Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 13886

PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(CREDIT 2197-KE)

JANUARY 20, 1995

Public and Private Enterprise DivisionEastern Africa DepartmentAfrica Region

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENT

I KSh = US$

ABBREVIATIONS

CBK Central Bank of KenyaEDP Export Development ProjectEPPO Export Promotion Programmes OfficeEPZ Export Processing ZoneEPZA Export Processing Zone AuthorityGDP Gross Domestic ProductGOK Government of KenyaIDA International Development AssociationIMF International Monetary FundIPC Investment Promotion CentreKAHL Kenya Air Handling Ltd.KEAS Kenya Exporter Assistance SchemeKTDC Kenya Tourism Development CorporationMUB Manufacturing Under BondOECD Organization for Economic Cooperation

and DevelopmentPCR Project Completion ReportPFP Policy Framework PaperREER Real Effective Exchange RateSAL Structural Adjustment LendingSAR Staff Appraisal ReportSDR Special Drawing RightsSPPF Special Project Preparation FacilityTDI Trade Development InstituteVAT Value Added Tax

FISCAL YEAR

July I - June 30

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washington, D.C. 20433U.S.A.

Office of Director-GeneralOperations Evaluation

January 20, 1995

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Program Completion Report on Kenya -Export Development Proiect (Credit 2197-KE)

Attached is the Program Completion Report on Kenya - Export Development Project (Credit2197-KE). Parts I and III were prepared by the Africa Regional Office with Part II contributed by theBorrower.

The operation consisted of both quick-disbursing, trade policy-related adjustment lending andlending for investment in an Export Processing Zone (EPZ), an export assistance scheme and severalstudies. The Credit, effective in December, 1990, and amended in July, 1992, totaled SDR 106.8million, including SDR 37.3 million of IDA reflows. It disbursed over four fiscal years, with 91%(i.e., the quick-disbursing portion) of the disbursements occurring in the first (FY91 - 26.4%) andthird (FY93 - 64.6%) years. Cofinancing from Japan in the amount of US$77 million equivalent wasreleased in FY94, along with the final portion of the Credit.

The trade adjustment policies linked to the fast-disbursing component included many of the tradeand exchange rate liberalization components of previous adjustment operations which had been laterreversed. The trade-related adjustment conditions seem to have been more successful this time becausesimilar trade liberalization programs in Tanzania and Uganda re-opened those markets to Kenyanexports. Much more successful was the Kenya Export Assistance Scheme (KEAS) which wasadministered by TDI of Ireland. On the negative side, the Export Processing Zone built and operatedwith funds from this credit, appears to be unsuccessful, particularly compared with a potential privatesector alternative. Based on these uneven results, as set out in the PCR, the operation's outcome israted as marginally satisfactory, and its institutional development negligible. The sustainability appearsto be uncertain.

An audit is planned. The audit will include a review of the role played by trade liberalizationin Tanzania and Uganda in the operation's marginal success and, how the Bank and the Governmentmight better design subsidized export promotion programs in the future.

Attachment

This document has a restricted distribution and way be used by recipients only in the performance of their official duties. Itscontents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

TABLE OF CONTENTS

Page No.

PREFACE ............................. 1........... .. . i

EVALUATION SUMMARY ................................. iii

PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE ... .... 1

1. Project Identity .................................... 12. Background ..................................... 13. Project Objectives and Description . ...................... 24. Project Design, Implementation and Results .................. 35. Bank Performance . ............................... 196. Borrower Performance .............................. 197. Achievements under the EDP .......................... 208. Sustainability .................................... 229. Lessons Learned .................................. 22

PART H: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE 24

PART m: STATISTICAL INFORMATION ...................... 26

Table 1: Project Timetable ........................... 26Table 2: Credit Disbursements . ....................... 27Table 3: Staff Resources ............................ 28Table 4: Supervision Missions ......................... 28Table 5: Status of Covenants . ........................ 29

This document has a restricted distribution and may be used by recipients only in the performance of theirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization. l

i

PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

PREFACE

This is the Project Completion Report (PCR) for the Kenya Export DevelopmentProject. The Credit (SDR 69.5 million) was approved by the Board on December 21, 1990,and became effective December 31, 1990. The Development Credit Agreement was amendedon July 9, 1992, to add SDR 37.3 million in IDA reflows, raising the total IDA financing toSDR 106.8 million. Both tranches of the quick-disbursing component, totalling SDR51,430,000 were fully disbursed, as were the reflows. As of December, 1993, just over SDR 2million remained undisbursed on the other components of the project. The project accounts are,however, fully committed and physical works are mostly complete. The project is expected toclose within the next quarter. Japan also supported the program with US$77 million equivalentin cofinancing, which was released in October, 1993.

The PCR was prepared by the Public and Private Enterprises Division, Eastern AfricaDepartment of the Africa Regional Office (Parts I and III). On January 21, 1994 the Bank sentthe Borrower Parts I and III. The Borrower prepared Part II and submitted it on March 20,1994.

The preparation of this PCR report is based on a mission to Kenya from October 24 -30, 1993, the President's Report, Supervision Reports, correspondence between the Bank andthe Borrower, and internal Bank documents, including a consultant's evaluation of severalcomponents of the project in September, 1993.

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PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

EVALUATION SUMMARY

Background

1. Kenya's economic performance was one of the success stories in Sub-Saharan Africaduring the first decade following independence in 1963, but began to run into difficulties in thelatter half of the 1970s and 1980s. The Staff Appraisal Report for the Export DevelopmentProject (EDP), presented in 1990, noted that trade ratios had fallen over the previous decade,reflecting the increasing inward-orientation of domestic production. The merchandise export/GDP ratio had dropped from 20% at the end of the 1970s to 12% at the end of the 1980s.

Objectives

2. The objective of the EDP was to increase the quantity and diversity of Kenya'sexports. The EDP intended to push aggressively toward increasing the neutrality of the traderegime. This was to be achieved by reorienting incentives, both toward enhancing the profit-ability of non-traditional exports (through appropriate exchange rate management andimproved access for exporters to inputs at international prices) and by squeezing profits inhighly protected import-substitution activities (through continued liberalization of imports). Tosupport the policy reforms and generate urgently-needed employment opportunities, and inorder to build the momentum for subsequent phases of export development, the EDP wouldsupport institutional and infrastructure development for an export processing zone, for thehandling of export products and for firm-level assistance to nascent and potential exporters.

Project Components

3. The program had a number of related components, including:

(1) policy reform (trade policy, export incentives, regulatory reform);(2) investment in on-site and off-site infrastructure for an export processing zone

and in equipment to facilitate air-freight exports;(3) direct assistance to exporters in the form of a facility based on cost-sharing

with the private sector to provide grant assistance for consultancy services toexporters;

(4) studies to assist in designing subsequent stages of the export program (as wellas preparatory studies completed through funding under the SPPF and PPF);and

(5) technical assistance for product development and to the Customs Department.

4. Policy Reforms: The policy reforms (described in detail in the main text of the report),were designed to support further increases in the transparency of protection, reductions in the

iv

level and dispersion of effective protection, and greater use of indirect taxes (rather thanimport duties) to meet the revenue needs of the Government. Some of the reforms were set aspreconditions to Board Presentation, and were implemented in 1990; others were set asconditions for the release of the Second Tranche, which was originally scheduled for June 30,1991.

5. The project faced a difficult period in implementation during 1991-1993 when theGovernment's performance on conditionality, including broad macro-economic indicatorsrelated only indirectly to the project, as well as governance conditionality external to theproject, was judged unsatisfactory. As a result, IDA and other donors to Kenya ceaseddisbursing balance of payment support between November 1991 and May 1993. A particularproblem of relevance to the project was that prudential supervision of a program of pre-shipment export financing (as well as other aspects of the financial system) was seriouslymismanaged, leading to severe abuse of the program, a surge of credit and excessive monetarygrowth and inflation. From late March, 1993, the Government began making a more seriousattempt to implement meaningful reforms and to tighten monetary and financial sector policiesand thereby control aggregate demand. The Government also took steps to strengthen andenforce prudential regulations in order to prevent a recurrence of the financial abuses. InMarch and April 1993, the Government took major steps to liberalize foreign exchangetransactions and devalued the Kenya shilling until it reached KSh 60 per US$, bringing itcloser to the newly-introduced inter-bank rate which stood at about KSh 70 per US$.

6. In May, 1993, IDA determined that the conditionality for the release of the SecondTranche had been met. The Second Tranche amounted to SDR 61.015 million, and wasapproved May 7, 1993. Combined with the reforms initiated for Board approval, it appearedthat the process had culminated in the enactment of a reform program that in many ways wentbeyond the scope of reforms as envisioned in the SAR. Strictly speaking, the projectconditionality has clearly been met and in some cases exceeded. However, there are stillcomplaints from a skeptical private sector about the continued lack of transparency in manygovernment procedures. Licensing systems have been significantly streamlined by theimplementation of the reforms, but private business people assert that there are still frequentirregularities (e.g., in Customs, in some verification processes prior to investment approval,and in some foreign exchange transactions).

7. Investments: The investment component of the Credit consisted of two parts: (a)support for construction of the first phase of an export processing zone (EPZ) at Athi Rivernear Nairobi; and (b) purchase of equipment to improve air cargo handling capabilities at JomoKenyatta International Airport in Nairobi.

8. As of October, 1993, most of the civil works contracted for the Athi River EPZ werenearing completion. However, the contract for electrical supply will probably incur final costsabout 40 percent higher than estimated at the time of appraisal; and no contract has been let forSites and Services for Low Cost Worker Housing. This item was specified in the AppraisalReport and estimated to cost about $0.66 million. The Export Processing Zone Authority(EPZA) proposed an upgrade in the standards, increasing the anticipated final cost of thiselement to just over $2.1 million. However, EPZA had solicited and obtained approval fromthe Bank to build Administration and Ancillary Buildings for the zone, which were notincluded in the SAR and cost over $4 million. This approval (along with escalation clausestriggered by the large devaluation of the Kenya shilling) led to a significant over-commitment

v

of IDA funds against the civil works category of the Credit Agreement. The contractoverruns were ultimately covered by reallocating funds within the project, but there was notenough to finance the worker housing component of the project.

9. In addition to the contract over-commitments, there are a number of issues regardingthe Athi River EPZ and the EPZA that need to be resolved: the management and operation ofthe zone, the lack of an appropriate fee structure for the zone, a potential conflict of interestwith the EPZA regulating private EPZs that compete with the Athi River EPZ, responsibilityfor the operation and maintenance of the off-site infrastructure, and finally, concerns about thefuture security of the green belt around the Athi River zone (see paragraphs 4.2.08-2.4.14 ofthe main text of this report). A study on alternative approaches for privatizing the EPZ, alongwith follow-up technical assistance for the privatization process, will take place under theauspices of the IDA financed Parastatal Reform and Privatization Technical Assistance Project.A well implemented privatization plan should resolve most of these concerns.

10. The project component for Export Facilitation Equipment was intended to improvecapacities, management and handling efficiency at Jomo Kenyatta International Airport. KenyaAir Handling Ltd. (KAHL) received the bids for the study in August 1991 and selected aconsulting consortium. However, after selection, the winning consortium stated that thepersonnel included in the proposal were no longer available. They presented new candidateswith lower qualifications but with higher costs. The World Bank responded that the newproposal was unacceptable and the contract would have to be re-bid, but Kenya Air Handling,which was undergoing major changes in management, never proceeded. The SDR 1.74 millionfor this category was reallocated to the EPZ and other components of the project in March1994 at the request of the GOK.

i1. Direct Assistance to Exporters: As described in the SAR, a grant scheme was to beestablished to finance the provision of consultancy services to exporters from competingprivate sector sources. This was to be a pilot project, administered by a two-person unitstaffed by technical personnel with backgrounds in business/engineering and specialized inexport development. The unit was to identify potential exporters and agree on an enterpriselevel export development program with them. Upon reaching agreement, the unit would fund,based on 50 percent cost-sharing with the recipient of the assistance, the technical andconsultancy services needed to achieve the export development objectives of the firm.

12. The Contractor for the Scheme, TDI of Ireland, has issued a report on the first fivequarters of operation, up to July 1993. The achievements are noteworthy: 175 grant-aidedprojects have been approved, a/ compared to a target for the period of 105; and the additionalexport revenues already achieved by clients stand at US$21.7 million, representing a ratio ofexport revenues to grants of 15:1, b/ substantially over the original target ratio, specifiedduring design, of 2: 1.

13. Studies: The following six studies were to be completed under the program: (a)Evaluation of the need for continuing the export compensation scheme in view of the

I/ Increasing to 269 as of March 1994.

b/ Up to 42:1 as of March 1994.

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introduction of the import duty/VAT exemption program, and the design of subsequent phasesof the latter for direct exporters; (b) Design of alternative schemes, such as common bondedwarehouse, to extend free trade status to indirect exporters; (c) Design of subsequent phases ofdevelopment of export financing facilities; (d) Evaluation of the effectiveness and efficiency ofofficial tourism sector institutions, including Kenya Tourism Development Corporation(KTDC); (e) Review of import duty exemptions extended to non-exporters; (f) Review offactors constraining cargo handling capacities at Jomo Kenyatta International Airport, anddesign of an approach to introduce private sector management to air cargo handling. All thestudies were completed except the one on air cargo handling, which fell into difficulties duringcontract negotiations and never proceeded to the implementation stage (see above).

Bank Performance

14. The Bank's performance on this project was uneven. The Bank was very diligentabout ensuring that the Second Tranche conditions (especially policy reforms) were met, whichled to significant improvements in the environment for private and non-traditional exports. Themajor implementation shortcomings (which were generally on the physical implementationside) were probably attributable to the high turnover in Task Managers, compounded by thecomplexities of a hybrid project with several disparate components. Official supervisionmissions took place about once per year in addition to on-going monitoring from headquartersand from the Resident Mission in Nairobi. Record-keeping was generally confused whenresponsibility for disbursements on the project was moved from Nairobi to Headquarters.Records pre-dating the move were never systematically entered into the DisbursementManagement Information System. Consequently, there was no simple or straightforwardmechanism for comparing disbursements to contract totals.

Borrower Performance

15. The Ministry of Finance's performance in managing the overall implementation of theproject was similarly uneven. Those components of the project most directly under its control(e.g., the Duty/VAT Remission Scheme) fared the best. They were instrumental in ultimatelyguiding the economic reform program through the Kenyan political system. Other componentsappeared to suffer from a lack of regular supervision. The EPZ component of the projectenjoyed the energetic attention of the staff of the EPZA, who kept construction work movingforward and aggressively marketed the Athi River EPZ among potential investors. However,EPZA has yet to arrange for private sector management of the zone or to gazette a Board ofDirectors for the EPZA and a fee structure for the zone. KEAS received considerable supportfrom the Ministry of Treasury, but often suffered from long delays in disbursements from theCentral Bank of Kenya. The KAHL, which was undergoing major changes in management,failed to follow up on the proposal for the study on commercialization with the selectedconsultants after problems developed in negotiations.

Achievements Under the EDP

16. It is certainly too early to judge the final achievements of the EDP. The most importantcomponent of the project in terms of impact on export earnings, the major policy reformsassociated with the release of the Second Tranche, have only been in place for about sixmonths. Typically, the supply response to major currency devaluations and liberalization ofexport and investment procedures emerges only after about 18 months. The data on real

vii

monthly export revenues from 1987 through May 1993 display considerable volatility, but itappears that there is a significant upward trend developing at the start of 1993. Part of thisupward trend may be related to the substantial trade liberalization programs enacted in Ugandaand Tanzania, which are rapidly developing as important new markets for Kenya's exporters.There is reason to hope that this trend will continue and even accelerate in the months ahead,as private investors adjust to the new opportunities available to them.

17. However, there may still be several significant obstacles to accelerating private sector,non-traditional exports: (a) continuing difficulties, delays and irregularities within Customs; (b)the very high cost of international communications initiated from within Kenya; (c) thecontinuing lack of export finance and the practical difficulties in arranging foreign exchangetransactions, (d) the high price of jet fuel which pushes up the cif price of Kenya's air freightexports (i.e., horticultural products, cut flowers, etc.); (e) the continuing monopoly of KenyaAir Handling Limited for the weighing of air cargo; and (f) the continuing inadequacies of aircargo handling equipment.

Sustainability

18. The economic policy reforms were probably the most successful and durable of theachievements of this project, supported by liberalization in regional export markets (notablyUganda and Tanzania). Although backtracking always remains a possibility, most observersagree that the most important reforms - the move to a flexible and open exchange rate regimeand the liberalization of trade controls - would be very difficult to reverse.

19. The Kenya Exporter Assistance Scheme was designed as a short to medium termprogram with a strictly limited life span. The long term benefits were expected to ariseprimarily from the demonstration effect. However, the Scheme would need to be in existencelong enough to assist firms at the level of improvements in product quality and the marketingof available products before it could be said to have completed its job. Unfortunately, itappears there will not be sufficient funds to extend the work begun in this area, although IDAis actively pursuing options in this area.

20. The economic viability of the Athi River EPZ needs to be ensured. Unless theborrower fulfills its agreement to transfer management and operation of the EPZ to the privatesector quickly, with incentives to develop an appropriate fee structure, cost recovery onphysical investment is expected to be unsatisfactory. An alternative is to sell the assets to aprivate investor--on the basis of a transparent auction process--who may then be able tomaximize returns over the long run. Another alternative would be to lease the assets of theAthi River EPZ to a private investor on the basis of competitive bidding.

Lessons Learned

21. The Export Development Project suffered significantly from high turnover among TaskManagers and resulting inconsistent supervision. It is clear that successive Task Managerswere unaware of the status of key components of the project and unsure of what actions theyshould be taking to keep the project on track. An established hand-over procedure, including adetailed memo outlining the current status of each element of the project and necessary futureactions, might mitigate this type of problem in the future.

viii

22. The pre-shipment export financing program suffered from mismanagement and abuseduring implementation, due to systemic failure in prudential regulation in Kenya. Theexperience with pre-shipment export finance in Kenya should not be cause to reject similarprograms elsewhere, but should be viewed as an example of how an otherwise sound programcan be abused in the absence of adequate oversight by both the borrower and the Bank.

23. The lessons of the economic policy reform program are more complex. Ultimately, theBank's firmness on conditionality yielded a very important and positive set of reforms.However, given its past policy reversals, the Government of Kenya still needs to work toachieve the credibility in the eyes of private entrepreneurs (both foreign and domestic) that isnecessary to bring forth significant new investment and a strong export supply response. Toachieve this credibility, the GOK must continue to improve the transparency and consistency ofits implementation of economic reform. Because of the time required to earn credibility, alongwith the inevitable time lag between trade policy reforms and a full export supply response, itwould be appropriate to initiate a post-closure evaluation of the project in 1995, focusing onthe trends in export earnings, export/import ratios, diversification of exports, and theexperiences of private sector exporters with the recent reforms.

PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

PART I: PROJECT REVIEW FROM THE BANK'S PERSPECTIVE

1. Project Identity

Project Name: Kenya Export Development ProjectCredit No.: 2197-KERVP Unit: Africa RegionCountry: KenyaSector: TradeSubsector: None

2. Background

2.1 Country Background: Kenya was one of the success stories in Sub-Saharan Africaduring the first decade following independence in 1963, but began to run into difficulties in thelatter half of the 1970s and 1980s. Economic growth suffered from the 1973 oil crisis,deteriorating terms of trade, diminished access to the markets of the former East AfricanCommunity, an import substitution strategy involving substantial tariff and non-tariffprotection, expanding government budget deficits and increased regulation of the economy.

2.2 In the early 1980s, the Government embarked on a major stabilization and adjustmentprogram to redress fiscal and financial imbalances and restore the economy to a sustainablegrowth path. The program, supported by a stand-by arrangement and two SALs from IDA,included a devaluation, reductions in the budget deficit, and reforms in the financial sector.Despite a world-wide recession, an attempted coup in 1982, and a major drought in 1984,considerable progress was made in reducing the economic imbalances. While the stabilizationprogram was successful in reducing the budget and the balance of payments deficits, and inmoderating inflation, little progress was made in structural adjustment. Trade liberalizationmeasures introduced under the SALs were eventually reversed, and protection through non-tariff barriers were intensified after 1983.

2.3 Sector Background: The SAR, dated November 1990, noted that trade ratios hadfallen over the previous decade, reflecting the increasing inward-orientation of domesticproduction. The merchandise export/GDP ratio dropped from 20 percent at the end of the1970s to 12% at the end of the 1980s and the merchandise import/GDP ratio dropped from 27percent to 22 percent over the same period. Private sector imports declined, reflecting thedrop in new investment, the existence of large unutilized capacities, and import restrictions.Conversely, public sector imports expanded, reflecting the growing importance of external aidinflows in supporting activity levels in the economy. Export growth, although higher than in

2

most other African countries during the 1980s, was considered inadequate in relation to theemployment and foreign exchange needs of the Kenyan economy.

2.4 Second, the lack of diversification of exports had increased Kenya's vulnerability toexternal shocks and limited the growth of an export constituency within Kenyan manufacturing.Product diversification was limited, with nearly two-third of export earnings derived fromcoffee, tea and tourism, and nearly 60% of merchandise exports from agricultural goods. Thereal value of Kenya's manufacturing exports had been declining through the 1980s. A lack ofdiversification was also seen in the market orientation of exports. A significant portion ofKenya's manufactured exports went to regional markets, often unrecorded and on the basis ofunofficial barter. While developing country exports of manufactures to developed countries hadbeen growing, Kenya's share had fallen. Although several new Kenyan products had appearedon export markets (e.g., horticulture products, high value finished garments), little of thecountry's diversified manufacturing output was competitive on a cost or quality basis in themore demanding OECD markets.

2.5 Policy context: At the time the project was being designed, the policy environment hadcreated an incentive structure that deviated significantly from neutrality among exportables,importables, and non-tradeables. The real effective exchange rate (REER, i.e., the nominalexchange rate adjusted for inflation differentials between Kenya and a reference group ofcountries) had depreciated by over 14 percent from 1985-89, due largely to the significantnominal depreciations undertaken in the Government's stabilization program. However, morerefined versions of the REER, focusing on competitiveness vis-a-vis Kenya's manufacturedexport partners and third countries that compete in the same markets, suggested that continuedanti-inflation and exchange rate actions would be needed to improve export competitivenessfurther. Import protection, involving both tariffs and non-tariff barriers, were considered tobe a significant constraint to the growth of exports, by reducing their profitability relative tothe import-competing sector. Export incentives were minimal and not sufficient to neutralizethe anti-export bias of other aspects of economic policy. A review of regulations revealedsignificant redundancies in licensing/approvals procedures, requirements for excessivelyfrequent renewals of licenses, and a lack of speed and transparency in the licensing/approvalprocess. Export licensing requirements were particularly cumbersome. Price controls,although improved since the implementation of an earlier ISAC, were still in place for 18categories under a General Price Control Order and for 11 other items (mostly consumerstaples), which were subject to a Specific Price Control Order. There was a marked absence oftrade financing available.

3. Project Objectives and Description

3.1 Sector development objectives: The Government of Kenya decided to implement abroad-based strategy that would draw mainly from the experience of successful exportingcountries in East Asia and Mauritius, where export promotion has been linked closely with thedevelopment of small and medium firms and inflows of private foreign investment. Exportwould be promoted through changes in trade incentives, parallel reforms in enterpriseregulations, and direct assistance to exporters through improved access to finance,production/marketing technologies, and high quality physical infrastructure.

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3.2 Linkages between project, sector and macro policy objectives: During implemen-tation, the following macroeconomic policies were expected to have an important bearing onthe success of the project: (a) flexible exchange rate management; (b) reduction in the publicsector deficit and its domestic financing; and (c) reduction in the growth of broad money.

3.3 Project objectives: The objective of the Export Development Project was to increasethe quantity and diversity of Kenya's exports. The EDP intended to push aggressively towardincreasing the neutrality of the trade regime. This was to be achieved by reorientingincentives, both toward enhancing the profitability of non-traditional exports (throughappropriate exchange rate management and improved access for exporters to inputs atinternational prices) and by squeezing profits in highly protected import-substitution activities(through continued liberalization of imports).

3.4 To support the policy reforms and generate urgently-needed employment opportunities,and in order to build the momentum for subsequent phases of export development, the EDPwould support institutional and infrastructure development for an export processing zone andfor the handling and transportation of export products. The program would also helpimplement institutional reforms and direct assistance schemes to support nascent exporters, andfinance studies to inform the next phase of export development.

3.5 Project components: The program had a number of related components, including:

(1) policy reforms (trade policy, export incentives, regulatory reform);(2) investment in on-site and off-site infrastructure for an export processing zone andin equipment to facilitate air-freight exports;(3) direct assistance to exporters in the form of a facility based on cost-sharing withthe private sector to provide grant assistance for consultancy services to exporters;(4) studies to assist in designing subsequent stages of the export program (as well aspreparatory studies completed through funding under the SPPF and PPF); and(5) technical assistance for product development and to the Customs Department.

Greater detail on project design is presented in the section on Design, Implementation, andResults, below, to facilitate comparison between project intentions and outcome.

4. Project Design, Implementation, and Results

4.1.01. Policy Reforms: The policy reforms (described in detail below), weredesigned to support further increases in the transparency of protection, reductions in the leveland dispersion of effective protection, and greater use of indirect taxes (rather than importduties) to meet the revenue needs of the Government. Some of the reforms were set aspreconditions to Board Presentation, and were implemented in 1990; others were set asconditions for the release of the Second Tranche, which was originally scheduled for June 30,1991. However, there was a difficult period in implementation from late 1991 to mid 1993,when donors withheld aid on the basis of governance and macro-economic conditionality andwhen the Government reversed many key policy reforms. In March 1992, in a letter from IDAto the Borrower, it was noted that the Government had met some of the conditions, but thatseveral other key conditions remained unfulfilled, and that there were significant discrepancies

4

between official policy and actual implementation, such that the letter of the agreement mayhave been met, while the spirit was still being violated. Overall, it was judged that themomentum on reforms had been lost, and that there had been significant back-tracking onimport liberalization in particular. Later memos noted that Customs, which was largelyuninvolved in the EDP, was a particular source of disruption. Other concerns, articulatedduring a formal review of the status of the conditionality in September 1992, includedexcessive growth of the budget deficit, of broad money and inflation, and appreciation of thereal exchange rate. Consequently, IDA held back the second tranches for the SecondAgricultural Sector Adjustment Operation (ASAO 11), and the Education Sector AdjustmentCredit (EDSAC) as well as for the EDP.

4.1.02. Kenya's macroeconomic policy performance was reviewed again by a jointIMF/IDA mission in February/March 1993 and was again found to be unsatisfactory. Since theprevious review in September 1992, the Government had implemented a number of additionalexternal sector policies as a step towards meeting the macroeconomic conditions for trancherelease. The measures included: (a) the introduction of foreign exchange retention accountscovering 50 percent of traditional merchandise exports (October 1992) and 50 percent ofservices (February 1993)1; (b) expanding the inter-bank foreign exchange market (February1993); and (c) abolition of the parastatal monopoly in the coffee auction and broadening privatesector participation in the export of tea (October 1992). However, expansionary monetarypolicies exacerbated inflation and created a widening spread between the market-determinedinter-bank exchange rate and the official exchange rate. Furthermore, because of negative realinterest rates, excess liquidity in the banking system and the continuing impasse between theGovernment and multilateral financial institutions, speculation against the Kenya shillingincreased. Instead of taking measures to tighten its monetary stance, bring inflation undercontrol, and achieve meaningful fiscal compression, the Government announced on March 22,1993 its intention to reverse previously adopted measures. 2 The Government stated thatretention accounts were no longer allowed and all export earnings were to be remitted to theCentral Bank at the official rate. The Government also indicated that it would re-impose pricecontrols, although this did not occur.

4.1.03. The Government ultimately recognized that while its actions might temporarilyrelieve the shortage of foreign exchange at the CBK, they would not redress the fundamentalmacroeconomic imbalances which were aggravating inflation, weakening the Kenya shilling,and undermining confidence in Kenya's economic management. From late March, 1993, theGovernment began making a more serious attempt to tighten monetary and financial sectorpolicies and thereby control aggregate demand. The Government also took initial steps to

I The introduction in August 1992 of 100 percent retention of foreign exchange for exporters of non-traditional goods helped to improve the incentives in this segment of the export market, but itdiscriminated against exports of services and traditional goods.

2 GOK responds: [This comment] shows a lack of appreciation on what was feasible with exchange ratemoving up on a daily basis indexing into inflation. Monetary policies in such a free-fall situation areineffective because expectations are running ahead of any policy position short of freezing thedeterioration. Measures were in place by mid-April, which indicates an extremely rapid return tomacroeconomic controls. This would not have occurred had the Government not already been indiscussion with the IMF prior to taking action even if the Fund disagreed with those actions.

5

strengthen and enforce prudential regulations in order to prevent a recurrence of the structuralproblems which led to monetary mismanagement. On April 20, 1993, the Governmentdevalued the Kenya shilling by about 23 percent to KSh 60 per US$, bringing it closer to theinter-bank rate which stood at about KSh 70 per US$. This adjustment followed a 25 percentdevaluation on March 9, 1993, which improved the competitiveness of the shilling, asmeasured by the Real Effective Exchange Rate (REER), significantly (see Chart 1, below).

Chart 1

Real effective exchange rate

90

so

70

60 I T N S50

40

30

20

I10

0 -

Source: IMF Information Notice System

4.1.04. By early May, 1993, IDA determined that the conditionality for the release ofthe Second Tranche had been met. The Second Tranche amounted to SDR 61.015 million 3,

approved May 7, 1993. Combined with the reforms initiated as conditions for presentation ofthe credit for Board Approval, it appeared that the process had culminated in the enactment ofa reform program that in many ways went beyond the scope of reforms as envisioned in theAppraisal Report. They included:

4.1.05. (a) Movement of Trade Controls from Quantitative Restrictions to Tariffs -Design: Except for products that would be retained in Schedule 3C (and subject to QRs) forpublic health, environment and public safety reasons, all other items currently in 3C would beshifted to Schedule 3B by June 30, 1991 (Second Tranche condition), with equivalent or lowertariffs imposed on their imports. Outcome: This element was fulfilled by the GOK in the June1991 Budget. The memo on the release of the Second Tranche stated that only twelve items areclassified under Schedule 3C, mainly on environmental grounds.

3 Including SDR 37.3 million from IDA reflows added to the Credit by an amendment signed in July1992, as well as the SDR 23.715 million held under the original Credit Agreement until theconditionality was satisfied.

6

4.1.06. (b) Reduction in tariff levels - Design: A reduction in tariff levels was to beimplemented and coordinated with more active use of the exchange rate and greater reliance onthe VAT for revenue collections. In the first year (undertaken as a condition of Boardpresentation), a reduction of 5 percentage points in the import-weighted average tariff of allSchedules except the current 3C was completed. Further tariff reductions were a condition ofthe release of the Second Tranche, aimed at reducing the level and variability of effectiveprotection. Outcome: The average level of import tariffs was reduced by 5 percentage pointsin June, 1992. While the average tariff rate had been nearly 50% in 1989/90, it was down toabout 33% by 1993/94. The dispersion of tariffs was also reduced, from a range of 0 percent -135 percent in 1989/90 to a range of 2 percent - 50 percent in 1993/94. However, theresulting loss of revenue was so great that the Minister of Finance, after consulting with theIMF in late September 1993, exercised his limited discretionary power to raise all tariffs ratesby 25 percent, such that the current average tariff rests at just over 40%. These rates willremain in effect until the next fiscal year, when Parliament approves the next budget.

4.1.07. (c) VAT - Design: To compensate for revenue losses from the tariff changes,VAT coverage and rates were to be raised. Outcome: By 1993/94, the number of ad valoremrate bands had decreased from 15 in 1990/91 (ranging from zero to 150 percent) to four(ranging from zero to 40 percent). The number of VAT exempt goods were reduced from over1000 to about 500. The number of zero rated goods declined from 275 to 260. Therefore, thedispersion in rates decreased while average levels of VAT increased, with the bulk of goods(over 75%) incurring a VAT of 18%.

4.1.08. (d) Tariff exemptions provided to non-exporters were to be reduced before therelease of the Second Tranche. In order to reduce speculation and erosion of import duties, theperiod for which imported items could be stored in common bonded warehouses on a tariffexempt basis was reduced to a maximum of one year in June 1990 as a condition of BoardPresentation. Outcome: Tariff exemptions for non-exporters were reduced statutorily bytightening the exemption criteria significantly in 1992. In addition, ministerial discretion togrant such exemptions was removed. As a result, the percentage of tariff-paying home-useimports (i.e., imports that are not re-exported) increased from about 50% to over 75%.Officially, the period during which imported items could be stored in common bondedwarehouses was limited to one year, but in practice, there are continued reports that the periodoften exceeds the limit.

4.1.09. Specific export incentives were designed primarily as measures to allowexporters access to inputs at international prices, and to promote the provision of tradefinancing and improved services for exporters. They included:

4.1.10. (a) an import duty/VAT exemption scheme (introduced as a condition ofBoard Presentation) was intended to provide direct exporters access to inputs at internationalprices. Outcome: This scheme was evaluated by an independent consultant in October, 1993.The evaluation concluded that the scheme, operated by the Export Promotion ProgrammesOffice (EPPO) within the Ministry of Treasury, has made a commendable start at achievingduty and tax-free status for firms exporting less than 100% of output, as well as indirectexporters (firms supplying significant inputs to direct exporters) and the original beneficiaries(firms that produced 100% of their output directly for export). The scheme is currentlyservicing around 140 firms, and has experienced a surge in volume following the recent large

7

devaluations of the shilling, which significantly increased the shilling price of imports andtherefore the total duties payable, as well as making exports more attractive in shilling terms. 4Delays in payments through the Central Bank, which plagued the scheme in the past, haveimproved. However, the EPPO Audit Unit (which verifies ex-post that individual firms havecomplied with the terms of the scheme) has accumulated an extensive backlog, and theevaluator judged that the scheme as a whole is still somewhat basic and unwieldy. Therecommendation was that Treasury start bringing it in line with best practice elsewhere in theworld. Concepts such as systems audit, period entry, risk-based sampling, and automatedrandom selection would greatly improve and simplify the current scheme.

4.1.11. (b) an existing export compensation scheme, which provided a flat 20 percentrefund to eligible exporters, was amended as a condition of Board Presentation to acceleratepayments to exporters and to broaden product coverage. According to the Appraisal Report,during project implementation, exporters were to be able to choose between the EC andexemption schemes. Outcome: After receiving a Consultant's study and after consultation withthe Bank, the export compensation scheme was phased out during 1991 and 1992 and closed inSeptember 1993. The Import duty/VAT exemption scheme, although somewhat cumbersome,is a fairer instrument, as the Compensation Scheme's flat 20% refund represented an excessivebenefit for some firms and a badly inadequate one for others.

4.1.12. (c) The manufacturing-under-bond (MUB) system was reformed as acondition of Board Presentation to reduce operating costs, to allow firms to sell rejects in thedomestic market, and to extend the scheme to new urban centers. Outcome: The scheme ismeant only for 100% exporters, and has in practice been taken up primarily by local investors,foreigners opting instead for the EPZ scheme. It is understood that over 40 factories are nowoperational under the scheme, most of them garment assemblers. The system still operates onthe traditional basis of having two locks on all storage areas, so that the Customs officer, whois posted full-time to an individual factory, can authorize, and physically supervise, allmovements of stock, using his second lock. This procedure is, however, cumbersome,outdated, and vulnerable to abuse. The treatment of local sales in the MUB scheme is anotherproblem. In most countries, factories given the substantial benefits of duty-free operation areonly allowed to sell a small percentage of their output into the local market, typically up to5%, consisting of genuine offcuts and seconds. Otherwise, they would be operating at anunfair advantage over local firms. However, in Kenya's MUB scheme, arrangements for localsales appear discretionary, and of dubious fairness. 5

4.1.13. (d) To meet the working capital needs of exporting firms, the GOK re-activatedthe CBK's facility for rediscounting private financial paper. The facility allowed commercialbanks which granted preshipment loans to exporters (against confirmed and irrevocableletters of credit or confirmed and verified export contracts) to rediscount with CBK theaccommodation bill created as a result of that transaction. (See also paragraph 4.4.04).Outcome: This feature turned into a financial scandal that received considerable attention fromboth the local and international press. Reportedly, instead of ensuring that pre-shipment loans

4 GOK notes that EPPO is servicing 205 firms as of 1994.

5 GOK comments that: MUB sales into the local market are discretionary within the statutory limit of2.5 percent. This is at rhe producers' discretion.

8

be confined to confirmed and irrevocable letters of credit, as specified in the Appraisal Report,the scheme as implemented allowed loans to be made to some individuals against unverifiedexport orders. These individuals presented export orders for, most often, "gold bars". Firstthey received pre-shipment financing loans, denominated in Kenya Shillings, capable of beingexchanged into hard currency at the official exchange rate, (again with only the unverifiedexport order), claiming they needed the hard currency to pay for imported inputs, which alsodid not require verification. They could then change the hard currency back into KenyaShillings, this time at the higher inter-bank rate, repay their preshipment loan, and pocket theprofits without necessarily exporting anything at all. They could also obtain subsidies from theExport Compensation Scheme (see above). The following chart, presenting data on the realvalue of non-gold exports and alleged gold exports, illustrates the scope of the problem. Thevalue of the transactions was so high that it was blamed for significantly affecting Kenya'smonetary growth and inflation rate. 6

Chan 2

Real Value of Domestic Exports

90

a70

f4SOI ovX C t FW ,frSwwa '~30

3 20 / >

00 C6 6~ a, " 0fi> 0>8888 Ch a, C:

real value of alleged gold exports ° real domestic exports excluding gold

6 The Kenya PFP for 1993/94 - 1995/96 (Second Draft prepared by the Government of Kenya in Oct.1993) states: 1992 witnessed a rapid growth in money supply of 35% compared to the previous year's

figure of 24% in 1991. This ... contributed to the escalation in the rate of inflation to 27.5% in 1992compared to 15.8% and 19.6% in 1990 and 1991, respectively. The sharp rise in money supply waslargely due to the growth of domestic credit to the private sector including preshipment export financing.

9

The preshipment export financing scheme was closed down at the request of the World Bank inApril, 1993, along with the closure of the so-called political banks in Kenya associated withthe Goldenberg financial scandal. 7

4.1.14. Other regulatory reforms intended to improve the environment for investment,production, capacity expansion and trading in Kenya were designed as follows:

4.1.15. (a) elimination of redundant licenses and procedures that affect exports,reduction of the frequency of license renewals, and improvements in the processing andtransparency of existing regulations. Specifically -

(i) Separate registrations required under the Industrial Registration, Statistics andFactories Acts and by the Kenya Bureau of Standards and National Social SecurityFund were to be consolidated before release of the Second Tranche. Outcome: Thiscondition was met prior to the release of the Second Tranche. The InvestmentPromotion Centre (Amendment)--IPC--Act of September 1992, and the MiscellaneousAmendment Act of October 1992 introduced a General Authority, which substitutes forall the registrations for the first 12 months after investment. After the first 12 months,separate registrations under the various Acts (except the one for Statistics Act that doesrequire registration) apply. While IPC's General Authority is limited to the first 12months, the memo recommending the release of the Second Tranche stated that renewalof separate registrations is now undertaken on a routine basis.

(ii) Licenses required under the Trade Licensing Act were to be consolidated intothree broad classes (manufacturer/trader; general trader; and small trader; with a singlelicense valid for export, import and domestic trade) and their validity extended to up tothree years before release of the Second Tranche. Outcome: The various licensesunder the Trade Licensing Act were regrouped (by Legal Notice No. 3 of January1991) into: Form B--Manufacturer's Trade License; Form C--General Trade License;and Form D--Small Trader's License. These forms were put into use beginningAugust 1992. In addition, traders now have the option of selecting an extendedduration period of 36 months (compared to 12 months before) for their license, albeitat higher cost. However, it appears that these changes might not be widely understood.It was apparent during an evaluation mission in September 1993 that many privatebusinesses were completely unaware of the changes, and continued to deal with theMinistry of Commerce on the basis of the 1967 version of the Trade Licensing Act. 8

7 About a dozen financial institutions were closed or liquidated between April and August 1993;according to the Central Bank, another financial institution, which has had its banking license revoked, isstill in the process of liquidation. An investigation was initiated by the GOK, with a prominentopposition politician at its head. This process is being monitored closely by the Bank in its ongoingfinancial sector work in Kenya.

8 GOK comments: While it is true that a number of traders are unaware of the three-year licensefacility, in justice, it should be pointed that the Government ran advertisements in the press to inform thepublic, besides using more conventionalfora.

10

(iii) The Borrower was to implement proposals approved by the Cabinet Sub-Committee in December 1989 to eliminate redundancies, speed approvals and increasetransparency in processing and approving of investment and operating licenses andpermits. Outcome: The memo prepared for the Release of the Second Tranche statedthat the condition was met, but noted that the proposal approved by the Cabinet Sub-Committee did not contain any specific list of licenses identified as redundant. Inaddition to the reform of the Trade Licensing Act, the memo noted that theGovernment mounted an exercise in late 1992 to identify redundant licensingrequirements in a number of Ministries. This process resulted in about 22 licenses inagriculture, livestock, and food processing being eliminated by Ministerial Orders.

(iv) The licensing requirement for individual export consignments was eliminatedprior to Board Presentation, except for a limited number of products covered by theImports, Export, and Essential Supplies (Exports) Order (and the number of productscovered under the Order reduced form 38 to 19). Outcome: An exporter now needs aspecific export license only for the 19 products covered by the Order. These include:

items that are effectively banned, such as ivory, rhino horns, coral, and guns(which probably should be explicitly banned, to remove any question ofpossible discretionality);

some buffer stock staple foods such as rice, maize meal, sugar, and some beans(but since imports are allowed in free of licensing restrictions, this type ofexport licensing is now redundant); and

* fish and meat, which require pre-shipment inspection and/or clearances forhealth reasons (in the case of fish, the September 1993 evaluation found thatauthorizations were required from 14 different government agencies, coveringover-fishing, disease control, suitability for export, etc.).

(v) A consistent and transparent queuing system for the external payment ofdividends and royalties was publicized and implemented prior to Board Presentation.Outcome: This was another case where it appeared that theory and practice may havediffered significantly. Private sector business asserted that, while there had beensubstantial improvement from the situation in the 1980s, the queuing system stillinvolved considerable delays for most requests and that irregularities were notuncommon. After September 1993, the problems were theoretically solved with theability to buy foreign exchange freely. However, many private sector business peopleinvolved in foreign trade asserted that access to foreign exchange is not as easy inpractice as it appears on paper. The Central Bank continues to require that traders fill aform similar to the old CD3 form, which had been used to ensure that exports allowedout corresponded with proceeds eventually repatriated and exchanged into shillings.Both the old CD3 and the new foreign exchange form (which is supposed to beprimarily for record keeping) are associated with considerable costs, delays, anduncertainties to exporters. There has been considerable confusion over the conversion

11

of external accounts to foreign currency accounts. 9 Some private sector businesspeople ascribe the continuing problems of foreign exchange transactions to confusionover a very new policy environment; others voice suspicions that there is a new set ofirregularities associated with the new policies.

4.1.16. (b) Price decontrols were to be systematically extended during the period ofimplementation of the Credit, especially for potential exportables and inputs into exportindustries. The use of import-parity pricing was to be expanded for items that remained underprice control. The scope and timing of specific actions was to be determined by theGovernment. Outcome: The memo on the release of the Second Tranche stated that theGovernment had made significant progress in this area, in particular with regard toliberalization of the prices of goods formerly under the Specific Price Control Order, and thatthe Kenyan Authorities went beyond the requirements of their April 1992 agreement with theIMF.

4.1.17. Summary of Outcome of Economic Reforms: The SDR 88.73 million spenton quick-disbursing balance of payments support was conditioned on the set of reformsoutlined above. The letter of these reforms was clearly met for the release of the SecondTranche (and some conditions were more than met, such as the liberalization of the exchangerate and import procedures), although there are still many complaints from a skeptical privatesector about the continued lack of transparency in many government procedures. Licensingsystems have been significantly streamlined by the implementation of the reforms, but privatebusiness people assert that there are still frequent irregularities (e.g., in some verificationprocesses prior to investment approval, in Customs procedures, and in foreign exchangetransactions processed through the banking system). Although great progress has been made inregulatory liberalization, the GOK's history of policy reversals and the resulting skepticism ofthe private sector indicates that the GOK's reform program has not yet achieved the credibilityneeded to bring about the level of investment required for the desired export supply response.10

4.2.01 Investments: The investment component of the Credit consisted of two parts:(a) support for construction of the first phase of an export processing zone at Athi River nearNairobi; and (b) purchase of equipment to improve air cargo handling capabilities at JomoKenyatta International Airport in Nairobi.

4.2.02. The Athi River EPZ (Design): According to the Credit Agreement, the creditwas intended to support Construction of the first stage of an EPZ at Athi River, roughly 18 k/nsouth of Jomo Kenyatta Airport south of Nairobi, including on-site and off-site infrastructureconsisting of access roads, water supply, sewerage and waste disposal facilities, power lines,common production and handling facilities, and basic structures and services for business and

9 External accounts were financed by foreign currency but denominated in Kenya shillings. InSeptember 1993, the Central Bank announced that these were to be converted to foreign currencyaccounts denominated in hard currencies. However, the documentation required for the conversionprocess led to many accounts being effectively frozen.

10 GOK comments: It is clear that what private business people assert gets more credibility than whatGovernment's reform has actually done. The benefit of the doubt goes to the skeptics.

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worker housing areas. The zone itself was expected to encompass about 93 hectares, and thecost was estimated at about $26.5 million.

4.2.03. On the basis of a consultant's study, which established the feasibility anddesirability of an EPZ at the designated site, a PPF was approved in April 1990 to completethe design and engineering analysis. Although the Athi River site required heavy investmentsin off-site infrastructure, it was considered superior to the alternative sites that wereinvestigated, where the terrain was much more uneven or required extensive drainage. Theeconomic rate of return for Phase I was estimated at 18% (including shadow wage andexchange rates). According to the SAR, Although owned and developed by the Government, thezone would be run on a commercial basis by a private sector operator.

4.2.04. With regard to environmental issues, the Appraisal Report noted that (a) basedon information collected about current land use, no resettlement plan was believed to berequired; (b) the Project was to provide water supply and sewerage/waste treatment facilitiesfor incoming industries as well as enhance existing community facilities, and preserve existingsupplies available for wildlife; (c) the Project was to provide sites and services for 500 plotsfor worker housing.

4.2.05. The physical and operational design of the EPZ included mitigation measuresto (a) preserve green belts around the industrial site to safeguard woodlands; (b) applyappropriate norms for factory-level emissions, require pre-treatment of liquid and solid wastes,as well as provide common facilities for the treatment of effluents; and (c) implement landzoning that would preserve the access of wildlife to the entry/exit points at the southeasternboundary of the Nairobi National Park (completed as a Board Presentation Condition).

4.2.06. Outcome: The necessary EPZ legislation was passed in 1990, which was theprecondition for disbursing funds for the civil works for the Athi River EPZ. As of October,1993, most of the civil works for the Athi River EPZ were nearing completion. According tothe consulting engineers, the Off-Site water supply was essentially complete; the On-SiteServices and Ancillary Works was about 95 percent complete; and the Off-Site Sewerage andSewage Treatment Works were expected to be completed within one month. Electrical supplywas over 50 percent complete, with expected final costs (all of which are listed as local) about40 percent higher than estimated at the time of appraisal. No contract has been let for Sites andServices for Low Cost Worker Housing. This item was specified in the Appraisal Report andestimated to cost about $0.66 million. EPZA has proposed an upgrade in the standards,increasing the anticipated final cost of this element to just over $2.1 million. However, EPZAsolicited and obtained approval from the Bank to build Administration and Ancillary Buildingsfor the zone, which cost over $4 million and (along with escalation clauses triggered by thesharp devaluation of the shilling) led to a significant over-commitment of IDA funds againstthis category of the Credit Agreement. The contract overruns were ultimately covered byreallocating funds within the project, but there was not enough to pay for the sites and servicesfor worker housing as envisioned in the SAR and Credit Agreement.

4.2.07. It appears that the original intention (as conceived at some point after theCredit Agreement was signed), was for the GOK to finance the contract for the AdministrationBuildings out of its own resources. The Bank wanted to ensure that specifications werecompatible with the rest of the project construction, and that competitive bidding procedures

13

were used, and so requested copies of all the bidding documents. However, in the course of aswitch of Task Managers on the project, the GOK sought IDA assistance in financing thecontract. At first, the plan was for GOK to finance the bulk of the contract and for IDA tofinance as much as it could within the confines of the budget as specified in the CreditAgreement (including contingencies). It was estimated at the time that the budget couldaccommodate about 20% of the cost of the $4 million contract. However, a no objection wasultimately issued for the contract by the World Bank without any qualifications as to thefinancial responsibilities of the GOK and IDA. In fact, IDA disbursed somewhat over 20% ofthe contract price before IDA funds for this category of the project were depleted. Work underthis contract is, however, running behind schedule and it appears that less than half the moneyhas been disbursed as of end 1993. The decision to complete the EPZ without an IDA-financed worker housing component was made to ensure that a fully functioning EPZ could beoperational as soon as possible.

4.2.08. In addition to the contract over-commitments, there are a number of issuesregarding the Athi River EPZ and the EPZA that will need to be resolved: the managementand operation of the zone, the lack of an appropriate fee structure for the zone, a potentialconflict of interest with the EPZA regulating private EPZs that compete with the Athi RiverEPZ, responsibility for the operation and maintenance of the off-site infrastructure, and finally,concerns about the future security of the greenbelt around the Athi River zone.

4.2.09. Management: Even at this advanced stage, the issue of who will actuallymanage and operate the zone is still unclear. Although the GOK, in its Letter of Export Policyreferred to in the Credit Agreement, committed itself to a policy of private sector operation ofthe zone, EPZA is already in the process of extending its staff, presumably to enable it toundertake the management role itself until they can make arrangements to bring in privatesector managers, a procedure they believe should take two years. In an effort to accelerate theprocess, a study on alternative approaches for privatizing the EPZ, along with follow-uptechnical assistance for the privatization process, is being initiated under the auspices of theIDA financed Parastatal Reform and Privatization Project.

4.2.11. Lack of an appropriate fee structure: EPZA has a proposed fee structurewhich is somewhat lower than the (geographically) nearest competitor 11 and submitted it to theMinistry of Finance, but it had not yet (as of October 1993) been approved for gazetting.However, a financial analysis of the Athi River zone, based on EPZA's expenditure andrevenue projections (which are in turn based on their proposed fee structure and projectedoccupancy rates), and including the costs of the on-site investment, is slightly negative.12 Inthe absence of management which is provided with incentives to maximize the commercialreturn to the zone, it is difficult to see how an appropriate fee structure can be developed.

11 Sameer Industrial Park is currently the only operational, multi-firm EPZ in the area and thereforemay enjoy a degree of market power.

12 Specifically, about negative two percent per annum, excluding the investment costs of extending off-site infrastructure (water, sewerage and electrical power supply) for 12 km at a total cost of about $18million, but including the most recent cost estimates for all on-site construction, and using a 20 year timehorizon for recurrent net revenues.

14

4.2.12. Conflict of interest: Concerning the role of the Export Processing ZoneAuthority, it had always been foreseen that its function would be regulatory, not executive.There is an inherent conflict of interest in having the Authority oversee the operation of privatezones while at the same time managing its own zones. For this reason, the Bank informed theMinistry of Finance it believes that it is inappropriate to have the Authority involved in themanagement of the Athi River zone, and requested that EPZA restrict itself to the regulation ofzones in general, and to move with all due speed toward privatization of the Athi River EPZ.

4.2.13. Management of off-site infrastructure: Responsibility for the operation andmaintenance of some of the off-site infrastructure is still unclear. According to EPZA, it istaking over management from the contractors as the work is completed, and is still developingterms and conditions for handing over management responsibilities to a variety of authorities,including the National Water Pipeline Commission, the Nairobi City Council, and MavokoTown Council. They say they need technical assistance during the transition period, but it isunclear how that will be financed.

4.2.14. Security of the Green-belt: The designated green-belt between the Athi RiverEPZ and Nairobi Park was zoned as a no-development area as part of the conditionality for theproject. However, the consulting engineers have expressed concern that the zoning regulationswill not be properly enforced. They note that there has been considerable market activity insome of the green-belt property, involving values that are significantly higher than one wouldexpect for real estate that cannot be developed.

4.2.15. Resettlement of Squatters: The resettlement of squatters was a potentialproblem that was handled well by all parties concerned. Although there was no one living onthe site of the EPZ, there was an informal community along parts of the route for the off-sitesewerage line, about 500 of whom had to be resettled. The consulting engineers followed theWorld Bank directives and guidelines from the start. They arranged with the local municipalcouncil to hold hearings six months in advance of construction. The municipal council madeland available which was about three quarters of a kilometer from the original housing site.The new land was on higher ground, and the individuals now have legal title to their new plotsof land, and access to water kiosks and latrines, none of which they had before. They weregiven new building materials and other logistical assistance in their moves. They will in thefuture be connected the same water and sewerage mains as the EPZ worker housing sites.

4.2.16. The project component for Export Facilitation Equipment was designed toimprove capacities, management and handling efficiency at Jomo Kenyatta InternationalAirport. The Credit was to finance the installation of additional cargo handling equipment,including high loaders, tractors, weigh bridges, cargo dollies, forklifts, reach trucks andhydraulic pallet trucks. In order to ensure effective utilization of the equipment andimprovements in air cargo terminal operations, a condition for disbursement of funds was to bethe completion of a study and initiation of an action plan to introduce private sectormanagement for air cargo handling operations.

4.2.17. Implementation: Kenya Air Handling Ltd. (KAHL) received the bids for thestudy in August 1991 and selected a consortium between two firms. However, after selection,the winning consortium stated that the personnel included in the proposal were no longeravailable. They presented new candidates with lower qualifications but with higher costs. The

15

World Bank responded that the new proposal was unacceptable and the contract would have tobe re-bid, but Kenya Air Handling, which was undergoing major changes in management,never proceeded.

4.2.18. Outcome: Meanwhile, KAHL's monopoly on the handling of air cargo exportswas lifted, and Kenya Airways (the parent corporation of which KAHL is a subsidiary) is nowoperating under a private management contract and is preparing for privatization. However,there is some concern that the market for services for air cargo handling is not yet open tomeaningful competition. KAHL still has a monopoly on the weighing of air cargo for export,and private exporters have complained about continuing irregularities in this process. The SDR1.74 million for this category was reallocated in March 1994 to the EPZ and other componentsof the project.

4.3.01 Direct Assistance to Exporters: Design - A grant scheme was to beestablished to finance the provision of consultancy services to exporters from competingprivate sector sources. This was to be a pilot project, administered by a two-person unitstaffed by technical personnel with backgrounds in business/engineering and specialized inexport development. The unit was to identify potential exporters and agree on an enterpriselevel export development program with them. Upon reaching agreement, the unit would fund,based on 50 percent cost-sharing with the recipient of the assistance, the technical andconsultancy services needed to achieve the export development objectives of the firm. Thedetermination of eligibility criteria for grant assistance under the scheme, and agreement withIDA on those criteria, were to be conditions of disbursement for funds allocated to thatcomponent. Initial implementation of the scheme would occur prior to release of the SecondTranche.

4.3.02. Implementation: The Contractor for the Scheme, TDI of Ireland, has issued areport on the first five quarters of operation, up to July 1993, which was reviewed by thedesign consultant as part of a larger evaluation of export activities in Kenya. Theachievements are noteworthy:

175 grant-aided projects have been approved, compared to a target for theperiod of 105. 13

The additional export revenues already achieved by clients stand at US$21.7million, representing a ratio of export revenues to grants of 15:1, 14

substantially over the original target ratio, specified during design, of 2:1within two years of disbursement. 15

13 GOK updates indicate that as of 1994, 269 grant-aided projects have been approved.

14 GOK updates indicate that the revenue ratio is 42:1 from 210 projects whose claims have beenprocessed as of March 1994.

15 Although the target 2:1 ratio could hardly be considered ambitious, and there has been no effort yetto establish the additionality of KEAS in these exports.

16

4.3.03. TDI deserves recognition for the way they have implemented this scheme.However, it must be recognized that the outcome achieved has been assisted by two majorchanges affecting exports since 1989. Firstly, the enabling regulatory environment has beenimproved more extensively than expected. Secondly, Tanzania and Uganda now both haveforeign exchange available with which to purchase goods from Kenya. This represents a majoropportunity for Kenya's substantial manufacturing base to return to its pre-1977 role assupplier to the whole regional market. 16

4.3.04. The pattern of grant usage has been different from initial expectations. In thefirst year, the average grant size was US$5,590, compared to earlier predictions ofUS$10,000. Also, around 80% of usage so far appears to have been for travel, most of it forinitial market exploration. There has been much less use than expected for in-factory services.It would appear that both these differences reflect the major shift of emphasis, away fromOECD markets, and towards regional African markets. Nevertheless, as expected by the KEASteam, this pattern is now beginning to change. In the most recent quarter, the average projectsize has increased to US$10,500. The regional focus is as before, but more firms are movingon from initial exploration into in-factory work.

4.3.05. As of September 1993, all but US$38,000 of the US$1.4 million in total grantfunding made available under the EDP had been committed to specific approved grants. TheTDI contract continues until May 1994. Even allowing for a one-month wind-down period atthe end of the contract, that still leaves from October to April, with no further funds availableto continue grant approvals as yet, although IDA is actively seeking a new mechanism tocontinue this program.

4.3.06. One significant problem that KEAS faced, especially in 1992-early 1993, wasthe long delay in disbursements from the grant fund in the Central Bank. At one point, thedelays reached six months, although part of the delay was related to the approvals processwithin the Ministry of Treasury. The delays in Treasury were eventually mitigated, such thatdisbursements could take place within five working days. However, the delay has recentlyincreased again to about 2 - 3 months. These delays have significantly soured KEAS'relationship with its clients. Not only do the delays represent foregone interest, but exchangerate risk as well (because clients were required to submit their claims in local currency even iftheir costs were incurred in foreign currencies and even though the special account is itselffunded exclusively by hard currency and denominated in US dollars; therefore, some clientssuffered when the Kenya Shilling was devalued). Another problem with the Central Bank is itsrecord-keeping. The Central Bank disburses funds from the special account directly into theclient's bank account, sometimes combining payments from two or more claims submitted atdifferent periods of time under differing exchange rates, and making development of a properaudit trail problematic. 17

16 GOK notes: While it is true that the opening up of Tanzania and Uganda have been beneficial, KEAShas infact been able to access 45 markets and 25% of its projects are in the developed world.

17 GOK responds: While the problems mentioned are true, the improvements over the months ofJanuary and February have demonstrated that a KEAS type of operation canfunction very efficiently

17

4.3.07. Also under the category of direct assistance to exporters, it was expected thatgrant assistance would be available to encourage export catalysts (multinational firms withproven technical expertise and marketing channels), who enter into sub-contracting or licensingarrangements with developing country producers, or consultants with proven expertise in thedesign, production, packaging and marketing of goods in international markets. Through aPPF, the Credit financed in May 1990 the recruitment of external consultants to assist in theidentification and design of high-quality consumer items based on traditional Kenyantechnologies.

4.3.08. Outcome: The marketing consultants began work with Kenyan designers andproducers to develop exports in the textile, leather, garment and accessories industries aimed atup-scale markets in North America and western Europe. According to the original TaskManager, they brought in about $7 million of exporter revenues and planned to expand withthe assistance of the UNDP, but the expansion program was never implemented. Althoughsome exports continue, this has never been developed into a major program.

4.4.01. Studies: (Design) The following six studies were to be completed under theprogram. 18 In the case of studies (a) to (c) below, they were to be completed and reviewedjointly by the Government and IDA, and as a condition for release of the Second Tranche anaction plan on their major recommendations were to be agreed with IDA. The study identifiedin (d) was to be completed by December 1991. The study identified in (e) would be conductedby the Government on its own, but actions to reduce the number and value of such exemptionswas to be taken prior to release of the Second Tranche. Finally, the implementation of anaction plan to introduce private sector management to air cargo handling at Jomo KenyattaInternational Airport, based on the design recommended in the study identified in (f) was to bea condition of disbursement for the funds allocated to the purchase of equipment for air cargohandling.

4.4.02. (a) Evaluation of the need for continuing the export compensation scheme inview of the introduction of the import duty/VAT exemption program, and the design ofsubsequent phases of the latter for direct exporters. Implementation: This report was preparedby Bellhouse Mwangi Ernst and Young and submitted in July of 1992. The reportrecommended a phase-out of the export compensation scheme and an expansion of the importduty/VAT remission scheme. Specifically, the report recommended (inter alia) that theeligibility of goods should be defined in a negative list, that the eligibility of persons should beexpanded to include indirect exporters, and that beneficiaries of the scheme be offered a choicebetween specific, consignment-based authorizations and general, six-month authorizationswhich would be self-regulated by balancing outputs against inputs. Outcome: The exportcompensation scheme was wrapped up in September, 1993. The principal recommendationsabout the expansion of the duty/VAT remission program were implemented in late 1992.

4.4.03. (b) Design of alternative schemes, such as common bonded warehouse, toextend free trade status to indirect exporters. Implementation: This report was included in the

18 In addition, feasibility and environmental studies for the export processing zone and a review ofinfrastructural capabilities for the transport and handling of exports were funded through the SPPF andPPF.

18

Bellhouse Mwangi Ernst and Young report described above in paragraph 4.4.02., above.Outcome: Current policy on MUB is described above in paragraph 4.1.12.

4.4.04. (c) Design of subsequent phases of development of export financing facilities.Implementation: This report was prepared by First Washington Associates and submitted inMay 1992. The report recommendations were, inter alia, for the Central Bank to change itsRediscounting Facility to extend eligibility to indirect exporters; to allow post-shipment as wellas pre-shipment credits; to exempt export loans and related bank loans from the general creditceiling; to allow Kenyan exporters to retain at least 50 percent of their foreign exchangeearnings; to facilitate mobilization of non-bank resources for export finance; to train bankersand exporters in the use of transferable letters of credit, to clarify rules governing specializeddiscount and export financing houses, and to establish an Export Finance Fund. Details ofrelated, recommended prudential regulations were included. Outcome: Many, but not all of therecommendations were implemented. It appears that the selective nature of the implementationprogram left out some of the checks on potential abuse that are needed for a sound, integratedprogram of financial reform. As implemented, the pre-shipment financing scheme, lackingproper checks, was severely abused (see paragraph 4.1.13., above.) The export financingscheme was closed at the request of the World Bank in April of 1993. Unfortunately, there iscurrently no facility for export financing beyond the normal channels for business finance ingeneral. The memo on the release of the Second Tranche noted that IDA has discouraged theGovernment in proceeding now with the recommendations of the ... study regarding additionalexport financing facilities. First, at this time, the availability of adequate export finance is nota major constraint on exports. Secondly, because of abuses in the rediscount of export credit atthe Central Bank of Kenya, the rediscount facility is being phased out as part of the effort tostrengthen control over the financial sector.

4.4.05. (d) Evaluation of the effectiveness and efficiency of official tourism sectorinstitutions, including Kenya Tourism Development Corporation (KTDC). Implementation:The draft report was prepared by Deloitte Haskins and Sells in October, 1993 and submitted tothe Ministry of Tourism and Wildlife.

4.4.06. (e) Review of import duty exemptions extended to non-exporters. Outcome:This report was included in the Bellhouse Mwangi Ernst and Young report described above inparagraph 4.4.02., above.

4.4.07. (f) Review of factors constraining cargo handling capacities at Jomo KenyattaInternational Airport, and design of an approach to introduce private sector management to aircargo handling. Outcome: This report was to be prepared by Lufthansa and GOPA Consulting,but was never completed. See paragraph 4.2.16., above, for details.

4.4.08. In addition, the SAR described a programn of Assistance for the CustomsDepartment. Funding through the PPF was provided to assist in the on-going computerizationof Customs operations. A review by consultants of computerization of Customs was underwayat the time of the SAR, and consisted of an evaluation of the status of development of computerprograms for information management. The consultants were expected to recommend acomprehensive set of measures to accelerate the completion of computerization.Implementation: The consultants submitted their report in January 1991. They determined thatthe computerization program that had been initiated by Customs was badly flawed, and

19

recommended that the program be completely replaced. Outcome: Although the originalcomputerization program was essentially abandoned, the Customs Department has notrequested further assistance under the EDP. It is, however working with the Bank on thisproblem under a transport project.

5. Bank Performance

5.1 The Bank's performance on this project was uneven. The Bank was very diligentabout ensuring that the Second Tranche conditions were met, which led to significantimprovements in the environment for private and non-traditional exports. The majorimplementation shortcomings were probably attributable to excessive turnover in TaskManagers, compounded by the complexities of hybrid project with several disparatecomponents and inadequate procedures for transferring authority and background information.The first Task Manager was also the principal designer of the project. He remained as TaskManager for the first 16 months of the project, and project activities appeared to proceedsmoothly, if not very rapidly. Later Task Managers became concerned primarily with theconditionality for the release of the Second Tranche, perhaps to the detriment of rigoroussupervision of other components of the project. 19 One of the major problems resulting fromthis situation was the issuance of the no objection to the contract for construction of theadministration buildings at the Athi River EPZ site that led to the over-commitment of IDAfunds. It also appears, however, that there were differing interpretations among the successiveTask Managers about the extent to which the Borrower was meeting the conditionality for therelease of the Second Tranche. Some appeared to be most interested in the fine points of thelaw; others about verifying the implementation of policies and their practical impact on theground. Official supervision missions took place about once per year (January 1991, August1991, August 1992, and October 1993 in addition to on-going monitoring from both Bankheadquarters and the Resident Mission in Nairobi), which is within the normal range, butprojects of this complexity, in a country experiencing the difficulties Kenya was, may requiremore than the normal level of supervision.

5.2. Finances were generally confused when responsibility for disbursements on the projectwas moved from Nairobi to Headquarters. Records pre-dating the move were neversystematically entered into the Disbursement Management Information System. Consequently,there was no simple or straightforward mechanism for comparing disbursements to contracttotals.

6. Borrower Performance

6.1. The Ministry of Finance's performance in managing the overall implementation of theproject was similarly uneven. Those components of the project most directly under its control(e.g., the Duty/VAT Remission Scheme) fared the best. They were instrumental in ultimately

19 The economic reform program associated with the quick-disbursing balance of payments support wasthe most important component of the project both in terms of the financial resources devoted to it and interms of the likely impact; it was also the area of greatest interest to the Task Managers, who were alleconomists.

20

guiding the reform program through the Kenyan political system. Other components appearedto suffer from a lack of regular supervision.

6.2. The EPZ component of the project enjoyed the energetic attention of the staff of theEPZA, who kept construction work moving forward and aggressively marketed the Athi RiverEPZ among potential investors. However, EPZA has yet to arrange for private sectormanagement of the zone.

6.3. KEAS received considerable support from the Ministry of Treasury, but often sufferedfrom confusing accounting statements and long delays in disbursements from the Central Bankof Kenya.

6.4. The KAHL, which was undergoing major changes in management, failed to follow upon the proposal for the study on commercialization with the selected consultants after problemsdeveloped in negotiations. As a result, this category of the Credit was never disbursed.

7. Achievements Under the EDP

7.1. It is certainly too early to judge the final achievements of the EDP. The most importantcomponent of the project in terms of impact on export earnings, the major policy reformsassociated with the release of the Second Tranche, have only been in place for about sixmonths. Typically, the supply response to major currency devaluations and liberalization ofexport and investment procedures, only emerges after about 18 months. However, somereforms, such as Duty/VAT exemption scheme, took place over three years ago as a conditionof Board Presentation, and other reforms, such as direct assistance to exporters, yield a quickersupply response. The graph below shows real monthly export revenues from 1987 throughMay 1993. Although there is considerable volatility, it appears that there is a significantupward trend developing at the start of 1993. Part of this upward trend may be related to thesubstantial trade liberalization programs enacted in Uganda and Tanzania, which are rapidlydeveloping as important new markets for Kenya's exporters. There is reason to hope that thistrend will continue and even accelerate in the months ahead, as private investors adjust to thenew opportunities available to them.

21

Chart 3

Real Domestic Exports Excluding Gold -

uwc 90

a8070

0I~~~~~~~~~~~~~~~~~~~I

~Z 50 _ VVTTIa

Xso 1F +1 17 111 11 11||111 11I 1111t111

CD 40,-30

O 201 0I

0

> rs r r- r- CD rn X cn cn cn cn o~~~~~~~0 o oL o _L S L : is cq= 0~~~

- Real Domestic Exports Excluding Gold \Date of EDP effectiveness

_ GOK notes: To see the effectveness of the Ezport Development Program, it is best to see thatfrom October1987 to September 1992 in only 7 months did the real value of exports erceeded KSh 65 million (1986 prices).From October 1992 to September 1993, the last month from which data are available, 10 months have e-ceededKSh 65 million.

7.2. However, there may still be several significant obstacles to accelerating private sector,non-traditional exports:

- Continuing difficulties, delays and irregularities within Customs;

* The continuing lack of export finance and the practical difficulties in arrangingforeign exchange transactions;

* The very high cost of international communications initiated from withinKenya;

* The high price of jet fuel which pushes up the cif price of Kenya's air freightexports (i.e., horticultural products, cut flowers, etc.);

nThe continuing monopoly of Kenya Air Handling Limited for the weighing ofair cargo; and

* The continuing inadequacies of air cargo handling equipment.

7.3. The EPZ at Athi River is nearing completion and has attracted significant interest frompotential investors. However, the numerous problems associated with this component of theproject will almost certainly result in considerable delays before any investors will be willingto commit themselves to a position within the zone.

7.4. KEAS has demonstrated the effectiveness of direct assistance to exporters, and led toover $21 million in new exports in the first five quarters of operation.

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8. Sustainability

8.1. At appraisal, sustainability was seen to hinge on two major factors: (a) the exportsupply response needed to be rapid and visible and (b) a constituency to support non-traditionalexports needed to be developed. The Government's longer-term strategy, articulated in itsLetter of Export Policy, was intended to: (a) implement a neutral incentive regime; (b) usetariffs for protective purposes while relying on indirect taxes to meet its revenue objectives; (c)reduce the scope of licensing in the economy; and (d) improve the functioning of the financialsystem in supporting production and investment. To make the policy reforms more effectiveand sustainable, actions were also required to remove impediments to efficient production andmarketing and to draw small and medium firms into the export effort. Bottlenecks in physicalinfrastructure for handling and transporting exports, and institutional inadequacies in specificareas needed to be addressed simultaneously.

8.2. The economic policy reforms were probably the most successful and durable of theachievements of this project, supported by extensive liberalization in regional export markets(notably Uganda and Tanzania). Although backtracking always remains a possibility, mostobservers agree that the most important reforms - the move to a flexible and open exchangerate regime and the liberalization of trade controls would be very difficult to reverse.

8.3. The Kenya Exporter Assistance Scheme was designed as a short to medium termprogram with a strictly limited life span. The long term benefit were expected to ariseprimarily from the demonstration effect. However, the Scheme would need to be in existencelong enough to assist firms at the level of improvements in product quality and the marketingof available products before it could be said to have completed its job. Unfortunately, itappears there will be sufficient funds to extend the work begun on this promising area,although IDA is actively pursuing options in this area.

8.4. The economic viability of the Athi River EPZ needs to be ensured. Unless theborrower fulfills its agreement to transfer management and operation of the EPZ to the privatesector quickly, with incentives to develop an appropriate fee structure, cost recovery onphysical investment is expected to be unsatisfactory. An alternative is to sell the assets to aprivate investor--on the basis of a transparent auction process--who may then be able tomaximize returns over the long run. Another alternative would be to lease the assets of theAthi River EPZ to a private investor on the basis of competitive bidding.

9. Lessons Learned

9.1. The Export Development Project suffered significantly from excessive turnover amongTask Managers and resulting inconsistent supervision. It is clear that successive TaskManagers were unaware of the status of key components of the project and unsure of whatactions they should be taking to keep the project on track. An established hand-over procedure,including a detailed memo outlining the current status of each element of the project, potentialproblem areas, and necessary future actions, might mitigate this type of problem in the future.

, ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ -- - ----

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9.2 It appears that the GOK had no mechanism to recoup the heavy costs of the investmentin the off-site infrastructure for the EPZ. Individuals who own property along the route of theoff-site water, sewerage and power infrastructure will be able to connect to municipal servicesat the same rates as residents of Nairobi. As a result, these individuals have enjoyed substantialwindfall gains in their property values without having made any meaningful contributiontoward the investment costs. In many other countries, property taxes are proportional toproperty values that are re-assessed regularly; or land-owners benefiting from majorimprovements in infrastructure are assessed development fees or property tax surcharges (whichcan often be paid off over a period of time), but there was no effort to recoup the off-siteinvestment costs in this project in any way. Since the SAR was written, the Bank has begun toencourage efforts to recoup infrastructure costs from identifiable, direct beneficiaries. Thispractice can substantially improve financial returns on some types of civil works projects andcan help ensure that economic benefits are more equitably distributed across the affectedpopulation.

9.3. The pre-shipment export financing program suffered from mismanagement and abuseduring implementation, due to systemic failure in prudential regulation. The experience withpre-shipment export finance in Kenya should not be cause to reject similar programselsewhere, but should be viewed as an example of how an otherwise sound program can beabused in the absence of adequate oversight by both the borrower and the Bank.

9.4. The lessons of the economic policy reform program are more complex. Ultimately, theBank's firmness on conditionality yielded a very important and positive set of reforms.However, given its past policy reversals, the Government of Kenya still needs to work toachieve the credibility in the eyes of private entrepreneurs (both foreign and domestic) that isnecessary to bring forth significant new investment and a strong export supply response. Toachieve this credibility, the GOK must continue to improve the transparency and consistency ofits implementation of economic reform. Because of the time required to earn credibility, alongwith the inevitable time lag between trade policy reforms and a full export supply response, itwould be appropriate to initiate a post-closure evaluation of the project in 1995, focusing onthe trends in export earnings, export/import ratios, diversification of exports, and theexperiences of private sector exporters with the recent reforms.

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PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE

The Government of Kenya undertook the Export Development Program during aperiod of very difficult macroeconomics. The fact that reforms did not backtrack in asustained way and that the Government experimented with devices to keep the reforms inprogress, like the FOREX C certificates and the consequential liberalization on foreignexchange, demonstrates the conviction that this was the appropriate direction of policy change.The Export Promotion Programs Office significantly increased the access of importers toforeign exchange throughout the period when it was very scarce. Furthermore, the shift toremove the anti-export bias was clearly biting since the lobbyists were able to get Parliament toraise tariffs slightly in 1993/94.

The design of the project was seeking adjustment to a very different Kenya from that inwhich implementation occurred. It is unfortunate that we were unable to take the new situationinto consideration in designing conditionality since, among other things, it was assumed thatEDP funds would be released appropriately in the course of 1992 to relieve anticipated balanceof payments requirements. The response of the economy to structural adjustment was, in part,predicated on having funds available.

A second difficulty encountered arose from the non-negotiated but variable,macroeconomic position which must underlie any sectoral structural adjustment program. Thecomment of fulfilling the letter, but not the spirit, of the agreement is relevant to this. In thecourse of attempting to establish a macroeconomic framework acceptable to the Bank, it wasfound that there was an implicit cross-conditionality to the IMF program. In fact, the crisis inFebruary of 1992 arose from taking liberalization measures that were said to be necessary forestablishing the macroeconomic framework, in particular, the extending of the retentionaccounts and opening of foreign exchange trading. This so-called moving goal posts problemis particularly difficult since there are no negotiated, or for that matter, agreed targets to beattained. It was not until Mr. Jaycox explicitly identified what the Bank required that theGovernment was able to concentrate its efforts appropriately.

It should be noted that the Government opposed the export finance facility, claimingthat it did not have the capacity to administer it effectively. It was persuaded that this was anecessary component of the program which had to be introduced early. This lack ofsympathetic understanding on the part of the Bank must be held in part responsible for the factthat the facility was seriously abused to the detriment of the macro economy.

25

These points, notwithstanding, the export development philosophy permeated thewhole of the project period in a very beneficial way; even though there were a variety ofdistortions and some back-tracking, exporters continued to benefit. This made the policychanges of the post-program period, since late 1993, much easier and the transition to a non-speculative, non-crisis, free foreign exchange market, an easy step.

26

PROGRAM COMPLETION REPORT

KENYA

EXPORT DEVELOPMENT PROJECT(Credit 2197-KE)

PART III: STATISTICAL INFORMATION

Table 1: PROJECT TIMETABLE

Item Date Planned Date Revised Date Actual

Identification 11/16/89 -- 11/16/89

Pre-Appraisal Review 04/24/90 -- 04/24/90

Appraisal Mission 06/26/90 -- 06/26/90

Appraisal Report (Yellow Cover) 10/05/90 -- 10/05/90

Loan Negotiations 11/05/90 -- 11/05/90

Board Approval 12/20/90 -- 12/20/90

Loan Signature 12/21/90 -- 07/09/92

Loan Effectiveness 12/31/90 -- 12/31/90

Amendment Signature 07/09/92 -- 07/09/92

Amendment Effectiveness 10/09/92

Second Tranche Approved 05/07/93

Closing Date 06/30/95

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Table 2: CREDIT DISBURSEMENT(in SDR Millions)

Item Credit FY91 FY92 FY93 FY94 a! ActualAgreement c/ Totals b/

Credit Amount 69.500(of which:)

Civil Works 13.550 0.000 2.765 7.327 3.466 13.557Air Cargo Equipment 1.740 0.000 0.000 0.000 0.000 0.000Studies 2.190 0.374 0.194 1.058 0.350 1.976Quick Disb. (1st Tr.) 27.715 27.718 0.000 0.000 0.000 27.718Quick Disb. (2nd Tr.) 23.715 0.000 0.000 23.712 0.000 23.712PPF/SPPF Refunding 0.590 0.143 0.000 0.000 0.000 0.143

Amendment (Reflows) 37.300 0.000 0.000 36.938 0.362 37.300

Totals b/ 106.800 28.235 2.958 69.035 4.178 104.406

Percentage of Credit Agreement 26.4% 2.8% 64.6% 3.9% 97.8%

a/ Through 12/30/93b/ Totals may not sum due to rounding discrepanciesc/ After reallocation in March 1994, some Category totals have been revised as follows:

Civil Works 15.467Air Cargo Equipment 0.0Studies 2.460PPF/SPPF Refunding 0.143

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Table 3: STAFF RESOURCES

Staff Weeks per Fiscal Year TotalFY89 FY90 FY91 FY92 FY93 FY94* Staff Weeks

Preparation/Identification 4.23 61.75 65.98Appraisal 0.05 23.08 23.13Negotiation 0.00 5.36 5.36Supervision 10.54 8.73 35.37 16.44 71.08Total Staff Weeks 4.23 61.80 38.98 8.73 35.37 16.44 165.55

* through 12/31/93

Table 4: SUPERVISION MISSIONS

Month/ No. of Date of Specialization PerformanceYear Persons Report Represented* Rating Status **

Supervision I Jan-91 2 1/18/91 E, C NRSupervision If Aug-91 4 8/15/91 E, DC, C 2Supervision III Aug-92 2 8/31/92 E, 0 2Supervision IV Oct-93 3 11/01/93 E, C 3

* **

E = Economist NR =Not ReportedC = Consultant 1 = Problem Free or Minor ProblemsDC = Division Chief 2 = Moderate Problems0 = Operations Off. 3 = Significant problems being addressed

29

Table 5: STATUS OF COVENANTS

Credit Agreemnent Status of Compliance

Schedule 1, paragraph 3: Borrower has Complianceenacted the EPZ legislation and completedthe formulation and publication ofimplementing regulations

Study of factors constraining cargo handling Study was never completed; however, Kenyacapacities at Jomo Kenyatta International Air Handling Ltd. is now under privateAirport and design of an approach to management along with its parent company,introduce private sector management to air Kenya Airways.cargo handling operations

Eligibility criteria formulated for bene- Compliance.ficiaries of a facility to make available fundson a grant basis to exporters to finance theemployment of consultants' services.

Schedule 4: The Borrower has extended Compliance.automatic licensing to the remainingSchedule 3C items by shifting these toSchedule 3B, with exceptions only forenvironment, public health and public safetyreasons.

The Borrower has implemented the second Compliance.phase of tariff reductions similar in scope tothose implemented in June 1990, so as toreduce the level and variability of effectiveprotection and reduce revenue lossesstemming from the extension of import dutyexemption to non-exporters.

The Borrower has commenced Compliance; Kenya Export Assistanceimplementation of the facility [for assistance Scheme operational.to exporters] referred to in Part C. 1 ofSchedule 2 to this Agreement.

30

The Borrower has implemented the following Compliance.reforms of enterprise regulations: (a)consolidation of all registrations requiredunder the Industrial Regulation, Statisticsand Factories Acts, as well as those requiredby the Kenya Bureau of Standards and theNational Social Security Fund; (b)consolidation of licenses required under theTrade Licensing Act, into three categoriesand elimination of distinctions made betweendifferent forms of trade; and (c)implementation of the proposals approved bythe Borrower's Cabinet Sub-Committee inDecember 1989, to eliminate redundancies,speed approvals and increase transparency inprocessing and approving of investment andoperating licenses and permits.

T'he Borrower has agreed with the Compliaice; although pre-shipment exportAssociation on action plans to implement the finance scheme terminated at request of IDA.recommendation of the studies on the exportcompensation scheme, alternative schemes toextend free trade status to indirect exportersand subsequent phases of development ofexport financing facilities.