Y Docunent of

The World Ban':

FOR OFFICIAL USE ONLY

Report No.p-5325-KE

MEMORANDUM AND RECOMMLNDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A PROPOSED

FINANCIAL PARASTATALS

TECHNICAL ASSISTANCE PROJECT

IN AN AMOUNT EQUIVALENT

TO SDR 4.7 MILLION

TO THE GOVERNMENT OF KENYA

MAY 9, 1990

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 EQUIVALENTS

Currency Unit - Kenyan Shilling (KSh)

US$ 1.0 = KSh 22.9

GOVERNHENT OF KENYA FISCAL YEAR

July 1 - June 30

GLOSSARY AND ABBREVIATIONS

CEO Chief Executive OfficerDFCK Development Finance Corporation of KenyaDFI Development Finance InstitutionFSAC Financial Sector Assistance CreditFSTAC Financial Sector Technical Assistance CreditGOK Government of KenyaICDC Industrial and Commercial Development CorporationIDA International Development AssociationIDB Industrial Development BankISAC Industrial Sector Adjustment CreditKIE Kenya Industrial EstatesSOE Statement of Expenditures

FOR omCIAL USE ONLY

PINANCIAL PhIASTATALS TECUNICAL ASSISTANCE PROJECT

CUDIT AID PROJBCT SBMOARY

Borrowers Government of Kenya

Beneficiaries: Ministry of PFinnce, Industrial Development Bank (IDB)and Industrial and Comercial Development Corporation(ICDC)

Credit Amounts SDR 4.7 million (USS 6.0 million equivalent)

Terms: Standard IDA terms with a 40 year maturity

Onlending Terms: Grant from the Borrower to IDB and ICDC

Financing Plan: IDA US$ 6.0 millionGovernment US$ 1.5 millionTotal USS 7.5 million

Economic Rateof Return: Not applicable

This document has a restricted distribution and may be used by recipients only in the perforn anceof their official duties. Its contents may not otherwise be disclosed without World Bans, authomsation.

16MORNDWM AND UECOKOENDAtION OF THE PRXIDENTOF THE INTEUNATIONAL DEVELOPMENT ASSOCIATION

TO TIIR )CUTIE DIRECTORSFOR A PROPOSED CREDIT TO TUE GOVERiNMET OF MINYA

FOR A FINANCI. PARASTATALS TECHNICAL ASSISTANCE PROJECT

1. The following memorandum and recommendation on a proposeddevelopment credit to Kenya for SDR 4.7 million (USS 6.0 million equivalent)is submitted for approval. The proposed Credit would be on standard IDAterms with 40 years maturity and would help finance a technical assistanceproject for the restructuring of two major financial parastatals--IndustrialDevelopment Bank (IDB) and Industrial and Commercial Development Corporation(ICDC). The proceeds of the Credit would be utilized partly by theBorrower--the Ministry of Finance, while the major part would be madeavailable by the Borrower as a grant to IDB and ICDC.

2. Background. Although Kenya has one of the most diverse anddynamic financial systems in Sub-Saharan Africa, the availability of long-term funds, both loans and equity, continues to be limited. This gap can beattributed to both structural and policy-induced factors, especially theexistence of interest rate and credit ceilings, and uncertain implementaticriof the legal framework for financial transactions. The Government of Kenya(GOK) has embarked upon major reforms to address these sectoral problems.GOK's financial sector &dJustment program, which is supported by two IDAcredits that became effective in 1989, includes the deregulation of interestrates (before mid-1991), actions to restructure weak private sector finan-cial institutions, and implementation of a new Banking Act to strengthen thelegal framework.

3. More recently, GOK expanded this reform agenda to include issuesof financial market segmentation--due mainly to the preferential treatmentof selected parastatal institut3ons..-and the sustainability of developmentfinance institutions (DFIs). Since 1963, six major DFIs--five of which areparastatals--have been established to support investment, production andemployment in the major sectors of the economy. Despite representing lessthan 8 percent of banking system assets, they have filled an important gapin the provision of term loans and equity, in which areas there has beenlittle involvement by other financial institutions. Nevertheless, they haveproved to be generally unprofitable, requiring periodic injections of fundsfrom the Government and external donors to continue operations. Amongindustrial sector DFIs, the three parastatals--IDB, ICDC and KenyaIndustrial Estates (KIE)--now face serious operational and portfolioproblems.

4. An evaluation by consultants, completed under the IndustrialSector Adjustment Credit (ISAC)--IDA Credit 1927-KE, and complementaryinformation from project experience and sector studies, suggest severalreasons for the current condition of the industrial sector DFIs. Policy-related and strategic deficiencies in their roles; financing arrangementsthat incorporate asset/liability mismatches; internal structural flaws; andinadequate information, control and analytical processes have circumscribedtheir effectiveness and affected their balance sheets adversely. Radicalmeasures are required to establish their commercial viability and long-term

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sustainability, and to enable them to compete effectively with new entrantsin their traditional market segment. Also, changes in the operation of theDFIs would help reduce the burden on the Government budget, and eliminatethe segmentation of the financial market that results from their targetedcredit and investment programs.

5. GOK and IDA have conducted an intensive dialogue on these issues.From a systemic viewpoint, a reduction in the number of DFIs is required.The Government has been urged to discontinue RIE's small-scale lending role,limiting it to the continued provision of technical serviceL, training, andphysical facilities for small enterprises. A discussion of the future roleof the Agricultural Finance Corporation has been initiated in the context ofan IDA sector report on rural finance. With respect to IDB and ICDC, theevaluation by external consultants established their potential viability,and showed a continuing need for the type of financial services theyprovide. Their effectiveness and competitive position can, however, beenhanced with appropriate policies to ensure financial sustainability. TheGovernment has prepared a proposal for reforming its strategy towards theseinstitutions to ensure effectiveness, commercial operation, and long-termsustainability. A broad restructuring plan covering revised mandates,funding, strategy, organization and the lending/investment process withinthese institutions was completed io October 1989 in compliance withconditions for the release of the second tranche of ISAC. Subsequently,actions have been taken to revise operational mandates, reconstitute thegoverning boards, and review staff capabilities and needs for IDR and ICDC.The Government intends further to: change the internal organization of theseDFIs to improve accountability for portfolio management and institute acompetitive and performance-oriented incentive mechanism; restructurebalance sheets through a phased program of divestiture and consolidation ofassets, and assumption of the foreign exchange risk on their liabilities;initiate corporate workouts among client firms; improve investment andcollection practices; and establish mechanisms to ensure commercial andself-sustaining operations (including explicit compensation from GOK'sbudget if the DFIs are rejuired to participate in projects that they wouldnot normally support on commercial grounds). Other external donors havebeen urged to undertake a similar restructuring of the smaller DevelopmentFinance Corporation of Kenya (DFCK), in which they have majority equityinterest.

6. Rationale for IDA Involvement. The action plans for restructuringthe DFIs are critical to maintaining the success of the Government's adjust-ment program. The ability of Kenyan enterprises to respond to improvementsin the policy environment will be determined partly by the availability oflong-term debt and equity financing, which are currently unavailable tother financial institutions. The plans also form an integral part of IDA'sindustrial and financial sector development strategy for Kenya, which hasbeen supported by three IDA credits--ISAC, Financial Sector AdjustmentCredit (FSAC) and Financial Sector Technical Assistance Credit (FSTAC).Both IDB and RIE have been past recipients of IDA credits. Financialrestructuring was a precondition for the extension of a second IDA credit toKIE in 1986, but has not proven to be very successful. The actions being

proposed currently are more radical in nature and have emerged out oflessons learned from the KIE experience and from the broader program ofsectoral adjustment for industry and finance. However, technical resourcesrequired for implementing the proposals are not currently available withinthe DPIs or the Government.

7. Proiect Objectives. The Government has adopted a framework forDPI restructuring, and the main principles and components of the programhave been agreed with IDA. The proposed IDA project would assist inimplementing action plans for IDB and ICDC. The action plans are intendedto establish self-sustaining and commercially viable institutions, and togive them the operational flexibility to develop appropriate market nichesand diversification strategies to compete effectively with banks and near-banks when the financial market is eventually liberalized. These plansinclude: restructuring the assets and liabilities of the two DFIs;introducing a revised organizational structure that enhances staff autonomyand accountability; improving credit management and information processes;and assisting in turning around potentially viable client firms held intheir portfolios. Further, through coordinated training, incentives andstaff retention policies, the project would improve indigenous capacities tomanage financial institutions.

8. Prolect Description. The project consists of three components:technical support for the implementation of restructuring plans for IDB andICDC; the design of corporate workouts for client firms; and training forstaff of these DFIs. For the first component, the project would finance theservices of eight long-term consultants and three desktop computers andaccessories (US$ 3.49 million). Consultants would assist in the followingareas: (i) Liabilities management - to restructure the foreign exchangeexposure and domestic liabilities of the DYIs, and implement appropriatefinancial provisions; (ii) Assets management - to design and Implement adivestiture program for assets held in their portfolios; (iii) Operationsmanagement - to assist the Chief Executive Officers (CEOs) of the DFIs withcorporate planning and all aspects of operations; (iv) Human resourcesdevelopment - to implement the personnel policies implied by the revisedorganizational structures of the DFIs, and to develop a training program forstaff; and (v) Systems management - to design and suDervise the implementa-tion of an improved credit/investment process (prepa ition, appraisal,approval, monitoring, closure) and supporting information requirements. Thesecond component of the project (US$ 1.45 million) would finance: (i) Short-term consultancies to undertake analyses and prepare corporate restructuringplans for approximately 25 potentially viable but non-performing enterprisescarried on the DPI portfolios; (ii) Legal assistance to the DFIs for revis-ing agreements with client firms; and (iii) Establishment of a panel ofinternationally-reputed experts to assist the DFIs periodically withstrategic planning. Finally, the project would support overseas and localtraining in basic financial and marketing skills for suitably qualifiedstaff from these institutions (US$ 1.06 million). The DFIs would providebudgetary and other resources for local support services and in-housetraining.

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9. Agreed Actions. The following restructuring actions have beencompleteds (i) initial classification of the DFI portfolios to identifyassets for divestiture and to isolate non-cammercial projects which wouldreceive direct subventions from the GOR Budget; (ii) reconstitution of thegoverning boards of IDB and ICDC, reducing Guvernment representation to onemember, establishment of new criteria to ensure greater professionalparticipation, and official (i.e. gazette) notification of the newcomposition of the governing boards; (iii) redefinition of the roles andresponsibilities of the CEOs of the DFIs; (iv) initipt inventory of humanresources at the two institutions, evaluated according to performancecriteria; (v) agreement on criteria for assumption by GOK of the foreignexchange risk on the external liabilities of ICDC and TDB; and (vi)ratification of the principles and specific components of the project by thereconstituted boards of IDB and ICDC. Agreement on the following actionswas reached during negotiations: (i) a ceiling on the share of new funds tobe invested annually by the DFIs in non-commercial government-directedprojects, and on the size of the annual Budget subvention to compensate theDFIs for undertaking such projects, would be determined by end-March eachyear; (ii) within two months of the start of assignments, the long-termconsultants recruited under the oject would complete inception reports tobetter define work programs; (iiLj IDB and ICDC would complete comprehensivebusiness plans, includixg monitorable financial targets, and review themwith IDA before June 30, 199,; (iv) an external advis'ry panel for the DPIswould be appointed before December 31, 1990; and (v) the trainingperformance and plans, tncluding in-house training, of IDB and ICDC would bereviewed annually with IDA.

10. Benefits. Economic benefits under the proposed project areexpected from: (a) elimination of the need for period': capital injectionsfor the two DFIs from the GOK Budget or external dor a; (b) reduction infinancial market segmentation and an increase in c% tition; (c) restruc-turing of potentially viable productive enterprises lad (d) improvements inthe skill levels of staff employed in the two DFIs. In addition, theestablishment of viable and commerciallv-oriented v: :s would improveresource allocation in the industrial sector, and facilitate the developmentof indigenous capacities and improved operating practices in the Kenyanfinancial system.

11. Risks. Possible risks includes (a) inability of DPI staff andmanagement to adapt to the proposed portfolio management approach, absorbthe skills required to manage commercial operations, and implement their newmandates; (b) inability of the Government to compensate the DFIs adequatelyfor undertaking non-commercial operations; and (c) inability of the DFIs togenerate sufficient cash for operations during the period of restructuringdue to problems with divestiture and consolidation of assets. To minimizethese risks, the project provides for: (a) early ratification of therestructuring plans by the DFIs' governing boards, and emphasis on trainingof DFI staff and the provision of suitably-qualified long-term advisors; (b)specific agreement with the Government on the level of compensation to beprovided to the DFIs; and (c) a phased program of asset and liability

restructuring, to be managed at the Ministry of Finance by well-qualifiedconsultants. and including actions for Government to assume the foreignexchange risk associated with the liabilities of the two DFIs.

12. Recommendation. I am satisfied that the proposed Credit wouldcomply with the Articles of Agreement of the Association and recomuend thatthe Executive Directors approve the proposed Credit.

Barber B. ConablePresident

AttachmentsWashington, D. C.May 9, 1990

;

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Schedule A

MENYA

FINANCIAL PARASTATALS TCHNICAL ASSISTANCE CREDIT

Estimated Costs and Financing Plan(US$)

A. Proiect Costs

Foreign Local Total

Technical Assistance:

Long-term consultants 3,100,000 230,000 3,330,000Short-term consultants 905,000 540,000 1,445,000

Subtotal 4,005,000 770,000 4,775,000

Training:

External Training

Overseas gracuate study 480,000 0 480,000Overseas short courses 240,000 0 240,000Local short courses 0 200,000 200,000

Subtotal 720,000 200,000 920,000

In-nouse Training 0 890,000 890,000

Equipments 22,000 0 22,000

Contingencies: 601,000 292,000 893,000

Total Costs 5,348,000 2,152,000 7,500,000

B. Financing Plan

Foreign Local Total

IDA 5,348,000 652,000 6,000,000Government 0 1,500,000 1,500,000

Total Financing 5,348,000 2,152,000 7,500,000

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Schedule B

PINANCIAL rSTATALS TECBRICAL ASSISTANCR CREDIT

Procurement Method and Disbursements(US$)

Procurement Method

Consultants 11 Equipment 21 Total

Technical Assistance 5,390,000 25.000 5,415,000(IDA) (4,917,000) (25,000) (4,942,000)

Training 2,085,000 2,085,000(IDA) (1,058,000) (1,058,000)

Total 7,475,000 25,000 7,500,000(Total IDA) (5,975,000) (25,000) (6.000,000)

Disbursemuts

Percent of ExpendituresCategory Amount of Credit to be financed

Technical Assistance- Long-term consultants 3,462,000 1002 of expenditures- Short-term consultants 1,455,000 lOOZ of expenditures

External training 1,058,000 100Z of expendituresEquipment 25,000 1002 of foreign expenditures

11 Consultants would be procured in accordance with Bank Guidelines onthe Use of Consultants.

21 Computer equipment and accessories to be procured throughinternational shopping according to Bank Guidelines.

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Schedule C

XENYA

Pinancial Parastatals Technical Assistance Project

Tlmetable of Kev Loan Processing Events

Time taken to prepare: 6 months

Prepared bys The Government of Kenyawith IDA assistance

First IDA mission: November 26, 1989

Appraisal Mission Departure: February 2, 1990

Date of Negotiations: April 11, 1990

Planned Date of Effectiveness: July 1, 1990

.4

-9-STATUS OF SAWK COUP OPERATIONS IN KENYA Schedule 0_-------- _____-_ --- --- _-_-_-_-----__ ---- Pags 1 of 2A. STATEMENT OF 6AWK LOANS AND IDA CREDITS

(as of Mach O, 1980)

U----US ultln …Anount (Loes Canco lition.)

Loan or Fiscal Undle-Credit No. Year -- Berrower Purpose ank IDA burned

Forty one (41) Loans and thirty-nine (89) cerdito fully disbursed 820.e2 477.06Of which SECAL, SAL. md Program Loan: s/

Cr.A021 1966 Kenya Agriculture Sector 0.00 40.00Cr.1717 I9N Keny Agriculture Sector 0.00 40.00Cr.A036 196S Kenya Industrial Sector Operation 0.00 40.00

Subtotal 0.00 120.00

Cr.1921-4 * l966 Kenys Industritl Sector Operation 102.00 -Cr.1927-1 * 1960 Kenya Industrial Sector Operation 63.70 -Cr.2049-0 * 1969 Kenya Financial Sector Operation 120.00 58.10Cr.2049-1 * 1990 Kenya Financiel Sector Operation 44.00 -Cr.1107 1961 Kenya Fifth Education 40.00 18.91Ln.2098 1962 Kenya Forestry III 11.50 4.00Cr.1287 1962 Kenya Cotton Pree. A Marketing 22.00 2.70Cr.1238 1962 Kenya Integrated Rural Heath a

Family Planning 25.00 6.67Cr.1 87 l968 Kenya National Extension 16.00 6.95Ln.2319 1968 Kenya Secondary Towns 0.02 -Cr. 1390 1968 Kenya Secondary Towno 22.00 11.40Ln.2359 1964 Kenya Kta_ere Hydroelectric 60.00 2.99Ln.2409 1964 SJnyo Second Highway Sector 4.00 8.88Cr.F017 1904 Kenya Second Highway Sector 40.00 84.91Cr.1486 19S4 Kenya C(othroml Exploration 24.50 0.26Cr.1666 196S Kenya Water Enognering 6.00 1.71Ln.2674 1965 Kenya Third Tel e_munication. 17.90 8.61Cr.1673 196S Kenya Sixth Eduecalon 87.50 85.66Cr.1675 19SO Kenya Petrolou Explor. Tech. Assist. 6.00 8.60Cr.1716 106 Kenya Agric. Sector Managemnt 11.50 7.13Cr.1738 1967 Kenya XIE 2nd Smll Scale lndustry q Ou 0.86Cr.1756 198? Kenya Anlml Health Service. 15.00 18.66Cr.1820 1967 Kenya Second Railway 28.00 16.19Cr.1840 109s Knya Agriculture Rreserch 19.60 10.92Cr.1904 1966 Kenya Population III 12.29 11.63Cr.1973 1969 Kenya Ceetherml Devslopmnht 40.70 40.64Cr.1974 1969 Kenya Rural Service. 20.60 19.12Cr.205 1960 Kenyo TA 5.00 4.14Cr.2060 1990 Kenya Third Nairobi Water Suppi. Proj 64.60 63.46Cr.2062 b/ 1960 Konya Coffee it 46.0 47.16Cr.2011 l90 Kmnys Popul4tion IV 85.00 U.99

Total 940.94 1380.05 469.04of which repaid 389.20 17.96

Total held by Bank & IDA 602.66 1821.07

Amount cold 11.74of which repaid 11.74

Total unditbursed 469.04

a/ Approved after FY60. / Net yet effective. e SAL, SECAL or Progras Loan.

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Schedule DPage 2 of 2

8. STATEMENT OF IFC INVESTMENTS IN KENYA(as of March 30, 1990)

Amount In USS MillionFiscalYear Obligor Type of Business Loan Equity Total

1967,1966, Kenya Hotel Properties Hotelo 5.2 0.7 6.9and 19731970,1974 Pan African Paper mills Pulp and Paper 40.7 6.3 47.01977,19791981, 1988, 19691972 Tourism Promotion Services Hotels 2.4 -1/ 2.41970 Rift Valley Textiles Ltd. Textiles 6.8 2.8 9.11977 Kenya Commercial Bank Ltd. Capital Market 2.0 - 2.01980,1984 Developmnt Finance Development Finance 6.1 1.3 6.4

Compny of Kenya Ltd.1981 Konya Coemercial Finance Money & Capital Market 6.0 - 5.01982 Bamburt Portland Cement and Construct. 4.4 - 4.4

Cement Co., Ltd. Material1962 Diamond Trust of Money a Capital Market - 0.6 0.8

Kenya Limited1982,1987 Industrial Promotion Money A Capital Market - 2.0 2.0

Services (Kenya) Ltd.1983 Tatra Pak Converters Pulp & Paper Product 2.2 0.4 2.6

Limited1984 Loather Industries of Tanning 2.1 0.8 2.7

Kenya Limited198B Madhu Paper International Pulp & Paper Product 37.1 2.0 89.1

Limited1986 Equatorial Beach Tourism 5.6 - 6.6

Properties1986 Oil Crop Developmnt Ltd. 9.7 1.4 11.1

Total Groes Commitmente 127.6 16.3 146.1Less: repaymente, cancellations,

terminations and sales 92.1 9.0 101.1

Total Ccnitmente now held by IFC 35.7 9.3 46.0Total Undisbursed 12.0 1.2 18.2

1/ 844,937

kon2edl.wkl4-19-90

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TICEIC^AL ANNX

SECTION At DETAILED PROJECT DSCUIPMION

Background

1. Although Kenya's growth rates since 1965 have been higher thanthose achieved by most Sub-Saharan African countries, they have been builton a narrow base of traditional production and entrepreneurship. Toaccelerate the pace of development and diversify its sources, economicpolicies have in the past been directed towards the creation ofopportunities for import substitution behind high tariff and non-tariffbarriers. In addition, a variety of economic and non-economic objectives,including a rapid increase in domestic investment, have been targeted. Toachieve these objectives, numerous attempts have been made to remove real orperceived distortions in the operation of the economy, and to accordpreferential treatment to selected groups and sectors.

2. The establishment of foreign joint-venture and parastatal DFIs wasan integral part of this strategy. Although Kenya has one of the mostdiverse and dynamic financial systems in Sub-Saharan Africa, theavailability of long-term funds, in the form of loans as well as equity,continues to be limited. This gap in the availability of financial servicescan be attributed to both structural and policy-induced factors, especiallythe existence of interest rate and credit ceilings and weaknesses in thelegal framework for the enforcement of financial contracts. The Governmentof Kenya (GOK) has embarked upon major reforms to address these problems.The financial sector adjustment program, supported by two IDA credits whichbecame effective in 1989 (IDA Credits 2049-RE and 2058-RE), includes aprogressive deregulation of interest rates, an improved legal and regulatoryframework, strengthened prudential supervision and monetary control, and therestructuring of insolvent private sector financial institutions. Morerecently, GOK has expanded this reform agenda by focussing on issues offinancial market segmentation--the result mainly of preferential treatmentof selected parastatal institutions--and the sustainability of DFIs, whichhave required frequent injections of funds in the past from the Governmentand other shareholders to maintain operations.

3. Despite individual client firm successes, Kenya's industrialsector DFIs have shown weak aggregate financial results. The three largestpublic sector institutions--Industrial Development Bank (IDB, with totalassets of about USS 65 million), Industrial and Commercial DevelopmentCorporation (ICDC, US$ 62 million) and Kenya Industrial Estates (KIE, US$ 36million)--now face serious portfolio problems. The absence of clearmandates, weak accountability, and poor financial practices have contributedto these problems. Under present conditions, it is unlikely that the DFIs--including the Development Finance Corporation of Kenya (DFCK), a DPI withmajority ownership by external donors including IFC--can provide the levelof domestic term finance required to support the Government's industrial and

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trade sector adjustment programs. It is also evident that they would beunable to compete effectively with other financial institutions if thecurrent program of interest rate liberalization and financial restructuringeventually encourages new entrants into this market segment.

4. GOK has formulated a comprehensive restructuring plan for IDB andICDC, and has taken early actions to change the mandates of theseinstitutions, reconstitute their governing boards, complete an initialclassification of their assets, and initiate performance evaluations oftheir staff. The foreign shareholders of DFCK have been urged to takesimilar actions. KIE undertook a financial restructuring prior to approvalof a second IDA credit to it in 1986, but the measures taken at that time,and subsequently through the use of technical assistance funds provided inthe credit, have not proven successful. The commitment date on funds forsub-projects under the credit, which expired at end-1989, was not extendedby IDA. The Government has been urged to discontinue KIE's lending role,limiting it to the continued provision of technical services, training andphysical facilities for small enterprises.

5. The Government has recognized that weaknesses in the operation ofthe industrial sector DFIs stem from three major sources:

(a) Policy-related and strategic deficiencies in the role of the DFIs(e.g. confusion about the objectives and performance parametersinherent in the DFIs' complex mandates; their financingarrangements which incorporate asset/liability mismatches; afailure to recycle funding and maximize earnings; adherence tolimited and traditional lending and investment approaches);

(b) Internal structural flaws (e.g. a functional approach toinvestments that compartmentalizes the investment process; absenceof accountability; lack of an appropriate incentive system);

5c) Inadequate information systems and analytical processes (e.g. weakmanagement information systems, and monitoring and supervision ofclient firms; absence of business plans with specific timetablesfor restructuring potentially viable client firms).

6. To address the problems identified above, GOK's restructuringproposals incorporate major reforms in mandates, autonomy, funding.organization and lending/investment processes. The long-term objective withrespect to the DFIs is to establish commercial institutions that complementthe role of other financial institutions in Kenya in providing criticalfinancial services. Sustainability has been established as the overarchingobjective for IDB and ICDC. In practice, this would mean movement alongfour major fronts. First, sustainability will require an appropriatefunding base for the DFIs. Second, it will require achievement of a rate ofprofitability on successful investments that matches returns elsewhere inthe financial sector; is adequate to finance new investments and loans; andallows the DFIs to withstand income fluctuations from external shocks.Third, sustainability will require the Government to stop viewing the DFIs

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as costless policy delivery vehicles; instead GOK would reimburse the DFIsin those cases where the activities or financing requested of the DFIs couldnot be justified on a commercial basis. Finally, the DFIs will be requiredto have a greater focus on complementing the private sector through improvedidentification and funding of potentially viable but underservicedenterprises, and by pursuing initiatives that aid the development of Kenya'scapital markets.

Project Ob ectives

7. The action program prepared by GOK to restructure the majorindustrial DFIs constitutes a set of radical proposals that build on theexperience gained through previous attempts to restructure IDB and KIE,while preparing for the transition to more competitive financial markets.The specific objectives of the Project are to implement these proposalsthrough a restructuring of the mandates, governance, portfolios, andinternal organization and processes of IDB and ICDC. The Project is alsodesigned to help in the rehabilitation of potentially viable butunderperforming industrial firms currently in the DFIs' portfolios. Thiswould enable IDB and ICDC to strengthen their financial condition, as wellas allow distressed firms to expand production and employment. Finally,through coordinated training, incentives and staff retention policies, theProject would improve indigenous capacities to manage financialinstitutions.

Project Description

8. The Government's preparation of the DFI restructuring program wasagreed and funded under the Industrial Sector Adjustment Credit (IDA Credit1927-KE), which became effective on August 11, 1988. A comprehensive studywas prepared by consultants, and most of its recommendations wereincorporated into action plans agreed with IDA in fulfillment of one of thesecond tranche release conditions under the credit. Subsequently, GOKrequested IDA assistance in identifying and financing the technical servicesrequired to achieve the objectives of the restructuring proposals.Agreement on the scope, delivery mechanism and timing of technicalassistance was reached during a mission in December 1989. Subsequently,agreement was reached on outline terms of reference for consultants to berecruited under the proposed Project.

9. The proposed Project consists of three major components:

(a) Technical assistance in restructuring the DFIs: Eight (8)long-term consultants will be selected to assist the Ministryof Finance, IDB and ICDC in the implementation of therestructuring proposals. Two (2) consultants will be basedat the Ministry of Finance for assignments of 12 months each,and will undertake the following tasks--(i') Liabilitiesmanagement: to design and implement a strategy for the

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assumption by GOK of the foreign exchange risk on existingliabilities of the DFIs and for managing future liabilities,and to implement appropriate financial provisions by theDPIs; and (ii) Assets management: to design and implement aselective divestiture program for marketable assets held inthe portfolios of the DPFs (approximately 472 of the totalassets of the two institutions), assist in the establishmentof mechanisms and budgetary compensation rules to managegovernment-directed non-commercial operations (estimated atapproximately 252 of the total assets of the twoinstitutions), and to structure and complete the first publicdivestiture of investments. In addition, the Project willsupport the recruitment of three consultants for each DFI,for individual assignments cf 24 months. The consultantswill assist the Chief Executive Officers (CEOs) of IDB andICDC in the following areast (i) Operations management:corporate planning and operations, including the evaluationand design of risk positions, oversight of treasuryoperations, asset-liability coordination, productdevelopment, marketing, divestiture, internal audit, andclient firm restructuring; (ii) Human resources development:including design and implementation of internalorganizational changes, establishment of job descriptions andevaluation criteria, recruitment, and the assessment oftraining needs, design of in-house training programs, andselection of staff for external training; and (iii) Systemsmanagement: including the desipn and implementation ofprocedures for project management and information andreporting systems, and assessment of office technology andsystems training needs. Three desk-top computers, includingprinters, software, tape backup and power supplies, would beprovided to the consultants to assist them in performingtheir tasks. In addition to the financing of long-termconsultants and equipment to be used by them, the Projectmakes a provision for periodic assistance to the twoinstitutions by a panel of internationally-reputeddevelopment tinance experts.

(b) Technical assistance in preparing restructuring plans: Ananalysis of the performance of firms carried on theportfolios of IDB and ICDC showed that of 159 firms surveyed,nearly a third were judged to be potentially viable butcurrently underperforming, while the remainder were eitherwell-performing firms or those which had largely beenundertaken for non-commercial reasons. The restructuring ofpotentially viable enterprises is essential not only from thepoint of view of restoring the DFI balance sheets toprofitability, but also to improve industrial efficiency andincrease production and employment. The Project will providefunds for consultants to undertake financial, managerial andtechnical analyses to assist in the restructuring of

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approximately 25 of this group of client firma. It isexpected that eacb firm-level study would require theservices of two consultants in the areas mentioned above,each for a period of two (2) months. In addition, theProject would make provisions for assisting the DFIs inrevising legal agreements with client firms and creditors.

(c) Training: The establishment of more systematic humanresource development programs is essential for upgrading thequality of services and financial practices at IDB and ICDC.The Project would support the design and implementation of acomprehensive training program within each DPI. Trainingwould consist, at each institution, of overseas graduateeducation for approximately five (5) senior staff members,and participation in short-term professional courses in Kenya(50) and abroad (20). A prelimAnary evaluation of trainingneeds shows that programs in the following areas arecritical: marketing of financial services, divestiturestrategies, foreign exchange management, negotiation, generalmanagement, and procurement. Further, in view of the needfor greater staff participation at all levels in theimplementatIon of the proposed portfolio management approach,conventional courses in accounting and project appraisalwould need to expanded. IDB and ICDC would provide adequatebudgets for the in-house training of staff, and necessaryequipment and facilities to support this type of training.

Proiect Issues

10. Counterpart Trainings: The selection of counterparts and theirretention in jobs for which they are trained is critical to the success ofthe Project. Detailed selection criteria and terms of reference would bedeveloped to ensure the quality of counterpart staff, and incentives wouldbe maintained at levels that are adequate to retain staff in the DFIs.Provision has been made for the phased withdrawal of long-term consultantsfrom their assignments at each DFI, and for at least one subsequent visit ofshort duration to provide troubleshooting assistance if required.

11. Use of Local Consultants: Although it is likely that the long-term consultants, selected under the Project through standard Bankprocedures, would be expatriates, an attempt would be made to involve alarge number of local short-temn consultants in conducting the financial,managerial, and technical analyses of the DPIs' client firms. In view ofthe detailed technical, market- and country-specific experience required toconduct such firm-level studies, it is expected that these corporate workoutteams would be composed of a mixture of expatriate and Kenyan consultants.

12. Funding Structure: A preliminary analysis showed that anappropriate mix of balance sheet restructuring, including the divestitureand rehabilitation of assets and the assumption by GOK of foreign exchange

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liabilities, would strengthen the financial condition of IDB and ICDC.Nevertheless, an expansion of their activities would require access toadditional and new sources of funding. Decisions regarding such fundingwould depend critically on the nature of fJnancial products the restructuredDFIs would offer, and future financial market conditions. Accordingly, themanagement of funding strategies would be an important element in the workprograms of the operations management advisors to be located at each DPI,although assistance in formulating broad strategies may also be initiated atan earlier stage by the long-term advisors to be located in the Ministry ofFinance.

13. DFI Performance Monitoring: Periodic evaluations of the effectof the technical assistance activities covered by the Project would berequired to ensure the achievement of objectives. The training performanceand plans, including in-house training, of the two institutions would bereviewed annually with IDA. An advisory panel consisting ofinternationally-reputed experts in development finance would be constitute!before December 31, 1990, to provide general guidance on strategic issues.in addition, comprehensive business plans, including medium-term financialtargets, would be established for the two institutions by June 30, 1991, andwould be evaluated jointly by GOK and IDA.

SECTION B. PROJECT AIMIISTRATION AND IPL3IEUT&TION

Pro3ect Implementation

14. Overall responsibility for implementing the Project will rest withthe Ministry of Finance, while specific components will be overseen jointlywith the governing boards of IDB and ICDC. The Permanent Secretary,Ministry of Finance, would be solely responsible for the components relatedto: designing an overall divestiture strategy for DPI assets, lcludingpublic issues; assumption by GOK of the foreign exchange risk on theexternal liabilities of the DFIs; and implementing mechanisms for theisolation of non-commercial projects currently carried on the DFI portfoliosand for compensating the DFIs appropriately for undertaking such projects inthe future. Together with the governing boards of 1DB and ICDC, thePermanent Secretary would also be responsible for approving business plans,setting financial targets, organizing periodic guidance to the DFIs by theinternational panel of experts, identifying the specific firms to beincluded in the corporate workout exercise, and supervising the workprograms of the consultants placed at the two DFIs.

Reporting, Accounts and Audits

15. Separate accounts would be kept for all expenditures under theProject. The Ministry of Finance will submit quarterly reports to IDA onthe progress of individual components. Accounts for each component wouldalso be submitted to IDA on a quarterly basis. The Ministry of Finance will

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maintain records of all transactions under the Credit in accordance withsound accounting practices. Not later than six months after the end of eachfiscal year of the Government, all accounts will be audited by independentauditors acceptable to IDA and submitted to the Association. Audit reportswill include a separate opinion with regard to the claims submitted to IDAon the basis of statements of expenditures (SOEs) and would state whethersuch claims have been effected in accordance with the Credit Agreement.

Project Costs and Financing

16. Total project costs are estimated at US$ 7.5 million equivalent,with a foreign exchange component of US$ 5.35 million, or 71 percent oftotal costs. Cost estimates are based on April, 1990 prices. A contingencyof 15 percent was added for major cost categories to cover price and scopechanges during implementation of the Project. The Ministry of Finance, IDBand ICDC would contribute US$ 1.5 million equivalent to cover local costsincurred in the provision of support services and physical facilities forconsultants and in-house training for staff at the two DFIs. Thiscontribution accounts for 100 percent of total costs for in-house training,49 percent of total costs for all training, und 20 percent of the totalcosts of the project. A summary statement of the project budget ispresented below, with a detailed breakdown of costs provided in Schedule Aof the Memorandum of the President:

Costs (US$ '000)

Category IDA Government Total

Technical Assistance 4,365 410 4,775Long-term consultants 3,100 230 3,330Short-term consultants 1,265 180 1,445

Training 920 890 1,810External 920 0 920In-house 0 890 890

Equipment 22 0 22

Contingencies 693 200 893

TOTAL 6,000 1.500 7,500

Procurement

17. Short- and long-term consultants to be recruited under theProject would be selected in accordance with Bank guidelines on the use of

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consultants. Three packages of consultancy services will be prepared. Thefirst will consist of recruitment of exceptionally well-qualifiedindividuals to serve as liabilities and assets managers at the Ministry ofFinance. The second package would consist of recruitment of long-termadvisors to assist within the DFIs, and the third would consist o' a coreteam to assist in corporate workouts. Internationally-reputed consultingfirms would be invited to provide the services required in the latter twopackages, and it is expected that consulting firms will bid separately foreach package. For purposes of control and effectiveness, the long-termconsultants recruited to assist each DPI with human resources developmentwould be responsible for selecting staff for external training, accordingto criteria that would be agreed with IDA. Equipment to be procured underthe Project is for the use of the long-term consultants, and would consistof three desk-top computers with monitors, printers, power supplies, otheraccessories, and associated software. The equipment would be procured byinternational shopping, with at least three price quotations received fromsuppliers.

Disbursements

18. Disbursements under the credit would be made against 100 percentof expenditures for consultant services and external (both local andoverseas) training, and against 100 percent of foreign expenditures forequipment. The Government and DFIs would finance 100 percent 'f the costof in-house training of staff, and office facilities and support servicesfor the consultants. Disbursements for external training would be made onthe basis of SOEs, and provisions for advance payment of per diem, traveland fees would be made under the Credit.

Proiect Implementation Schedule

19. The proposed Credit is expected to become effective by July 1,1990. Initially, long-term advisors for liabilities and assets managementwould be recruited to assist the Ministry of Finance. The advisors willcomplete inception reports within two months of starting their assignments,and these will be reviewed by GOK and IDA. If necessary, appropriatemodifications would be made at that time in the design of specificassignments for all long-term advisors to be funded under the Credit.Short- and long-term consultants to assist the DFIs with restructuring,corporate workouts and training would be expected to be in place bySeptember, 1990. Project completion is expected to be December 31, 1993,with the closing date being June 30, 1994.

FrIACIL ?AAStA?ALS IKKCAL A8SIS?AUOC MOn=C?

NU NROJEC ACYIVIfES

Malor Activlty Timetable Responslble Agency Expected Output

(1) Assets restructuring July 1990 - June 1991 Ministry of Finance - Asset classlficatlon,consolldation anddivestiture

- MechamL for manaSingn."n-ccierclal projects

- Flrst public issue of DIAssets

(2) Llablifties July 1990 - June 1991 Ministry of Finance - Assumptlon of forelgerestructurlng exchange risk by GM0

- Negotlatlons withcredltors on liabillty £

restructuring- Financial provisloning on

DFI balace sheets

(3) Rehablitatlon of Sept. 1990 - August mintstry of Finance/ - 8valuatloildeslga of rlskoperations 1992 tDI/ICDC pooltions

- Improved treasury andInternal audit operatlons

- Corporato planning andproduct development

- Implementatloan ofdivestiture and corporate nworkouts

o . "

(4) Systems reforms Sept. 1990 - August Ministry of Finance/ - Revised procedures for

1992 IDBIICDC portfolio management- Xanuals on procedures- Management Information

System

(5) Training and Sept. 1990 - August Ministry of Finance/ - Internal organizational

personnel policies 1992 IDBIICDC changes- Personnel, performance

and incentives policies- Training needs evaluation

and training program

(6) Corporate workouts November 1990 - June Ministry of Finance/ - Restructuring of client

1992 IDBJICDC firms

(7) Advisory panel March 1991 - October Ministry of Finance/ - Periodic guidance to DFIs

1991 IDBIICDC on overall strategy andoperations

(8) Legal agreements December 1990 - June Ministry of Finance/ - Restructuring of DFI-

1992 IDB/ICDC debtor relationships

00m

KEYA

FINANCIAL PARASTATALS TECHNICAL ASSISTANCE PROJECT

KEY TRAINING ACTIVITIES

Major Activity Timetable Responsible Agency Components

(1) Overseas graduate Jan. 1991 - Dec. 1993 Ministry of Financel - 10 training opportunitiestraining IDBIICDC in finance for higher

level staff

(2) Overseas professional Jan. 1991 - Dec. 1992 Ministry of Finance/ - 40 trainingcourses (short- IDBIICDC opportunities, mainly for Nduration) lower level staff, in

accounting, finance, andprocurement skills

(3) Local professional Jan. 1991 - Dec. 1992 Ministry of Finance/ - 100 trainingcourses (short- IDB/ICDC opportunities, mainly forduration) lower level staff, in

accounting, finance, andprocurement skills

(4) In-house training Continuous IDB/ICDC - Induction courses andspecialized training inportfolio management,accounting and projectappraisal g