RESTRICTED FILE CO PY'VREST FILE COPY IReport No. P-405 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDtT TO KENYA FOR A HIGHWAY PROJECT November 30, 1964 REPORT AND RECOMMENDATIONS OF TIHE PRESIDENT TO THE EXECUTIVE DIRECTCRS ON A PROPOSED DEVELOP- MENT CREDIT TO ICNYA FOR A HIGHWAY PROJECT 1. I submit the followiing report and recommendations on a proposed development credit of $4.5 million to Kenya for a highway project. PART I - INTRODUCTION 2. In M4ay 1960, the Bank made a loan (256 KE) of $5.6 million to Kenya for the development of agriculture and roads in African areas of high agricultural potential. The loan was guaranteed by the United Kingdom. The project has now been completed and the loan is fully dis- bursed. The road part of the project involved a total expenditure of about $4.4 million equivalent, of wihich about $2.5 million was from the Bank loan. 3. Early this year, shortly after Kenya's independence, the Government asked for assistance by IDA in financing additional roads of high economic priority. An IDA mission, which visited Kenya in May to appraise the pro- posed project, recommended some works to complement the road program executed under the Bank loan. The project was subsequently revised by the Government in conformity with the IDA mission's findings. Credit negotiations were held in WTashington in October. The Kenya representatives informed the Association of a pending amendment to the present Constitution under which Kenya would., as of December 12, 1964, become a Republic. The credit docu- ments have been drafted on the assumption that they would be signed after the effectiveness of the constitutional amendment. The Kenya legislature has since approved the proposed amendment to the Constitution. 4. The proposed credit would be IDA's second lending operation in Kenya. A credit of $2.8 million (64 KE) to help finance a smallholder tea develop- ment project was signed in August this year; it is now effective. 5. Of the Bank loan of $5.6 million made in 1960, about $4.9 million were outstanding at the end of October, 1964; about $1.3 million of this amount owxed to the Bank and the remainder to participants, After the 1960 loan, the Bank made a second loan of $8.4 million (303 KE) to Kenya in 1961 for a land settlement and development project; it was guaranteed by the United Kingdom. Because of major changes in the economic and administrative bases of this project, a Supplemental Loan Agreement (R 64-28, circulated on M4arch 13, 1964) had to be negotiated with Kenya and the United Kingdom and it was signed in April this year. The Bank has since approved three sub-projects under this loan and about $0.4 million have since been disbursed. There are no participants in this loan. 6. Kenya was one of the three territories which guaranteed the 1955 Bank loan of $24 million to the East Africa High Commission (now the East African Common Services Organization) for railways; this loan also carried the guarantee of the United Kingdom. By the end of October, 1964, the Bank held $110,000 of a total outstanding anDunt of about $16.4 million. -2- PART II - DESCRIPTION OF TIE PROPOSED DEVELOPMENT CREDIT 7, The main characteristics of the proposed credit would be as follows: Borrowier: Republic of Kenya. Amount: The equivalent in various currencies of $4.5 million. Pur,pose: To help finance the design, improvement and construction of 7 roads, totaling 194 miles in length, and 18 bridges. Term and Amortization: 50 years with no amortization for the first ten years; repayment to be in 80 instalments, !2 of 1% of the principal amount to be repaid semi-annually begin- ning Idarch 1, 1975 and ending September 1, 1984, and ljJ4 semi-annually thereafter to September 1, 2014. Service charge: 3/4 of 1% per annum on the principal amount of the credit disbursed and outstanding. Payment dates: Ilarch 1 and September 1. PART III - APFRAISAL OF THE CREDIT The Economy of Kenya 8. An economic report entitled "The Economy of Kenya" (No. AF 26-a, dated July 10, 1964) was circulated to the Executive Directors in connec- tion with their consideration of the development credit for smallholder tea development project (IDA/64-23). The developments which have taken place in Kenya since the report was prepared do not require any change in its main conclusions. 9. In tlhe second. half of this year, political conditions in Kenya have remained stable. The position of iNr. Kenyatta as the national leader has been further enhanced. The amendment to the Constitution has considerably strengthened the powers of the Central Government while the powers of the Regions have declined. The Central Government is responsible, inter alia, for the construction and maintenance of all trunk roads; some qualified local authorities will continue to maintain certain trunk roads on behalf of the Central Government. 10. The economic expansion of 1963 has continued into 1964. Despite some problems arisen from a transfer of European farmlands into African hands, crop production has been showiing a steady advance over previous years, iith coffee, tea, sisal, wheat and rice in the lead, while the out- put of pyrethrum, sugar,maize and barley, and of livestock products has been below the last year's level. Except for sisal, which has experienced -3- a substantial drop, prices for Kenya's exports have been well maintained and gross agricultural revenue may increase by 7-8% in 1964. Assisted also by a continued expansion in manufacturing and, to a lesser extent, in the service industries, gross domestic product is expected to exceed by at least 4% the 1963 level and by some 10% the 1962 level. With the value of exports scme 7% higher tlhan in the previous year while imports are running at approximately the same level, the current external balance is likely to improve in 1964. 11. Kenya's econoraic prospects for 1965, on the other hand, are clouded by some major uncertainties. The gradual transfer of the European agri- cultural sector into African hands may, at least temporarily, be accompanied by losses of production. Like coffee, sisal has begun to suffer setbacks in traditional markets; it also faces a keener competition from synthetic fibres. A "tripartite agreement" was made last February by the labor unions, employers and the Government, under which the unions accepted a wage freeze and to abstain from striking in return for an increase of 10% and 15% in employment by the private employers and the Government,respectively; it has been fairly successful, but will terminate early next year. As a result of the withdrawal of British troops from Kenya,which is due to be completed by the end of 1964, there will be some reduction in African employment. The Government may be confronted with a renewial of labor un- rest and an upward pressure on wages which, if allowed to become wide- spread, may affect adversely Kenya's production and weaken its competitive position abroad. 12. Private investment in Kenya has been recovering only slowly and is unlikely to provide a major stimulus to the economy in the short run. As to the external accounts, after some reduction in stocks this year, Kenya may experience a resurgence of imports in 196g. The "Kampala agreement" which Kenya, Uganda and. Tangany ka reached last l1ay on trade matters, has confirmed the three Governments' determination to maintain the present East African com-,on market and common currency. If fully implemented, this agreement should strengthen in the long run Kenya's position as the main exporter of manufactured goods in East Africa. In the short run, however, it may tend to have an adverse impact on Kenya's economy as it provides for the allocation of some specified industries away from Kenya and for the restriction in some measure of IKenya's exports to the other two East African countries. 13. Or the whole, Kenya's economic performai:e so far hans been satis- factory. Provided that political stability will be maintained, the longer- term prospects for economic growfth are quite good. Implementation of a realistic development plan, which provides for an annual spending of about L22 million by the public sector over a six-year period 1964-70, is uncdr way; substantial sums for its financing have been secured. A gap in the Government's current budget to the tune of L2-4 million is still covered by grants from the United Ilingdom; but the Government has recently increased taxation to strengthen its budgetary position and contemplates further steps towiards this end. 14. By April 1964, Kenya's external public debt amounted to about $173 milli n equivalent, excluding its contingent liability for a notional one-third of the East African Common Services Organization debt. The service payments on this debt are equivalent to roughly 10% of Kenya's 1963 export earnings. Further external borrowing under the nevr develop- ment plan i-ill increase the debt service charges significantly. Any re- maining margin for carrying conventional debt is likely to be needed to support borrowings by the East African Common Services organization for investment in the services provided by this organization and I consider it appropriate that Kenya should have access to IDA resources in fi- nancing the proposed highway project. The Project 15. An appraisal report entitled "Appraisal of Second Highway Project - Kenya" (TO-449a) on the highway project is attached (No. 1). 16. The proposed project consists of the design, improvemlent and con- struction (or reconstruction) of 7 roads of a total length of 194 miles, and the design and construction of 18 bridges. Essentially, it is an extension of the earlier road program financed by the Bank loan (Loan 256 KE) and government funds. It provides for works to improve some low-standard sections of the existing trunk roads network. The vorks *nc'ude relocation of certain road sections, improvement of drainage, paving, and replacement of certain narrow and poorly-located bridges. 17. The total cost of the project, including provision for design and supervision, is estimated at about $6.0 million equivalent. The proposed IDA credit would be equivalent to tne estimated foreign exchange require- ments, some 75% of the total cost. The remainder of the funds would be prcvided from the government budget. W4ith the exception of some small works which would be let competitively to East African contracting firms, all roads would be built by contractors selected on the basis of inter- national competitive bidding. The first contracts are expected to be awarded early in 1965 and the project is scheduled for completion by June, 1967. 18. The project was prepared by the Roads Branch of the Kenya Ministry of Works, Communications and Power. The design work is due to be completed by mid-1965. The Roads Branch is capable of executing this project. During the credit negotiations, the Kenya Government has agreed to take certain measures which will strengthen the organization of the Roads Branch, and to retain consultants for supervising the execution of the project. 19. An extensive road network is of primary importance for the continuing economic development of Kenya. The railway, which provides for long distance haulage between major centers inland and the port of ilombasa, needs to be supplemented by roads, Although the rate of growth of the Kenya economy has been relatively slow since 1960, road traffic has been steadily growing at rates of 7-13% per annum. Kenya now has about 19,500 miles of roads, of which 3,900 miles are classified as international or national trunk roads. The roads included in the proposed project serve important cash crop production areas and their improvement is important for economic growth and for securing economies in transport and road maintenance costs. The roads are located in widely scattered parts of the country and their improve- ment should contribute to the overall efficiency of the whole trunk roads network. The proposed project includes four of the five roads which were singled out by the Bank's survey mission of 1961/62 as high priority in- vestments. Two of the remaining three roads in the proposed project are justified mainly by the subsequent development of cash crops (including smallholder tea) and new settlements in the areas to be served; improvement of a third road, a section of the Mombasa-Malindi road, will open up coastal areas for intensified agriculture and tourism. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 20. The draft Development Credit Agreement between the Republic of Kenya and the Association, copies of which are being circulated to the Executive Directors separately, conforms generally to the pattern of the Association's credits for road projects. Attention is called to the provi- sions requiring the use of contractors and consultants satisfactory to the Association in the carrying out of the project (Section 4.01 (b) and (c)), and to the provision requiring the adequate maintenance of project roads and bridges and also of other trunk roads and bridges in Kenya (Section 4.01 (f)). PART V - COMPLIANCE 1WrITH ARTICLES OF AGREEMENT 21. I am satisfied that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI - RECOi1ENDATIONS 22. I recommend that the Executive Directors adopt the foUowing resolu- tion: RESOLVED: THAT the Aseociation shall grant a development credit to the Republic of Kenya in an amount in various currencies equivalent to four million five hundred thousand dollars ($4,500,000), to mature on and prior to September 1, 2014 to bear a service charge at the rate of three-fourths of one per cent (3/4 of 12) per annum, and to be upon other -6- terms and conditions substantially in accordance with the terms and conditions set forth in the form of Development Credit Agreement (Highway Project) between the Republic of Kenya and the Association which has been presented to this meeting. George D. Wdoods President by J, Burke Knapp Attachment TWTashington, D.C. November 30, 1964