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

FOR A Public Disclosure Authorized

NAIROBI- 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 - 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 to economic reforms. A Country Assistance Strategy for Kenya is at an advanced stage of preparation and will be presented to the Board for consideration early in 1996.

Sector Background

10. Road transport dominates the transport sector in Kenya, accounting for over 70 percent of tonne-kms (excluding pipeline traffic) and over 90 percent of passenger-kms. Since Independence, the Government has invested heavily in extending and upgrading the road network; the network of paved roads has increased from less than 2,000 km at Independence to over 8,600 km. The classified road network now totals 63,100 km and there are also approximately 85,000 km of urban streets, unclassified roads and tracks. A very high proportion of the total traffic flow (over 80 percent) is concentrated on the trunk and primary roads (about 20 percent of the classified network).

11. The coverage of Kenya's road network is generally adequate, but its condition is deteriorating. A recent assessment identified road conditions as a significant constraint to private sector development and less than a third of the paved network is now classified as in good condition. The causes of the deterioration - inadequate road maintenance, vehicle overloading and sometimes inadequate design/construction - are neither unique to Kenya nor of recent origin. The road maintenance issue was recognized in the late 1970's but the real level of road maintenance funding continued to decline, eventually financing less than 30 percent of maintenance needs. The road sector is now further from a position of maintenance sustainabilitythan at the start of the First Highway Sector Project in 1979.

12. Action has been initiated to reverse this downward trend. The Government has established a Road Maintenance Levy Fund which is financed by a levy on automotive fuels and charges on transit vehicles. Agreement has been reached with the Government - 4 - on a schedule for increasing funding from at least 50 percent in FY96 to full maintenance funding by FY2000. The Ministry of Public Works and Housing (MOPWH) has defined a Strategic Plan for the Road Sector which allocates expenditure in priority from maintenance, rehabilitation, upgrading to new construction based on economic returns to the expenditure, defines a rural roads improvement and maintenance strategy which is adapted to Kenya's resource endowment and financial situation and provides the policy framework necessary to ensure the effective implementation of these priorities including increased involvement of the private sector in road maintenance. IDA is now in the process of preparing a Third Highway Sector Project to support the implementation of the Strategy, with appraisal of the project expected in 1996. MOPWH has also initiated a major review of the institutional framework within which the road network is managed.

Project Rationale

13. A sustainable road sector, which provides for cost-effective road transport, is essential for the social and economic development of Kenya. The basis for sustainability is being built with increased road maintenance funding and more defined expenditure priorities but substantial assistance is required to help overcome the legacy of past under-maintenance and substantially increased traffic. Deterioration on sections of the 500 km Nairobi-Mombasa road, the crucial transport link to the sea, has become so severe that serious constraints to transport operations have emerged. In view of the very urgent need for major remedial action, agreement was reached with the Delegation of the European Commission and GOK, in early 1993, on the need for the comprehensive rehabilitation of the road prior to the completion of the full sector strategy, since safeguarding operations along the Nairobi-Mombasa Road would receive the highest priority in any realistic strategy for the road sector. The present road was constructed during the 1960's and early 1970's to design standards based on Kenya Railways carrying most long distance bulk freight. Since its construction, the road has carried much heavier traffic than was anticipated; transit traffic shifted to road transport during the 1970's and long distance domestic traffic moved to road during the 1980's and early 1990's. The road has become the primary freight route in Kenya and annually carries well over 3.5 million tonnes. The road also provides the landlocked regions of Eastern Africa (Uganda, Rwanda, Burundi, eastern Zaire and southern Sudan) with access to the sea.

14. The road has been resealed, some sections have been overlaid and one section, Machakos Turn-off - Ulu, was reconstructed as part of the IDA assisted Second Highway Sector Project. There has not, however, been a comprehensive program to provide the geometric standards and pavement strength required for present traffic. The design life of the road has been exceeded, much of the pavement has been eroded to 5.5 meters, and major failures are occurring. MOPWH is maintaining the road through patching and resealing but the engineering life and effectiveness of these interventions are very limited. The option of providing a 5 cm overlay on the existing pavement was considered but without major rehabilitation and strengthening, conditions will deteriorate further and will impose a major constraint to development in Kenya and Eastern Africa. Successful restructuring of Kenya Railways should increase capacity on the parallel rail route but - 5 - heavy freight traffic, estimated at over 2.5 million tonnes, will continue to use the road and its improvement will remain essential.

15. Increased road maintenance funding is critical but the funds must be allocated efficiently and the maintenance work implemented in the most productive manner. Improvements to the existing road management database and planning systems are needed to complement the increased funding. Periodic road maintenance (resealing and regravelling) is already almost entirely contracted to the private sector but routine maintenance (pothole and shoulder repairs, culvert cleaning, grading etc.) is still undertaken by MOPWH force account units. MOPWH recognizes that the private sector could potentially provide cost effective routine, as well as periodic, road maintenance but would like its practicality and effectiveness demonstrated in the Kenyan environment before making fundamental policy changes.

Project Objectives and Outcomes

16. The key objectives of the project are: (a) to rehabilitate, widen and strengthen Kenya's primary transport link between Nairobi and the port of Mombasa; (b) to help MOPWH determine the most cost-effective delivery option for routine road maintenance through a pilot program of routine maintenance contracts, independently monitored and assessed within a structured learning framework; and (c) to strengthen maintenance financing, planning, execution, inspection and monitoring. The Government's strategy for the road sector is outlined in the Government's Letter of Sector Policy, presented in Annex 8 of the SAR.

17. The main outcomes of the project, when completed, will include: (i) substantially improved operating conditions on the Nairobi-Mombasa road, lower vehicle operating costs and a reduction in the accident rate on the road; (ii) increased private sector involvement in road maintenance activities; (iii) more efficient and rational allocation of maintenance funding; (iv) improved control and more cost-effective utilization of maintenance funds; and, (v) improved accountability and transparency in the use of maintenance funds.

Project Description

18. Nairobi-Mombasa Road Rehabilitation (US$111.6 million, including the equivalent of US$10.0 million in local costs from GOK and an equivalent of US$58.8 million which is expected to be financed by the EU): The component will reconstruct or widen/strengthen the most critical sections of the Nairobi-Mombasa road, a total of 285 km. IDA would assist GOK with the strengthening and widening (to 7 meters with 2- meter shoulders) of the Mtito Andei - Bachuma Gate section (155 km). The detailed design for this section was prepared by the Design Branch of MOPWH and subjected to an independent design and risk review. No re-alignment of the road is proposed but some short sections, totaling 3.5 kmn,will be raised by 0.5 - 1.0 meter. The EU is presently funding the feasibility and detailed design for the reconstruction of the Sultan Hamud - - 6 -

Mtito Andei section (135 km) of the road, and it is expected that project financing will follow the completion of the feasibility study and design. In the unlikely event that such financing is not forthcoming, the section would be included in the proposed Third Highway Sector Project. GOK is already funding remedial works on a further 26 km of the road. The remaining 190 km of the route is in fair condition and presently only requires adequate, well-executed maintenance.

19. Road Maintenance Strengthening (US$6.7 million, including the equivalent of US$3.1 million from GOK): The component will finance routine maintenance contracts, totaling 374 km, on five sections of the Northern Corridor, including one contract on the Nairobi-Mombasa section. Three of the sections will be contracted to the private sector, and two sections to resealing units of MOPWH. The pilot contracts will be closely monitored within a framework of "structured learning" by an independent research institution to assess the impact of private sector contracting on the quality, quantity, and cost of work performed as well as to determine the most appropriate form of contracting arrangement. The initial contracts will be awarded for two years. The results of the structured learning will then be used to fine-tune the arrangements for a second phase of two-year contracts. The development of the contracts and the recruitment of the structured learning consultants have been initiated under PPF financing.

20. Institutional Support (US$3.7 million): The component will provide assistance to MOPWH to establish a Road Works Inspectorate within the Roads Department to undertake performance auditing of the Department's activities. In addition, the component will update the road inventory and condition database, revise and rationalize MOPWH's maintenance management systems in the light of the Roads 2000 labor-based approach to maintenance of the unpaved road network, and provide assistance for the preparation of fiiture projects. The component envisages a twinning arrangement with an external road agency as the primary vehicle for the provision of support for both the Road Works Inspectorate and the implementation of the routine maintenance contracts. The establishment of the Inspectorate is being assisted through PPF funding and its establishment and appointment of key staff will be conditions of credit effectiveness.

Project Financing

21. The total project cost is US$122.0 million, based on preliminary cost estimates for the reconstruction of the Sultan Hamud - Mtito Andei section. Foreign costs total US$96.5 million and local costs are US$25.5 million. The IDA credit of US$50.0 million represents 41 percent of the estimated total project costs, net of taxes and duties. The Government's contribution will be US$13.2 million as counterpart funding for the IDA assisted components. The EU is expected to provide 100 percent of the costs for the reconstruction of the Sultan Hamud - Mtito Andei section. A breakdown of costs and the financing plan are shown at Schedule A. The economic and financial analysis tables and key performance indicators are shown in Schedule B. The procurement and disbursement profiles are shown in Schedule C. A timetable of key project processing events and the Status of Bank Group operations in Kenya are given in Schedules D and E, respectively. - 7 -

More detailed information is provided in Staff Appraisal Report No. 13798-KE. A map is also attached.

Project Implementation

22. The project will be implemented by the Roads Department of the MOPWH. The Roads Department has already implemented 12 Bank-financed projects and is thus familiar with Bank procedures and requirements. The Credit is scheduled to be effective in the third quarter of FY96 and will take six years to complete. The main component of the IDA credit, the strengthening/widening of the Mtito Andei - Bachuma Gate section, will be implemented by a large contractor supervised by engineering consultants. Kenya has relatively well developed construction and engineering consultancy sectors and locally-based companies were awarded many of the contracts let under the IDA assisted Second Highway Sector Project. The Roads Department will be assisted in the implementation of the routine maintenance contracting and Road Works Inspectorate components by a Twinning road agency already experienced in such activities. The Twinning agency will not only provide short-term expertise in Kenya but will also train Road Department engineers in the agency's home country.

Lessons from Previous Bank/IDA Involvement

23. The Bank has assisted Kenya in the Roads sector since the early 1960's. After the completion of eight road projects, the First Highway Sector Project was approved in 1979 (Ln. 1684-KE). The Second Highway Sector Project (Ln. 2409/SF017-KE) was approved in 1983 and was closed at the end of 1992. The Project Completion Report for the First Sector Project stated that the project did not meet all its objectives as a result of inadequate counterpart funds, lack of implementation capacity, and inappropriate project selection criteria and technical standards. The Second Highway Sector Project experienced many of the same difficulties. While the individual components were successfully implemented (after the project was restructured), the condition of the overall network declined as no significant progress was achieved toward securing sufficient domestic funding for adequate maintenance of the road network.

24. Demonstrated Government commitment to increasing the road maintenance funding to adequate levels has been central to the preparation of this and other proposed projects in the road sector. The establishment of the Road Maintenance Levy Fund and the commitments of GOK in its Macro-economic and Structural Policy Framework 1995- 97 document, submitted to the Consultative Group Meeting in December 1994, for increased maintenance funding indicate that progress has been achieved. Further support for the sector will be conditional on the progress being sustained. The introduction of the Roads Works Inspectorate and MOPWH's agreement to prepare annual reports on maintenance and the operations of the Maintenance Levy Fund will help ensure that there is a transparent and accountable framework for the increased maintenance funding. -8-

Rationale for IDA Involvement

25. IDA's participation in both this project and the proposed Third Highway Sector Project is critical for the accomplishment of the difficult policy reform measures that are needed to establish an efficient and sustainable program for the rehabilitation and maintenance of Kenya's road network. The Project is consistent with the Country Assistance Strategy discussed by the Executive Directors on April 5, 1994. The rehabilitation of the Nairobi-Mombasa road, Kenya's primary link between the main production centers and the port of Mombasa, is an essential condition for achieving the Country Assistance Strategy objective of stimulating economic growth through the development of an export-oriented private sector. The project will also promote the Country Assistance Strategy through increasing the role of the private sector in road maintenance and helping to ensure cost-effective maintenance of basic infrastructure which is a critical function of Government. The problems of the road sector fall within the mainstream of the Bank's dialogue with the Government: more productive use of government resources, civil service reform, increased reliance on the private sector, and greater accountability. It is also becoming increasingly apparent that, unless major improvements are made, transport conditions will become an increasing constraint to economic growth and development.

Agreed Actions

26. The following have been agreed: (i) the reporting schedule for the maintenance monitoring; (ii) the carrying out of a mid-term review by December 31, 1998; and (iii) a detailed annual maintenance funding plan, consistent with the undertaking by the Government to raise domestic funding for road maintenance to 50% of maintenance needs in FY96 and to full funding by the year 2000. The Government has submitted to IDA a satisfactory Letter of Sector Policy included in the Staff Appraisal Report which describes overall road sector policies, strategies, investment priorities as well as the time frame for taking key actions, and a satisfactory draft of the Strategic Plan.

27. Credit effectiveness would be conditional on Cabinet approval of the Strategic Plan for the Roads Sector, and the effective establishment and staffing of the Road Works Inspectorate.

Environmental Assessment

28. This project is classified as Category B, with only a minor impact on the environment. The project will reconstruct/strengthen an existing paved road, and widen the pavement to 7 meters, with 2-meter shoulders. The road surface may be raised in a few, short sections but there will be no significant re-alignments and no resettlement will be involved. There should be no adverse long term effects on the environment. Special care will be taken during the execution of road works and maintenance to ensure that environmental hazards, even of short duration, are not created. The IDA component of the major civil works - the strengthening and widening of the Mtito Andei - Bachuma - 9 -

Gate road section - has been given particular attention. The road forms part of a transport corridor, including also the railway and oil pipeline, which separates the Tsavo West and East National Parks. A full environmental mitigation plan has been prepared in conjunction with the Kenya Wildlife Service to ensure that construction does not adversely affect the National Parks. All quarries and borrow pits will be backfilled, no blasting will be allowed in the Parks, no construction camp or machinery unit will be located in the Parks, deviations will be watered to reduce dust, special erosion control measures will be implemented in association with the improved drainage, and close liaison will be maintained at all times with the Kenya Wildlife Service. Certain accident blackspots have been identified along the section and special remedial measures are planned.

Program Objective Categories

29. The project will contribute to development of the private sector, which has hitherto been constrained by the poor condition of the roads; it will also, during implementation, provide increased opportunities for private sector contractors in road rehabilitation and routine maintenance. In addition, public sector efficiency will be enhanced through institutional support to MOPWH.

Participatory Approach

30. The project was identified during preparation of the Strategic Plan and proposed Third Highway Sector Project. The Strategic Plan has been produced by the Roads Department with limited assistance from external and local consultants. The Mtito Andei - Bachuma Gate section was designed by the Design Branch of the Roads Department and reviewed by Kenyan consultants. The Roads Department prepared the pilot program for routine maintenance contracting and the outline contracts. Similarlythe Road Works Inspectorate element of institutional support was fully prepared by the MOPWH.

Benefits

31. The main benefits from the project will be the substantial reduction in present and future vehicle operating costs along Kenya's main road route. While the project will initially benefit vehicle owners, the Kenyan road transport industry is highly competitive and consequently it is expected that the project will result in lower transport rates. The economic internal rate of return for the widening/strengthening of the Mtito Andei - Bachuma Gate section is estimated at 43.9 percent with a Net Present Value of US$138.2 million, using a 12 discount rate (see Schedule BI). Underlying these estimates are a number of engineering and operational assumptions, especially regarding the growth in traffic and deterioration in operating conditions, based on relatively moderate expectations for the Kenyan economy and the HDM III road deterioration model. Operating conditions on the road are already poor, however, and the project generates a First Year Rate of Return of 20.6 percent, indicating the need for immediate intervention. It is also expected that there will be some reduction in the severe accident rate, through widening the - 10 - carriageway and providing 2 meter shoulders, thus allowing vehicles to park off the carriageway. In view of the uncertain magnitude of the reduction and the problems inherent in valuing accident costs, these additional benefits were not quantified.

32. A full engineering and economic feasibility has not yet been finalized on the section, Sultan Hamud - Mtito Andei. In view of present operating conditions on this section, especially during the rainy seasons, a very high economic rate of return is expected. Preliminary analysis suggests that the economic benefits of reconstructing this section will be at least as high as for the Mtito Andei - Bachuma Gate section, with a FYRR of well over 20 percent.

33. The benefits of the other project components are less easy to quantify but experience, elsewhere, suggests that private sector contracting can reduce routine maintenance costs by 20 percent but the precise level is country specific and needs to be determined through the piloting proposed under the project. The institutional support component should also generate substantial benefits for the sector, through the development of improved maintenance planning, implementation and monitoring.

Project Sustainability

34. The long-term sustainability of any road improvement is largely dependent on continuing maintenance and, in the past, many road improvements have subsequently deteriorated through inadequate maintenance. Even without the supporting actions described below, there is relatively little likelihood that the Nairobi-Mombasa road rehabilitation would not be sustained as the road is crucial to Kenya and the Government has always concentrated the available maintenance funding on the core road network. It is possible, however, that maintenance on the rest of the network would continue to be inadequate. This project has to be viewed within a changed environment for the road sector in which: (i) continued donor support is increasingly conditional on the provision of adequate maintenance funding; (ii) the Government's Sector Strategy places highest priority on the maintenance and rehabilitation of the existing network; (iii) the internal constituency for adequate road maintenance, supported by the Road Maintenance Initiative, is growing rapidly; and, (iv) the importance of the proposed Third Highway Sector Project which will link assistance directly to the progress toward sustainabilityin the sector. In view of the particular importance of this road and the more general changes in the sector, the project is expected to be sustainable.

Risks

35. The economic benefits of the strengthening/wideningwould be significantly reduced by slower than expected growth in traffic and the diversion of heavy freight traffic to rail. Even if, however, annual traffic growth was only one percent, and a million tonnes of freight were to transfer back to Kenya Railways, the EIRR would still be 29.5 percent, with a FYRR of 12.0 percent. In view of the existing level of traffic and present road conditions, the robustness of the economic desirability of the proposed investment is not - 11 - surprising. The EIRR would be reduced to 12 percent only if simultaneously construction costs doubled, benefits were halved and the project life was reduced to 10 years. The rehabilitation works will be undertaken by major contractors and should raise no implementation problems. It is implausible that construction costs could rise to levels which would negate the economic feasibility of the project.

36. Past experience in Kenya suggests that the main risks in the road sector are not with respect to particular project investments but with the more general failure to provide adequate funding for road maintenance. Future maintenance should not be an issue for this high priority project and the Road Maintenance Levy Fund is designed to provide the solution to the overall funding problem. Despite the Levy fund, there could still be risks that (a) funds are used ineffectively; and (b) funds are diverted from maintenance to investment in new roads. The Road Works Inspectorate is designed to reduce, as much as possible, these risks through transparent performance monitoring and reporting.

Recommendation

37. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and recommend that the Executive Directors approve it.

James D. Wolfensohn President

Attachments

Washington D.C November 8, 1995 SCHEDULE A Page 1 of 2

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

Costs by Project Component (US$ million)

Component Description Local Foreign Total % Foreign % Total Base Cost A. Reconstruction/strengthening of Nairobi-Mombasa Road Civil Works: Km 103 - 238 9.2 36.7 45.9 80 46 Km 238 - 393 8.2 32.9 41.1 80 41 Supervision: Km 103 - 238 0.3 1.7 2.0 85 3 Km 238 - 393 0.4 2.2 2.6 85 3 Sub-Total Nairobi-Mombasa Road 18.1 73.5 91.6 80 91

B. Road Maintenance Strengthening Pilot Maintenance Contracts 2.5 2.6 5.1 50 5 Structured Learning 0.1 0.3 0.4 85 Sub-Total Maintenance Strengthening 2.6 2.9 5.5 53 5

C. Institutional Support Road Inspectorate 0.0 0.1 0.1 100 Other Institutional Support 0.2 3.0 3.2 93 3 Sub-Total Institutional Support 0.2 3.1 3.3 93 3

BASE COST 20.9 79.5 100.4 79 100

Physical Contingencies 2.0 7.2 9.2 78 9 Price Contingencies 2.6 9.8 12.4 79 12

PROJECT COST (net of taxes and 25.5 96.5 122.00 79 119 duties) Note: Taxes and duties are estimatedat US$10.22million SCHEDULE A Page 2 of 2

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

Financing Plan (US$ million)

Foreign Local Total IDA 49.3 0.7 50.0 Others 47.2 11.6 58.8 Governrent - 13.2 13. 2

_ 96.5 25.5 122.00

In addition,Government will financeUS$10.22 million in taxesand duties SCHEDULEB1

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

Project Benefits and Costs Mtito Andei - Bachuma Gate Section

1995 US$ million

Present Value of Flows Fiscal Impact Economic Financial Analysis Analysis2 Taxes Subsidies Benefits 165.7 n.a. Negligible Costs 27.5 n.a. Net Present Value 138.2 n.a. Internal Rate of Return 43.9% n.a. Overall Risk Probability that NPV

Main Assumptions: Discount rate: 12% Traffic growth: 6% (GDP growth of 5 - 6%) Project life: 15 years, no residual value, overlay in year 10 Constant real vehicle cost inputs, full road maintenance with and without project No generated traffic

Switching Values of Critical Items: If, simultaneously, construction costs increased by 100%,'o,benefits were reduced to 50%0,and the project life was reduced to 10 years, the NPV would be reduced to zero

Nature of Benefits: Vehicle operating cost savings Passenger time savings Road maintenance cost savings Reduction in accident rate (not quantified)

Main Beneficiaries: Road users - reduced vehicle operating and time costs Consignees/consignors of freight - the Kenyan trucking sector is very competitive and reduced truck operating costs will result in lower freight tariffs. Government - reduced road maintenance costs

Althoughthe detaileddesign and feasibilitystudy has not been completed,preliminary analysis indicates that the economicresults for the SultanHamud - MtitoAndei sectionwill be very similar.

2 Financialanalysis of road projectsis only undertakenfor toll roads. The ratio betweenfinancial and economic costs is very similarfor both vehicleoperating costs and constructioncosts, consequently the use of financial costs would have only a marginaleffect on the overall results. SCHEDULE B2

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

FINANCIAL SUMMARY (US$ millions)

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Implementation Period Operational Period

Project Costs

IDA Component

Investment Costs 1.8 13.7 13.5 12.0 6.0 6.1 3.1 - - - RecurrentCosts 0.5 1.7 1.5 1.5 1.5 1.5' 1.5' 1.8 1.8 1.8

Donor Component2

Investment Costs - 5.6 14.3 17.6 15.1 6.2 - Recurrent Costs ------0.3 0.3 0.3 0.3

Financing Sources Percentages Percentages

IDA 78 58 40 34 24 39 55 0 0 0

Government 22 15 11 9 9 16 45 100 100 100

Donor - 27 49 57 67 45 - - - -

Total 100 100 100 100 100 100 100 100 100 100

Includes continuation of maintenance contracts after pilot phase 2 These costs are preliminary as final design is still underway SCHEDULE B3

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

Key Performance Indicators

Performance Indicator 1996 1997 1998 1999 2000 2001 2002

GOK road maintenance funding (Kf mn) 182 209 230 265 305 305 305

Nairobi - Mombasa Road Rehabilitation Mtito Andei - Bachuma Gate: Completion % 15 45 75 100

Routine Road Maintenance Contracts: Pilot phase: Award of first phase contracts July Award of second phase contracts July MOPWH contract maintenance strategy July

Full strategy implementation Jan SCHEDULE C Page 1 of 2

KENYA

NAIROBI-MOMBASAROAD REHABILITATIONPROJECT

Procurement Summary (US$ millions)

P'rojectElement |Procurement Methodl Total Cost* |ICB LCB I Other | NBF |Total Cost A. Civil Works Nairobi-Mombasa Road 50.0 .56.5 106.5 (39.5) (39.5) Routine Maintenance 6.2 652

______(3.5) (3.5) B. Goods 0.4 0.4 (0.4) _ (0.4) C. T.A & Consultants Services Consulting Services 5.3 2.3 7.6

______(5.3) (5.3) Training 0.3 0.3

______(0.3) (0.3) Studies 0.4 0.4

______(0 .4 ) _ _ _ __(0 .4 ) D. Repayment of PPF 0.6 0.6 (0.6) (0.6) TOTAL 50.0 6.2 7.0 58.8 122.0 (39.5) (3.5) (7.0) (50.0)

Note: Figures in parenthesis are the respective amounts financed by IDA

* Including contingencies SCHEDULE C Page 2 of 2

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

Summary of Disbursements (US$ millions)

Amount of Category Credit % of Expenditure Allocated to be financed Civil Works: Widening/strengthening Km 238 -393 33.46 100% Foreign expenditure Pilot Maintenance Contracts 2.66 50% Consultant Services and Studies 5.42 100% Goods 0.33 100% Foreign expenditure and 80% Local expenditure Training 0.05 100% Refinancing of PPF Advance 0.60 Amount due Unallocated 7.48 TOTAL 50.00

Estimated Disbursements of IDA Credit (US$ millions)

IDA Fiscal Year 1996 1997 1998 1999 2000 2001 2002

Annual 1.8 12.2 11.8 10.7 5.4 5.4 2.7

Cumulative 1.8 14.0 25.8 36.5 41.9 47.3 50.0 SCHEDULE D

KENYA

NAIROBI-MOMBASA ROAD REHABILITATION PROJECT

TIMETABLE OF KEY PROJECT PROCESSING EVENTS

Time Taken to Prepare: 10);rmmntlls

Prepared by: Government with assistaiwe tiom IDA and/or Consultants

First IDA Mission: Fdeharv i c;94

Appraisal Mission: Jurie I994

Negotiations: Ec'! .i 199S

Planned Date of Effectiveiiess: Apri: 19t46

Relevant ICRs/PPARs: OPR\AR#46 datWd8/27'75 (SIcond Highways) PPAR #2(1f;'2dated 5.'i2'B Tlhird Higlhways) ppAR 36,59d_c o 10/'26181(Highway NMaiitenianice) PPAiR#453," dl,?d 6/3;83 lFourth and(iFifth Highways) Pi'PAR #9560 Ldated5> d/ (Ru0a9Access Roads) P'CR #iU745 dited o!2.'2'92 (First L-tighway Sector)

Themission vasled h; S. 'Ihoinas(iransporti cunorm,s ) aid ;n2luJcd C IHoban (Highwaiy Engineer), W. Matthev (ConsUltantMaintenance Lngineel) andR I-lanin-.mid ((onsultant Design Engineer). Mr. B. Becq (Al- IEl) wvasthe Lead Advisor and Mr. C. Quciroz(I tiL31V)v asthc peuc reviewer. Ms. NM.C.Li provided secretarial support. Messrs. S. Weissman anidJ. Adianisare tile Division (Chicf and Director, respectively for the operation. SCHEDULE E Page 1 of 3

STATUS OF BANK GROUP OPERATIONS IN KENYA

A. STATEMENT OF BANK LOANS AND IDA CREDITS (as of September 30, 1995)

Fifty-four (54) loans and sixty seven (67) credits 985.87 1522.83 6.62 closed,of which SAL, SECAL or Program Loan/Credit: (60.90) (925.53)

Cr.19040 1988 Population III 12.09 5.29 Cr.19730 1989 Geothermal Development 40.70 3.50 Cr.20600 1990 Third Nairobi Water Supply 64.80 26.29 Cr.20620 1990 Coffee Improvement 11 46.80 18.02 Cr.21110 1990 Population IV 35.00 32.35 Cr.21980 1991 Forestry Development 19.90 13.20 Cr.21990 1991 National Agric. Ext. II 24.90 18.64 Cr.22040 a/ 1991 Agric. Sector Adjust. II 41.52 5.92 Cr.23090 1992 Universities Investment 55.00 50.70 Cr.23100 1992 Health Rehabilitation 31.00 26.25 Cr.23330 1992 Mombasa and Coastal Water 11 43.20 32.42 Cr.23340 1992 Wildlife Services 60.50 34.48 Cr.24400 1993 Parastatal Reform TA 23.32 19.43 Cr.24450 1993 Agric. Sect. Mngt. 11 19.40 14.99 Cr.24600 1993 Emergency Drought Recovery 20.00 13.77 Cr.25960 1994 Micro & Small Enterprise 21.83 21.76 Cr.26710 1995 Institutional Development 25.35 24.01 Cr.26860 1995 Sexually Transmitted Infections 40.00 40.40

Total 985.87 2148.14 401.42 of which repaid 708.62 55.09 Total held by Bank & IDA 277.25 2093.05 Amount sold 11.74 of which repaid 11.74 Total undisbursed 408.04

a/ SAL, SECAL or Program Loan/Credit. SCHEDULE E Page 2 of 3 B. STATEMENT OF IFC INVESTMENTS IN KENYA (as of September 30, 1995)

1967/73 a/ Kenya Hotel Properties Hotels and Tourism 4.20 0.72 0.96 5.88 1970/74/77/79/ 1981/88/90/94 at Panafrican Paper Mills Timber, Pulp and Paper 52.26 5.79 3.97 62.02 1972 Tourism Promotion Serv Hotels and Tourism 1.63 0.00 0.79 2.42 1976 Rift Valley Textiles Ltd Textiles 6.87 2.77 1.30 10.94 1977 a/ X-Loans to Sml & Med Co. Financial Services 2.00 0.00 0.00 2.00 1980/84 Development Finance Co. Financial Services 5.07 1.31 0.00 6.38 1981 a/ Kenya Commercial Finance Financial Services 5.00 0.00 0.00 5.00 1982 Bamburi Portland Cement Cement & Construction 4.43 0.00 0.00 4.43 1982 Diamond Trust of Kenya Financial Services 0.00 0.80 0.00 0.80 1982/87 Industrial Promotion Services Financial Services 0.00 1.17 0.00 1.17 1983 al Tetra Pak Converters Ltd. Timber. Pulp and Paper 2.17 0.37 0.00 2.54 1984/92 Leather Industries of Kenya Manufacturing 2.12 0.63 0.00 2.75 1986 a/ Madhupaper International Timber, Pulp and Paper 8.50 1.97 28.65 39.12 1986 Oil Crop Development Ltd. Food and Agribusiness 9.65 1.40 0.00 11.05 1986 Equatorial Beach Properties Hotels and Tourism 3.67 0.00 0.00 3.67 1988/92 Ukulima Tools Ltd. Motor Vehicles and Comp. 0.00 0.06 0.00 0.06 1989 Premier Foods Industries Food and Agribusiness 0.00 0.11 0.00 0.11 1989 Premier Refrigeration & Frigoken Ltd. Food and Agribusiness 0.00 0.14 0.00 0.14 1990 Premier Refrigeration & Frigoken Ltd. Food and Agribusiness 0.00 0.06 0.00 0.06 1991 Malaa Industries Ltd. Food and Agribusiness 0.53 0.16 0.00 0.69 1991 Novaskins Tannery Ltd. Manufacturing 0.00 0.14 0.00 0.14 1992 Integrated Wood Complex Timber, Pulp and Paper 0.40 0.00 0.00 0.40 1992/93 Allpack Industries Ltd. Timber. Pulp and Paper 0.00 0.36 0.00 0.36 1993 Future Hotels Ltd. Hotels and Tourism 0.50 0.00 0.00 0.50 1994 Aura Garments Mfg. Textiles 0.30 0.00 0.00 0.30 1994 East Africa Reinsurance Co. Financial Services 0.00 1.10 0.00 1.10 1994 Mosi Ltd. Food and Agribusiness 0.29 0.00 0.00 0.29 1994 Sawa Flora Ltd. Food and Agribusiness 0.32 0.19 0.00 0.51 1994 Waterfront Hospitality Hotels and Tourism 1.00 0.00 0.00 1.00 1995 Capital Fish Kenya Ltd. Food and Agribusiness 0.65 0.00 0.00 0.65 1995 Intemational Hotels Hotels and Tourism 6.00 0.00 0.00 6.00 1995 Kihingo Roses Ltd. Food and Agribusiness 0.52 0.00 0.00 0.52 1995 Vegpro Kenya Ltd. Food and Agribusiness 0.95 0.00 0 00 0.95

Total Gross Commitments b/ 119.03 19.25 35.67 173.95 Less: repayments, cancellations, exchange adjustments, writeoffs. terminations and sales 78.44 8.47 35.27 122.18 Total Commitments now held by IFC c/ 40.59 10.78 0.40 51.77

Pending Commitments: AEF-Island Farm 0.50 0.00 0.00 0.50 AEF-Kenfunds 0.00 0.17 0.00 0.17 AEF-Kenfunds Mgt 0.00 0.09 0.00 0.09

AEF-Wakatee Center 0.50 0.50 0.00 1.00 Magadi Soda Co. 9.00 0.00 0.00 9.00

Total Pending Commitments 10.00 0.76 0.00 10.76

Total Commitments held and Pending Commitments 50.59 11.54 0.40 62.53 Total Undisbursed Commitments 7.92 1.11 0.00 9.03 a/ Investments which have been fully cancelled, terminated, written-off, sold, redeemed. or repaid. b/ Gross commitments consist of approved and signed projects. c/ Held commitments consist of undisbursed and undisbursed investments. ScheduleE Page 3 of 3

KENYA - IMPLEMENTATION ISSUES

As of September30, 1995, there were 18 ongoing projects in the Kenya portfolio representing total commitments,exclusive of cancellations,of $625.4 million. Undisbursedamounts totaled $401.4 million. FY95 disbursements totaling $151.4 rmillion were only slightly below the $168.4 million and $166.8 million disbursed in FY93 and FY94, respectively. However, the FY95 disbursement ratio (i.e., for investment operations) of 16.3 percent showed an improvement over the respective FY93 and FY94 ratios of 14.2 percent and 15.4 percent. Disbursements for investment operations during the first quarter of FY96 were $29.8 million (translating into a disbursement ratio of 6.6 percent).

As of September30, 1995, four of the 18 ongoing credits were rated (in the course of the FY95 ARPP exercise)as "problem" projects - all four were carryoversfrom the FY94 exercise. Sincethe FY95 ARPPexercise, one of these projectshas been upgraded to "satisfactory"in view of progress made in meeting outstandingpolicy- related conditionalities;another project is being restructured;and for the renmainingtwo projects,action programs for addressing outstanding issues (procurement in one instance; inadequate budgetary allocations and noncompliance with financial covenants) have been agreed with the Government. The FY95 experience in dealing with these problem projects and a number of developments as elaborated below, should result in an improved FY96 portfolio with supervision inputs (i.e., in terms of supervision staffweeks) similar to the FY95 average of slightly less than 16 staffweeks per project.

However,Government commitment and owvnershipremains critical to timely and efficient project implementation, including resolution of major implementationproblems if and as they arise. To this extent, IDA will continue its supervision dialogue and follow-up with the Government, especially through the Resident Mission and the recently established Operations UJnit,on a number of generic implementation issues and corresponding remedial actions agreed within the CPPR process initiated in August 1994 - the first such exercise since the October 1990 Country Implementation Review. The major objective of this exercise was to initiate an ongoing process by which the Borrower would play a greater role in overseeing and monitoring the portfolio. The primary generic areas for which specific bottlenecks were identified and dated corrective actions agreed, included (a) provision of adcquate budgetary allocations, (b) more timely processing and monitoring of drawdowns and replenishments of the Special Accounts (which are centrally maintained and managed by the Borrower), and (c) timely preparation and auditing of all accounts required under IDA-financed projects, and subsequent submission of the respective audit reports to IDA. A mini- CPPR meeting was held in March 1995 (another review was held in July) to follow up on progress since last August, and further actions and timefra.nes agreed within which to resolve these outstanding issues.

Results have been encouraginig, although mixed. With one exception (noted above), the IDA portfolio was adequately budgeted in FY95. In addition, a number of projects have expenrenced implementationdelays resulting from counterpart funding not being released in a timely manner - adequate and timely project budgetary provisions, including counterpart funds, will therefore continue to be a focus of supervision attention during the coming year. While improvements in special accounts management and utilization are being achieved, progress in timely submission of required/overdue audit reports has been less-than-anticipated. The ongoing dialogue through the CPPR process initiated last year is expected to facilitate resolution of these problems. Progress will continue to be reviewed periodically and additional further corrective steps taken, as necessary. In the meantime, the Governrnent has been advised that unsatisfactory progress in these areas as per agreed benchmarks will result in IDA taking appropriate remedial actions and could result in delays in future project processing. IBRD26642

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