Document of

The World Bank

FOR OFFICIAL USE ONLY -

Report No. 4427-KE

STAFF APPRAISAL REPORT

KENYA

SECONDARY TOWNS PROJECT

May 20, 1983

Water Supply and Urban Development Div:iLsionEastern Africa Projects Department

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 = Kenya shilling (K:Sh)l/

KSh 1.00 = US$ 0.08US$ 1.00 KSh 12.6SDR 1.00 = US$ 1.08163 2/US$ 1OG = SDR 0.924527

ABBREVIATIONS AND ACRONYMS

CBS Central Bureau of StatisticsDCA Development Credit AgreementDOH Department of HousingE, DP Electronic Data Processing (Equipment)EMC Eldoret Municipal CouncilERR Economic Rate of ReturnGOK Government of KenyaGRF General Rate FundHABITAT United Nations Center for Human SettlementsKIE Kenya Industrial EstatesKMC Kitale tlunicipal CouncilLGLA Local Government Loans AuthorityMLG Ministry of LocaL GovernmentMLSP Ministry of Lands, Settlement, a-nd Physical PlanningMOH Ministry of HealthMWD Ministry of Water DevelopmentMtWH Ministry of Works and HousingNHC National Housing CorporationNMC Nakuru Municipal CouncilNyMC Nyeri Municipal CouncilPMU Program Managemerit UnitPPF Project Preparation FacilityRHE Rural Housi'ng Estates Ltd.SOE Statemnent of ExpendituresTMC Thika Municipal CouncilTMCECS Thika Municipal Council Employees' Cooperative SocietyUNDP United Nations Development ProgramUSAID United States Agency for International Development

FISCAL YEARS

Central Government - July 1 to June 30Local Authorities - January 1 to December 31

1/ Since December, 1982, the Kenya shilling has been pegged to the SDR atthe rate of SDR = KSh 14.06. The dollar-shilling con-version factorgiven here is based on the approximate exchange rate in effect inJanuary - February, 1983.

2/ As of April 29, 1983.

FOR OFFICIAL USE ONLY

KENYA

STAFF APPRAISAL REPORT

SECONDARY TOWNS PROJECT

Table of Contents

Page No.

I. THE SECTOR BACKGROUND ...... *................. . 1

A. The Macroeconomic Setting for Urban Growth..... IB. Secondary Towns in Kenya's Economic Development 2C. Urban Investment Picy................... .y.. 3D. Existing Institutions Involved in Urban Devel-

opment in Kenya .............. ..................... . 4E. The Bank's Strategy in the Urban Sector

in Kena.. e..n...y.....a . 6F. Experience of the First and Second Urban

Projects ...*...*..... ... . .................., ...... 7

II. THE PROJECT .............................. ... 8

A. Project Objectives ............ . .... ....... .. .. 8B. Approach to Project Preparation .............. 9C. Project Components . .............. 10D. Project Costs . ........ 16E. Financing Plan .... . ......... * . *, ... 16

III. PROJECT ORGANIZATION, MANAGEMENT, AND IMPLEMEN-TATION ....... ..... ,- 20

A. Overview of Institutional Arrangements. 20B. Organization of the Local Authorities 21C. Central Government Agencies . 22D. Project Monitorig. .24E. Legal Arrangements. ..ngm.. .ts. .- ......... ..... 25F. Implementation Sc ............... 25G. Procurement..... ... ..... . *...... .............. . 25H. Disbursements ... 27I. Accounts and Audit.u.d .... a........ . ....... .. *. 28J. Project Supervision ............ ............ 28

This report is based on the finclings of appraisal missions which visitedKenya in July and October, 1982. The missions consisted of Ms. C. Carr(Mission leader), Messrs. R. Westin, G. Beier, and R. van Puymbroeck(IBRD), and Mr. A. Kennefick and Ms. S. Wakeham (Consultants); Mr. A.Forte assisted in the production of the report.

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.

IV. FINANCIAL ANALYSIS 29

A. Municipal Finance in Kenya 29B. Financial Position of the Municipalities 30C. Central Government Financial Intermediaries. 32D. Project Impact on Municipal Budgets 34E. Affordability 35...... ....... 35

V. PROJECT BENEFITS AND RISKS 35

A. Project Benefitsn......... *see ....... * .......... 35B. Project Risks . .37

VI. RECOMMENDATIONS............................. .... 38

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LIST OF ANNEXES

ANNEX DESCRIPTION

1 The Project Towns2 Table 1. Project Costs - Towns and Central Government

Table 2. Detailed Cost Estimates2(a) - Eldoret2(b) - Kitale2(c) - Nakuru2(d) - Nyeri2(e) - Thika2(f) - Central Government Project Management

Support and Technical AssistanceTable 3. Flow of FundsTable 4. Project Cash FlowsTable 5. Physical/Financial Implementation ScheduleTable 6. Procurement ArrangementsTable 7. DisbursementsTable 8. Cost RecoveryTable 9. Financial Impact on TownsTable 10. Affordability

Table 11. Cost and Benefit Streams and Economic Rates ofReturn

Table 12. Project Rep,orting3 Local Authority Project Implementation Arrangements4 Description of Studies5 Documents in Project F'ile

Text Tables

Table 2.1: Project ComponentsTable 2.2: Project Cost SummaryTable 2.3: Project Financing Plan

Maps

IBRD 16820 General Map of Kenya Showing Project TownsIBRD 16821 NyeriIBRD 16822 KitaleIBRD 16823 ThikaIBRD 16824 EldoretIBRD 16825 Nakuru

KENYA

SECONDARY TOWNS PROJECT

STAFF APPRAISAL REPORT

I. THE SECTOR BACKGROUND

A. The Macroeconomic Setting for Urban Growth

1.01 As with most East African countries, Kenya is going through dif-ficult economic times. The rapid grovrth of agriculture which fueled Ken-ya's economy during its first decade after Independence has slowed consi-derably and is below the rate of growth of the population. Kenya's manu-facturing industry has proven to be iniefficient and inward-oriented due toits protected position behind high t:ariff barriers and other types of quan-tity restrictions. At the same time, the external environmerit for Kenyahas become increasingly harsh with high petroleum prices and declining cof-fee prices causing a major shift in Kenya's terms of trade and severebalance of payments difficulties. Finally, the population growth rate inKenya has climbed to around 4% p.a.,, one of the highest rates Ln the worldand a serious burden on the country's long-term prospects for economicdevelopment.

1.02 In the face of these prob'Lems, the Government of Kenya has begunto institute major policy changes t-o restructure Kenya's economy and im-prove its overall performance. This effort has been supported by the Bankthrough two Structural Adjustment operations (approved in March, 1980 andJuly, 1982 respectively) and by a continuing economic dialogue on manyaspects of economic policy.1 / Kenya's structural adjustment policies fo-cus on issues of trade policy and industrial promotion, agriculturalgrowth, energy policy, and family planrning. The adjustments in trade poli-cy call for the elimination of the quantity-restriction system of indus-trial protection and its gradual replacement by moderate and more uniformtariffs. This will be supplemented by appropriate levels of export compen-sation to industrial firms and adjustments in the exchange rate to improvethe terms of trade in favor of agriculture and provide an incentive forKenya's industry to become more efficient and export-oriented. The agri-cultural program focuses on pricing policies, marketing, and land relatedissues to provide the basis for an increase in productivity. Energy policyhas been the subject of a special Bank review which focused on investmentpolicies, energy production, and conservation. Finally, the Governmenthas agreed to provide leadership and direction to the family planningeffort as a matter of high priority.

1.03 Beyond the direct effect of these policies on the indicated sec-tors, Kenya's structural adjustment program will have far-reaching impactson the rest of the economy. Becauset of Kenya's long history of industrialprotection, the size distribution of manufacturing firms in Kenya bearsmore resemblance to that of a high-wage, capital-rich country than to a

I/ "Growth and Structural Change in Kenya: A Basic Economic Report,"(grey cover), August 31, 1982.

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low-wage, labor-intensive economy. The planned adjustments in trade poli-cy should cause a shift to smaller fLrms with higher labor-absorption fac-tors and closer ties to Kenya's agricultural resource base. This will inturn affect the spatial distribution of employment, as experience has shownthat such firms are more likely to locate away from major cities and closerto areas of resource availability. Thus, one can expect the structural ad-justment policies to strengthen the diversification of economic activitythroughout Kenya and into secondary urban areas. This will strengthenrural-urban linkages such as remittances to rural areas from off-farm em-ployment, which current estimates place as high as one-fifth of the urbanwage bill.

B. Secondary Towns in Kenaya's Economic Development

1.04 The recent (1979) populat[on census revealed that urban growthin Kenya over the past ten years has occurred on a disproportionate basisin secondary towns.2/ As a result, the population share of secondarytowns grew from 7% to 31% of the urban population, while the share of Nai-robi and Mombasa fell from 70% to 51% between 1969 and 1979. This patternof urban growth is not typical of the experience of many other Africancountries, and the reasons for it in Kenya have yet to be fully documen-ted. However, Kenya's macroeconomic policies may have played an importantrole in reducing the polarization of urban growth on Nairobi. For exam-ple, since 1972 the Government has restricted wage increases in the modernsector to 75% of the growth in the cost of living, significantly moderatingrural-urban income differentials. In addition, the Government has re-frained from subsidizing food, housing, and transportation in urban areas.By avoiding policies with an urban bias toward the distribution of incomebetween rural and urban areas (with the exception of trade policies, whicihave mostly benefited the relatively insulated modern private sector), Ken-ya has reduced the strong urban pull which has brought masses to the capi-tal cities in other countries. Instead, Kenya has developed a spatiallyextensive urban growth pattern which is complementary to the economic in-centives being introduced through the structural adjustment program.

1.05 Secondary towns have an imlportant role to play in Kenya's eco-nomic development. This includes such obvious considerations as providingfocal points for regional economic development and strengthening the spa-tial linkages for agricultural marketing and processing activities. In ad-dition, secondary towns absorb rural migration which would otherwise con-centrate in the major cities, thus providing an efficient settlement pat-tern for the additional six million urban inhabitants expected by the year2000. Finally, secondary towns provide the basis for strengthening therole of local initiatives in providing for urban growth, a factor whichwill be important in providing an institutional structure capable of sup-plying basic services to a large urban population.

2/ Secondary towns can be defined roughly as urban areas with apopulation in the range of 20,000 to 100,000 inhabitants with strong linksto their regional economy.

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1.06 In preparing for a decentralized pattern of urban growth, Kenyais in a better position than most of its neighbors to establish a stronginstitutional base. Kenya inherited a tradition of strong local govern-ments from colonial times, and this system has been maintained reasonablywell as compared to radical changes introduced by such countries as Tanza-nia. However, there are clear signs that the system of local governmentis outgrowing its financial and instLtutional base. Central-local coordi-nation procedures are inadequate, local revenues lack sufficient buoyancyto cope with rapid inflation, and scarcity of technical staff constrainsthe ability of the local authorities to extend basic services to the grow-ing urban population.

1.07 The urban strategy contained in the 1979-83 National DevelopmentPlan provides an articulate declaration of the need to decentralize urbangrowth in response to emerging patterns of population and the regionalneeds of the economy. The Government has proposed a limited range of in-centives to attract economic activities to secondary towns. However, thechoice of urban investments constitutes the major way in which the Govern-ment will pursue its urban spatial policy.

C. Urban Investment Policy

1.08 Urban investment policy in Kenya has followed a basic needsstrategy emphasizing investments in water supply, sanitation, low-costshelter, primary education, and basic health care. Urban water supply hasbeen extended to the majority of urban residents, either through indivi-dual water connections or by provision of water kiosks. Free primary edu-cation is provided through the middle grades (Form VII), and the Govern-ment has talken over the financial burden of teachers' salaries in order toensure that schooling is extended on a universal basis. Kenya has alsobeen a leader in promoting a basic needs approach to urban shelter, empha-sizing site and service type developments and initiating programs of urbanupgrading.

1.09 Despite Kenya's achievements in providing for urban development,current estimates indicate that from 18-40% of the population in differentsecondary towns live in unplanned, informal housing developments, oftenwith minimal access to urban services. In order to provide for the growthof population in secondary towns, it will be necessary to invest in the ex-tension of urban service networks, develop additional land for residentialhousing, and provide schools, markets, community facilities, and essential

maintenance equipment for the community. The local authorities will playan important role in this investment program, both for managing the imple-

mentation of most components and shouldering the debt-burden of the invest-ments, to be repaid from locally generated revenues. Hence, an importantrequirement for Kenya's urban investment program is to build-up the techni-cal and financial capabilities of the! individual local authorities. This"bottom-up" approach to urban planning is compatible with the! existinginstitutional structure in Kenya, but the system needs to be strengthenedin order to cope with the demands of an expanding number of urban growthcenters.

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1.10 Even with a strengthening of the role of local authorities, itwill be impossible to provide for urban development without involving theprivate sector in a more constructive fashion. Over 80% of the housingstock (including unplanned housing development) is provided by the privatesector in Kenya. Private sector housing grew at an annual rate of 10% be-tween 1975-1979, while the public sector managed a growth rate of less than2%, even on a much smaller initial base. Moreover, the amount of publicland available for low-income housing projects is becoming increasinglylimited in urban areas in Kenya, with some communities having virtually ex-hausted their stock of suitable public land. Given the limited financialresources and technical staff available to the local authorities, as wellas Kenya's historical emphasis on the private sector, it is clear that pri-vate sector development must continue to take the leading role irn providingshelter, with the public sector adopting a facilitating rather than a con-trolling stance. This will require the development of innovative methodsof achieving public/private cooperation, and must be done in a manner whichfully recognizes the profit-motivation and relevant time-frame for privatesector responses.

D. Existing Institutions Involved in Urban Development in Kenya

1.11 The most important agencies involved in urban developme!nt in Ken-ya are the following:

a) Local Authorities - Local authorities are divided into muni-cipal councils (currenlly 20 in number) which provide thewidest range of urban services; town councils which providea somewhat more restricted range of services; an,d countycouncils which are regional in focus and have functionsoverlapping with the existing district administration. Ur-ban councils represent a transitional form of council forsmall urban areas and fall under the jurisdiction of thecounty council for their particular region.

b) Ministry of Works and Housing, (MWH) - The M\H has responsi-

bility for housing poLicy and coordination of low-incomehousing projects. Public funds for low-income housing pro-jects are provided thrcough the National Housing Corporation(NHC), which can implement housing projects on behalf of thelocal authorities.

c) Ministry of Local Governiment, (MLG) - The MiG has oversightresponsibility for local authorities in Kenya and providesfinancial review and technical support. Most local authorityinvestments except for low-income housing projects are finan-ced through the Local Government Loans Authority (LGLA),which is under the control of MLG. Early in 1982,MLG was also assigned responsibility for urban developmentpolicy, a mandate which is currently being defined.

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d) Ministry of Water DeveLopment, (MWD) - The MWD is respon-sible for the development of water resources throughout Ken-ya and manages the water systems in a number of urbanareas. In cases where thie water system is operated by thelocal authority, MWD provides technical support t:o MLG inreviewing proposed investments in water and sanitation.

e) Ministry of Lands, Settleiment, and Physical Planning (MLSP)- The MLSP controls the allocation of public land and theacquisition of land for public sector projects. The Phy-sical Planning Department in MLSP prepares physical. develop-ment plans for urban areas.

Other agencies which assist in urban clevelopment programs include the Min-istry of Transport and Communications, the Ministry of Basic Education, theMinistry of HIealth (MOH), and parastataLs such as Kenya Industrial Estates(KIE) which provides assistance to small-scale enterprises in urban areas.

1.12 Several recent events have demonstrated the need to clarify theinstitutional arrangements for urban development in Kenya. The recent re-port of the Government-appointed Working Party on public expenditures,while acknowledging the positive role of urban local authorities in thedevelopment process, has recommended that the central Government should

assume greater control over the activities of the local authorities.3/On the other hand, a ministerial-level mandate for urban development whichwas formulated in 1980 in order to improve the coordination of urban de-velopment activities, has since been shifted twice between ministries andhas yet to be translated into a consistent framework for urban developmentplanning. In view of these conflicting initiatives, the recent Kenya ur-ban sector memorandum prepared by the Bank focused specifically on the in-stitutional and financial priorities for the urban sector.4/ This reportwill be discussed with senior Government officials within the next fewmonths. It is intended that these discussions should lead to an agreedframework for institutional change in the urban sector, to be supported bythe Bank's ongoing sector and project dialogue in Kenva. In the meantime,the urban investment program cannot come to a halt as these discussionstake place. The process of institutional change will take time, particu-larly to build a technical and political concensus on the need and direc-tions for change. It is important in the interim period that institu-tional arrangements for urban development be maintained in a consistentframework ana with a view to promoting the most important priorities inthe urban sector.

3/ "Report and Recommendations of the Working Party on GovernmentExpenditures,"' Government of Kenya, June, 1982, pp. 55-59.

4/ "Kenya: Economic Development and Urbanization Policy," (yellowcover), October 15, 1982.

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1.13 One of the major conclusions of the urban sector memorandum isthat a strong system of urban local authorities is consistent with Kenya'soverall development strategy for several reasons. First of all, localauthorities, because they are responsible for their own revenue base, havean incentive to emphasize cost recovery in their choice of investment proj-ects. Secondly, local authorities can respond more effectively to localpriorities in the promotion of economic activity. The rapid populationgrowth of secondary towns and the decentralization of economic activityinto smaller urban areas will create requirements on the local authoritiesto provide basic urban services in order to facilitate the growth of localemployment. In addition, most local enterprises have their prim,ary pointof contact with government activities through local authorities, either bythe regulatory and licensing functions of local government or through theneed to obtain urban services to run their businesses. Efficiently-managedlocal authorities are important to maintain the services required for anexpansion of urban employment and production on the scale which is neces-sary.

1.14 Strong local authorities do not diminish the need for centralGovernment involvement in urban development. Local authorities in Kenyaoperate under a tightly-defined legal structure which limits their flexi-bility and requires central input for approval and supervision of localauthority activities. Furthermore, virtually all capital developmentfunds for local authorities are provided through central Government minis-tries, with a corresponding need to ensure that the use of the funds meetsnational development priorities. The report of the Working Party onGovernment expenditures has emphasized the need for local authorities tointegrate their activities with national development planning, to improvetheir budgeting and financial control procedures, introduce more accounta-bility into their staffing, and play a more active role in the integrationof urban and rural development. If Kenya is going to achieve these objec-tives while maintaining a decentralized system of urban management, itwill require both technically strong ministries providing advice and en-couragement to the local authorities and also clearly defined and consis-tent policies on the rights and obligations of local authorities and thefinancial resources needed to provide for urban services.

E. The Bank's Strategy in the Urban Sector in Kenya

1.15 The involvement of the Bans in the urban sector in Kenya hasemphasized: a) the design of urban investment programs which are finan-cially viable and affordable to the lower income groups; b) development ofthe managerial and financial capacity of the local authorities to providefor urban growth; and c) the establishment of an institutional structure atthe central and local levels to plan and implement urban investments on aspatially extensive basis. The Bank's approach was to begin with a singlesite, implemented by Nairobi City Council, the largest and most experiencedlocal authority, with a clear intention to progressively expand to otherurban centers and broad policy areas. The Second Urban Project includedurban investment programs in two additional cities besides Nairobi andintroduced wide ranging policy init:iatives in areas such as municipal

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finance. The proposed Secondary Towns Project is intended to consolidatethe initiatives which have already begun, both by extending Bankinvolvement to a number of smaller urban centers and by makinginstitutional and other changes designed to address weaknesses uncoveredduring the implementation of the earlier projects. By taklng thisapproach, it is felt that the additional experience obtained during thepreparation and implementation of the Secondary Towns Project, as well asthe wider sectoral discussions to be pursued through the urban sectormemorandum, wiLll lay a firm basis for the introduction of programmatic-typelending in future urban operations.

F. Experience of the First and Second Urban Projects

1.16 The Bank's first urban project at Dandora in Nairobi (NairobiSite and Service Project; LN 1105-KE/Cft 543-KE) was initiated in 1975 andis now in the final stages of completion. The Dandora project has suc-ceeded in fulfilling almost all of its original objectives, and it is nowconsidered to be a model for this type of development in Africa. Costrecovery has t,een good throughout the project. Cost overruns for the proj-ect have been moderate, and time delays in implementation have been reason-able for a first project. Because of its successful record, the Dandoraproject has helped to dispel many inil:ial preconceptions about site andservice projects, such as that they will degenerate into slums. The proj-ect has been instrumental in achieving official Government recognition ofthe objectives of low-income housing projects, a commitment which has beenconfirmed in the last two National Devalopment Plans and in the prioritygiven to site and service projects in the allocation of urban investmentresources.

1.17 Based on the initial results of the Dandora project, the SecondUrban Project (LN 1550-KE/CR 791-KE) undertook to finance site and servicedevelopments and urban upgrading in Nairobi, Mombasa, and Kisumu. Experi-ence with this project has demonstrated a number of lessons which havebeen incorporated into the Secondary Towns Project. For example, the per-iod of project implementation (1978 - present) has been a time of increas-ing constraint in local authority finances, as costs have risen much morequickly than revenues. Many local authorities have faced difficulties inmaintaining services and repaying their debt obligations. Because of this,the appraisal of the Secondary Towns Project included a detailed analysisof the financial position and accounting procedures of each local authori-ty, combined with a plan to strengthen their financial operations. TheBank stood ready to delete from the project any local authority which couldnot produce a viable financial plan for the period of project implementa-tion.

1.18 The Second Urban Project has also illustrated institutional con-straints on the implementation of low-income shelter projects. The estab-lishment of separate project departments within each of the municipali-ties, while desirable from the standpoint of long-term institutional deve-lopment, created internal conflicts and staffing problems which took longerthan expected to be resolved. Where the project sites required the acqui-