates program generally, with additional aid to a much greater number of firms. The average monetary assistance to these firms might be as low as L5,000. Some firms in this size range are already assisted primarily by ICDC programs but the total number of ICDC loans to small industrial business up to March 30, 1973, was only 572, of which 59 were simple transfers of established businesses. 1/ Some of the traditional problems of the industrial estate program will perhaps be minimized. In particular, there is considerable awareness of the possibility of promoting export firms, or failing that of supporting firms which can compete economically with imports, and there is an equal awareness of the capital intensitivity problem. How far this industrial estate will succeed in establishing labor intensive and internationally competitive firms remains to be seen. ANNEX 5 APPENDIX 2 Page 5 13. There are several smaLl manufacturing and service activities in each of which a large number of smal:L firms operate. By specializing part of the cadre of development assistants in the activities containing the greatest number of small firms, or in those activities where demand is obviously great enough to support a large number of small firms, several advantages would be gained. First, market surveys could be conducted, not only to devise market- ing procedures for the firms in the activity, but to determine the number and size of firms that the local market can support. This will help to limit market overcrowding, or excessive shortage of firms in the activity. Second, plant design, production planning, simple bookkeeping systems and control mechanisms, inventory plans, and so forth -- in other words, overhead know- ledge required for technical assistance and the evaluation of the need for and potential productivity of goveiniment assistance -- could be obtained once for all the firms in a given activity. For each activity selected, much more expertise could be invested in forming up a prototype of an efficient opera- tion, because the prototype wilL be reused. The cost of a thorough, first rate analysis would be small per firm assisted. Third, because the heavy emphasis on design will permit adviceto be much more precise and detailed, a relatively inexperienced man can quickly be trained to undertake the actual extension work in a single activity. In contrast, only a highly competent and experienced expert could be expected to advise many firms in many different fields. Since Kenya is rapidly developing an oversupply of young, well-educated but inexperienced men, the economic cost of the actual technical assistance would be small. Fourth, the extension worker would quickly develop into a first-class expert in his very limited field able to evaluate, advise and command respect for his ability. The number of failures due to unwarranted advice or error in evaluating a firm's procedures and development aspects should be relatively small. 14. To adopt a specialist approach to development of small business would obviously be inadequate in itself because there are many firms that are either truly unique or too large (actually or potentially) relative to the market for replication to be economic. But this approach would fit in very well as a supplement to the government's industrial estates program and as a subsidiary function of the proposed Small Business Development Agency. We do not suggest that a few specialists can substitute for the staff of the proposed Small Business Development Centers. On the other hand, the task of each of the regional centers would be greatly simplified if, for five or six important types of activities covering perhaps half of the small firms in the area, pre- trained experts with pre-packaged projects were available. 15. It remains to be investigated how many activities have enough firms to make specialization in them worthwhile and how great a percentage of the total of small businesses could be served in this manner, but some indications are available. ICDC data, for example, show that 88% of their loans to small business have been concentrated in only ten rather narrowly defined activities, with the number of loans in each activity ranging from 14 to 216. ICDC manage- ment doubts that they have come close to exhausting the market in more than one of these activities. It would seem from these numbers that the potential for conscious specialization of assistance is reasonably large. Nearly APPENDIX 2 Page 6 homogeneous groups of firms in the service trades would probably be still more common, for example, retail trade of various types, commercial handling and bulking of agricultural products, small transport firms, or food preparation firms. 16. Although we are persuaded that a specialist approach such as the one outlined above would produce large savings of skill in planning and opera- tion, compared to other methods of assisting small business, it cannot be denied that, in its initial phases, such a program would require a lumpy investment. of planning. A unit to lay the groundwork for assistance to be channeled to a number of specialized activities would have to be highly skilled and liberally financed. For this reason, we suggest that the Government seek foreign expert advice, under technical assistance, for the nucleus of these planning units. This assistance should be available not only for the design and testing of the most suitable prototype businesses, but also to help in the initial implementa- tion period. In this way, the training of Kenyans who would serve as loan officers, the initial field trials of the prototypes, and any amendments to the package of services which initial experience reveals to be necessary, could also be assisted by the expatriate experts. Minimum Package Programs for Small-Scale Agriculture 17. The Special Rural Development Program, which is at present the leading effort in small-scale agricultural development, suffers from the same lack of replicability as the successful industrial programs. Once again the problem is less that the SRDP areas have not made development strides (although the record has been spotty) than that the development has been purchased at too great a cost in terms of skilled manpower and financial resources. It is clear that Government is seeking an alternative to SRDP type development efforts. 1l/ A feature of these efforts must be the applicability to a large segment of the rural area, since it is apparently politically unpalatable as well as inefficient to concentrate resources in a few small areas. 18. An approach that offers some hope for broadly based improvement in a short time is the minimum package approach. The central ideas of this approach are (a) to select one or two key services which can make a noticeable impact on production of an important crop; (b) to design a plan for the use of these one or two services; (c) to design a mechanism and an optional management unit for delivering them; and (d) to replicate the management unit as fast as possible. The minimum package approach proceeds from a recog- nition that the Government is in no position to launch a "best practices" development effort over any large share of the agricultural sector. The minimum package approach is to settle for some second best combination which will nonetheless be effective, and spread this second best alternative as broadly as possible. 1/ See Annex 8 of the Agricultural Sector Survey, op cit, for discussion of SRDP experience, including some of the benefits that have been gained. ANNEX 5 APPENDIX 2 Page 7 19. In some countries, the IBRD has recommended a separate administrative unit for minimum package programs, partly in response to an absolute shortage of technical personnel doing axtension work. 1/ In the Kenyan case it would probably be more appropriate to design a minimum package effort to work directly through the Ministry of Agriculture. Even in Kenya, however, some specialization by area, and a thorough and deliberate programming of effort of ministerial personnel spec:ializing in minimum package assistance would be necessary. 20. We believe that there are many applications of the minimum package approach. The Ethiopian kind of project concentrates on an area in an attempt to bring a critical mass to bear on the poverty of the people in a particular area. Another variant is to concentrate on one crop. A minimum package arrangement for an important subsistence crop such as maize, is an excellent example fo the shadow area between "projects" and "programs". Enough project elements exist, that is, enough work must be done in identification, prepara- tion for financing, detailed planning and programming of staff, so that a minimum package approach to maLize development would greatly benefit from a project approach. No doubt an!y "projectt' prepared would have very large local cost elements; except for grain handling and importation of recurrent inputs, it is hard to isolate any foreign cost elements. On the basis of discussions with bilateral donors the Mission believes that this type of project would nonetheless appeal to several of the important bilateral donors and we strongly recommend that the Government seek assistance for the design and implementa- tion of this type of development effort. 21. Another example, already tried with some success in the horticultural industry is the concentration of a minimum package of marketing services (e.g., collection, grading and packing centers) or of stockist services (supply of seed, fertilizers and chemicals, in appropriately sized packs). Often, these two forms of service will be combined into a wider package, combining both the supply of inputs and the provision of marketing. 22. This approaches what the Mission feels is probably the most valuable variant of the minimum package approach -- the entrepreneurial package. This concept, which is very similar to our proposals for small-scale business, entails the identification of one type of activity -- most probably the production of one commodity -- and designs a complete, but standardized, management system, covering design of the operation, the flow of inputs, technical production requirements, and the sale of t:he product. Like the small-scale business project, this need be neither costly nor require much manpower. The essential features are that it supplement:s (or replaces) the small farmer's limited entrepreneurial ability, and is replicable many times over. 23. Much of the national commodity planning should, in our opinion, be designed with a more-or-less standardized production unit of this kind in mind. 1/ See, for example, Pa-143a, Annex 10, Agricultural Sector Survey, Ethiopia. APPENDIX 2 Page 8 This kind of approach has already demonstrated its relevance to special zrops such as tea or pyrethrum; we feel it could be extended more than it has been in commodities like horticulture, pigs and poultry production. 24. One final application of the minimum package approach relates to the particular problem of subsistence farmers who have too little land to break out of their cycle of subsistence production. In outline form the problem can be summarized: (a) Subsistence farmers are growing low value crops, primarily cereals. (b) Land crowding and poor husbandry practices combine to hold output down to a bare subsistence level, or even below sub- sistence levels. (c) The traditional farmer's desperate response is to concentrate more and more on the subsistence crop. If all of his land and labor resources are not sufficient to grow enough food, it is impossible to convince him that he should divert azky of his resources to anything else. (d) But, given the land endowment, many farmers are doomed to subsistence or subsistence levels of income unless they shift into higher value crops. There just isn't any way to become even modestly well off by supporting several people on a few acres by growing traditional grain crops. (e) Hence a dilemma exists. To become reasonably well cff a farmer must change cropping patterns but to change cropping patterns he must feel secure in his basic food supply, whicn is difficult given his land endowment. 25. We feel that there may be a way out of the dilemma if the Government can only get hold of some land in the area -- either by using State land, or by buying or leasing Trust land or registered private land. The reqairements for a site and service project are: (a) A sizeable tract of land, say fifty acres, tocated 4I a densely populated subsistence farming area with potential for growing high value crops. (b) Market connections (a road and market knowledge) for supplying necessary inputs to this tract of land, and for marketing the high value crops. (c) A single extension agent who understands the t&chnolvgy of the crop, and who can organize the supply of inputs and the marketing of crops. ANNEX 5 APPENDIX 2 Page 9 26. The method of operation of the site and service project is to rent small portions of the land, say cine acre per farmer, on a crop year basis to subsistence farmers in the immediate neighborhood, on the condition that they use the land to grow the high value crop under the supervision of the extension agent. Land rental would be on a proportion of sAles basis and inputs would be provided without liability except the claim on a proportion of sales. In other words, the growing of the c.rop is a no-risk venture to the farmer except that he risks his labor time. The project acts as entrepreneur, except that some of the profit accrues to the farmer as a payment for his labor risk. 27. A project of this kind might increase the income of subsistence farmers very quickly at small cost, and introduces them to a cash income, without the awful risk they now run of running short of food if they take a risk. The Mission does not believe that a site-and-service project is the single answer to rural development, but we recommend that this approach might be tried on an experimental basis. We also think that the site-and-services approach may also have relevance to more sophisticated farmers who would be willing to pay a site rent for a plot of land, on a block where certain minimum services (perhaps irrigation) are provided and charged for. We even think the concept might be applied to the urban areas, if land could be made available for market gardeners to use. ANNEX 6 PRIORITIES FOR EXTERNAL ASSISTANCE ANNEX 6: PRIORITIES FOR EXTERNAL ASSISTANCE CONTENTS Page No. CHAPTER 1 INTRODUCTION 1 CHAPTER 2 AID REQUIREMENTS AND TERM OF AID 3 Past Aid Flows 3 Debt Service and Creditworthiness .5 Future Aid Requirements 6 CHAPTER 3 SECTORA1 COMPOSITION OF EXTERNAL ASSISTANCE 11 Overall Priorities 11 Sectors of Aid Concentration 11 Future Commitments 12 CHAPTER 4 CONDIT:ONS OF FINANCIAL ASSISTANCE 14 Priorities for Reform 14 Toward Further Improvements in Lending Conditions 20 CHAPTER 5 CONDITIONS OF TECHNICAL ASSISTANCE 23 CHAPTER 6 AID COORDINATION 27 The Coordination Problem and Its Real Costs 27 Some Suggestions for Improvement in Coordination 28 Aid Coordination Machinery 30 STATISTICAL TABLES CHAPTER 1: INTRODUCTION 1.1 In assessing Kenya's progress during the past decade and attempting to set out the main elements of a strategy of development for the next decade, we have reached the following conclusions which have special significance for shaping priorities for foreign assistance: (a) Kenya will probably face a more stringent resource position during the second decade than she did in the first. This is partly because Kenya's invest- ment needs are growLng in absolute terms and partly because the early growth phase of private and government savings has ended.l/ From the balance of payments point oE view, the same conclusion of growing resource difficulties emerges. Import replacement will become much more difficult than it was during the f:Lrst decade and export growth out- side the agricultural sector will require penetration cf new and more difficult markets.2/ (b) The desirability of a shift in investment priorities toward more directly productive investment, parti- cularly in agriculture and resource based processing has been indicated by the macroeconomic analysis in the report.3/ Our microeconomic analysis indicates that there is considerab:Le scope for improvement in the quality of investment in larger scale manufacturing,4/ and a need for a national program to support small scale businesses in all kilnds of activities. 1/ The present average rate of savings out of GDP is already high (about 19-20% of GDP) and an increase in this rate would imply quite a strenuous efforts for modest advances. See Annex 4 for an analysis of private savings and Annex 2 for a discussion of the prospects for increased public savings. 2/ The East Africa Community markets, which has until now supported both Kenyan import substitution, by allowing larger scale, and export promotion by providing potential markets, is now fairly well supplied with simple import substitutes. See Annex 1 for further discussion of export prospects. 3/ In particular, we have emphasized that agriculture has a high export content of output, low import content cf inputs, low ICOR, high employment/invest- ment ratios, and is the most suitable sector through which to intensify the attack on the poverty. See the main report and Annex 1. 4/ See Annex 3, Chapters 3 and 5. 2- (c) However, we have concluded that Kenya does not appear to be well equipped for the large addi- tional effort that is required to plan, execute, and operate expanded development programs in the productive sectors.l/ 1.2 This annex considers the requirements and priorities for foreign assistance which can be deduced from these conclusions. To a great extent the aid issues are qualitative issues, but before considering these issues, we attempt to answer two quantitative questions. Is prospective aid suf- ficient for a continuation of rapid growth? Are the terms of aid reasonable in view of Kenya's long run development prospects? 1/ See Annex 5, Chapter 2 for a detailed discussion of this point. ANNEX 6 -3- CHAPTER 2: AID REQUIREMENTS AND THE TERMS OF AID Past Aid Flows 2.01 Since Independence, Kenya. has received a large and growing volume of official aid. The annual level of disbursements has more than doubled during the period (from about 1lO million in 1964 to over h2l million in 1972) and the total value of external debt has also doubled (see below). On a commit- ment basis, this has meant that Kenya has received about $4 a year per capita, between 1965 and 1971, which is around the median for countries at a similar stage of development.l/ 2.02 Loan commitments have increased quite rapidly, particularly in 1972, when they jumped to I37.2 million, compared with E19.7 million in 1971 (see Table 2). This surge in commitments has resulted in a large increase in undisbursed debt (nearly L56 million at the end of 1972), so that disburse- ments can be expected to rise quite sharply in the near future. Thus, in general, it can be said that tlhere has been a movement towards a substantially higher level of assistance, not yet fully reflected in the disbursement data. Taking in account the existing undisbursed debt, together with the new commit- ments expected over the 1974-713 plan period,2/ it is projected that annual dis- bursements might increase to about E50 million by the end of the period. 2.03 The amount, source and terms of external assistance to Kenya over the last five years are given in the tables to this annex.3/ Some of the more noticeable features of these figures are the changes and diversification which have taken place in the sources of external aid to Kenya (see Tables 1 and 2). As recently as the end of 1968, over half of Kenya's external debt was held by the United Kingdom. All other bilateral donors accounted for 20 percent of debt, and international institutions held less than 15 percent. By the end of 1972, the United Kingdom's share had fallen to only 28 percent, other bilateral donors maintained their combined share at about 20 percent, but international institutions had increased their share to over 37 percent. As we shall refer to below, this changing composition of aid -- as well as the increasing magni- tude of aid flows -- has considerable significance for Kenya. 1/ See Table 8. Nearly half of the countries in the $100-200 per capita income categories had per capita commitments within the range of $3-5 per year. 2/ New commitments are projected by the Mission to be about E56 million a year over the plan period. 3/ See also Table 4 in the main report for more information about Kenya's external debt. 4 2.04 The terms of financial assistance to Kenya have tended to harden somewhat in recent years (see Table 3). Although the average terms are still reasonable, since 1968 the average interest rate on all loans outstanding has increased by about.l/2 percent (to nearly 4% in 1972), and, average maturity has slightly fallen. As a result, the grant element of all loans outstanding has fallen from 51 percent in 1968 to 48 percent in 1972 (see Table 3). The terms of new debts contracted duringlyecent years have deteriorated even more significantly. A recent Bank report- shows the following comparison between new debts contracted during the periods 1965-68 and 1969-71: 1965-68 1969-71 average interest rate 2.2% 4.8% average maturity 29.6 years 27.9 years average grace period 4.8 years 7.2 years grant element of loans (for discount rate of 10%) 60% 40% grant element of loans and grants (for discount rate of 10%) 77% 67% 2.05 The primary reason for the deterioration in the average terms of lending to Kenya is the changing pattern of lending described above, and particularly the growing weight of multilateral aid in Kenya's external debt. The blend of aid from multinational agencies has hardened very considerably since 1968, as the ratio of IBRD and ADB loans to IDA credits has increased (see Table 1). The composition of Bank Group lending is an especially sensitive variable in the average terms of Kenya's external aid, not only because of the growing weight of Bank Group assistance in meeting Kenya's resources require- ments, but also because IBRD and IDA terms tend towards the two extremes in the range of terms now available to Kenya. 2.06 The average terms of loans from bilateral donors have remained virtually constant over the last five years (see Table 4). However, the average interest rates changed by individual donors have risen in some important cases, and as a result, the average terms would have hardened if it had not been for the fact that the share of new commitments provided by the soft-term donors (particularly Sweden, the Netherlands and more recently Canada) been rising over the period. 2. "'7 Thus, the experience of the last few years has been for Kenya to face a gei,erally hardening blend of aid. But many bilateral donors have gone a long way towards liberalizing the terms of their lending) and some, together with IDA, are providing loans virtually on grant terms. There is also some evidence that the terms of financial assistance from Governments have tended to soften in 1972 and 1973. Interest rates on loans have been lowered: almost all new commitments in 1972, for example, were at interest rates of less than 3 percent, 1/ See "World Debt Tables", IBRD Report No. EC-167-72, December 15, 1973. ANNEX 6 -5 and rates of between 2 and 3 percent were typical for aid planned in 1973. The lower interest donors -- Sweden, Netherlands, Canada, Denmark and Norway are also becoming proportionally more important sources of funds, and pure grant aid is increasing. Important portions of the Swedish program (the 1973 small industries loan), the U.K. program (land transfer), the U.S. program (population control) will be in grant form, in addition to smaller grants available from Norway, Denmark and Netherlands. As a result, there is some prospect that the grant element of bilateral aid may increase still further in the coming years. However, many bilateral donors have already gone as far as their national policies allow in softening their aid to Kenya, and there is probably only limited scope for a continuing improvement in the average terms of all lending. 2.08 Moreover, the supply of concessionary aid is limited and certainly nowhere sufficient to meet Kenya's increasing needs for external capital. In the past, therefore, Kenya has had to rely to an increasing extent on harder- term sources of assistance -- primarily IBRD, but more recently a growing amount of commercial borrowing. As we discuss below, Kenya is presently quite capable of absorbing some further hardening in the average terms of lending, but there is a limit to how far it will be in Kenya's own interests to increase its borrowing, at the margin, on terms which will significantly increase the future burden of debt servicing. Debt Service and Creditworthiness 2.09 Although the marginal cost of borrowing from abroad has been rising, as indicated above, most of Kenya's external debt is still held on generally favorable terms, and her present creditworthiness is not in any dispute. The total debt outstanding at the end of 1972 was just under $510 million (of which $354 had been disbursed) or about 30 percent of GNP. On a per capita basis, Kenya's total outstanding debt has risen from about $32 in 1968 to about $40 by the end of 1972, which is a high, but not excessive, level for countries at Kenya's stage of development (see Table 8). 2.10 The cost of servicing debt has not so far been a significant burden on Kenya's foreign exchange earnings. Total service payments due in 1973 amounted to $33 million, of which $17.7 million was for repayment of principal and $15.3 for interest charges. In 1972, the debt service ratio was 4.2 per- cent, and it has never been higher than 4.5 percent in the previous five years. The repayments schedule on existing debt suggests no servicing problems in the future, except perhaps for one isolated year (1978) when a substantial portion of one loan falls due for repayment. At present about 30 percent of total out- standing debt is undisbursed. But: even so, allowing for the likely schedule of disbursements, the cost of servicing existing debt will not rise appreciably. 2.11 Kenya also has obligations under loans made to the East African Community, most of which are Joinl:ly and severally guaranteed by the governments of all three Partner States. At the end of 1969,1/ the East African Community had external debts outstanding of some $216,000 and annual service payments which were projected to mount to some $26 million by 1972. Compared with the Partner States' external debt, the East African Community has borrowed on generally hard terms. Even in 1969, some 44 percent of the Community's debt was held by the IBRD, and this proportion has almost certainly increased further since then. Another third of the Community's debt was held in the form of public bonds issued in the United Kingdom. No IDA funds have been available to the Community and only the United Kingdom has been a substantial source of bilateral official aid. Since 1969, bilateral aid has increased, including commitments from new donors such as Canada, but an up-to-date report is not available. 2.12 Bank reports have conventionally assigned a one-third share of the outstanding debt contracted by the Communit,/(and of the servicing costs) to each Partner State in the analysis of debt.- If this notional one-third share is added, Kenya's total external debt is probably in excess of $600 million in 1973, and her notional debt service ratio about 5.3 percent. Even allowing for the additional cost of Community borrowing, therefore, it is clear that Kenya's external debt position is still basically sound. As we indicate below, the extent to which Kenya's debt becomes more burdensome in the future will depend upon the magnitudes and terms of new capital flows, but particularly upon the availability of concessionary aid. Future Aid Requirements 2.13 It had been anticipated that the Mission would look at Kenya's aid requirements during the period of the forthcoming 1974-78 Plan. However, at the time of the Mission's visit to Kenya neither the plan investment program nor the financing plan had been finally determined and we shall not therefore 1/ This is the last year for which a full report on the external debt of the Community has been provided. The only information available on new commit- ments over the last four years (1970-73) is for the Bank Group which made IBRD loans, amounting to some $87 million over the period. 2/ This notional allocation of debt is not very satisfactory since it repre- sents neither the legal responsibility for debt nor the economic impact of Community borrowing on the three Partner States. The Community is presently undertaking a study of the national distribution of community services which might subsequently provide the basis for a more useful formula. ANNEX 6 -7- address ourselves to Kenya's quantitative aid requirements in this Annex.-/ However, the analysis of Kenya's longer term resource availability undertaken by the Mission does allow a number of general. conclusions to be drawn about future aid requirements. 2.14 The most obvious feature of the "basic scenario" projections, derived from the macro-economic mve form of assistance. But this assistance has generally been tied aid, with the consultant being hired from the bilateral donor's country, and generally it has been confined to assistance for a single project to be financed by the same donor. Any liberalization of the tying arrangement, which would both widen the consultant market and prevent undue bias in favor of the techniques in vogue in the donor's country, would improve the efficiency of consultancy expenditures and encourage their expanded use. If consultancy assistance can be broadened beyond the single project level (e.g. a sum granted for hiring consultants to prepare and execute a series of projects in small scale industry) the intelligent programming and use of consultants by the ministries would be greatly facilitated. 2/ 1/ It is no coincidence, as we have pointed out in Annex 5, that ministries such as the Ministry of Works, which have established a pool of tested consulting firms in their sectors, have substantially expanded absorptive capacity. 2/ Both forms of liberalization strongly imply that donor's cooperate in pre- paration and use of consultanits reports. It would be of little use to build up multinational, sector-speciific consultancy experience, if in the event of each loan, a bilateral (or muiltilateral) donor insisted upon duplicating t'be consultant's effort. - 24 - 5.04 The second form of manpower supplementation is the provision of expatriate manpower to do professional work in those areas where the (tem- porarily) fixed supply of Kenyan manpower is less than the permanent demand. In these cases, to simply ration the available Kenyan manpower would be inefficient; truly competitive bidding for their services would raise their wage rates without increasing the quantity of services, causing distributional problems and complicating the problem of Government wage policy. For this reason, importation of talent makes economic sense. If demand is very large or growing very rapidly relative to Kenyan supply, it is probably sensible to hire expatriate supplementary manpower on long term contracts, recognizing that qualified Kenyans will not be available sooner. The planning horizon for supplementation is the length of time required for training a pool of Kenyan manpower equal to the demand and growing at a rate equal to demand growth. It is quite inefficient to hire such supplementary manpower on a short cycle, constantly replacing them with other experts who require considerable running- in time before they are effective in the Kenyan content. 5.05 For those professionals with alternative employment opportunities in private industry, in other government agencies, or in other closely related professions, the relevant supply/demand considerations pertain to the entire market. It would be frustrating and short-sighted to expect, for example, that the Ministry of Commerce and Industry could train the number of financial analysts that it requires for its own personnel establishment and then dispense with supplemental manpower. They will in practice need supplemental manpower until the supply/demand relationships for financial analysts in the labor market as a whole have achieved equilibrium and the ministry can hire and retain qualified analysts at a reasonable price. It is poor economics to expect any one ministry or industry to Kenyanize any occupation before that point is reached. To con- tinue the example, the Ministry of Commerce and Industry may have trained several times the number of Kenyan financial analysts it needs, and still require expatriate assistance because the analysts have found employment elsewhere. The manpower policy of the ministry can legitimately be judged on its training rate and on the effectiveness of its trainees, wherever they end up working, but it cannot be criticized (legitimately) for its failure to retain the services of the men it has trained. Donors who insist that a Government institution gets into a bid- ding race, in such a situation of inelastic supply, only complicate the mainten- ance of a reasonable wage policy and shift the problem of manpower shortage to other (perhaps non-aided) Government institutions or private firms. 5.06 The main implication of this discussion for the donors is that they should be prepared to provide supplementary manpower, of a given type of skill, i-l -. .-nimura of turnover, for as long as the scarcity of qualified Kenyan a.anpowqer .s projected to last. Only by coincidence would this period coincide with the disbursement period for any particular project using this skill, or with any period arbitrarily chosen in advance. The result of shorter-term time horizons will probably be excessive costs of turnover of expatriate personnel. If a short time horizon leads to frustration and the withdrawal of needed ANNEX 6 25- technical assistance, the cost will clearly be much higher, taking the form of inadequate eaesr: inpults into the planning and execution of Government progrns. 1is 5.07 A secatnl kind of technical assistance is advisory assistance. This is temporary assistance designed to provide Kenyan officials, who are them- selves in an operational job, with technical or management advice, particularly duiring the running-in. period after their first appointment. This type of assistance can be particularlly valuable wheen the newly appointed Kenyan cfficial is well qualif ted technically, but lacks operational or management experience. T.his acrdvisory assistance may be combined with manpower supplemen- tation In a single techni.cal assistance project, but if an individual is assigned both supplesentary and advisory duties, confusion and poor performance of the advisory functIon are invited, because the line of job responsibility is easi.lv blurred. The advisor may end up performing the duties of the officer (uisually badly becauise of ar. un2rlear job description), at the expense of both the routlne tasks and the advisory function. In this case the advisor would only uindermine the confidence o:E the official and delay the time when he can stand on his owni feet. 5.08 A third class of technical assistance is assistance in training. Unfortunately, there is a great deal of confusion over the process of training, -and the responsibility for trainiing, under the kind of manpower circumstances which face Kenya. &1l too often, expatriates in operational or advisory positions are ex?ectecl to "undertake training", in addition to their primary responsibilities3, bat their job descriptions fail to specify how, or when, this functicrn shoald be carried out. Moreover, in many cases, their workload leaves no time for any kI.nd of trainiing, formal or informal. In our opinion, it is very desirable to include a training function in the terms of reference of expatriate officers and consultants, whether they are in operational or advisory positions, whenever this can be done without conflict with their other responsibilities. But their job descriptions must make clear what their training functions are. 5.09 In most cases, training will be directed at relatively junior officers or apprentices, preferably in an explicitly designed and budgeted training program, In some cases, technical assistance personnel might be called upon to give training courses for several hours a week in a formal training environment. This would have the additional advantage of exposing students in academic institutions to problems in the real world. More fre- quently, however, we believe that the most valuable service is to provide on- the-job training, guidance and encouragement to young and newly qualified Kenyans. This can seldom be accomplished through a process of osmosis; the 1/ A frustration often mentionedl by the donors was the disappearance of "icounterparts", and the MissiLon got the impression from several donors that the failure to retain counterparts was in their opinion a Government failure. Whether any technical assistance was actually terminated or discouraged becau.se of this Fsupposed "failure" was not clear. - 26 - function has to be explicitly defined, responsibilities allocated, and time budgeted for individual contact. Unless this is done, the result is almost invariably that other pressures prevail, and excellent young Kenyans fail to gain the experience and the guidance they need. 5.10 It may often be advisable for the training function to be at one stage removed from the expatriate personnel. For example, an expatriate may supplement an experienced and senior Kenyan official, who can then devote more time to training his subordinates because the expatriate is doing some of his more routine work. If the result is that the Kenyan senior officer, by virtue of his local knowledge as well as his own competence, can do an excep- tional job at training junior personne-l, such an arrangement should get high marks for training, or even for replacement of expatriates in a broader, longer- run sense, in spite of the fact that there is no "trained counterpart" to point to as evidence of success. 5.11 In the Missi6n's opinion, a great deal of the confusion about training could be avoided if the "counterpart" nbtion were dispensed with. In most cases, training should probably be directed at junior officers or apprentices, preferably in an explicitly designed and budgeted apprenticeship program. The suggestion that the trainee should replace the trainer is applicable only in the very special case where a local officer is needed to be exact-ly the same task as the trainer and has the academic qualifica-tions aid practical experience necessary to replace the trainer' in a fair-ly short time. Ard in that special case, it would probably be better to appoin-t the Kenyan to the job immediately with the trainer reverting to a role of advisor (see above). There are in fact no circumstances we can think of in whidh the provision of a counterpart seems to be appropriate instrument of trainifg or Kenyanization. If training can shed the counterpart requirement; technidal training assistanice will be more flexible and straight-'forward. Consultanci-es or long run manpower supplementation will also be relieved of a constant source of friction. 5.12 In a developed non-colonial administration, the usual "counterpart" to an official is his subordinate, all the way down the line. It is generally regarded as good management practice to grade officiais partly on how well they are training subordinates to replace themselves. Surely such a self- training bureaucracy is desirable for Kenya in the long run. The implication is that a good deal of training might take the form of advice to senior officials on how to train subordinates, plus the supplementation of manpower which would be necessary to allow every competent Kenyan civil servent or manager time to carry out a training function. ANNEX 6 - 27 - CHAPTER 6: AID COORDINATION The Coordination Problem and Its Real Costs 6.01 Both the Government and the donors stand to gain in efficiency of planning and effectiveness of aid from an improvement in aid coordination at all levels. Chapter 4 of this annex argues that, for support of the sectors of investment concentration recommended in this report, the agricultural and industrial sectors, an increase in coordinated effort is almost essential, mass programs would be insupportable if left to a single donor. The integra- tion of technical assistance projects with financial assistance was one of the main themes of Annex 5, and Annex 3 showed fairly clearly the need for similar coordination between technical assistance and the administrative arms of the Government dealing with conditions and incentives for private invest- ment. The Mission encountered no argument from Government or from the donors against the proposition that coordination should be improved. Surprisingly, there do not seem to be even the usual bureaucratic reservations about loss of flexibility or freedom of maneuver. 6.02 Immediately below this "coordination is a good thing" plane of generalization, however, some :real impediments are quickly obvious. First and most obvious are the institutional weaknesses of both the Government and the donors. The Governmenl: is simply not using enough manpower to do a thorough job. The donors are, by and large, represented by field staff having very little negotiating power, except as delegated on a case by case basis, from their national heacLquarters. 1/ Thus the usual procedure is for a small Government staff to conduct a good deal of the actual business of assistance negotiations outside the country, thereby spreading the Government resources even more thinly and isolating each bilateral negotiation. Coordina- tion based on quick response tco detailed proposal and counterproposal is clearly impossible in this context. 6.03 A second obvious impediment to coordination is competition among the donors for "the best" projects. The operational limitations on the donors are remarkably similar. Almost all of them finance foreign exchange costs more easily than local costs. They all favor easily managed projects because of the common shortage of management personnel. They all prefer to be associa- ted with visible projects which have a high probability of success. Although there is some diversity in stated goals of individual aid programs, it remains true that from a given list of government development programs, readily avail- able donors would cluster arond a very few. This competition for the few 1/ The field staff of the United Kingdom ODA office have recently been given considerable freedom of operations. Loans up to i 0.25 million can be approved by the field staff subject to the overall limit on aid from ODA and within the guidelines of an annually revised policy paper. This recent innovation is a hopeful contrast to past ODA practices and the usual practices of other donors. - 28 - projects that fit well with donor preferences is surely unfortunate, but it is hard to imagine changing it in the short run. 6.04 A third impediment to coordination grows out of the first two. This is the (often expressed) impression of the donors that the Government is purposefully vague and uncommunicative in coordination matters in order to plan one donor off against the other. An apparent result is that donors sometimes set up counterstrategies of vagueness with both the Government and one another, in order to compete for the best projects at the greatest advantage. For the donors as a group, the competition is useless and, for the Government, the only possible gain is better matching of investments and donors. Meanwhile, the attitude of secrecy (most often expressed as the statement that everyone else is secretive) has real costs to the Government: (a) uncertainty over who is to finance which project leads to delays in project preparation and appraisal since donors are, by and large, unwilling to accept each others appraisals; (b) switching of (usually implied) project commitments from one donor to another wastes technical assistance or aid manage- ment because of duplication of preparation effort; (c) uncertainty biases donors against the more complex project, with a longer preparation period, in favor of the project that can quickly be negotiated, committed, and disbursed. 1/ Some Suggestions for Improvement in Coordination 6.05 Any attempt at improving the machinery and coordination should probably take as given, at least in the short term, the manpower shortages in the Government staff and the limited authority of the donors' field staffs. 2/ But even working within these constraints, there is, in our opinion, considerable room for improvement. Some suggestions are: (a) Early commitment in principle, on the part of the Government, to undertake a given project or program, should be given wide publicity among the donors, and this publicity should include 1/ The area or country desks in aid agencies are naturally inclined to grasp any "bird in the hand" project in the country for which they are responsible, if the alternative is to see their financial provision run out at the end of the fiscal year by default, or reallocated to another project. It is by no means unusual for a country's allocation to be influenced, if not determined, by the speed with which the previous tranche was disbursed. 2/ This is not to go back on our former recommendation (Annex 5) that Govern- ment increase its aid coordination staff. Rather, it is a recognition that, even with good effort to build up that staff, the scarcity will remain for quite some time. ANNEX 6 - 29 - an approximation of the financial aid and the technical assistance that will be required. Technical assistance requests should be liberal, to give donors the opportunity to realize, in fact, their stated intention to relate technical assistance: to projects. (b) The donors should, in their own interests, attempt to establish their own assistance programs on a long term basis; a rolling four year operations program for each of the donors would probably suffice, for practical purposes. Such a program would allow both Government and donor to plan man- power and financial budgets, establish the critical path for individual projects, line up necessary joint donors and so forth. In order that these programs should have real opera- tional content, they should be based as much as possible on the Government's investment commitments. The four year operations programs of the lenders should be the basis for (perhaps yearly) discussions with Government, and a statement of intent by the Government and the donor should be issued as a result of that meeting. Clearly, these statements of intent would only be morally binding, and even this depends upon the program or projects being judged to be sound in a final appraisal. 1/ (c) Wherever necessary, the Government should attempt to confront donors with the necessity for cooperation at the project level. For example:, if apparently available technical assis- tance from one source would fit efficiently with financial aid apparently available from another, the two donors should be given adequate opportunities to confront and, where possible, compromise their institutional limitations at the earliest possible time. (d) The Government should seek very wide joint involvement in the major programs, particularly in the productive sectors. Risk of failure is a legitimate cost of vigorous development efforts, but this risk is best shared as much as possible. Similarly, projects having a high local cost or imprecise 1/ Several donors have now introduced this form of aid programming and it is to be hoped that others will follow suit. Some donor agencies carry out elaborate internal programming exercises, but do not have a procedure foi discussing their programs with the Governmient. But to form operations programs without discussions with Government is no more sensible than it would be for a commer- cial bank to decide on its lending to Mr. Jones without consulting Mr. Jones. - 30 - borderlines should be presented to all donors on the under- standing that they are asked to take only a part of the burden of the hard project. Donors should respond in a generous spirit to this Government request for support in administratively difficult projects. (e) The earliest agreement on all joint projects and programs should be the agreement over technical assistance (joint, multilateral, or bilateral) and the agreement in principle to accept the results of the analysis of the program, with ample provision for participation in staffing or supervision of work in progress. Once again, the technical assistance should be requested early, in liberal amounts. (f) The Government should be seen to be cooperative and even- handed in dispensing information to other donors concerning its commitments and agreements on bilaterally aided projects. This appears to be perfectly compatible with shopping for the best terms, attempting to match donor limitations with the requirements of the overall investment program, and so forth. This would require increased government manpower to present data and descriptions systematically and periodically; indeed much of the criticism on the part of the donors of government "secrecy" may be due to a failure of the donors to understand the extremely tight limits on the Government's staff. Systematic tabulations of the state of play of various assistance negotiations simply do not exist. 6.06 Although improvements in coordination at the project level seem to be the most necessary and the most probable coordination attempts at the level of the overall investment program and its financing should be continued and, if possible, upgraded. Preparation of the project list for the Consultative Group meeting, for example, appears to have been useful and should be continued, with whatever refinements in the project descriptions that are practicable. The UNDP effort to present a periodic overview of technical assistance is also use- ful. If it could be supplemented with a forward view of Government technical assistance it would be still more helpful in general program planning by the donors. It is the firm impression of the Mission, however, that additional effort to increase coordination at the level of the individual development undertaking (discrete project or major program), would have the highest rate of return of all marginal coordination efforts. Aid Coordination Machinery 6.07 The major formal mechanism for coordinating external aid in East Africa is the Consultative Group for East Africa which meets separately on the three East African countries under the chairmanship of the World Bank. There appears to be agreement from both donors and the Government of Kenya - 31 - that the Consultative Group is performing a useful function, particularly in providing a periodic opportunity for reviewing the overall prioritiee Zor external assistance to Kenya. However, the Consultative Group meets o-nly every second year and has little or no junction between times. There have been several suggestions from members of the Group that the World Bank, in its capacity as secretariat to the Group, might undertake a more continuous func- tion in coordinating aid, particularly at the project level and in Kenya. 6.08 This raises the question whether the World Bank should take on a wider function as broker in the coordination of aid. It can be argued that the Bank, as an apolitical but project-oriet.ted international agency, might be in a position to help the Government and other donors in streamlining the flow of external aid. Elements of the Bank's experience, in Kenya and elsewhere, such as serving as executor for special project-oriented studies, identification and appraisal of projects, and cooperation with other donors in joint or parallel financing, would clearly be valuable as a background to this effort, as would the Bank's position as chairman and secretariat to the Consultative Group. For all of this experience, however, the Bank can claim little special achievement in coordination per se, and the Bank's main desirable attribute as broker would be a genuine disinterest in the special goals of the other donors. The Bank's own objectives appear to coincide fairly well with those required of a broker: the Bank is concerned to maxamize the flow, the speed and efficiency of aid, to support the efforts of the Government in developing difficult mass programs, and to promote joint or parallel financing whenever possible. 6.09 As a broker, the Bank has shown that it can establish liaisonwLth both the field staff and the headquarters staff of the various bilateral donors. These contacts could be fuirther used in an attempt to generate wide support for programs to which the Government has coumitted itself, particularly for the more difficult mass programs in the productive sectors. The Bank's reputation for serious and disinterested project analysis, as well as its financial participation, is useful in lining up support for such programs. The Bank may also help to eliminate some duplication of bilateral donor's effort, and to minimize delay. The Bank has already undertaken some brokerage of this kind, and could no doubt dco more if requested by the Government and by other donors. 1/ 6.10 There is also scope, in our opinion, for much closer cooperation among donors in country economic work and sector analysis. As things stand, each donor country, as well as the World Bank and the International Monetary Fund, feels obliged to mount its own economic missions from time to time. While each agency onviously has special interests to follow up in such missions, there is much common ground, and much of the time of each mission is spent in asking the same questions of the same hard-pressed Government officials as the 1/ It should be emphasized that thease suggestions only relate to the possible role of the Bank as an honest broker. Any assistance which the Bank might give would in no way lower the basic responsibility of Government for aid coordination. Nor could it interfere in the bilateral relationships between Government and other donors, or in the valuable role played by UNDP in programming its technical assist:ance work. - 32 - last mission. This is not only an unfortunate duplication of effort on the part of the donors but, much more serious, preempts a great deal of the time of senior Government officers. 6.11 We are not overly optimistic about a dramatic change in these pro- cedures; there is certainly no immediate prospect of achieving, for example, a unified annual review mission, however sensible that might seem in principle. But some closer coordination is clearly both possible and necessary, if only to relieve the burden on Government. Again, it is possible that the World Bank might provide some leadership in coordinating the activities of donors, not only because of its central role in the Consultative Group, but because it is the only donor which regularly makes available its economic reports (such as this one) to other donors. As a start, it might be useful for all donors to assess the extent to which Bank reports can be relied upon to provide the information and analysis they want in planning their own program. The bi-annual meetings of the Consultative Group provide an obvious (but seldom used) oppor- tunity for donors to suggest any improvements or addition to the Bank's economic work which would make it more widely useful. In addition, there is no reason why bilateral donors should not participate in joint economic missions with the Bank, and this might be of particular value to some of the smaller donors operating in Kenya. STATISTICAL TABLES Index Table No. 1 Debt Outstanding and Loan Disbursements, 1968-1972 2 New Commitments of External Loans by Source, 1968-1972 3 Average Terms of Lending, 1968-1972 4 Terms of Lending on Loans from Governments, 1968-1972 5 Technical Assistance ar,d Financial Aid on Grant Terms, 1969-1971 6 Anticipated Annual Commitments of Financial Assistance, 1973-1975 7 Expected Disbursements of Financial Assistance, 1973-1976 8 Indicators of Debt in Kenya and Other Countries T113T.- 1 .1')B'37 0Jf2ST 3131DT A12) LOA, T ;22228 1968-1972 ( C1i% itillions) Tot:- Debt 0ntstan4i>! ut Ieor-,nd (including TJridisbursed) Annual Disbursements 1 :3 1 "Q3, 1 nyc 1 971 1972 1968 1969 1970 1G71 1 972 International Lrgonizatio4s `1 .2 74.6 .102.0 128.8 137-i. 10.5 10.0 9.7 26.9 of whi-ich I}-D 6.3 29.7 36.y 59.o 88.6 0.1 0.o 2.9 12.5 PA1#: i,2.6 42.6 (1.3 61.8 91 .8 6.2 9.7 6.6 3.1 5.C Y~ OL' 2. 2 . 3 . 6.8 6. 0.1 0.2 0.4 - 1 .0 v Jt 1°1. 7. 32. 24-3 21.2 16.1 16.3 21.7 16.6 ofuhi.chUY 121~~~~~~~ " i.1i 177.7 1 72_.3 i7~5 1L.3 TI7T T3. 1.9 USA 1S.5 195.9 10.8 26.1 27.6 2.1 1.2 0.7 11.1 0..6 Germany 12.2 15.6 16.6 19.3 13.2 1.9 0.5 1 2.7 1. Sweden 3.7 3.7 6.3 15.5 26.1 - - 0.1 MI. 1.7 It 11 y 7 .5 7 .5 7 . 1 8.1 _ _ - - ,.5 Nether:.ands _ _ 1. 3.6 . - - - 1.2 Otlhers 5.2 7 .0 9.0 12.L 2.2 6.0 1.54 2.6 1.2 Private Sources 6.9 6)2. 57.1 69.7 77.3 7.3 0.1 1. I 11.5 16.1 T(1i2A 33.3 31 6.0 3)3.6 6"30. 510.0 37.0 26.7 30.3 2 _2 Source: Tr ble 4, i.'"in 1Repno-t. -, Thcludilur s;neL amounts o: u1-nmdentified debt. TALE E 2 I'VE.1 COPII4TMITMSE OF EXTE1UEAL LOAITO BY SOURCE, 1 968-72 (U-S$ Mill ion) NEW COT liTMI4ENTS Amount SOURCES _L - ____ Undi sbursed 1968 1969 1970 1971 1972 of 1972 IE.RD - 26.1 8.3 23.0 29.0 56.0 IDA 16.L - 18.7 - 28.0 L8.0 Other International Organizations _ - 15 3*5 - 5.2 TOTAL IITTERThA'TIOlIIAL ORA,GlIIZAT TON 1 6.4. 26.1 28.5 26.5 57.0 109.2 Canada 0.5 -_ 3.7 4.O Deraia rk 2 . 7 - - - 0.7 Germaan 1.1 3.1 1.8 1.2 - 2.5 Israel 1.5 - _ _ Italy - _ 2--S Ja-pan _ 0.7 - 0.2 IFetherlands - - - 1.7 6.8 7.L I orw avJ - 1 .) L- _ _ £xteden 3. - 4.6 6.2 17.1 20,3 United Kingdom 0. 0.5 0.1 - 4.1 United Stntes - - 3.5 7.8 2.3 227 TOTAL GOVER\DITT 9.4 5.5 9.9 17.7 29.9 L4.5 Pr- vate Banks _ _ - 3.5 17.3 2.l S-uppliers Credit-s 1.1 7.3 - ,-rclassi_ ied _ _ - 2.1 - _ 0.1 TOTAL PEIWATE - - 32 108 17.3 2.5 mOTAL 2l'r/! CO>'; . 4I I -.51 604. ct z. . .r~ UNIL7L CTr'|, 1 'sT-VE U1,.'-DI 'Bt '-* _ C OI , I ITTjEU',`IT7, A? i YLk)l SlD .1 .7 -1 09 c 2)4. -156.3 156.3 S.r.urce Economic iri ly'is nncd Pro,jections -npartL-aro T-'ID. ANNEX 6 TABLE 3: AVERAGE TERMS OF LENDING, 1968-1972 (1) Lending Terms on Debt Outstanding at Year's End 1968 1969 1970 1971 1972 Average interest rates.(percent) 3.38 3.59 3.54 3.90 3.87 Average original grace period (yrs) 4.6 5.0 5.6 5.2 5.7 Average original maturity (yrs) 29.4 29.2 30.2 29.4 29.4 Average grant element of loans (perce:at)* 51 50 51 47 48 Grant equivalent of loans at discount ratio of 10% (US' millions) 174 181 199 203 244 *At Rate of Discounts of 10% (2) Average Interest Rates on Debt Outstanding at End of Year Sources: International Organizations IBRD 5.82 6.86 6.97 7.08 7.14 IDA. 0.75 0.75 0.75 0.75 0.75 African Development Bank 5.00 5.00 5.39 5.66 5.66 Interiaticnal Coffee Organization 0.00 0.00 0.00 0.00 0.00 Governments 3.44 3.41 3.41 3.61 3.43 Suppliers 6.87 6.87 6.89 5.86 6.11 Pri-vrately Placed Bonds 8.00 8.00 8.00 8.00 8.00 Publiclv Issned Bonds 4.02 4.03 4.21 4.21 4.23 Banks 5.99 6.04 6.08 5.82 5.88 Average Interest Rates on Total Debt 3.38 3.59 3.54 3.90 3.87 Source: Economic Analysis and Projections Department, IBRD. TABLE 4: TER145 OF LENDING ON LOA1B FROM GOVE1lM1TS, 1968-72 (1) Average Terms of Government Loans to Kenya on Loans Outstanding at Year's aid 1968 1969 1970 1971 1972 Average Interest Rate (percent) 3.44 3.41 3.41 3.62 3.42 Average Grace Period (years) 4.5 4.6 4.9 4.6 5.0 Average OrLginal Maturity (years) 27.7 27.7 27.9 28.1 28.0 Grant Element of Loans (percent)* 49 50 50 48 50 Grant Equivalent of Loans ($ millions)* 111 113 118 112 123 *At rate of discount of 10% (2) Distribution of outstanding Loans by Interest Rate (US $ Million) Interest Range 1968 1969 1970 1971 1972 O to 3 percent 109 113 120 112 130 Over 3 to 6 percent 48 47 46 54 52 Over 6 to 9 percent 69 67 66 63 61 Over 9 percent 0.2 0.2 1.9 2.1 2.1 (3) Average Interest Rates and Loans from Governments by Donor, Percentage of Outstanding on Loans Outstanding at Year's End Loans by Donor 1968 1969 1970 1971 1972 1968 1972 Canada - - - 1_7 Denmark - - - - - 12 12 Federal Republic of Germany 3.32 3.26 3.17 3.10 3.08 5.4 7.4 Israel 6.oo 6.oo 6.00 6.oo 6.oo o.8 0.5 Italy 4.5o 4.5o 4.50 4.5o 4.50 3.3 3.7 Japan - 5.75 5°75 5°75 5.75 0.9 Netherlands _ 2.50 2.50 - 3.5 Norway - 0.75 0.75 0.75 0.75 - o.6 Sweden 0.75 0.75 1.48 0.85 1.01 1.6 1o.6 United Kingdom 3.61 3.60 3q66 4.04 4.13 80.1 58.8 United States 2.07 2.06 2.10 3.27 3.03 703 11.2 USSR 2.50 2.50 2.50 2.50 1.47 0e2 0.2 Source: Economic Analysis and Projections Department, IBRD. M?;5-'q- 6 TABLE 5: TECHUICAL ASSISTANCE AND FINANCIAL AID ON GR0.TT TE 4Y3, u &'-7 (Annual Average, US $ Million) Technical Financial Tr'--g. Assistance Grants Oxr a r Austria 0.2 0.0 02 Australia OA 00 0.1 Canada .9 0.e1 2.O Denmark 1.3 0r2 Federal Republic of Germany 2.6 0.1 2.' Italy 0.2 0.0 0,2 Ja.pan 0.6 0.0 O.6 Netherlands 1.5 0.0 1-5 Norway 1.4 1.1 2, Sweden 2.5 0.4 '9 Switzerland 0.1 0.1 O^2 United Kingdom 7.2 O.7 r2 Uni'ted States 4.3 1.0 . 53 TOTAL 23.9 3.7 2716 Soaxrce: Economic Analysis and Projections Department, IBRD (Data Retrieval System) TABLE 6:. ANTICIPATED ANNUAL COMMITMENTS OF FINANCIAL ASSISTANCE, 1973-1975 (USs millions) Anticipated Commitments Donor (Annual Average) IBRD/IDA 87.0 United Kingdom 13.0 Sweden 10.5 United States 9.0 Federal Republic of Germany 6.0 Netherlands 3.0 Denmark 2.5 Norway 3.5 Canada 2.5 Japan 1.5 All other Bilateral Loans 3.0 All other Multilateral Loans 5.0 Suppliers Credit 10.0 Loans from Private Financial Institutions 3.5 Total Commitments 160.0 Source: Mission estimates TABLE 7 EXPECTED' 1-)ISBUTI'SiSENTS OF FITNANCIAL ASSISTANCE, 1973-76 COMPARED TO RECENT GOVIU!-E1NT INVESTIENTS (Millions of U.S.) Exoected Disbursements j Government Investments b/ 1973 197l4 1975 1976 1970/71 - 1972/73 Annual Average Agriculture, Veterinary and Forestry 8 iL 22 32 23.2 Industry and Commerce 4 8 15 18 10.3 TIflrastructure 46 60 65 6$ 59.6 Social Sectors 3 5 7 3 20.7 Other (including General Purpose) 6 6 8 8 36.1 Total 66 93 117 131 159.0 a/ Source: Mission estimate 1973 sectoral disbursements proportional to estimrates of sector distribution of undisbursed debt ouitstanding, Janiuary 1, 1973. Thereafter, sectoral composition shifts according to sectoral plans of donors for comritments, 1973-74. b/ Source: Annex 2. TABLE 8: INDICATORS OF DEBT IN KENYA AND OTHER COUNTRIES (For selected countries with an average per capita income of US$101-200) Loan Commitments Debt Service Debt Outstanding Per Capita Per Capita Per Capita Countrv 1965-68 1969-71 1965-68 1969-71 End 1968 End 1971 Average Average Average Average Bolivia 6.66 18.89 1.51 4.08 81.21 120.17 Botswana 1.49 27.03 1.09 1.15 16.98 93.72 Mauritania 4.98 16.33 1.77 2.53 33.38 76.31 Swaziland 4.75 3.62 5.22 4.94 72.16 71.96 Tanzania 2.41 10.41 0.59 1.27 17.97 44.40 Cameroon 4.85 5.68 1.00 1.62 26.14 38.88 Kenya 4.33 3.96 1.77 1.73 32.05 36.68 Pakistan a/ 4.02 4.20 0.88 1.30 26.58 34.49 Sudan 3.30 3.57 1.09 2.02 21.25 26.83 Togo 1.66 1.60 0.83 1.11 22.15 24.67 Dahomey 1.44 3.66 0.68 0.95 15.89 24.08 Central African Rep. 1.41 4.51 0.76 1.22 14.21 22.45 Uganda 2.45 1.98 0.76 1.19 17.80 20.03 MIalagasy Rep. 2.20 1.78 0.83 1.03 17.46 19.26 India 2.12 1.57 0.75 0.92 15.53 17.91 Lesotho 1.77 0.34 0.31 0.39 8.31 8.70 Nigeria 1.29 1.79 0.73 1.01 12.00 1.34 a/ Includes Bangladesh. Source: "World Debt Tables", IBRD Report No. EC-167-72, December 15, 1973.