Mombasa Road Rehabilitation Project
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Document of The World Bank FOR OFFICIAL USE ONLY Public Disclosure Authorized ReportNo. P-6503-KE MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE Public Disclosure Authorized EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN THE AMOUNT OF SDR 34.0 MILLION TO THE REPUBLIC OF KENYA FOR A Public Disclosure Authorized NAIROBI-MOMBASA ROAD REHABILITATION PROJECT NOVEMBER 8, 1995 Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency unit = Kenya Shilling (K Sh) US$ 1.00 = K Sh 55.00 (As of October 1995) K Sh 1.00 = USSO.02 K Sh 20.00 = K£ 1.0 WEIGHTS AND MEASURES Metric System GLOSSARY OF ABBREVIATIONS EU European Union GOK Governnmentof Kenya ICB International Competitive Bidding IDA International Development Association LCB Local Competitive Bidding PPF Project Preparation Facility SDR Special Drawing Rights GOVERNMENT FISCAL YEAR Julv I - June 30 FOR OFFICIALUSE ONLY KENYA NAIROBI - MOMBASA ROAD REHABILITATION PROJECT CREDIT AND PROJPFCTSU MMAIRY Borrower: The Republic of Kenya Implementing Agency: Ministry of Public Works and Housing Beneficiary: Not applicable Poverty: Not applicable Amount: SDR 34.0 millioni (USS50.0 millioni equivalent) Terms: Standard IDA terms with 40 year-s maturity Financing Plan: Schedule A Net Present Value: US$138 millioni at 12% discount rate. ERR 43.9%Z,(NItito Andei - Bachuimia Gate Section. 43 % of project cost) The Sultan Hamud - Mtito Andei Sectioniis expected to gyenerate similar economic benefits, see Para. 30 Staff Appraisal Report: 13798-KE Map: IBRD No. 26642 Project ID KE-PA-35691 This documenthas a restricteddistribution and may be ured by recipients only in the performance of their official duties. Its contents may not otherwise be disclosedwiihout World Bank authorFzation. MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF KENYA FOR THE NAIROBI-MOMBASA ROAD REHABILITATION PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed development credit to the Republic of Kenya for SDR 34.0 million, the equivalent of US$50.0 million, on standard IDA terms with a maturity of 40 years to help finance a Project for the Rehabilitation of the Nairobi-Mombasa Road. The European Union has indicated interest in providing parallel financing for the reconstruction of the remaining deteriorated section of the road. Country Background 2. Kenya is a low income country, with a GDP per capita estimated in 1994 at $260. The economy is dominated by the agricultural sector, which accounts for about one- quarter of GDP. However, Kenya possesses a relatively developed and diversified industrial sector, which contributes roughly 15 percent to GDP. Kenya's population is estimated at around 26 million and, in spite of recent declines in fertility, population growth remains high, in the order of 3 percent a year. Unemployment and poverty remain serious problems in Kenya, with more than 2 million people unemployed and an estimated 10 million people living in poverty. Addressing these problems is a major challenge, made more difficult by the high rate of population growth. Because of this, reductions in unemployment and poverty necessitate high rates of economic growth, in the order of 7-8 percent a year. 3. The Kenyan economy has not been consistently able to generate the levels of economic growth needed to reduce unemployment and poverty. After a period of strong economic growth, averaging about 8 percent a year, in the decade immediately after independence in 1963, economic growth decelerated as the external environment worsened and structural weaknesses became more pronounced. During the 1980's, economic growth averaged only about 4 percent a year. The main structural factors constraining growth were the increasing burden of public enterprises (whose inefficiency has been estimated to reduce potential GDP growth by 2 percentage points a year) and lower producer incentives resulting from Government intervention in product markets, particularly in the agricultural sector. 4. In the early 1990s, Kenyan macroeconomic performance deteriorated sharply as reflected in higher fiscal deficits (equal to 7.9 percent of GDP in FY91) and current account deficits (equal to 8.1 percent of GDP in 1990). Key to this deterioration was a breakdown in expenditure control as fiscal discipline weakened significantly in the runup to the Parliamentary and Presidential elections in late 1992. The fiscal and balance of payments deficits were fundamentally unsustainable, and led to a large monetary expansion - 2 - (and resulting inflation whichipeaked at over 100 percent on an annualized basis during the second quarter of 1993) and an accumulation of arrears on external payments. On the structural side, the Government reimposed a ban on maize movements, reversing one of the key structural reforms in the agricultural area. These developments, together with dissatisfaction with thie slow pace of political reform, led donors to suspend balance of payments support and freeze new project lendinig. 5. The Government eventullay reached ag,reement with the IMF and IDA in April 19931on an action plan to redress the situation. As part of this plan, monetary policy was tightened resulting '.nsharply higher-nominal interest rates and the exchange rate was successively devalued. This paved the way for negotiation of a new Policy Framework Paper and associated ESAF arrangemnentin the Fall of 1993, which have provided the context for policy reforms pursued over tle last two years. Substantial progress has been made un-derthis program. Budget deficits have been sharply reduced (to a level of 2.5 percent of GDP, exclusive of grants, in FY95), quantitative restrictions on imports and exports were eliminated (except for a few prodUcts controlled for health or environmental reasons), exchange controls abolishiedand the exchange rate floated, price controls eliminated and reforrns of the public enterprises and civil service initiated. The economy has responded positively to these developments, with real growth in 1994 of just under 4 percent after three years of effectivz stagnation. and growthithis year projected at around 5 percent. Inflation has fallen to less than 3 percent on an annualized basis and the current accouLnt,boosted by higher coffee prices, hlasshiarply improved and resersvelevels increased. 6. Progress was not uniform thioughiand there have been occasional policy reversals which have ser-vedto raise doubts about the sustainability of the process. Public enterprise reform, particularl] the restruicturing of the larger parastatals, proceeded very slowly and last year the Government intervened extensively in the maize rnarket through periodic impositionisof quantitative restrictions on imports and large scale maize purchases. 7 Of parLicuiarconcern lias been the Government's commitment to improved budgetary allocations and control. Much of the fiscal indiscipline in recent years is attributed to large unbudgeted expenditur-es. Government's comnritmelntto improved expenditure control and adherence to budgetary priorities was brought into question by the announcement that a turnkey contract had been signed for an international airport at Eldoret whichihad not been originally budgeted. This, together with IDA's insistence that the Government demonstrate its co7mmitrmientto adequate road maintenance funding, led IDA to delay submission of'the proposed project. 8. However-,over recent months the Government has undertaken a number of positive actions. These include a decision to no loiiger guarantee a maize floor price and to commercialize the maize marketing parastatal, and to scale back the airport investment. In addition, the Government has re-allocated funding for road maintenance in accordance with its agreement with IDA. The Government has also been in active discussion with the Fund and iDA on a ne"wprogram of reforms which could be supported by a new ESAF - 3 - arrangement and a structural adjustment credit. On the basis of these developments and the importance of the road rehabilitation, we propose proceeding with the project at this time. 9. Kenya is capable of generating the high rates of growth needed to reduce poverty and unemployment but this will require pursuit of improved economic policies over an extended period of time. The efforts taken over the last two years represent a significant step forward, the fruits of which are already evident. However, the progress to date remains fragile and reforms must be sustained and deepened if poverty is to be reduced. Through its activities, IDA has sought to support the Government in achieving this objective while recognizing that the success of this effort depends ultimately on the Government's own sustained efforts. Accordingly, IDA lending to Kenya has fluctuated significantly, responding to perceived Government commitment to a program of economic reform. From an IDA commitment level of over $300 million in FY92, IDA lending fell sharply to only $65 million per year in FY 94 and 95. Improving economic policies over the last two years has enabled IDA to move forward on a number of new operations; however, the extent and timing of IDA support will depend upon the Government's demonstrated commitment