Document of

The World Bank

FOR OFFICLAL USE ONLY

CRe. 42 R -Yc

Repot No. P-5415-KE

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED IDA CREDIT OF SDR 52.2 MILLION

TO THE

REPUBLIC OF KENYA

FOR A

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

DECEMBER 14, 1990

This doem.mt hi a resticted distibution and may be used by recipens oly in the perfonce ofthefr ildal d dks Its contents may not otderwise be disclosed withut Wotrd Bak autrIadon.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY AND EXCHANGE RATES a/

Currency Unit - Kenya Shilling (KSh)and Pound (Xi)

RSh 20 K KL 1.0KSh 1.00 US$ 0.0425US$ 1.00 = KSh 23.5US$ 1.00 - 0.741 SDR (as of July 30, 1990)

a/ Since August 1985, the Kenya Shilling has been pegged to the SDR at arate of SDR 1 = Ksh 17.4. The rate vis-a-vis the US Dollar fluctuates. Arate of USS 1 - Ksh 23.5 has been used in this Report.

FISCAL YEAR

July 1 - June 30

ABBREVIATIONS AND ACRONYMS

AEF African Enterprise FundADB African Development BankAPDF African Project Development FacilityASAL Arid and Semi Arid LandsASAO Agricultural Sector Adjustment OperationCBS Central Bureau of StatisticsCLSMB Cotton Lint and Seed Marketing BoardEC European CommunityESAF Enhanced Structural Adjustment FacilityFSAC Financial Sector Adjustment CreditGOK Government of KenyaIMF International Monetary FundISAC Industrial Sector Adjustment CreditKCC Kenya Cooperative CreameriesKfW German Aid AgencyKGGCU Kenya Grain Growers Cooperative UnionKNFA Kenya National Fertilizer AssociationMADIA Managing Agricultural Development In AfricaMEARDS Monitoring & Evaluation of Agriculture & Rural Development

StrategiesMLHPP Ministry of Lands, Housing and Physical PlanningMOA Ministry of AgricultureMOP Ministry of FinanceMOLD Ministry of Livestock DevelopmentMPND Ministry of Planning and National DevelopmentMSM Ministry of Supplies and MarketingNCPB National Cereals and Produce BoardODA Overseas Development Administration (of the UK)OECF Japanese Aid AgencyOP Office of the PresidentPC Performance ContractPDMD Project Development and Monitoring Division (MOA)PFP Policy Framework PaperPMS Project Management SystemPPRS Project Performance Reporting SystemSAL Structural Adjustment LoanSONY South Nyanza Sugar CompanySMS Subject Matter SpecialistSPA Special Program of AssistanceUNDP United Nations Development ProgrammeUSAID United States Agency for International Development

KENYA FOR OMCIAL USE ONLY

SECOND AGRICULTURAL SECTORADJUSTMENT OPERATION

TABLE OF CONTENTS

PART I. COUNTRY POLICIES AND THE BANK GROUP'S ASSISTANCE STRATEGY . 1

A. THE ECONOMY . . . . . . . . . . . . . . . . . . . . . . . 1

Structure .... . . . . . . . . . . . . . . . . . . . 1Performance .... . . . . . . . . . . . . . . . . . . 2

B. RECENT STABILIZATION AND ADJUSTMENT EFFORTS . . . . . . . 2

C. DEVELOPMENT STRATEGY AND MEDIUM-TERM ECONOMIC FRAMEWORK . 3

D. COUNTRY ASSISTANCE STRATEGY . . . . . . . . . . . . . . . 4Economic and Sector Work. . . . . . . . . . . . . . . . . 5Adjustment Lending: Experience and Prospects. . . . . . . 5Investment Lending: Experience and Prospects. . . . . . . 7Lending Program: Level and Composition. . . . . . . . . . 9Sunmming Up ............... 10

F. DONOR ACTIVITIES . .......... ... 11

PART II. THE AGRICULTURAL SECTOR ADJUSTMENT PROGRAM . . . . . . . 12

A. BACKGROUND .. 12

B. THE SECTOR ADJUSTMENT PROGRAM . . . . . . . . . . . . . . 13Origins and Objectives . . . . . . . . . . . . . . . . 13Experience With The First Adjustment Operation . . . . 14Goals And Strategies In The Second Operation . . . . . 15Sector Reform Themes and Actions Under ASAO II . . . . 16

Deepening Reforms ... .16New Initiatives . . . . . . . . . . . . . . . . . 17

Maize .... 17Background . . . . . . . . . . . . . . . . . 17Achievements Prior To ASAO II . . . . . . . . . . 18Further Steps Under ASAO II . . . . . . . . . . . 19

Fertilizers .... 21Background .... 21Achievements Prior To ASAO II . . . . . . . . . . 22Further Steps Under ASAO II . . . . . . . . . . . 22

This President's Report is based on the findings of an appraisal missioncommenced in June, 1990, comprising Messrs. F. Abmed (Task Manager), G.Donovaa., K. Anson, 0. Saadat, and A. Sodhi. The report was reviewed SM^-rs. J. Shivakumar (Chief, AF2AG), S. Lateef (Lead Economist, A'2),and C. Madavo (Director, AF2).

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

Public Expenditures In Agriculture . . . . . .. . . . 24Background . . . . . . . . . .. . . . . . . 24Achievements Prior To ASAO II . . . . . . . . . . 24Further Steps Under ASAO II . . . . . . . . . . . 24

Steps Toward Assisting Vulnerable Groups . . . . . . . 25Background . . . . . . . . . . . . . . . . . . . 25Achievements Prior To ASAO II . . . . . . . . . . 27Further Steps Under ASAO II . . . . . . . . . . . 27

Capacity Building in Agriculture . . . . . . . . . . . 27Further Steps Under ASAO II . . . . . . . . . . . 28

Letter of Sectoral Policy . . . . . . . . . . . . . . . . 30Ownership and Commitment . . . . . . . .. . . ... . 30

PART III. THE PROPOSED CREDIT ................ . . 30

A. BACKGROUJND .. . . . *...... .30

B. RATIONALE FOR IDA INVOLVEMENT . .. . . . . . . . . . . . 31

C. USE OF THE PROCEEDS . . 31Procurement .. 32Disbursements . . . . . . . . . . . . . . . . . . . 32

D. MANAGEMENT, MONITORING AND IMPLEMENTATION . . . . . . . . 33

E. BENEFITS AND COSTS. 34Environmental Impact. . . . . . . . . . . . . . . . 36

F. RISKS.. . . . 36

PART IV. SUMMARY OF AGREEMENTS AND CREDIT CONDITIONS . . . . . . . 37

PART V. RECOMMENDATION .... . . . ........ . . . . . . . 38

ANNEXES

I Letter of Sectoral Policy & Matrix of Policy ActionsII Supplementary Data SheetIII Performance Contract Between NCPB and the TreasuryIV Kenya - Indicators for the Agricultural SectorV Kenya - Macro-Indicators, Balance of Payments and External

Financing RequirementsVI Kenya - Outstanding Bank Group Loans and CreditsVII Supervision Plan and Implementation ScheduleVIII Capacity-Building ComponentIX Documents in the Project File

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

CREDIT SUNNARY

Borrowert The Republic of Kenya

Amount: IDA Credit: SDR 52.2 million (US$75 mil. equivalent)

Beneficiariess Smallholder agricultural producers, marketing agentsand traders of agricultural inputs and outputs;selected agricultural Ministries.

Termst Standard for IDA, with 40 years maturity

Prolect and Program Objectivess The goals of the operation are to: (a)accelerate agricultural growth through smallholders, while safeguardingthe environment; (b) contribute to fiscal stabilization; (c) improvepublic sector resource use in agriculture; (d) begin to assist lowerincome groups who are vulnerable to climatic and economic shocks; and(e) improve agricultural sector institutional capacity includingcapacity for environmental management. Strategies to achieve thesegoals will: improve maize producer incentives, and increase marketcompetitiveness; rationalize maize stocks, compatible with market needs;increase input supply, particularly fertilizer, and promote itsefficient use; improve efficiency and composition of publicexpenditures; develop targeted measures to protect vulnerable groups;and strengthen the institutional capacity in the agricultural sector toimprove policy planning, project preparation and implementation. Theoperation aims at substantial advances in three policy areas (maize,fertilizer, and public expenditure), representing a deepening of reformsbegun under the first operation, while beginning initiatives in twoother areas (steps toward assisting vulnerable groups, and buildingcapacity for policy analysis).

Proiect Description: The operation will support: (a) improvingincentives for smallholder maize producers through prompt payments tofarmers, and sustaining adequate producer prices through reducedmarketing margins; increasing the efficiency of maize marketing throughremoval of maize movement controls and achieving a higher degree ofcompetitiveness; and reducing the budgetary burden of NCPB's operationsthrough consolidation of a new role for NCPB and reducing its operatingcosts; (b) increasing fertilizer availability to small farmers, of theright type, in a timely fashion, at lower cost, and promoting transferof more efficient and environmentally safe fertilizer use technology;(c) improving the efficiency of public expenditures, through morerigorous criteria (including environmental factors) for includingprojects in the public investment program, a better balance betweensalary and non-salary operating expenditures, and improved budgetaryoperations; (d) promoting targeted programs to protect vulnerable lower-income groups, based on the Government's completed Food Security Paperand new initiatives to develop preparedness for droughts; (e)strengthening finance and accounting functions within the Ministries ofAgriculture and Livestock Development, as well as inter-Ministerialplanning, and management capacity in selected Ministries which deal with

ii

major subsector issues, and undertake strategic studies which cut acrosssubsectors, or have macroeconomic and environmental implications.

Benefits and Costs: The operation supports the growth, employment andstabilization objectives of the Government's reform program. Inparticular, the operation contains policy measures which are essentialif the target 4.5Z per year growth rate for agriculture is to beattained. Agricultural growth will be promoted through: increased useof fertilizer, improved incentives for farmers arising from a morecompetitive maize marketing system, increased returns to sectoral publicinvestment programs, and enhanced productivity of key agriculturalservices, particularly extension, research and animal health. Moreefficient NCPB operations, and containing personnel costs in the twomain sectoral ministries will contribute to reducing the fiscal deficit.

The proposed reforms will contribute to increased incomes ofa large number of smallholders and thus to reduction of poverty in ruralareas. In addition, the proposed food security action plan will addressproblems of vulnerable population groups. The monitoring and evaluationsystem will enable Government to identify possible adverse effects andtransitional costs of reform measures, and adopt targeted remedialmeasures.

By providing incentives for intensifying production inhigher potential areas, the operation will relieve pressure on the lessproductive, arid and semi-ar'd lands, which are more susceptible toenvironmental damage from inappropriate cropping practices andovergrazing with livestock.

Related benefits include strengthened capacity to plan,implement, monitor and evaluate sectoral policies, programs andprojects. Improved budgetary procedures will lead to a more timely flowof funds to priority sectoral investments and key services, thusincreasing returns from public resources. The proposed operation willalso lead to better coordinated donor support, enabling the Governmentto focus efforts on key strategic areas.

The main costs which may occur as a result of the operationare related to the reduction in the rate of growth of public sector andparastatal employment, and possible reductions in real income forparticular groups in marginal areas, as subsidies implicit in NCPB'soperations are withdrawn. These costs will be reduced by efforts toreduce the intake of training institutions whose output of studentstraditionally is destined for the public sector in agriculture, newemployment opportunities in the private sector resulting fromliberalizing the grain trade, and measures recommended by the EmploymentCommission which the Government has established to examine ways ofstimulating employment in the economy. As part of the conditionality ofthe project, the Government has commenced a study of the grain marketreforms, with the aim of identifying any adverse impacts of thesereforms upon vulnerable groups, and taking measures necessary toalleviate such impact.

iii

Riskst The main risks are: (a) fragmented and unsustained governmentcommitment and limited capacity to implement the reform program in atimely manner; (b) opposition by vested interests to specific reformmeasures; -nd (c) lack of the anticipated private sector response. Toreduce the risk of fragmentation, a Steering Committee chaired by thePermanent Secretary of the Ministry of Finance will coordinate actionsby several ministries, and oversee implementation of the reform program.Furthermore, the Technical Review Committee which meets regularly tomonitor reforms in the cereals sector will continue its activities. Inaddition, technical assistance and training provided under the Creditwill strengthen capacity in several key ministrieslagencies to formulateand implement reform measures. It is anticipated that as markets forcereals and agricultural inputs continue to be liberalized, there willbuild up private sector pressure groups which will resist activelyattempts by the public sector to over-regulate them. Although thereforms can take place only gradually, eventually sufficient momentumwill have been created to make it more difficult for them to be reversedthan for the reforms to proceed. The risks of 'ownershipw have beenaddressed by a participatory preparation process. The operation seeksto build a monitoring system, and a sharing of information, which willmake the market more transparent and well understood, together with aframework for consultation between the private and public sectors whichshould allow each side to air its concerns in a way which will head offadverse reactions by either. It is anticipated that continueddevelopment of the financial sector under the ongoing financial sectoradjustment program will assist with ensuring a private sector responseto policy changes.

Estimated Costs: The IDA operation will finance agricultural sectorimports costing US$67 million (including fertilizer, seeds, agriculturalchemicals, agricultural equipment and machinery, and fuel), and trainingand technical assistance estimated to cost about US$8 million.

Financing Plan (US$ million): Agricultural CapacityImports Building Total

IDA 67 8 75

The anticipated cofinanciers are the African Development Bank (ADB), theFederal Republic of Germany (KfW), the United Kingdom (ODA), theNetherlands, and Japan (OECF). Their funds will be mainly quickdisbursing, and will finance additional agricultural imports.

Estimated Annual Disbursements of IDA Funds (USS million):

FY91 FY92 FY93 FY9434 36 2.5 2.5

Economic Rate of Return: Not calculated

Map: IBRD 21659

INTERNATIONAL DEVELOPMENT ASSOCIATION

REPORT AND RECOMMENDATION OF THE PRESIDENTTO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT

TO THE REPUBLIC OF KENYA FOR A SECONDAGRICULTURAL SECTOR ADJUSTMENT OPERATION

1. I submit the following report and recommendation on a proposedCredit to the Republic of Kenya to assist in the financing of the SecondAgricultural Sector Adjustment Operation (ASAO II). The Development Creditfor SDR52.2 million (US$75 million equivalent) would be on standard terms,with a maturity of 40 years. The Operation would be implemented by theMinistries of Finance, Agriculture, Livestock Development, and Supplies andMarketing; and the National Cereals and Produce Board (NCPB).

2. The operation is part of IDA's continuing strategy to supportpolicy reform in Kenya through a series of sector adjustment credits. Quickdisbursing IDA assistance for sectors started with agriculture under the ASAOin 1986, and was followed by adjustment operations in the industrial sector(1987) and financial sector (1989). Further operations are underconsideration in export development (FY91), education and health. The reformprogram is further supported by an Enhanced Structural Adjustment Facility(ESAF) of the IW for a three year period, which became effective in February,1988. The policy base for IDA's and the Fund's interventions has been laidout in a revised Policy Framework Paper (1990-1992), presented to theCommittee of the Whole of the Bank's Board on April 26, 1990.

PART I. COUNTRY POLICIES AND THE BANK GROUP'S ASSISTANCE STRATEGY

A. THE ECONOMY

Structure

3. Kenya's per capita income of $373 in 1989 places it at the higherend of the range for low income countries. The economy has recorded anaverage growth in per capita income of about two percent per year sinceIndependence in 1963. Agriculture is an important sector of the economy, interms of share of output (30 percent), employment (70 percent) and foreignexchange earnings (almost 60 percent of merchandise exports in 1989). Kenya'smanufacturing sector is among the largest in Sub-Saharan Africa, and accountsfor about 12 percent of output and 8 percent of employment. The sector isdominated by long-established multinational and other firms producing mainlyfor the domestic market. There is some evidence of disinvestment by thesefirms during much of the 1980s, due mainly to unfavorable enterpriseregulations. While manufacturing has contributed significantly to economicgrowth, exports from the sector have fallen since 1980. The service sectoraccounts for about one-half of total output, and has served as an importantsource of employment in recent years. It includes tourism, which is nowKenya's largest single foreign exchange earner. Wages for unskilled andskilled workers are competitive with those found in developing countries thathave attracted foreign investors. In addition, Kenya possesses the basicresources necessary to compete in the world marketplace--agricultural andnatural resources; and abundant, inexpensive and industrious workers whc havebeen found to be easily trainable.

-2-

Performance

4. Four phases can be distinguished in Kenya's economic performancesince Independence: (a) rapid growth (averaging 6.5 percent p.a.) and lowinflation (below 4 percent p.a.) in the first decade until 1973, resultingmainly from increased agricultural output, manufactured import-substitutionand access to the East African Community markets; (b) slower growth and risinginflation during 1973-80, due to adverse movements in the terms of trade andthe emergence of structural constraints in agriculture and manufacturing; (c)serious macroeconomic imbalances and low growth during 1980-85, caused mainlyby the oil shock of 1979 and the erosion of fiscal discipline; and (d) arevival of growth since 1986, that resulted initially from improved terms oftrade but has subsequently been sustained by a favorable response fromsmallholder agriculture to improvements in incentives and by maintainingpublic spending through increased reliance on foreign savings. Astabilization package has been implemented since 1987 to set the economy on asustainable growth path. Despite significant fluctuations in the terms oftrade, a large external debt burden, and continuing structural bottlenecks inthe economy, GDP growth has held above 5 percent p.a. during 1986-89. Thecurrent account deficit in 1989 declined to 5.9 percent of GDP, while thebudget deficit for FY90 is estimated to have been held at 4.2 percent of GDP.

5. Although Kenya stands out as a good performer by most criteria,there are several reasons for concern about its future. This concern has itsroots in three factors. First, high rates of population growth imply anintense pressure for employment generation, with nearly 400,000 new entrantsinto the labor force each year. Large and steady increases in output arerequired to preserve social and economic progress. Second, since 1986, whenKenya benefitted from a sharp but temporary upswing in coffee prices, theGovernment has found it difficult to restrict aggregate expenditures and theoperations of parastatals, and has relied partly on expansion of the publicsector and concessional assistance to support growth. Since 1981, the privatesector share in total modern sector employment has fallen from 53 to 49percent, and its share in gross investment has dropped from over 13 percent ofGDP to about 11 percent. Unlike in agriculture, the Kenyan private sector hasnot been very active in the structural transformation of the manufacturingsector. Third, recent political events point to the need for greaterattention to effective governance. There is a clear perception that earlyactions need to be taken to improve decision-making and resource allocationprocesses. Lack of transparency, weak accountability, and concentration ofeconomic and political power could act as severe constraints on thedevelopment prospects of several sectors of the economy, through adverseeffects on the use of public resources and on the willingness of the privatesector, both foreign and domestic, to make longer term commitments toinvestment and production.

B. RECENT STABILIZATION AND ADJUSTMENT EFFORTS

6. The Government implemented major stabilization and adjustmentprograms twice during the 1980s. Kenya has enjoyed good reLt ions with theIMF, which has actively supported the Government's stabili'.a, ):n efforts,although several programs in the early 1980s failed when t&-7ZJts werebreached. In 1982, the stabilization program was supported by a stand-by

- 3 -

arrangement with the IMF, and included a devaluation, reductions in the budgetdeficit, limits on credit expansion, and adjustments of nominal interestrates. While these measures were successful in reducing the budget andcurrent account deficits, and in lowering inflation, little progress wasachieved in structural adjustment despite IDA support through two StructuralAdjustment Loans (SALs) in 1980 and 1982. Trade liberalization measuresintroduced under the SALs were eventually reversed, and protection throughnon-tariff means intensified after 1983.

7. The Government began implementing another major stabilization andadjustment program in late 1986 to correct renewed macroeconomic imbalancesand deterioration i.n economic performance resulting from the loss of fiscaldiscipline and adverse external developments. This program has been supportedby the IMF through its stand-by arrangement, structural adjustment facility(SAF) and enhanced structural adjustment facility (ESAF), and by IDA withsector adjustment credits in agriculture, industry and finance. Through thePolicy Framework Paper (PFP) process, a stabilization program coordinated withstructural reforms has been agreed annually since 1988 between GOK, the IMFand IDA. The latest PFP, covering 1990-92, was discussed by the ExecutiveDirectors of the Bank, meeting as a Committee of the Whole, on April 26, 1990.The second annual arrangement under the ESAF was approved by the IMF Board onApril 30.

8. Despite progress toward stabilization and the successfulimplementation of sector adjustment programs, which have contributed to thegood growth performance over the past four years, Kenya's economic recovery isfragile. Because of the lack of growth and diversification of non-traditionalexports, the economy has relied excessively on foreign savings to financeimports and the budget deficit, leaving Kenya vulnerable to external shocks.The remaining macroeconomic imbalances, unless corrected, threaten toundermine recent economic and stabilization gains. While the medium-termeffects of the Gulf crisis remain uncertain, preliminary estimates by IDA andthe IMF suggest that Kenya may face additional financing needs of at least$300 million over 1991-92. Since the expansion of foreign exchange earningsfrom the adoption of an export-oriented st-ategy will take time, and in viewof the import liberalization that has occurred over the past 18 months,inflows of quick-disbursing external funds will continue to be required.Further stabilization measures to deal with Kenya's more difficult economicenvironment, especially in terms of fiscal policy, have been agreed within thecontext of the IMF program.

C. DEVELOPMENT STRATEGY AND THE MEDIUM-TERM ECONOMIC FRAMEWORK

9. The Government's long-term development strategy is articulated inSessional Paper No. 1 of 1986, Economic Management for Renewed Growth, whichforms the basis of the Development Plan for 1989-93 and the series of PFPsincluding the current one ror 1990-92. The Sessional Paper emphasizes theneed to create productive employment opportunities for a labor force that isexpected to increase by 90 percent between 1985 and 2000. Accordingly, itsets a high target GDP growth rate, which is to be generated primarily by theprivate sector. Increasingly, the Government's role is expected to be theprovision of an appropriate enabling environment rather than directparticipation in economic activity. The strategy emphasizes the need to

- 4 -

increase agricultural productivity, strengthen links between rural non-farmactivities and the formal sector, and restructure manufacturing to Improveefficiency and enhance export competitiveness. This strategy is appropriate.

10. As spelled out in the current PFP, the Government's specific aimsfor 1990-92 are to attain output growth of over 5 percent; reduce inflation by1992 to the level forecast for Kenya's trading partners (about 5 percent)compared with 10.1 percent in 1989; and reduce the external current accountdeficit to a sustainable level of 3.6 percent of GDP by 1992 (from 5.9 percentin 1989). To achieve these objectives, the Government intends to: (a) reducethe budget deficit to levels that can be sustained by foreign and non-inflationary domestic financing, and do not crowd out the private sector; (b)limit the use of new non-concessional sources of external financing; (c)pursue an exchange rate policy that, in addition to complementingliberalization in the trade regime, promotes sustained export-led growth; (d)reorient trade and industrial incentives to reduce anti-export bias, encourageefficiency, promote the growth of non-traditional exports and encouragedomestic and foreign investment; (e) rationalize the budget by limiting publicsector employment and improving the quality and implementation of the publicsector investment program; and (f) further improve farmer incentives,agricultural input supply and agricultural services, particularly forsmallholders.

D. COUNTRY ASSISTANCE STRATEGY

11. IDA's country assistance strategy has three main objectivess (a)encouraging the Government to provide a stable macroeconomic environmentwithin which public resources are utilized more efficiently; (b) supportingchanges in the incentive framework and infrastructure base that wouldfacilitate the development of an efficient and export-oriented private sector;and (c) addressing longer-term human resource issues and arrestingdeterioration of Kenya's physical environment.

12. While actions are required on several fronts, there are threepriority areas in which IDA is well planed to support GOK's efforts: (a)Imeroving public sector management, to atain fiscal expansion, improve theeffectiveness and efficiency of public e *,enditures, particularly the publicinvestment program, and limit the scope and size of parastatal operations.These issues have been at the center of the Bank's economic and sectordialogue with the Government, with implementation steps being agreed in termsof sector adjustment and selected investment operations, technical assistance,and discussion and agreement on the content of the public investment program.(b) Expanding and diversifying the export base to reduce dependence onexternal assistance. Support for these efforts woul be provided throughpolicy-based lending, mainly in the industrial sector, and selectedinfrastructure investments to relieve transport and other physicalbottlenecks. (c) Strengthening the basis for sustainable development byaddressing human resource and environmental issues. The human resourcestrategy would be implemented through sector adjustment operations andinvestment operations in health and education, and support for the GOK'spopulation program. Environmental problems would be addressed throughprojects focussed on arid and semi-arid lands, forestry, and wildlife, as wellas the development with the GOK of a national environmental action plan. The

Bank's country strategy, consisting of analytical work, the lending programand aid coordination, is designed to address the issues identified above,while taking account of the Government's receptivity, the role of other donorsactive in Kenya, and the Bank Group's comparative institutional advantages.

Economic and Sector Work

13. The ESW program will underpin the country strategy by enhancingthe policy dialogue, meetiag the analytical needs of the lending program, andstrengthening aid coordination. The ESW program seeks to support three keyareas of the country strategy: (a) deepening structural adjustment; (b)rationalizing public expenditures; and (c) addressing longer-term issues ofsustainable and equitable development. Key studies planned include theIndustrial Review (FY91) focussing on the regulatory and physical environmentfor the efficient expansion of the industrial sector, the Public InvestmentReview (FY91) to improve the quality and composition of developmentexpenditure, and a Capacity Building study focussing on improving publicsector management. In addition, the ESW seeks to place greater emphasis onlonger-term issues, especially poverty alleviation, human resource needs andthe environment. A report on Human Resource Development (FY91) addressingissues of the quality of social services, access and equity is currently underpreparation. Further work is planned in FY91 and FY92 under the SocialDimensions of Adjustment umbrella to develop targeted interventions forpoverty alleviation. With regard to the environment, assistance has beenprovided to the Government to formulate a comprehensive wildlife managementand environmental investment strategy. A sector report and action plan isexpected to be developed during FY92.

Adjustment Lending: Experience and Prospects

14. The increased reliance on sectoral reform programs since 1986represented a shift in Bank strategy in Kenya away from global adjustmentoperations, following the poor performance of the SALs of 1980 and 1982.Implementation of the SALs fell short of expectations because the programconditionality covered too many areas; the proposed pace of adjustment was tooambitious and unsustainable; the loans involved few substantive up-frontactions; and consensus within the Government on key issues was ofteninadequate. Instead, by emphasizing coordinated sectoral adjustmentoperations that are clearly-focused, measured .nd administratively feasible,it has been possible to sustain a comprehensive and successful reform processin the Kenyan economy. IDA approved adjustment credits for agriculture(Agricultural Sector Adjustment Operation--ASAO I) in 1986, industry(Industrial Sector Adjustment Credit--ISAC) in 1988 and the financial sector(Financial Sector Adjustment Credit--FSAC) in 1989.

15. The Government began implementing ASAO I in 1986, and it includedmeasures to improve the timeliness, availability and application of keyagricultural inputs; improve agricultural credit policies; enhance priceincentives for agricultural producers; rationalize budgetary allocations andexpenditures; and restructure designated agricultural parastatals. Thisprogram has been implemented, although with slower progress than expected, inrestructuring two parastatals. The second tranche of the Credit was releasedin March 1988.

16. The ISAC was approved in 1988. Progress in implementing thereform program has been satisfactory in all areas and the second tranche ofthe Credit was released on schedule in October, 1989. The objective of theISAC program was to stimulate efficiency and investment in the industrialsector, and to initiate reforms to promote export production. Therefore, itspolicy package included a broad range of actions in the areas of importliberalization and industrial policy, During this early phase of importliberalization, emphasis was given to enhancing the transparency of protectionby replacing quantitative restrictions (QRs) on competing imports withtariffs. The number of tariff categories was also cut, and initial steps weretaken to reduce average tariffs; as a result, rates on non-competing importshave come down. The Government also moved vigorously in the areas of pricedecontrol, investment incentives, financial sector measures to activate themoney and capital markets, and the reform of development finance institutions.Through improved incentives for the operation of the manufacturing-under-bondscheme, ISAC also included a first set of actions to reduce the anti-exportbias in the industrial and trade policy regime. However, such actions need tobe intensified, as the response of investment and non-traditional exports isyet to be manifested. Moreover, the reform process initiated under ISAC hasto be sustained over a considerable period to build sustainedbusiness/investor confidence.

17. The financial sector reform program of the Government, which issupported by FSAC and an associated Financial Sector Technical AssistanceProject, is currently under implementation. Measures implemented in thesector include: passage of a new Banking Act which improves the legalframework for the regulation of financial institutions; strengthenedprudential supervision by the Central Bank; improvements in monetaryprogramming and the use of indirect monetary policy instruments; restructuringof several insolvent financial institutions; and maintenance of positive realsavings and lending rates. Implementation of the reform program has exceededexpectations in several areas. The second tranche of FSAC was released inAugust 1990 after all conditions for tranche release were met. Under thefinancial sector reform program, interest rates are expected to be fullyliberalized by June 1991.

18. IDA's experience with adjustment lending in Kenya suggests thatsector-based programs have been more effective than the SALs of the early1980s becauset (a) key government agencies have been better able to monitorand administer critical components of the adjustment programs; (b)accountability and ownership by implementing agencies has been stronger; and(c) sectoral programs have stressed incremental changes that are sustainable,rather than too rapid liberalization. The sustainability of these adjustmentmeasures has been enhanced by careful coordination with the annualmacroeconomic stabilization program designed in the context of the PFP, and byconsiderable donor support that allowed Kenya to continue to maintainliberalization measures.

19. Sector adjustment lending continues to be the most effectiveinstrument for achieving policy changes that are essential for improvingKenya's economic performance. With the Financial Sector Adjustment Credit,IDA will have completed a first generation of policy-based lending (threeoperations) to support sector adjustment efforts. Although this strategy hasbeen successful, Kenya's reform agenda and its balance of payments financing

gap remain considerable. The need to be alert to stabilization concerns,coupled with the length of time required for the realization of benefits fromthe shift to a more outward-looking development strategy, suggest thatadjustment operations will have to continue as major elements of donorassistance in the medium-term, In addition, the constituency for policyreform needs to be broadened within Kenya. An attempt would be made through asecond-generation of policy reforms to consolidate the gains made and deepenthe adjustment process. Planned sector adjustment credits include: (a) theagricultural sector adjustment operation (ASAO II) proposed in this documentwhich, though quick-disbursing, is the centerpiece of a larger program ofoutlays in the sector that includes investments for forestry development,establishment of a national extension system, wildlife conservation, dairydevelopment, agricultural marketing and agricultural technology; (b) anexport development program, which recognizes that reforms in policies, whilenecessary, would need to be supported by investments in infrastructure andtechnical assistance to remove simultaneously the various bottlenecks thatconstrain a supply response; (c) a parastatal reform program which would seekto improve the functioning of the public sector and parastatal enterprises,while encouraging the divestiture of public sector firms as appropriate; and(d) programs in health and education that would address the objective ofstrengthening Kenya's human resource base.

20. Recent experience has confirmed the importance of ensuring abalanced macroeconomic policy environment within which sector adjustmentprograms can be implemented effectively. Without appropriate demandmanagement, exchange rate, and public expenditure policies, the payoffs to thesectoral adjustment approach would be reduced substantially. The rollingthree-year macroeconomic policy framework developed jointly with theGovernment and IMF as part of the PFP process establishes an appropriatepolicy umbrella under which sector operations can proceed, and will beconsidered a precondition for such operations. Moreover, continued efforts toassist the Government in improving public sector management and establishingeffective control over public spending in key sectors such as education andagriculture will play a major role in improving the macroeconomic framework.

Investment Lending: Experience and Prospects

21. The Bank Group has at present 4 loans and 23 IDA credits underimplementation in Kenya. Total amounts outstanding on loans and IDA creditsare $585.5 million and $1,326.0 million respectively. Eighty-two loans andcredits have been disbursed fully. Over the past five years, IDA commitmentsamounted to $6s7 million (Table 1) for a total of 18 credits, including threesector adjustment operations. Annex VI provides a summary statement of Bankloans, IDA credits, and IFC investments in Kenya as of June 30, 1990. NetBank Group transfers to Kenya fell from $125 million in 1982 to a negative $40million in 1986, rising gradually over the next three years to reach $56million in 1989. There has been no IBRD lending since 1986, when the debtservice ratio began to exceed 20 percent. The drop in transfers resultedfromt (a) the rising burden of interest payments on over $700 million of IBRDloans; (b) the restructuring of the project portfolio; (c) the absence ofquick-disbursing loans following the poor performance of the two SALs; and (d)the fall in new commitments from an annual average of $184 million during1978-82 to $94 million during 1983-86. Net transfers have increased in recent

- 8 -

years due to the resumption of quick-disbursing lending and the recent IDAreflows initiative.

Table 1: IDA Commitments to Kenya, FY86-90 a/($ million)

FY86 FY87 FY88 FY89 FY90

Commitments 115.0 49.0 143.8 181.5 157.6

a/ Excludes IDA reflows of $53.7 million in FY89 and $44.0million in FY90.

22. The status of the Bank's project portfolio and implementationperformance in Kenya are satisfactory, but several areas for improvement havebeen identified. Credit effectiveness is often delayed because of the timetaken to obtain the Government's legal opinion and clearance of projectdocuments; the management of procurement, especially of technical assistance,needs to be standardized and accelerated; and compliance with auditrequirements has been low. Further, delays in intra-governmental payments andin the setting of domestic tariffs (e.g. railways), and lack of effectivecoordination among official agencies have resulted in project implementationdetays. A comprehensive action plan to tackle these and other portfoliomanagement issues in Kenya was launched by IDA during FY90. The action planshave resulted in an increase in supervision coefficients, and consist of thedesignation of Divisional portfolio managers, systematic midterm reviews ofproject performance, broader role in project supervision for the ResidentMission, organization of country implementation reviews, intensive training ofproject counterparts in procurement and disbursement issues, and coordinationand participation by IDA in multi-donor reviews of procurement and projectimplementation. This focus on implementation, including restructuring andcancellations of loans where required, will be a continuing feature of thecountry strategy.

23. Lcoking to the future, investment projects would be selected anddesigned to support the Bank's strategy. Given the importance of theagriculture sector to Kenya's development prospects, the investment lendingprogram has a focus on agricultural intensification by enhancing services,inputs, marketing and rural infrastructure. During FY91-95, operations areplanned in the areas of agricultural extension and marketing, forestrydevelopment, wildlife conservation, dairying, agricultural marketing, andrural roads and water supply. To improve Kenya's neglected infrastructure,the lending program focuses on transportation, energy and the strengthening oflocal government self-financing. Special emphasis is placed in the lendingprogram on human resource development, poverty alleviation, women indevelopment, and the environment. The human resource strategy focuses onsupporting policy reforms in education and health, continuation of thesuccessful population program, and implementation of the Women in DevelopmentAction Plan for Kenya. In line with the Action Plan, the emphasis is onintegrating gender issues in projects and policy reform programs; a primary

- 9 -

focus will be on agriculture, where efforts will be made to increase theproductivity of women farmers through extension. Environmental problems wouldbe addressed through projects on forestry and wildlife, as well as throughdevelopment with the Government of an environmental action plan.

24. Poverty concerns will be addressed through the dialogue on foodsecurity and nutrition, as well as in the lending program. For example, foodsecurity is a crucial objective of ASAO II, which would require thepreparation of action plans for improving food security and droughtpreparedness. The Government has also asked the Bank to assume a lead role inhelping to formulate and implement a long-term strategy for the development ofarid and semi-arid lands. Strengthening the human resource base in theseareas will be a key element of this work. In addition, as mentioned above theGovernment has requested Bank assistance within the Social Dimensions ofAdjustment framework in developing a welfare monitoring system and indesigning targeted interventions for poverty alleviation.

25. The effectiveness of the policy reform effort will dependcritically on generating a supply response from the private sector. In thisrespect, IFC can play an important catalytic role. IFC has invested in 15enterprises in the industrial, financial and tourism sectors, with total grosscommitments of $146.1 million, of which $18.3 million represent equityholdings. In industry, IFC has invested in the pulp and paper, textiles,tanning, and agro-processing subsectors. Although during the early 19809 IFCwas able to average two new projects per year, the last three years havewitnessed a decline to one per year. The prospects for the next few yearswill depend on the Government's ability to reduce the large public sectorclaims on the economy's resources, and to improve the climate for privateinvestment. IFC has broadened its involvement with the private sector inKenya through the establishment in 1989 of the Nairobi office of the AfricanEnterprise Fund (AEF). The AEF allows IFC to make loan and equity investmentsin smaller projects than IFC's mainline business; it is currently revievingtwo such projects in Kenya. In addition, the Africa Project DevelopmentFacility (APDF), based in Nairobi, continues to assist entrepreneurs toprepare project proposals and financing. To date, APDF has assisted 10 Kenyanfirms at a combined project cost of $32.1 million. The IFCI/IGA affiliate,Foreign Investment Advisory Services, is assisting the Government in preparingan investment policy statement. A seminar has been held for senior governmentofficials, and an official statement is under preparation.

Lending Program: Level and Composition

26. The lending program envisages a volume of Bank Group assistance toKenya of roughly $240 million per year. The strategy calls for a reduction ofquick-disbursing assistance, which will amount to roughly 50 percent of IDAlending over FY90 and FY91, to a lower level of 35 percent by FY93. This ispredicated upon a relatively high level of economic performance which, givenrecent experience, has a good probability of being attained. The resolutionof recent political problems and the maintenance of tourist receipts and aidinflows at current levels would play a critical role in ensuring continuedstability and economic performance. These concerns suggest that theGovernment will have to accelerate the implementation of policy reforms inthose areas already earmarked for action, as well as in those not covered bycurrent and planned adjustment operations, in order to demonstrate a continued

- 10 -

commitment to economic reform and to overcome the effects of a possibledownturn in external receipts. Areas requiring more vigorous governmentefforts include: restraints on the growth of public sector employment,improvements in the efficiency of public investments, and parastatal reform(including the divestiture of activities better suited to private ownershipand operation). Thus, in the event of a deterioration in the economicenvironment, the maintenance of current levels of IDA lending will dependcritically on the adoption of even stronger measures by the Government, alongthe lines identified above.

27. The assistance strategy would call for a raduction in the proposedlending program under two sets of circumstances. First, in the event thatagreement with the Government on structural reforms proves elusive or isdelayed, IDA would proceed only with the investment components of the lendingprogram. Despite continued soundness in macroeconomic management, if thereform dialogue in a sector shows little progress, only the affectedadjustment operation would be dropped from the lending program until suchprogress is visible. To this extent, the proposed lending strategy would beself-adjusting, and IDA lending would fall to roughly $140 million for thatyear. Thus, the criteria for judging progress would be the Government'sability to sustain previous reform efforts and to develop and implement sectorreform programs which address the structural constraints discussed above. Thereform agenda in these sectors is being defined through the policy dialogueand the Government's own strategic and policy statements. Second, a markedand sustained deterioration in the macroeconomic policy environment wouldtrigger the cancellation of policy-based lending as well as of investmentoperations that would not be viable in such circumstances. An inappropriatemacroeconomic framework, that is, the collapse of the PFP process, would thusresult in a lower level of assistance, essentially to a core level of lending.Progress would be evaluated on the basis of the Government's ability to meetagreed stabilization targets, especially in terms of the exchange rate,containing the growth of public expenditures, and reducing inflationarypressures.

Summing Up

28. In evaluating the proposed country strategy, two sets of questionsemerge. First, whether in Kenya's complex socio-political environment therecan be a sustained commitment to improving economic management while grapplingwith the country's longer-term problems. Second, whether the pace and natureof the reforms supported by the Bank Group are appropriate and realistic inaddressing Kenya's development constraints. While it is not possible toprovide definitive answers to these questions, Kenya's recent macroeconomicimbalances have helped focus the attention of decision-makers on the need fora serious reform effort that could be supported by donors. The Government hasitself cogently articulated the need for stabilization and structuraladjustment, and in many instances has taken ownership of reform programsadvocated by donors. However, the process of internalizing Kenya'sdevelopment agenda is far from complete across all sectors, so that there is aneed to reinforce continuously the internal forces that advocate change. TheBank Group is well-placed to support this process. The economic dialogue willcontinue to press for a faster pace of adjustment, with the size of theassociated lending program and its quick-disbursing component being determinedby needs generated from implementing this pace. However, these efforts must

- 11 -

be tempered by the realization that in Kenya's current socio-politicalenvironment, policy shifts that are too dramatic, even if implemented, may notprove sustainable.

29. At the end of 1988, IBRD and IDA held 23 percent and 16 percent,respectively, of Kenya's stock of long-term public and publicly-guaranteeddebt (including IMF). By 1994, IBRD's share of total debt is expected to fallto 7 percent, and IDA's to rise to 28 percent. With respect to public debtservicing, IBRD's share is expected to range between 26 and 32 percent during1990-94 and IDA's share between 2 and 4 percent. Within the preferredcreditor category, which includes IMF, AfDB and EIB, IBRD's share in disbursedand outstanding debt is expected to decline to about 15 percent by 1994.Although Bank Gr.4p exposure is relatively high, risks are low given Kenya'srecord in terms of avoiding debt rescheduling and relatively good prospectsfor the continuation of the Government's adjustment efforts.

F. DONOR ACTIVITIES

30. The task of supporting policy reforms and development programs inKenya is a large one, and it is clear that the Bank cannot do this alone. Akey element of the country strategy is, therefore, to strengthen thecoordination of donor activities. Fortunately, Kenya is assisted by a largenumber of bilateral and multilateral donors who have actively supported theGovernment's adjustment efforts. Japan has recently become the largestbilateral donor to Kenya, followed by the United States and the UnitedKingdom. Major multilateral donors include the African Development Bank, theEuropean Community, and the European Investment Bank. As of June 30, 1989,cofinancing commitments for IDA adjustment operations totalled $221 million,and coordinated financing amounted to $142 million. In addition, the countryhas benefitted from debt forgiveness of bilateral loans, most notably from theUnited Kingdom, Japan, Germany, the United States and France. A significantnumber of bilateral donors currently extend only grant assistance to Kenya.The country also participates in the Special Program of Assistance (SPA),which has proven to be an effective vehicle for mobilizing and coordinatingdonor support.

31. Effective donor coordination has and will remain an $mportantelement of the country strategy, especially in assisting Kenya to meet theadditional financing needs caused by the Gulf crisis while maintainingprogress in stabilization and adjustment. Efforts to seek donor backing forthe Government's adjustment programs will be a key aspect of this strategy.An active role in mobilizing and coordinating this support and, if necessary,in organizing meetings of donors to address major policy issue, would beplayed by the SPA. The Bank will continue the practice of holding bi-annualConsultative Group (CG) meetings in Paris, mini-CGs in Nairobi in theintervening years, monthly informal donor meetings in the Resident Missionand, where appropriate, organizing sector coordination groups. Implementationof the sectoral adjustment approach has required close cooperation with theIMF, not only to monitor the macroeconomic framework and prepare the PFP, butalso in sector adjustment programs, particularly in trade and finance. Thiscooperation has been maintained in preparing the present Credit.

- 12 -

PART II. THE AGRICULTURAL SECTOR ADJUSTMENT PROGRAM

A. BACKGROUND

32. Kenya's population is predominantly rural (85X), and the economydepends fundamentally on agriculture. Agriculture's contribution to GDP(nearly 30Z in 1988), labor force (70? of the total), and export earnings(average 662, 1985-88), are the highest of any sector. In addition,agriculture is the engine of growth for the service and industrial sectors.

33. Smallholder agriculture is now the dominant mode of production interms of output, employment, and land area cultivated. Of the 2.7 millionsmallholdings, about 80Z have less that two hectares, and 40? are managed bywomen. Most smallholders combine subsistence food crop and livestockproduction (primarily maize, milk and meat) with varying amounts of cash crops(mostly coffee, tea and horticulture) and sell surpluses of food, especiallyduring years of favorable weather. About 85? of the cultivated area is infood crops. Maize is the major food commodity; it accounts for about 22? ofthe total value of agricultural production, and 41? of the total cropped area.

34. The performance of the agricultural sector during the 25 yearssince Independence (1963-1988) has been better than the average for Sub-Saharan Africa. The agricultural growth rate of 3.5Z per year during the1980s, however, has not been sufficient to keep up with the high populationgrowth rate of close to 42 per year. Consequently, it has proven difficult toraise per capita income levels and protect the natural resource base. Theproportion of rural households with insufficient income to secure their basicfood needs has not been reduced, and the number of persons in poverty hasalmost certainly increased substantially. The major sources of pastagricultural growth have been land expansion in the fertile areas, switchingto high value coffee and tea production for export, and increases in cropyields and livestock productivity. These two latter sources offer thegreatest scope for future increases in agricultural production. By contrast,fertile soils with adequate rainfall comprise only a small proportion of thearable land, and area expansion in them cannot continue at past rates. Undersevere population pressure, the amount of high potential land per capita hasdecreased significantly, and as farm sizes have diminished, migration hasincreased to the lower potential areas in Kenya's vast arid and semi-aridlands, which are more susceptible to environmental damage.

35. Despite these trends, Kenya's agriculture can grow faster than theapproximately 3.5? per year average achieved during the 19809. The Bank'srecent study on Agricultural Growth Prospects identified priority measureswhich, if effectively implemented, could raise the growth rate above 4? peryear. Yields of crops and livestock for the majority of smallholders areabout one half of those achieved by large scale farmers or progressivesmallholders. It is from improving the performance of small farmers in thisregard that most growth will come. Kenya also has a distinct advantage insustaining exports of high quality coffee and tea, increasing exports in therapidly growing horticultural sector, and in diversifying its exports evenfurther, both by commodity and market. Both milk and beans, for example,offer promising opportunities for the future.

- 13 -

36. The growth of agriculture is being constrained by the followingmajor factors:

(a) Insufficient incentives for producers, resulting from delayedpayments and unnecessarily high costs of marketing because ofinsufficient competition in the marketing of key agriculturalcommodities, especially maize. This has lowered effective pricesreceived by producers ir. surplus areas.

(b) Low use of yield-augmenting inputs, notably fertilizer, due toinstitutional factors affecting demand (delayed payments forcrops, and low returns from available technical packages), andsupply constraints (high cost of imported fertilizer, inadequateand uncertain allocation of foreign exchange, excessive licensingcontrols, and poor and high cost distribution). Consequently,only a small proportion of Kenya's smallholdeL farmers usefertilizer. The full and sustained benefits of the Government'srecent decision, (in the context of its dialogue with IDA on theproposed operation), to decontrol fertilizer prices, will dependlargely on removing these constraints.

(c) Inadequate availability of financing, including institutionalcredit, to enable longer term investments, as well as provideworking capital, both for smallholders and for financing croppayments by private traders.

(d) Declining efficiency and returns to public expenditures in thesector, arising from weak project selection, underfunding ofongoing programs, marked imbalances between non-wage operatingexpenditures and personnel costs, and serious funding delays forapproved projects.

B. THE SECTOR ADJUSTMENT PROGRAM

Origins and Obiectives

37. As laid out in its Sessional Paper No. 1 of 1986, Government'sobjectives for agriculture are that it should grow rapidly, thereby playingits role in supporting overall economic growth, enabling the country to remainself-sufficient in major foods through the year 2000, generating increasedexport earnings, and serving as an engine for employment creation, both onfarms and in adjacent rural areas. The strategy for achieving theseobjectives includes measures to: improve producer incentives and marketingarrangements by allowing the private sector an increased role; expand publicand private financing for high priority investments; strengthen extensionservices; and accelerate the generation of new technologies through research.Government also intends to divest and restructure marketing and serviceparastatals in the sector.

38. The Sessional Paper presented a bold strategy for growth above 5percent per year over the long term, and provided the framework and originalcontent for the Government's five year agriculture sector adjustment agram.Government approached the Bank in mid-1985 with a formal request for

- 14 -

assistance in preparing and implementing the first phase of this five yearprogram. This coincided with a shift in the Bank's strategy toward supportingadjustment programs in the main sectors, beginning with agriculture. AnAgricultural Sector Adjustment Operation was appraised in January/February of1986 and approved in June of that year. Taking the emphases of theGovernment's Sessional Paper as its objectives, the ASAO was growth-orientedand included key actions to assist Government implement three inter-relatedstrategies: intensifying production through increased supplies of key inputs;enhanced producer incentives and market de-regulation; and improved allocationand efficiency of sectoral public investments and expenditures.

Experience With The First Adjustment Operation

39. While implementation of some of the measures in the ASAO was good,for others it was slow or weak. Good progress was made in: maintainingadequate producer price levels, taking steps toward market de-regulation,particularly maize and beef; beginning the financial and organizationalrestructuring of two parastatals, the National Cereals and Produce Board(NCPB) and the South Nyanza Sugar Company (SONY); and improving cost recoveryin the provision of animal health services. Disappointing progress occurredin: the removal of supply constraints on fertilizer availability; supervisionand management of parastatal reform; and achievement of concrete improvementsin rationalizing the composition of sectoral public investments/expenditures.The noticeable slackening in Government's conmitment and capacity to fullyimplement the reforms since the final tranche in early 1988 was in part dueto: changes in the key Government decision-makers since the beginning of theASAO, and a lack of 'ownership' by their successors of the agreed program;fragmentation of institutional responsibilities within the agriculture sector(from two to five Ministries), and to some extent Government's being lulled byimproved economic performance in the early part of the program.

40. The main shortcomings from IDA's side were: (a) focussing onfinancing the preparatory steps for adjustment (studies, elaboration of policypapers, and restructuring plans) rather than on implementation; (b) settingtoo many conditions whose initial definitions were loose; (c) underestimatingthe time it would take to carry out difficult reforms (and especially toinitiate actions which required decisions by Cabinet); and (d) placing toogreat a reliance on a small number of key individuals in Government, whosereplacement would make a difference in the conmitment to certain actions.

41. In spite of these shortcomings, the Project Completion Reportjudged ASAO to have been: (a) well embedded in a macroeconomic policyframework understood between Government and IDA; (b) a useful instrument forpromoting policy and institutional improvements in agriculture whici wouldlead to faster growth, and improved efficiency in the allocation and use ofsectoral resources; (c) a source of momentum for implementing reforms inimportant policy areas; (d) a contributor to good agricultural growth duringits implementation period, 1986-1988 (average exceeding 4X per year); and (e)helpful in mobilizing substantial external resources for balance of paymentssupport. Government met satisfactorily the main agreed conditions to justifyrelease of the two tranches. A Project Performance Audit Report (No. 8862) byOED was distributed to the Board of Executive Directors on August 22, 1990.

- 15 -

42. The quality and speed of ASAO implementation suffered after aninitial satisfactory phase. Towards the latter part of the implementationperiod in 1987, Government appeared to be more committed to fulfilling theloosely defined conditions for tranche release, than to full implementation ofa reform program. 'While the direction of the policy reforms has remained ontrack in most areas, and the majority of the conditions were met, thetimeliness of doing so fell short of expectations. The Project CompletionReport highlighted a number of areas where actions were still pending andwhere Government should concentrate its efforts to sustain and carry out fullythese actions. The most important of these are to establish an improvedpayment system for cuffee producers, and to complete the process ofrestructuring the Cotton Lint and Seed Marketing Board (CLSMB), divesting itof its ginning activities, and speeding up payments to farmers. The coffeepayment system was a condition of effectiveness of the Second CoffeeImprovement Project (now declared effectiv3), which also provides financingfor a revolving fund to allow the new payment system to be introduced. Therehas been significant progress on actions relating to the CLSMB, including thepassage of the Cotton Act by Parliament. The final steps are being monitoredunder the IDA-financed Cotton Processing and Marketing Project, which wasextended to finance supporting studies for implementing the Cotton Act.Progress on both coffee and cotton issues will continue to be monitored underASAO II.

43. In the light of experience with the first Operation, the proposedSecond Adjustment Operation aims at deepening the reforms in key areas, andbuilding more capacity for policy analysis, design and implementation. Thisdeepening of the reforms should ensure their being sustained in the longerterm, and leave behind the capacity for further advances as they are needed.The areas of emphasis are the right ones for making the policy environment asconducive as possible for agricultural growth based on the smallholder sector.Maize is the most important food and cash crop for further growth insmallholder incomes, and fertilizer remains the most critical input. Theactions remaining on budget content and process are few in number, anddifficult to implement, but critical for increasing efficiency of publicexpenditures in agriculture.

44. The uneven implementation performance under the first operationoffered important lessons for the second one, namely: the importance ofsecuring and sustaining Government commitment, at both political and technicallevels; the need to focus on a few strategic areas which are clearlymonitorable; including fewer specific conditions, achieved as early aspossible; general monitoring of the Letter of Sectoral Policy; improving theeffectiveness of coordination and implementation through a Steering Committeeof Permanent Secretaries; the need to explicitly strengthen linkages betweenthe policy framework and complementary investments and actions; the use ofASAO as a common framework for multi-donor support, and for encouragingGovernment. to focus its implementation efforts in priority areas. Theselessons have guided preparation of the proposed second operation.

Goals And Strategies In The Second Operation

45. The goals of the proposed operation are tot (a) accelerateagricultural growth through smallholders, while safeguarding the environment;

- 16 -

(b) contribute to fiscal stabilization; (c) improve public sector resource usein agriculture; (d) begin to assist lower income groups who are vulnerable toclimatic and economic shocks; and (e) improve agricu,tural sectorinstitutional capacity including capacity for environmentally protectivemanagement. Strategies to achieve these goals will: improve producerincentives, and increase market competitiveness; rationalize maize stocks,compatible with market needs; increase input supply, particularly fertilizer,and promote its efficient use; improve efficiency and composition of publicexpenditures; develop targeted measures to protect vulnerable groups; andstrengthen the institutiona! capacity in the agricultural sector to improvepolicy planning, project preparation and implementation. The proposedoperation addresses the major constraints on agriculture with the exception ofavailability of finance; the latter is expected to be improved as the reformsin the financial sector are implemented under an adjustment program explicitlytargeted to it.

46. Preparation of the Operation built on experience and momentum ofthe recently completed ASAO, on sector work (agricultural growth, foodsecurity and rural finance), on lessons from the MADIA study, and on thechallenges set by the Bank's Long Term Perspective Study. The operation, inaddition to financing imported inputs, will include a technical assistance andtraining component to sustain on-going and planned reforms.

Sector Reform Themes and Actions Under ASAO II

47. The operation aims at substantial advances in three policy areas,representing a deepening of reforms begun under the first operation, whilebeginning initiatives in two other areas. The operation will thereforesupport:

Deepening Reforms

(a) improving incentives for smallholder maize producersthrough prompt payments to farmers, and sustainingadequate producer prices through reduced marketingmargins; increasing the efficiency of maize marketingthrough removal of maize movement controls andachieving a higher degree of competitiveness; andreducing the budgetary burden of NCPB's operationsthrough consolidation of a new role for NCPB andreducing its operating costs;

(b) increasing fertilizer availability to small farmers,of the right type, in a timely fashion, at lower cost,and promoting transfer of more efficient andenvironmentally safe fertilizer use technology;

(c) improving the efficiency of public expenditures,through more rigorous criteria (includingenvironmental factors) for including projects in thepublic investment program, a better balance betweensalary and non-salary operating expenditures, andimproved budgetary operations;

- 17 -

New Initiatives

(d) promoting targeted programs to protect vulnerablelower-income groups, based on the Government'scompleted Food Security Paper and new initiatives todevelop preparedness for droughts;

(e) strengthening planning and management capacity inselected Ministries which deal with major subsectorissues, and undertake strategic studies which cutacross subsectors, or have macroeconomic andenvironmental implications.

Maize

Background

48. White maize is Kenya's staple food crop, providing 452 of thecountry's calories and 40Z of protein. It is the single most important farmcommodity in terms of area under crops (41Z of total) and value of production(22Z of total). It is grown by 90Z of the country's farmers, largely underrainfed conditions, and production can fluctuate widely (in the 1984185 cropyear, for example, production was 39? lower than the average of the previousthree years; with better rainfall in 1985186 it recovered to a level 41 abovethat average, leaping 702 in one year). Over an extended period (1963-1987)maize production is estimated to have increased, on average, by about 3.8? peryear, close to the rate of growth of population. In times of domesticshortages, imports of white maize are difficult to secure because of a limitedinternational trade, while the yellow maize which dominates internationalmarkets is considered by consumers to be an inferior foodstuff. thesedifficulties, which have led to a political aversion to relying on maizeimports, together with production variability and infrastructural bottlenecks,have been claimed to justify maintaining high domestic stocks of white maize.Government has used these reserve stocks as the main instrument in itsattempts to assure supplies in good times and bad, and to maintain reasonableprice stability throughout the country.

49. Around one half of the maize produced is for subsistence. In an"average" production year, some 40? of marketed quantities (202 of production)are procured by the National Cereals Board (NCPB), while the remaining 60? aretraded in the informal market. Until 1987, NCPB had a statutory monopoly,maintained in particular by very strict movement controls. As a consequenceNCPB dominated the market, exercising almost total control of the movement ofmaize from surplus production areas west of the Rift Valley, to the majordeficit consuming regions of Nairobi, Mombasa, and rural areas in the east.

50. While the above market dominance has been secured by statute forNCPB or its predecessors for at least fifty years, the system has becomeincteasingly untenable in recent years. Partly as a result of politicalpressures, it became increasingly difficult to ensure that official producerprices reflected the reality of maize production, and surpluses began to

- 18 -

develop with good weather in several successive years. In the absence of acompetitive trading environment, there was an uncontrolled expansion of NCPB'sstaff, and extension of its network of depots and storage facilities. Between1980 and 1987, for example, while the level of NCPB's maize purchases remainedapproximately the same, its staff increased threefold. With its operationsbecoming progressively more inefficient, the price it was paying for maizeincreasing, its stocks growing far beyond the levels required for its foodsecurity and price stabilization functions, and resultant forced export salesat prices substantially below purchase levels, NCPB's financial situation wasseverely eroded. At the same time, although private road transport and smallscale ('Poshol) maize millers were increasing, development of an efficientprivate trade was hindered by the tight net of controls in place to maintainNCPB's dominance. As a result, the economic benefits which can accrue to bothproducers and consumers from a well-functioning private market have not beenrealized.

51. In total, over the 1981-1987 period, NCPB operational deficitscost Kenya's exchequer R£200 million. In addition, cumulative debts of theBoard by late 1987 totalled KR287 million. It was estimated that without areorganization of both finances and management, the cost to Treasury of NCPB'soperations would continue to be more than KU120 million per year (US$102million at current exchange rates). These and other fiscal problems led theGovernment, in the context of the first Agricultural Sector AdjustmentOperation, to embark upon a Cereals Sector Reform Programme (CSRP), aimed atrestructuring NCPB's organization and finances over the period 1988-92. Thesedecisions, and the supporting studies on which they were based, were fosteredunder the first ASAO, and the program commenced with financial support fromthe European Community (EC) initially tor the first three years. There hasbeen close collaboration between the EC and IDA in developing details of theCSRP.

Achievements Prior To ASAO II

52. The major actions taken prior to ASAO II resulted from Cabinetdecisions in late 1987 to redefine NCPB's role in more narrow terms of foodsecurity and price stabilization, allow cooperatives and private tradersincreasingly to market maize, phase downwards progressively the percentage ofmillers' purchases from NCPB, raise the quantities of maize allowed to bemoved without permit across District boundaries from 2 bags to 10 bags, andwrite off NCPB's debts in the 1988/89 budget (US$330 million equivalent). Inthe course of agreeing on these changes, the Cabinet also decided to increaseNCPB's food security reserve to 6 million bags of maize and 0.5 million bagsof beans. During 1988 virtually all of NCPB's higher and middle levelmanagement was removed, a new organizational structure with greateraccountability was adopted, new managers were recruited, almost 70Z of theBoard's buying centers were closed, and the first phase of lowering (siftedmaize) millers' mandated purchases from NCPB was accomplished.

53. As shown by an evaluation report completed in July, 1990, NCPB'sshare of the primary market (maize purchases from farmers) fell from 30? ofproduction in 19s5186 to 20X in 1989/90, with comparable levels of production.Reducing this to less than 152 is an expected outcome of the ASAO II reformpackage. In the sifted maize miller's market, NCPB's share has fallen from1002 to 73Z over the same period. At the same time there has been a decrease

- 19 -

in the variations in maize prices among and within Provinces, and amongvarious seasons of the year. Average open market maize prices have movedincreasingly into place between the producer and consumer prices officiallyset by Government.

Further Steps Under ASAO II

54. The goal of the grain market reforms is for private merchants tobe managing all domestic trade, with prices de-regulated. The well-functioning private trade envisaged would assure the country's food security,and achieve a good measure of price stabilization through its own operations.Private traders would manage both primary and secondary markets, moving grainfrom farmer to mill, and from mill to consumer. This complete privatizationis, however, some distance off in Kenya, and because of infrastructural andpolitical constraints, can be reached only in stages. In this phasedapproach, the intermediate goal is for the private sector to manage alldomestic trade except those transactions which Government deems necessary tosafeguard the country's food security and achieve a reasonable degree of pricestabilization, and to achieve prompt payments to farmers. NCPB will continueto be Government's agent for carrying out the food security and stabilizationfunctions; its goal in doing so will be maximum efficiency. Its role in themedium term will be as buyer and seller of last resort, maintaining floorprices for producers and ceiling prices for consumers, while turning over itsfood security stocks as efficiently as possible. It is envisaged that publicsector stabilization activities will diminish over time.

55. The measures in ASAO II are designed to achieve a major expansionof private trade in both primary and secondary markets, and NCPB's transitionto an efficient role in food security and price stabilization. The measuresfor market liberalization include: discontinuing NCPB operations in numerous(loss-making) minor crops now on its scheduled list, along with beans (theminor crops have been de-scheduled, and beans are to be de-scheduled prior tosecond tranche release); in the secondary market, a phased drawdown in theproportion of their purchases which sifted maize millers must procure fromNCPB to a level around 60? (condition of second tranche release); and removalof maize movement controls. The latter will be achieved in three steps: theGovernment recently increased the amount which can be transported without apermit to 4 tons (45 bags); it will raise this to 8 tons (90 bags) by the endof 1991 (condition of second tranche release), and agree with IDA a dateduring 1992 when removal of movement controls would be completed (thisagreement would be a condition of second tranche release).

56. Performance Contract. The framework for raising NCPB's efficiencyis established in a Performance Contract (PC) with Treasury and the Ministryof Supplies and Marketing, which has been finalized for a first three yearperiod. The PC incorporated Government's policy statement on maize, NCPB'srole and responsibilities in regard to maize handling, the principlesgoverning budgetary support to NCPB, and the detailed accounting conventionsand formulae to be used to assess the full costs of maintaining mandatoryminimum reserve stocks of maize; the PC constitutes a binding commitment fromTreasury that these costs will be met in full from public budget allocations.The agreement also specifies actions to which NCPB has committed itself toincrease its efficiency, including closing down redundant buying centers anddepots, reducing staff, and lowering transport and handling costs. The PC

- 20 -

will reflect the results of a rolling financial plan, and will be signed eachyear; the second such signing will be for second tranche release. NCPB willprepare a detailed operational plan to implement the PC. The PC will bereviewed semi-annually, and the results fed back into NCPB's operationalplanning process. In preparation of the PC, key decisions have been takenabout reserve stock levels and management, targets for secondary marketliberalization, efficiency criteria in turning over reserve stocks, andtargets for staff reductions and depot rationalization. The adequacy ofprogress in these areas were, and will continue to be, the criteria forjudging acceptability of the PC. The framework of the PC is in Annex III.

57. The measures planned take into account the serious practicalconstraints under which the reform program must progress, among them thestrict budgetary guidelines agreed with the IMF under its ESAP, and politicalopposition to the reforms. In order to make the progress required over thenext two to three years, NCPB needs to increase its efficiency rapidly, whilealso shedding quickly a substantial proportion of its enormous maize stocks.This involves short term book losses since stocks purchased at prices close toimport parity are being exported at significantly lower prices. These lossesadd to the budgetary burden in the short term. Furthermore, a crucial stepfor enhancing efficiency will be staff reductions which are politicallydifficult in an atmosphere of increasing concern about unemployment.

58. To address these concerns, the operation contains provisions whichwill assist with the transition. Among these are improvements in the maizepricing methodology which will link price setting explicitly to the budgetaryimpact of NCPB's turnover of reserve stocks at gazetted prices; this has beenintroduced into the 1990191 price review, and will be further refined forsecond tranche release. Furthermore, the operation provides for acceptableimprovements in monitoring of maize flows to sifted maize millers. Theofficial stock level itself is being re-examined, and steps taken to makestock management as flexible and cost-effective as possible. Improvementshere, and in the management of NCPB's operations, will minimize budgetaryoutlays for NCPB, and give Government confidence to expand further the role ofprivate traders, especially in the secondary markets to which currently theystill have limited access. An efficient NCPB also will be less threatened byremoval of maize movement controls.

59. The above measures will be reinforced by support from USAID andthe EC, respectively for private sector grain trade development, and forestablishing NCPB on a sound financial footing, able to realize efficientlyits revised role in the grain trade. Under its Kenya Market DevelopmentProgram, USAID has agreed to provide US$15 million in dollar grants and US$40million worth of PL480 Food for Progress food aid, in support of policyreforms, technical assistance, and a program of rehabilitating and maintaining1500 km of selected rural roads important for grain marketing. Under itsCereal Sector Reform Program, the EC committed ECU 72 million for the period1988-91, part of which was in the form of agricultural sector imports, withcounterpart funds used to finance crop purchase by NCPB; the program has alsosupported studies, and the implementation of NCPB's financial andorganizational restructuring. It is likely that the CSRP will be extended fora further period beyond 1991, in support of the next phase of NCPB'srestructuring and modernization.

- 21 -

Fertilizert.Background

60. Government recognizes that future growth in agriculture would haveto rely overwhelmingly on improved crop yields. The strategy of yieldenhancement critically depends upon increased and more efficient use offertilizer in the country. To achieve an agricultural growth rate of over 4?per year, fertilizer consumption must increase at an estimated rate of ll peryear, close to double the rate achieved during the period 1974-1987. Lately,fertilizer consumption has been stagnating at an annual growth rate of lessthan 1 and the current fertilizer usage in agriculture is no more than 37Z ofthe estimated potential. One reason for this has been adverse pricedevelopments for tea and coffee during the past two years. A more fundamentalreason, however, is that whereas most of the estates and large farms usefertilizer, and many close to recommended levels, the 2.7 millionsmallholders, who cultivate 66? of the cropped area, and are expected tocontribute up to 852 of incremental production until the year 2000, either donot use fert4 lizers at all (74?), or use much lower than recommended doses.Much of the fertilizer (67X) used by smallholders goes to cash crops. Lowfertilizer usage by small farmers largely explains why their average cropyield levels are about one half of those obtained by large farmers; and it ishere that the maximum potential for crop intensification and yieldmaximization lies. 'While the average consumption of fertilizer nutrients perhectare of arable land is higher in Kenya than is most other Africancountries, it is below the average for the whole of South Asia, and far belowlevels attained in China.

61. Access to fertilizers is a major issue for cereal producingsmallholders who need only a bag or two of fertilizer each but for whom theretail network to satisfy this need is almost non-existent. The production ofcash crops by estates or even smallholders is backed by institutional inputsupply arrangements. For instance, the Kenya Tea Development Authority (KTDA)imports and supplies tea-specific fertilizers to smallholder tea growers.Similarly the relatively fewer large farms producing cereal crops are servicedby private trade without the latter having to make significant investment inthe development of a dealer net-work. The lack of investment in, and poorgrowth of the fertilizer supply network in smallholder areas is attributed tothe uncertainty and lack of profitability resulting from small turnovers andthe Government's tight control over fertilizer importation, distribution andretail prices in the late seventies and through the eighties.

62. The situation became more complex in the eighties due to theprogressive increase of *in kind" fertilizer aid by various donors, whicheventually reduced commercial (mostly private sector) imports to less than 50?of annual requirements. Increased Government control of the fertilizersub-sector discouraged commercial imports, and highlighted the currentinadequacies of the fertilizer-related institutional structures andcoordination arrangements. For example, while MOA allocated commercialfertilizer import quotas to interested fertiliz-r distributors, the Ministryof Finance in a parallel exercise allocated quotas for donor fertilizers fromthe port in Mombasa, or the store in Nakuru. In both cases, the criteria forallocations lacked transparency. As a consequence, private traders operatedin an environment of uncertainty characterized by serious government delays(in fertilizer allocation as well as in price announcements), and inadequate

- 22 -

incentives to invest in fertilizer market development. Furthermore,infrastructural inadequacies, such as absence of soil-testing facilities inthe countryside, led to instances of fertilizer types being used which tend toacidify the soils over time.

Achievements Prior To ASAO II

63. Under ASAO I, Government adopted an improved pricing formula fordomestic marketing of fertilizers, increased the number of private importersand distributors, promoted the use of smaller fertilizer bags, and afterprolonged deliberation, prepared and approved (June, 1989) a fertilizer policypaper which provides a sound framework for further reform in the sector. Morerecently, consistent with its long-term objective in the approved policypaper, Government announced, ahead of schedule, decontrol of fertilizer pricesin the domestic market, which IDA has been advocating as a central plank ofthe continuing adjustment process.

Further Steps Under ASAO II

64. Under ASAO II, three further constraints are being addressed.First, the fertilizer import licensing and MOA's quantity allocationprocedures, apart from being vexatious and time consuming, have created anuncertain environment for private trade and inhibited investment in fertilizermarket development. Second, lack of current information on demand and supplyof fertilizers in Kenya has discouraged import of full requirements. Theestablishment of an institutional framework for free flow of information andregular consultation between Government and the private sector, at thedistrict and national level, will result in better assessment of the demandand supply situation, identifying constraints, and establishing andmaintaining an appropriate incentive framework for expanding fertilizer use.Third, major institutional inadequacies in the management of the fertilizersector are being addressed to induce the development of a private sectordistribution network. The measures include: unification of fertilizer importand allocation functions (for donor fertilizers) in MOA, with Treasuryproviding only liaison with donors; steps to commercialize aid-fertilizers andreduce dependence on in-kind donations; substantial strengthening of theformer Inputs Unit in MOA; developing a suitable data base for monitoring thefertilizer subsector; designating subject matter specialists (SMSs) in Soiland Fertilizers at district levels; and developing district action plans forfertilizer promotion, soil testing and training with the active participationof the private sector.

65. A continuing and comprehensive dialogue with the Government,private fertilizer trade and fertilizer related institutions has resulted inconsiderable progress towards the goal of complete liberalization of thefertilizer subsector. This are summarized below.

(a) Pricing and Subsidies: There are no fertilizer subsidies inKenya, and fertilizer prices were decontrolled in January, 1990;

(b) Fertilizer Imports: (i) Commercial Imports: Government haseliminated the import quota allocation system for commercialimports. While this has the effect of moving fertilizer fromSchedule II to Schedule I in the Import Licensing Schedules,

- 23 -

Government will officially confirm this change of Schedules at thetime of the next annual revision (about May, 1991). Terms ofreference have been finalized for a study of ways for the privatesector to improve its capacity for efficiently importingfertilizers at the most economical prices. Government willcomplete the study, and review the findings with IDA before secondtranche release. (ii) Donor Fertilizers: In order to minimize thedistortions caused by "in-kind' fertilizer aid, Government hascommenced preparation of an issues paper which will be discussedwith IDA and principal donors in early 1991 (its finalization, andan exchange of views with IDA on proposed measures, is a conditionof second tranche release).

(c) Consultative Process with the Private Sector: To enhanceGovernment awareness of the real constraints impeding fertilizeruse (particularly amongst smallholders), and to support realisticprograms of fertilizer promotion involving farmers, privatetraders and government, a well structured periodical consultativeprocess among the private sector, cooperatives and the Governmenthas been established at the district and the national level. Atthe national level a Fertilizer Development Committee has beenconstituted under the chairmanship of the Permanent Secretary,MOA; its membership includes leading private fertilizerimporters/distributors, representatives of the Kenya NationalFertilizer Association (KNFA) and KGGCU, and representatives ofthe concerned ministries. At the district level, DistrictFertilizer Committees have been constituted as sub-committees ofthe District Agricultural Committees, with strong private andcooperative sector and farmer participation.

(d) Institutional Strengthening: The MOA has taken, or agreed totake a number of actions to strengthen the institutional base forthe fertilizer subsector. First, the Inputs Unit in MOA has beenupgraded in status to a Branch, moved to be under the Director ofAgriculture, and its staff complement increased. Second, a database for this Unit has been agreed and data collection hascommenced. Third, subject matter specialists in soils andfertilizers have been assigned in each district and province topromote more efficient and environmentally safe fertilizer use.Fourth, the KNFA representing fertilizer importers/distributorswill be involved in the consultative process at the nationallevel. Fifth, Government will undertake measures to improve soiltesting services for the farmers to strengthen the scientific basefor fertilizer use.

(e) District Action Plans: the MOA has developed guidelines forpreparation of district action plans, in consultation with theprivate sector, for fertilizer promotion, soil testing and thetraining of fertilizer retailers, extension personnel and selectedfarmers to identify district specific constraints; action planshave been prepared for five districts, and will be prepared forall major fertilizer consuming districts as a condition of secondtranche release.

- 24 -

Public Expenditures In Agriculture

Background

66. The public investment and expenditure program in the ministries ofagriculture and livestock is characterized by a large number of projects withlow or uncertain viability; a worsening imbalance between salary and non-salary operating (O&M) costs; low or negligible cost recovery; severeshortfalls and delays in budgetary releases; and a weak institutional capacityfor monitoring project implementation performance. Currently the developmentbudgets of the two agricultural ministries contain about 130 projects, with anannual budget outlay of about US$ 64.0 million. Of this amount almost 85Zrepresents donor financing. The relatively high degree of external financingfor development projects, particularly through grants, tends to soften therigor of project selection. More importantly, the excessive number anddispersion of projects taxes heavily the ministries' limited implementationcapacity, and generates considerable recurrent cost demands eventually borneby GOK. The existing budget and project monitoring systems in the twoministries continues to be extremely weak, so that even when the overallproject parameters change significantly, resources continue to be expended inaccordance with original projections.

67. The net result of the foregoing has been a thin spread of localresources over a large, under-funded project portfolio, with particularly lowbudget utilization rates for donor assisted projects. Furthermore, theeffectiveness of critical agricultural support services and staff productivityis being seriously affected by the imbalance in salary and supporting O&Mresources in both ministries. The share of recurrent expenditures absorbed bysalaries and allowances in the two main agriculture ministries was a high 72percent in FY90. Despite the fact that the Treasury has tried to introduce ahiring freeze over the past two years salary ceilings have been regularlyexceeded and recruitment has continued to grow. The excessive intake in theagricultural training institutes and the lax enforcement of public sectoremployment policies have been major constraints in meeting the budgetrationalization objectives of the agricultural reform program.

Achievements Prior To ASAO II

68. To improve the management of public sector resources theGovernment began implementing, in 1986, a budget rationalization program inagriculture, supported by ASAO I. Some of the measures taken already by MOAand MOLD are: (a) establishment of a forward budget and expenditure planningprocess indicating priorities in resource allocation within a ministry; (b) aproject registry as the basis for improved project selection and monitoring;and (c) creation of Budget and Project Secretariats to ensure the timelypreparation of budget estimates and expenditure returns. While bothministries have made significant progress in building up institutionalcapacity to address the underlying budgetary problems, implementation of thespecific budget rationalization measures lagged and in many cases reforms havenot been completed.

Further Steps Under ASAO II

69. Under ASAO II the major areas of further reform are to:

- 25 -

(a) improve the structure and quality of the investment programs byreviewing the existing project portfolio and all future projects on thebasis of new economic and environmental project selection criteria. Aspart of ASAO II, a comprehensive review of the existing projectportfolios has been initiated, and in the 1991192-1993194 (PY92-FY94)Forward Budget the MOA has excluded about 10 of its projects, which itjudged to have lower priority. Similarly, the MOLD has consolidated itsproject list to a more manageable level of 47 compared to 60 projects ithad in the 1989190 development budget. Furthermore, a 'core investmentprogram, for both ministries has been agreed with IDA for full fundingin the 1991/92 budget. As a condition of second tranche release a 'coreinvestment program of priority projects will be agreed with IDA andincluded in the 1992/93 - 1994195 Forward Budget.

(b) enhance the operational efficiency of existing agricultural andlivestock support programs by: raising the ratio of O&M to salaryoperating expenditures, identifying areas for privatization of services,and more efficient deployment of existing staff. Based on a recentlycompleted review of recurrent cost issues, the Treasury has made acommutment to inject additional non-wage resources to support the1991192 and 1992/93 recurrent budgets of the two ministries. TheGovernment has also taken a decision to privatize some key livestockservices (cattle dipping and clinical veterinary services), which wouldhelp reduce salary and other overhead expenditures. As a condition ofsecond tranche release an action program for revising user costs andidentifying further areas for privatization of services will be agreed.To ensure a more efficient deployment of existing staff both ministrieshave completed a staff count, and reconciled this with the complementregister. Furthermore, work has been initiated on the development ofstaffing norms for key services and consequential adjustments in theintake into training institutions. Before release of the secondtranche, Government will adopt an action plan to use the revisedstaffing norms in its operations; and

(c) improve budgeting, and expenditure control systems: by developingbudget cost centers to monitor effectively the entire expenditure(development and recurrent) for all major programs or projects;streamlining the cash flow releases from the Treasury to theimplementing ministries and from there to the project entities; andestablishing improved expenditure control systems at the project/programimplementation and central level. The foregoing objectives will beachieved through implementation of the ASAO II technical assistanceprogram to strengthen the budget management and expenditure controlsystems in both ministries. A review of performance during 1991, andexchange of views with IDA on the findings of the review, will be acondition of second tranche release.

Steps Toward Assisting Vulnerable Groups

Background

70. Kenya has achieved creditable growth during the 1980s, both inagriculture and in the general economy, without which the magnitudes of

- 26 -

poverty and food insecurity would be greater than they are today.Nevertheless, since growth has not been fast enough to keep ahead of the veryrapid increase in population, it has not improved the extremely low standardof living experienced by a significant proportion of rural households. Thesecontinuing low incomes, especially in rural areas, are one of the root causesof the very significant level of the country's chronic food poverty, which isshown bys

- an estimate that more than 1.25 million children under five yearsof age are stunted, as a result of undernourishment over anextended period, especially during the first two years of life;

- an estimate that more than 202 of rural households, containingmore than 3 million persons, do not have enough income to securefor themselves a minimum nutritional diet;

- indications that food availability per capita has declined,reflecting diminished purchasing power on the part of lowerincome households.

71. In the absence of sustained growth in the incomes of those in thepoorest groups of households, these problems are capable only of partial andshort term solution. The main sources of such income growth will be increasedagricultural production from smallholders, and productive employmentopportunities outside agriculture, especially in rural areas, which willgradually reduce the proportion of the labor force engaged in agriculture.Consolidating the policy framework for such growth is the major aim of theproposed Second Adjustment Operation. Within the context of such economic andagricultural growth, however, there is a need for specific interventions toassist those who are most susceptible to economic distress, arising from thereform program itself, or from other physical or economic shocks. Some ofthese specific interventions require further study to firm up details.

72. While the aim of grain marketing liberalization measures is toraise farmers' incomes, some groups may be adversely affected, particularly inmarginal areas, and during the transition period. After identifying any suchgroups, targeted interventions, such as food subsidies, rationing, or othermeans of direct income maintenance should be designed to address their povertymore directly. The Government also needs to expand its program of publicworks, especially in high potential rural areas. This would accelerate theprovision of needed infrastructure (and its maintenance) in support of growthin these areas, and provide new income earning opportunities for the ruralpoor. Such a program could be financed by a combination of food and financialaid.

73. Several other measures are needed to round out a plan forimproving food security. As the Food and Nutrition Study recently completedby the Bank confirms, measures to raise incomes, while necessary. may not besufficient to bring about improvements in the situation of those sufferingfrom undernutrition. Measures to improve the efficiency and coverage ofhealth services are required, as well as nutrition education and targetedfeeding programs, though details of these programs remain to be worked out.Analysis of experience with the drought which Kenya experienced in 1984 showsthat valuable time could be bought for responding to such an event, and the

- 27 -

effectiveness of the responses substantially increased, by having in place acontingency plan for drought which included a better early warning system.

Achievements Prior To ASAO II

74. Under the first adjustment operation, Government began preparing aFood Security Paper, which has now been completed following discussion amongseveral ministries. This paper addresses the issues described here;developing an action plan from its recommendations should be a matter ofpriority.

Further Steps Under ASAO II

75. Under ASAO II, the major steps to be taken includet (a) completinga Food Security Action Plan, which would include proposals for institutionalchange, nutrition interventions, marketing measures, and data needs; adoptingsuch a plan, and beginning to implement it will be a condition of secondtranche release; (b) preparing a plan for Drought Contingency and EarlyWarning (including procedures for assessing drought severity, population atrisk, food import needs, transport capacity, public employment programs, NGOcoordination, and release of stored foodt with proposals for improved weatherforecasts and crop estimating techniques); adopting such a plan, andestablishing the institutions and procedures necessary for its implementationwill be a condition of second tranche release; and (c) monitoring the impactof adjustment on vulnerable groups, and targeting assistance to them,especially any losers from the transitional phase of grain marketing reforms;adopting an action plan to address any adverse effects on vulnerable groups ofthe marketinRg reforms, completing a baseline survey, and implementing anongoing household survey to monitor the effects of economic reform programs onvulnerable groups will be conditions of second tranche release.

Capacity Building in Agriculture

76. Inadequate institutional capacity for policy formulation andsector management is widely recognized as a serious problem. The ongoingAgricultural Sector Management Project has provided support for training andtechnical assistance to policy making and management groups in several sectorministries and related agencies/parastatals. Among them were the DevelopmentPlanning Divisions of MOA and MOLD, and budgetary procedures were streamlinedunder a Budget Rationalization Program (BRP). While significant progress wasachieved in initial stages to develop institutional mechanisms, implementationof the BRP has lagged in more recent years. The Project Management System hasnot functioned, so that there is no real review of public investment programs.Progress in building analytical and management capacity has been hampered bydeterioration of the database, cuts in technical assistance, and high turnoverof trained staff, who have left for the private sector.

77. Agricultural sector management is also made difficult byfragmentation of responsibilities, lack of coordination, and inadequate

- 28 -

agricultural data. Nine 1/ ministries now share sector management, withnone responsible for overall planning or for performance of the sector as awhole. As a result, public interventions often involve multiple ministrieswith overlapping functions, and functional lines are poorly drawn. Governmentis aware of the issue, and is seeking ways to address it.

78. To address the problem of inter-ministry coordination, theMinistry of Finance established a steering committee under the chairmanshipof the Permanent Secretary during the implementation of ASAO I to guide andoversee implementation. This committee has also guided preparation of theproposed operation. It will assume responsibility for overseeing andorchestrating ASAO II. For detailed monitoring it will depend on theDevelopment Planning Divisions of MOA and MOLD, and the Policy Analysis andMonitoring Unit of the Ministry of Planning and National Development (MPND).The IDA supported Rural Services Design Project is strengthening the capacityof MPND, in close collaboration with participating Ministries, to monitor thesector reform program and evaluate its impact.

Further Steps Under ASAO It

79. The proposed operation will be used as a vehicle for strengtheningsector planning and management capacity in four areas: (a) policy analysis andstudies; (b) land policy and administration; (c) management of the publicinvestment portfolio in agriculture, together with budget and expenditurecontrol; and (d) the fertilizer sector. An extensive training program,provision for technical assistance, and upgrading of staff and technicalfacilities, will be undertaken in all four areas. The policy analysiscomponent will be implemented in selected ministries which deal with majorsubsector issues and handle strategic studies which cut across subsectors andhave macroeconomic or environmental implications. It will also strengthen theprocess for setting agricultural prices, NCPB/cereal sector planning,environmental, natural resource conservation and land use planning. Thesecond component will improve land administration, valuation, registration,titling, and land information systems. The third component will develop linksbetween planning divisions of MOA and MOLD and other departments within eachministry, improve data availability, and enhance project appraisal/analysismethods and annual and mid-term reviews of public investment programs. Thefourth component will, among other things, improve data collection onfertilizer matters, strengthen the flow of information of information andanalysis, and lead to better estimation of demand. Terms of reference for thetechnical assistance proposed have been agreed between the Government and IDA.

80. The policy analysis component will be coordinated by a unit in theMinistry of Planning and National Development. A training institution, usinglocal advisers to the extent possible, will be engaged to plan trainingcourses in Kenya for policy analysis staff, design arrangements for improvingdata collection, and implement the technical assistance and training in theMinistries of Finance, Agriculture, Livestock Development, and Supplies and

I/ Agriculture; Livestock Development; Cooperative Development; Supplies andMarketing; Environment and Natural Resources (including Forestry); Reclamationand Development of Arid and Semi Arid Areas and Wastelands; Research, Scienceand Technology; Lands and Housing; and Regional Development.

- 29 -

Marketing. The component will provide funds for limited in-service degreetraining both in Kenya and outside, as well as for computers and otherequipment for improving data collection and analysis. The cost of thiscomponent is estimated to be US$3.8 million, spread over four years.

81. The land policy and administration component will be implementedby the Department of Lands of the Ministry of Lands, Housing, and PhysicalPlanning. It will comprise short term, non-degree, and in-country trainingfor the Department's staff in both headquarters and districts, technicalassistance to help with the training program and to develop an action plan forimproving land policy and administration, and equipment in support of theaction plan. The Credit will provide about US$0.3 million as an initial timeslice of a larger program.

82. The public expenditure component will be implemented in theMinistries of Agriculture and Livestock Development. It will comprisestrengthening of the Project Development and Monitoring Division (PDMD) in theMOA, and the Project Management Unit (PMU) iu the MOLD, as well as theaccounting functions in both ministries. The PDMD will be reorganized,expanded in size and in reach, with the appointment of staff to the Provinces.These field staff will upgrade the flow of information from projects underimplementation, and the capacity will be increased for analysis of thisinformation both in the field and at HQ. A similar process will take placefor the PMU, whose staff establishment will be expanded significantly.Accounting functions will be improved by training clerical staff in Districtoffices to enable holders of Authority to Tncur Expenditures (ATEs) to achievetimely submission of reliable monthly expenditure returns. The component willsupport improvements in data coding and computer hardware and software toenhance District reporting. At HQ, the accounting divisions in the twoministries will replace manual accounting processes with computerized systems,and standard procedures for carrying out various operations, such as advancedeposit accounts, will be upgraded. Training for staff in the finance,accounting and supplies divisions will be supported. The component isestimated to cost US$3 million, spread over four years.

83. In the fertilizer sector, training will be supported for HQ staffof the new Inputs Branch of the MOA (in fertilizer policies, marketing andtechnology, and data processing); District extension staff (workshops onfertilizer technology and appropriate extension packages), farmers (two dayworkshops at Farmer Training Centers), dealers (short courses for senior staffof suppliers, District level workshops for stockists covering especiallymanagement and accounting, and national seminars), soil analysis (graduatefellowships in soil science, post graduate courses in soil analysistechniques, and local courses for laboratory technicians), and subsectorleaders. Short term consultancies will be financed to assist with specifictasks for which in-house expertise is lacking. Among others, this is likelyto include developing a training program, designing data collection andprocessing, specifying fertilizer standards, designing quality controlmeasures and regulations, studying the nutrient status of soils, andelaborating guidelines for operating soil testing laboratories, developingDistrict action plans and reviewing the fertilizer program at mid-term. Thecomponent is estimated to cost US$2.7 million, spread over four years.

- 30 -

Letter of Sectoral Policy

84. While the conditionality of the proposed operation concentrates onthe areas outlined above (as a result of lessons learned from the firstOperation about focusing on fewer areas), the Government's Letter of SectoralPolicy (attached) provides a more comprehensive overview of ongoing andfor hcoming sector reforms. The Letter reflects progress made in studiesunder way on the dairy sector, which will lead to restructuring the dairyindustry, with a new role for Kenya Cooperative Creameries (KCC), increasedparticipation by private traders and cooperatives in milk collection,processing and marketing, and improved pricing arrangements which will lead inthe direction of de-regulation. The Letter also covers Government'sinitiatives in the areas of natural resource management, particularly relatedto arid and semi-arid land, wildlife and forestry, besides dealing with thedirection of reforms in land policy and legislation. In addition, the Letterdescribes commitments for an improved coffee payment system throughcooperatives (which is receiving financial support from IDA under the SecondCoffee Improvement Project), the improved cotton pricing and payment systemassociated with divestiture of the Cotton Lint and Seed Marketing Board(CLSMB), and Government's objectives in the sugar subsector.

Ownership and Commitment

85. During preparation, a sectoral ministry was identified as the leadGovernment agency for each specific reform area. This helped to create*ownership, in the agency nominated for leadership. This leadership role willbe built upon during project execution, through intensive supe.vision andimplementation assistance by Bank staff in the Resident Mission.

86. Broad support to the reform program has also been obtained fromdonors, again working with specific donors for specific reforms (e.g. the ECand USAID for maize, USAID for fertilizer, and DANIDA for dairying).Preparation also involved discussions with private sector and cooperativefertilizer importers and distributors, as well as private sector maize tradersand millers. A constituency for the major elements of the reform program hasthus developed outside Government.

PART III. THE PROPOSED CREDIT

A. BACKGROUND

87. When the first agricultural sector adjustment operation wascompleted in 1988, IDA carried out five related studies in preparation for thenext phase. First, the Project Completion Report (August, 1989) on the firstoperation outlined lessons of that experience upon which the second operationwould draw. Second, a Project Performance Audit Re?ort by OED was issued onAugust 22, 1990. Third, under its sector work program, studies were completedby IDA on Agricultural Growth Prospects (March, 1990), Rural Finance (January,1990), and Food and Nutrition Policy (January, 1990). At the same time, theGovernment was preparing its own study on Household Food Security andNutrition Policy (prepared in draft by June, 1988, and released September,1990). At Government's request, preparation of the second adjustmentoperation began during FY89, and various studies were undertaken subsequently

- 31 -

of particular aspects of cereal sector reforms, fertilizer development and thepublic sector investment program. In November, 1989 a joint Government-IDAworkshop was held, attended by Permanent Secretaries and key officials oftwelve ministries, in which the components of the proposed operation werediscussed in depth. An IDA mission to appraise the proposed Credit began inlate June, 1990, and negotiations took place in Washington in November, 1990.Supplementary data on processing of the Credit are in Annex II.

B. RATIONALE FOR IDA INVOLVEMENT

88. Deepening economic adjustment is critical if Kenya is to achievethe growth targets Government has set for the country, as described in theSection above on Country Assistance Strategy. Because of its role inleadership and coordination, and its ability to link macroeconomic concernswith project investment initiatives, IDA has a comparative advantage among thedonors in supporting adjustment, and has been doing so across the board in thesecond half of the 19809. IDA is well placed to reinforce the domestic forceswhich advocate the sectoral reforms, and to continue to promote theGovernment's ownership of the reform programs which are advocated by donors.The Bank's and IDA's share of Kenya's total debt is such that IDA mustcontinue to have a comprehensive policy dialogue with the country'sauthorities. The adjustment measures being undertaken are designed to raisethe productivity of private sector investments in smallholder agriculture,grain marketing and input supply, while also increasing the rate of returnfrom the public sector investment program in agriculture. IDA's support foradjustment thus provides an umbrella for both its own investment projects andthose of all the other donors.

C. USE OF THE PROCEEDS

89. It is proposed that the IDA Credit of US$75 million will beallocated as followss

Indicative Amount(US$ million)

Agricultural Imports 67 (89Z)Sectoral Management Support 8 (112)

Total 75 (1002)

90. The component for agricultural imports is estimated to contribute2.9Z towards external financing requirements estimated at US$2,315 millionduring the 1991-1992 period (Annex IV, Table 1). It comprises approximately2.52 of projected imports for 1991 and 1992, and 7.92 of the projected publicsector deficit for the same two years. Foreign exchange will be sold at theexchange rate prevailing at the time of allocation (the Kenya Shilling ispegged to a basket of currencies of the country's main trading partners, andfluctuates against individual currencies). Imports eligible for financingfrom the Credit include (with indicative amounts in brackets): fertilizers(US$25 m); agricultural chemicals and seeds (US$10 m); agricultural machinery,equipment, and spare parts (US$20 m); veterinary supplies (US$2 m); and

- 32 -

petroleum products (US$10 m). The amount allocated for financing imports ofpetroleum products reflects increased costs of fuel imports in view of therecent crisis in the Gulf, and a list of agricultural chemicals eligible forfinancing was agreed at negotiations. With respect to pesticides, only thoseagreed by IDA as suitable for use under the conditions prevailing in Kenyawill be permitted to be purchased with credit provided through the Operation.

91. The first ASAO was cofinanced by the EC, the Saudi Fund, and theGovernments of Japan, the Netherlands, the Federal Republic of Germany, andDenmark, providing in all US$155 million equivalent on soft terms or as grantsin addition to the IDA funding. A significant proportion of these funds wasmobilized during Implementation of the operation. It is anticipated thatseveral other donors will participate in financing the proposed operation,among them the African Development Bank (ADB), the Federal Republic of Germany(KfW), the United Kingdom (ODA), the Netherlands, and Japan (OECF). Totalcofinancing is currently expected to be in the vicinity of US$100 millionequivalent. The African Development Bank will also participate in financingthe capacity building component. In general, conditions of disbursements forfunds from these donors will be similar to those outlined above for the IDACredit.

92. Procurement procedures have been designed to permit rapid use ofthe funds while ensuring efficiency and accountability in the process.Imports by Government and the private sector will follow internationalc spetitive bidding for amounts exceeding US$2 million equivalent. Foramounts below US$2 million: (a) Government will follow public procurementprocedures, which have been reviewed and are acceptable to IDA; they wouldseek three price quotations, a procedure generally followed in Kenya; and (b)private sector purchases would follow established commercial practices;wherever possible, quotations from eligible suppliers from at least twocountries would be sought. Direct contracting (single source purchase) wouldbe allowed only for proprietary equipment or where the need for compatibilitywith existing equipment calls for standardization. Expert agencies alreadycarry out pre-shipment inspection to certify goods in respect of quality,quantity and price; continu& n of this service would be ensured for thisSector Adjustment Operation. Consultants for sector management support (US$8million) would be recruited in accordance with IDA guidelines for theemployment and use of consultants.

93. Disbursements. That part of the Credit allocated to suppoitSector Management (US$8 million) will become available at CreditEffectiveness, and is expected to be disbursed over a four year period. Thecomponent allocated for imports will be released in two tranches, each ofUS$33.5 million. The first tranche will be released upon credit effectiveness(expected about March, 1991), and the second upon fulfillment of agreedconditions listed in Annexes I and I1, and in Schedule 3 of the DevelopmentCredit Agreement. The second tranche is expected to be released about 12months after the first tranche. Project disbursements are estimated at US$34million in FY91, US$36 million in FY92, US$2.5 million in FY93, and US$2.5million in FY94. The closing date is December 31, 1995.

94. The proceeds of the proposed credit (US$ 75 million in total) willbe used for financing agricultural imports and fuel, and for sectoralmanagement support as detailed. These will be reimbursed at 100 percent of

- 33 -

their CIF cost. Provision has been made for retroactive financing ofexpenditures on imports incurred up to four months prior to signing of theCredit, for an aggregate amount not exceeding US$13 million.

95. To facilitate disbursement, assurances were obtained from theGovernment that two special accounts will be established in the name of theCentral Bank of Kenya in a corresponding off-shore commercial bank. At crediteffectiveness, an initial deposit of US$5 million will be made into theaccount for the quick disbursing component, and US$0.5 million into theaccount for the capac'ty building component. The quick disbursing accountwill be replenished regularly up to the limit of the first tranche.Replenishment will be made on the basis of fully documented reimbursementapplications, except for expenditures under US$100,000, which will be on thebasis of statements of expenditure (SOEs). The Central Bank will forwarddocumentation to the External Resources Department of Treasury, which will beresponsible for maintaining accounts and preparing withdrawal applications;the SOEs will indicate the nature and origin of the goods, as well as thepayment date, and Treasury will maintain all relevant supporting documentation(invoices, customs declarations and evidence of payment) for review bysupervision missions. Expenditures covered by the IDA credit will be inaccordance with normal IDA rules. The Central Bank will receive interest andbear the foreign exchange risk on its own account. Payments from the accountnevertheless will be made only on the instructions of the Foreign ExchangeAllocation Committee.

96. The Treasury's External Resources Department will keep theOperation accounts, which will comprise: a record of drawings on the Creditwith copies of all disbursement requests and underlying documentation; arecord of transactions on the Special Account and copies of the Central Bankstatements of these accounts; and a record of transactions on the counterpartfund accounts and documentation relating to these transactions. These recordswill be updated on a daily basis; monthly statements of transactions andbalances together with necessary recommendations (e.g. disbursement claims inprocess) will be prepared and forwarded to IDA. The External ResourcesDepartment will arrange for an annual audit by auditors acceptable to IDAwithin twelve months after credit effectiveness and annually thereafter. Theaccounts and auditor's report will be submitted to IDA not less than sixmonths following the end of the financial year. The auditor's report willinclude an opinion on the operation of the Special Account and a separatespecific reference to the use of SOEs. Assurances on the above arrangementsfor accounts and audit were obtained at negotiations.

D. MANAGEMENT, MONITORING AND IMPLEMENTATION

97. The Ministry of Finance (MOP) will have the overall responsibilityfor coordinating the adjustment program. A Steering Committee of PermanentSecretaries chaired by the Permanent Secretary, Ministry of Finance willprovide guidance and monitor overall progress. The committee includesrepresentatives from ministries and corporations participating in theoperation. The Ministries of Agriculture and Livestock Development willimplement reforms in public expenditure and the Ministry of Agriculture willexecute the reforms in the fertilizer sector. In its capacity asadministrative head of NCPB, the Ministry of Supplies and Marketing will be

- 34 -

involved in the execution of maize subsector adjustment measures. The OP,MPND and MOA will implement measures related to vulnerable groups, and droughtpreparedness.

98. To assist the Steering Committee in assessing progress of ASAO II,the Policy Analysis Division of the Ministry of Planning will have overallresponsibility for monitoring and evaluation of the key actions, as part of anon-going project funded by UNDP and IDA ("Monitoring and Evaluation ofAgriculture and Rural Development Strategies Project", initiated in 1989 aspart of the IDA-supported Rural Services Design Project). This project willalso help institutionalize within Government a greater capacity to monitor andevaluate follow-up phases of sectoral adjustments, and therefore help sustainthem in future years. The Steering Committee will submit semi-annual progressreports to IDA on the implementation of the adjustment program. The purposeis to provide feedback on effectiveness of policy and institutional changesand identify problems in a timely manner. These reports will be the basis fordiscussion with IDA supervision missions. An assurance that the reports asdescribed would be submitted to IDA was obtained at negotiations.

99. There will be a need periodically to review progress and report onimplementation of individual components. The policy reforms will change therole and financial requirements of NCPB. It is essential to monitor NCPB'sperformance, particularly against the provisions of its Performance Contract.NCPB will submit half-yearly performance reviews which will be discussedbetween NCPB, the Ministry of Supplies and Marketing, and Treasury, and thensubmitted to IDA. Project portfolios of MOA and MOLD need to be reviewed atregular intervals. A half yearly report on the project portfolio review willtherefore be submitted to IDA. Fertilizer availability, use and prices willneed to be monitored. The MOA will provide IDA with half yearly reports onthe country's fertilizer situation covering inter alia imports, sales, pricesand stocks. Assurances that reports as described will be submitted to IDAwere obtained at negotiations.

100. The Development Planning Division, the Inputs Unit in MOA, theDevelopment Planning Division and PMU in MOLD, and the Policy AnalysisDivision in the Ministry of National Planning and Development (MPND) willcarry out the monitoring functions described above. The Finance and AccountsDivisions in both MOA and MOLD will be responsible for budget management andexpenditure control. The DPDs in MOA and MOLD and other units will besuitably strengthened under the training and TA component of the proposedoperation, to handle the monitoring of policy and institutional changes. Eachof these implementing agencies will prepare and submit to IDA semi-annualreports on progress with the capacity building component. Assurances thatreports as described would be submitted to IDA were obtained at negotiations.

E. BENEFITS AND COSTS

101. The operation supports the growth, employment and stabilizationobjectives of the Government's reform program. In particular, the operationcontains policy measures which are essential if a growth rate of over 4Z peryear for agriculture is to be attained.

- 35 -

102. Agricultural growth will be promoted through: (a) increased use offertilizer; (b) a more competitive marketing system particularly for maize;(c) improved incentives for maize farmers; (d) increased returns to sectoralpublic investment programs; and (e) enhanced productivity of key agriculturalservices, particularly extension, research and animal health. Fertilizersector reforms are expected to increase availability to farmers at a cheaperprice. Increased efficiency of NCPB and an expanded role for private tradersare expected to reduce marketing margins and contribute to higher producer andlower consumer prices. By increasing the share of private traders and cashtransactions, maize marketing reforms will result in more prompt payments forfarmers and hence higher incentives to intensify production. Removal ofmovement controls on maize will encourage domestic trade between surplus anddeficit areas, and lead to greater competitiveness and efficiency inmarketing.

103. NCPB reforms will reduce its overall requirements for credit andincrease the efficiency of credit use. Increased accountability and costeffectiveness in NCPB operations is expected to contribute to more efficientuse of public resources and reduced transfers from the Government budget.Reforms in public expenditures in the two major sectoral ministries,Agriculture and Livestock Development, will contain the growth in outlays forpersonnel costs and contribute to improving the performance of keyagricultural services.

104. The proposed reforms will contribute to increased incomes of alarge number of smallholders and thus to reduction of poverty in rural areas.In addition, the proposed food security action plan will channel increasedresources to address problems of vulnerable po :lation groups. The monitoringand evaluation system will enable Government to identify possible adverseeffects and transitional costs of reform measures, and adopt targeted remedialmeasures.

105. Related benefits include strengthened capacity to plan, implement,monitor and evaluate sectoral policies, programs and projects. Improvedbudgetary procedures will lead to a more timely flow of funds to prioritysectoral investments and key services, thus increasing returns from publicresources. The proposed operation will also lead to better coordinated donorsupport which will enable the Government to focus efforts on key strategicareas.

106. The main costs which may occur as a result of the operation arerelated to the reduction in growth of public sector and parastatal employment,and possible reductions in real incomes for particular groups in marginalareas, as subsidies implicit in NCPB's loss-making activities are withdrawn.It is anticipated that the agreed public expenditure norms which will increasethe ratio of non-salary operating expenditures to the total in the Ministriesof Agriculture and Livestock Development, will result in a slowing of theincrease in recruitment to these two Ministries. At the same time, to achievethe efficiencies expected of it, the NCPB will have to shed a significantproportion of its staff. The measures in public investment will includeefforts to reduce the intake of training institutions whose output of studentstraditionally is destined for the public sector in agriculture.

- 36 -

107. It is expected that liberalizing the grain trade will open upconsiderable employment opportunities in the private sector, and the numbersof parastatal staff to be laid off are small in relation to the total labormarket. The Government has established an Employment Commission to examineways of stimulating employment in the economy. Its report is expected during1991. As part of the conditionality of the project, the Government hascommenced a study of the grain market reforms, with the aim of identifying anyadverse impacts of these reforms upon vulnerable groups, and taking measuresnecessary to alleviate such impact.

Environmental Imact

108. By providing incentives for intensifying production in higherpotential areas, the operation will relieve pressure on the less productive,arid and semi-arid lands, which are more susceptible to environmental damagefrom inappropriate cropping practices and overgrazing with livestock. Morespecifically, the operation includes provisions for soil testing throughoutthe agricultural areas, with the aim of improving the environmentally sounduse of fertilizers, making fertilizer recommendations appropriate to eachagro-ecological zone, and ameliorating soils which may have become too acidicfrom past fertilizer use. Untder the operation, projects in the publicinvestment program will be selected on the basis of environmental as well aseconomic criteria. Furthermore, under the operation IDA will monitor progresson the new forestry policy (which is also being supported by the ForestryDevelopment Program), on the Government's proposed Sessional Paper on arid andsemi-arid lands, and on the emerging policy framework for wildlifeconservation and development.

F. RISKS

109. The main risks are: (a) fragmented and unsustained governmentcommitment and limited capacity to implement the reform program in a timelymanner; (b) opposition by vested interests to specific reform measures; and(c) lack of the anticipated private sector response.

110. As noted above, following release of the second tranche of ASAO 1,the Government's attention to the policy reforms flagged noticeably, and inspite of serious efforts made over a number of years, it has proven difficultto sustain the Government's policy analysis capability by keeping qualifiedpersons working in the public sector. There is always the possibility thatadverse weather conditions could be used by Government to stall reforms, oreven reverse them. To reduce the risk of fragmentation, a Steering Committeechaired by the Permanent Secretary of the Treasury will coordinate actions byseveral ministries, and oversee implementation of the reform program.Furthermore, the Technical Review Committee which meets regularly to monitorreforms in the cereals sector will continue its activities. These twocommittees will sustain a process of consultation among the ministries,established at the workshop in 1989 which debated the adjustment operation Indetail. In addition, technical assistance and training provided under theCredit will strengthen capacity in several key ministriesiagencies toformulate and implement reform measures It is anticipated that as marketsfor cereals and agricultural Inputs continue to be liberalized, there willbuild up private sector pressure groups which will resist actively attempts by

- 37 -

the public sector to over-regulate them. Although the reforms can take placeonly gradually, eventually sufficient momentum will have been created to makeit more difficult for them to be reversed than for the reforms to proceed.The risks of *ownership' have been addressed by a participatory preparationprocess (made possible at least in part by the presence of staff in the Bank'sResident Mission), which included a high level workshop with all concernedPermanent Secretaries, to agree on the agenda for the operation. Intensivesupervision, largely by staff of the Bank's Resident Mission, will have as amajor objective maintaining commitment to reforms.

ill. Some specific reform measures touch upon sensitive issues and mayencounter opposition. For example, maize reserve stocks and movement controlsare linked to a deeply held belief in the concept of self-sufficiency, notonly for the country as a whole but also often within boundaries of adistrict, and fear of cereals moving across the country's borders.Elimination of movement controls may also be resisted because of losses ofsubstantial *rents', especially at District level. Reforms in the imports andmarketing of fertilizer have been resisted for similar reasons. Some of thefears about maize movement have been alleviated by providing for Government tore-introduce movement controls temporarily in the event of a major droughtemergency. It is also expected that the benefits of the liberalization willmanifest themselves as the reforms bear fruit. The rationalization of publicexpenditures, particularly redressing imbalances between salary and non-salaryoperating expenses, will be difficult in the absence of a clear governmentpolicy to restrain public employment. Effective implementation also involvesa decision on intake policies at universities and training institutes.

112. If the reforms do not result in an adequate response from theprivate sector, the Government may have an incentive to reverse the reforms,or neglect their implementation. This applies especially to development of aviable, competitive private sector distribution system for fertilizer.Because of the relatively small quantities involved, there is always thedanger that large business interests may drive smaller competitors out of themarket. Because fertilizer is such an important input, the Government will betempted to interfere if the private sector does not appear to be importingenough, or if other bottlenecks appear in the distribution system. Theoperation seeks to build a monitoring system, and a sharing of information,which will make the market more transparent and well understood, together witha framework of consultation between private and public sector which shouldallow each side to air its concerns in a way which would head off adversereactions by either. It is anticipated that continued development of thefinancial sector under the ongoing financial sector adjustment program willassist with ensuring a private sector response to policy changes.

PART IV. SUMMARY OF AGREEMENTS AND CREDIT CONDITIONS

113. The following agreements and assurances were obtained atnegotiations:

(a) terms of reference for the techiacal assistance for building policyanalysis capacity were agreed (para. 79);

- 38 -

(b) the positive list of imports, including petroleum products, and theagricultural chemicals eligible for financing were agreed (para. 90).

(c) the Government will open and operate two Special Accounts, accordingto procedures satisfactory to IDA (para. 95);

td) accounting and auditing procedures, satisfactory to IDA, will befollowed (para. 96); and

(e) procedures for progress reporting, satisfactory to IDA, will befollowed, and reports as described submitted to IDA (paras. 98-100).

114. As a condition for release of the second tranche of the quick-disbursing portion of the Credit, the Government would implement the measuresdescribed in the Policy Matrix attached to the Government's Letter of SectoralPolicy (Annex I), and summarized in Annex II.

PART V. RECOMMENDATION

115. I am satisfied that the proposed Credit complies with the Articlesof Agreement of the Association, and recommend that the Executive Directorsapprove the proposed Credit.

Attachments

Barber B. ConablePresident

Washington, D.C.December 14, 1990

- 39 -

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

ANNEX I

LETTER OF SECTORAL POLICY ANDMATRIX OF POLICY ACTIONS

- 41 - ANNEX

Page 1 of 15REPUBLIC OPF KNYA

OFFICE OF THE VICE-PRESIDENT AND MINISTRY OF FINANCETelgephic AreU: TH'E TRESURYFINANCE-NAIROBI P.O. ox 3000Telephone: 338111 HAl tOIWhen replying please uote aE AR*t usoZZ 40/42S/OI 1lrPe. W............

and date 23rd November

Mr. Barber B. Conable,PresidentWorld BankWashington, D.C. 20433

Dear Mr. Conable,

i. The Government of Kenya is seeking further assistance fromthe World Bank in support of its agricultural sector adjustment.The purpose of this letter is to outline the long-term objectivesand rationale of the programme and to set out the furtheradjustments which the government intends to undertake In the nextphase of the programme.

I. DEVELOPMENT STRATEGY

2. Kenya's development strategy for the remainder of thiscentury is contained in the Government's 1986 Sessional Paper onEconomic Management for Renewed Growth. The strategy emphasizesthe importance of financial stabilization and economicadjustment, and stresses the dominant role of the private sectorin revitalizing the economy and the need for the Government toestablish market-based incentives to promote private sectoractivity. Emphasis is being place on increased productivity inagriculture and in rural non-farm activity, a dynamic informalsector, and the restructuring of industrial incentives toeliminate the existing anti-export bias and to improve exportcompetitiveness.

Macroeconomic Policy Framework

3. Within the context of this strategy, the objectives andpolicies to be pursued in the years ahead are set out in theSixth Development Plan (1989-1993) and in the Third PolicyFramework Paper (1990-92) and the recently agreed revisions with

- 42 - ANNEX IPage 2 of 15

the International Monetary Fund; the PFP was prepared by theGovernment in collaboration with the World Bank and theInternational Monetary Fund. The key macroeconomic objectivesincluded reducing the rate of inflation from just over '0 percentin 1989 to the level expected for Kenya's trading partners by1992 strengthening the balance of payments, and progressivelyreducing the current account deficit excluding official transfersto a sustainable level. The Gulf crisis and its consequencepressure on the balance of payments, which gave rise to therecent revisions, have undermined the PFP targets over the nextcouple of years. The Government budget deficit will now bereduced to (2.5 percent of GDP 4 n 1990/91 and 2.0 percent in1991/92), with the public invest-tent reflecting in its size andcomposition clearly defined and viable priorities. In addition,the Government intends to implement sector-specific measures toensure the attainment of a more ambitious real GDP growth above 5percent per annum, which would allow a continued increase in percapita income in spite of a high population growth rate.Agricultural value added, which grew by an annual average of 4.3percent in 1987 and 1988, is expected to maintain the high growthachieved, owing to increased yields primarily on smallholdings.Manufacturinq value added, which expanded by 5.9 percent annuallydurinq 1987 and 1988 is anticipated to grow by an average of 6.4percent over 1989-92, reflecting the processing of agriculturalproducts, a gradual recovery in manufacturing exports, and arevival of manufacturing investment. High economic qrowth isexpected to come mainly from improvement in the efficiency ofinvestment, particularly in the agricultural and industrialsectors, while the savings rate is expected to rise slowly duringthe programme period mainly reflecting the improved performanceof state corporations and the reform of the financial sector, aswell as the reduction in the budget deficit. The behaviour ofexports will be strongly influenced by the prospects for coffeeand tea as well as tourism, and the evolution of non-traditionalexports. Merchandise export volume is expected to increase onaverage by about 6 percent annually in the 1990-92 period, withmanufactured exports increasing by about 7 percent annually inreal terms.

Aaricultural Sector Adiustment

4. As implied above, rapid and sustainable growth ofagriculture will be a vital component of Kenya's developmentstrategy well into the future. The agriculture sector accountsfor approximately one-third of gross domestic product, providesproductive employment for the bulk of the work force, providesall but a small proportion of the nation's food needs, andremains the largest source of export earnings. Most Kenyans liveand work in rural areas and are dependent either directly orindirectly on agriculture for their livelihood.

- 43 - AI-XIPagc 3 of 15

S. The World Bank provided support for agricultural adjustmentin the oaly 1980s as a component of SAL II and it continued thissupport botween 1986 and 1988 under the first Agricultural SectorAdjustmet Operation (ASAO I). World Bank assistance with themanagememt of adjustment has been provided for the past fiveyears through the on-going Agricultural Sector 1lanagementProject. Many important adjustments were undertaken during the1980s aimed at improving efficiency in the areas of input andcredit supply, crop and livestock production, the pricing andmarketing of agricultural commodities, and public support andintervention in the agricultural sector. The dchievements havebeen comprehensively documented in the project completion reportsof SAL II and ASAO I.

6. The Government intends to consolidate the adjustments whichhave taken place and to undertake a programme of further policyreform with the aim of promoting agricultural growth by removingpolicy constraints, stimulating investment and supportinginstitutional development. As with the adjustment programeunder ASAO I, the focus of the new programme will be the breakingof constraints to production faced by Kenya's small farmers.These farmers now produce the majority of all the majoraqricultural commodities, including maize, beans, sorghum,millet, sugar, tea, coffee, rice, horticultural products, milkand meat.

7. To achieve the objectives set for the agricultural sector,the Government will undertake further reform measures in thefollowing areas:

II. INCENTIVES AND MARKETING

8. The Government of Kenya is committed to continuedimplementation of a number of improvements and reforms in theareas of pricing and marketing. These will contribute to meetingthe objectives of increased agricultural growth particularlyamong smallholders and reductions in the public budgetary burdenof various interventions. For this to be achieved, the mainstrategies will be: to promote pricing policies which providefarmers with appropriate and timely incentives and which lead toan improved allocation of resources within the agriculturalsector and between it and the rest of the economy; to encouragethe role of the private sector in production and marketing; andto streamline institutional arrangements in the public sector,particulairly the relevant marketing boards to enable them to playa facilitating role with minimum budgetary outlays.

9. The Government is giving priority to promoting theseadjustments for the maize subsector as part of the on-goingCereals Sector Reform Programme (CSRP) which was initiated in1987. In addition, Government is also formulating and

- 44- ANNEXI

Page 4 of 15

implementing specific adjustments involving other keycommodities: dairy products (being addressed through an on-goingDairy Master Plan Study); coffee (as part of a second phasecoffee development programme); cotton (in accordance with the newCotton Act passed in 1988 and the Government's 1988 report:Policies for the Development of the Cotton Subsector); sugarcaneand sugar (based on an action plan to be developed from the on-going Sugar Subsector Study). With the aim of sustaining anappropriate incentive and marketing framework, Government alsoplans to continue the strengthening of its capacity foragricultural policy analysis (including price analysis). Thiseffort will be supported by technical assistance and training tobe provided under ASAO II.

Naize Mubsector

10. Government reforms in the maize subsector were initiated in1987 and are currently being continued under the on-going CSRP. Anumber of important reforms have already been achieved, includingwriting-off the cumulative debt of the National Cereals andProduce Board, (NCPB), cumulative debt which amounted to some Ksh5 billion; the partial funding by Government of NCPB's losses;raising from 2 to 10 the number of bags of maize which can bemoved across district boundaries without a permit; and allowingsifted maize millers to purchase directly 20 percent of theirthrouqhput from cooperatives and private traders. In addition,the number of NCPB's buying centres have been reduced from 680 to220 and the number of licensed buying agents and cooperatives hasbeen increased substantially. The higher and middle levelmanagement of the NCPB has also been replaced with new and morecompetent managers and a new organisational structure of theBoard has been adopted.

11. Government objectives in this subsector are three-fold: tohelp provide food security by ensuring maize availability at alltimes throughout the country, with reasonable price stability andat minimum cost to the public budget. This will require NCPB toundertake its functions at an acceptable cost to the economy; toimprove producer incentives and smallholder productivity bypromoting an efficient, competitive and sustainable maizemarketing system; and to protect producers and consumers fromunacceptably low and high prices respectively.

12. These objectives will be fulfilled by (a) consolidatingNCPB's role of buyer and seller of last resort and manager ofmaize security reserve stocks in a manner which is efficient andminimises the budgetary burden, making the full costs of maizesecurity reserves and maize price stabilisation explicit, andborne by the public budget (b) increased private-sectorparticipation in maize marketing whilst ensuring that NCPB isable to secure sufficient maize to allow it to achieve its foodsecurity objectives at minimum public cost (c) giving priority to

- 45 -ANNEX 1

Page 5 of 15

NCPB's maize and wheat operations (d) improving price signals toprivate traders and cooperatives operating in the primary andsecondary markets, with a progressive reliance on market-determined prices, while ensuring prompt payments to producers andacceptably stable prices to producers and consumers, andprogressively phasing out the restriction of internal maizemovements.

13. Over the next two years, the following key actions will beimplemented:

(i) Maize Policies and NCPB Operations: Government willestablish a Performance Contract (PC) between Treasury, Ilinistryof Supplies and Marketi-.g, and NCPB. The Contract willincorporates

(a) a policy statement on maize and NCPB's role andresponsibilities in regard to maize trading and on principlesgoverning budgetary support to NCPB;

(b) accounting reforms to segregate NCPB's commercialoperations from its price stabilisation and food securityoperations;

(c) reserve stock levels and guidelines for managementthereof;

(d) Government budgetary allocations to compensate NCPB fullyfor losses incurred on food security and price stabilisationoperations; and

(e) monitorable NCPB performance targets for achievingreduced costs.

The Government plans to finalise an initial PC by the end of 1990,for the period 1991/92 to 1993/94, and to update this PC on anannual basis to cover a three-year period, taking into accountexperience gained. The Government is committed to implementingthe PC to achieve the stated objectives and targets, which wouldbe reviewed and updated on an annual basis.

14. (ii) Maize Marketi.s: The Government's strategy is toliberalise the maize market to increase cooperative and privatetrader participation whilst ensuring that the NCPB is able to meetits food security and financial objectives. On the buying side,the Government will continue to increase the number and coverageof licensed buying agents. On the selling side, the Governmentplans to reduce further NCPB's assured share of the secondarymarket. The precise share guaranteed to the NCPB would need totake into account NCPB's maize stocks, the required level of stockturnover and the objective of minimising NCPB losses. To reducethe budgetary burden on the NCPB, Government would remove minorcrops from NCPB's scheduled list followed by removal of beans in1991.

ANNEX 1Page 6 of 15

15. Government recognises the benefits which have accrued fromrelaxing the restrictions on maize movement, particularly in termsof ensuring increased availability of maize at reduced prices toconsumers. In this context, the problem of availability in remoteareas arising from controls of wholesale and retail margins willalso be addressed. For producers and consumers to achieve fullbenefits of this measure, Government plans to remove progressivelyall controls on domestic maize movement. The quantity of bags tobe moved without a permit will be increased to 4 metric tonnes byDecember, 1990 and to 8 metric tonnes by second tranche releaseand eventually to total removal before 1993. To facilitateachieving the targets and to minimise any possible adverseeffects, Government will: (a) implement its action plan to improvethe mill monitoring system in order to ensure that NCPB maintainsits mandated share in the secondary market; (b) develop andimplement a maize price market information system in order to helpguide NCPB's interventions and thereby help ensure maizeavailability throughout the country.

(iii) Maize Pricing: Government will modify its maize pricingsystem in a manner which increasingly relies on market-baseddeterminants while ensuring adequate price stability for producersand consumers. The pricing improvements will be coordinated withthe marketing reforms outlined above. More specifically, plansare underway to adopt a price system which would encourageincreased market efficiency and competition by setting an into-depot price. Eventually, as the maize market is furtherliberalised, Government will seek to remove all price controlsfrom the ex-depot through to the consumer levels, while stillretaining effective interventions by NCPB for the purpose ofstabilising maize prices to producers and consumers.

16. During the transitional period, the Government will inaddition to the above pricing strategies, continue to develop theempirical basis for setting maize producer price levels employedin the annual review. This will include the estimation of exportand import parity prices. In developing recommended prices,account will also be taken of the projected impact of pricechanges on NCPB stock levels and on the cost of stockholding.These methods will be reflected in the analysis for the 1990/91season, and will be refined further in subsequent seasons.

III. FERTILISER SUBSECTOR

17. Significant advances have been made in the recent past interms of the liberalisation of fertiliser marketing and pricing.In June 1989, the Government approved a policy framework forpricing and marketing of fertiliser. In pursuance of the approvedpolicy, the Government decontrolled fertiliser prices completelywith effect from January 1990. This has led to improvedfertiliser use in the smallholder cereals growing areas.

- 47 -ANNEX 1

Page 7 of 15

The accessibility to fertilisers by smallholders has also beenimproved through the introduction of 10 and 25 kg bags tosupplement the standard 50 kg bags. At present, there are nofertiliser subsidies in Kenya and its marketing and distributionwithin the country is purely in the hands of the private tradeand cooperatives.

18. As no fertiliser is manufactured in Kenya, adequate importsand availability of the right types of fertilisers, at the righttime, place and at reasonable prices is an important issue. Topromote competition, the Government will abolish the Ministry ofAgriculture's current fertiliser allocation system. Importers ofcommercial fertiliser will register with the Ministry (for datacollection purposes) when they submit applications to import tothe Ministry of Commerce. Government will move fertilisers fromSchedule 2 of the import licensing schedule to Schedule 1 at thetime of the next annual revision. To capture some economies ofscale in international purchase of fertilisers, as well as inocean freights, small importers will be encouraged to grouptogether by prescribing reasonable minimum shipment sizes formajor fertiliser products. This would save the countryconsiderable foreign exchange, and through competition indomestic trade, reduce fertilizer prices and improve theeconomics of fertiliser use particularly by smallholders. Astudy will be carried out to determine suitable institutionalmechanisms in the private sector to fully capture the economiesof scale in fertiliser importation and shipment.

19. The Government supports direct import of aid fertilisers byprivate traders with Government only having to set a reasonableprice for aid fertilisers to generate counterpart funds. Theinitiatives of donors towards commodity import programmes e.g.USAID and Netherlands, are fully supported by the Government.The problems of handling aid fertilisers will be reviewed in somedepth and donors will be consulted in this respect. An IssuesPaper will be prepared and views exchanged with IDA by mid-February 1991.

20. It is recognised that in a liberalised market, with theprivate sector handling fertiliser importation, distribution andpricing, and government pursuing the national objectives ofagricultural growth through measures which include a considerablyexpanded use of fertiliser, the establishment of an institutionalframework for free flow of information and regular consultationbetween the trade and Government is important. Periodic reviewof fertiliser related issues by Government with the privatesector and cooperatives at the district and nationaL levels wouldassist government in establishing and maintaining an appropriateincentive framework for fertiliser use to expand. For thisreason, Fertiliser Development Committees, will be set up at thenational level and Fertiliser Coordinating Committees establishedat the district level. Both Committees will have private sector

- 48 -ANNE 1

Page 8 of 15

and cooperative representatives and will be consultative andadvisory in nature. It is expected that such interaction betweenthe fertiliser trade, agricultural extension, research and othergovernment agencies will result in improved importation,distribution and increased fertiliser use by farmers.

21. The institutional arrangements in government to handle thewide spectrum of fertiliser issues will need to be streamlinedand strengthened. The donor fertiliser import function will beunified in the Ministry of Agriculture, with the Treasury onlyproviding liaison with donors and retaining responsibility forthe collection of counterpart funds. The Inputs Unit in theMinistry of Agriculture will be strengthened and relocated underthe Director of Agriculture. Subject matter specialists in soiland fertiliser will be designated in the districts to support thefield extension, work. Government intends to prepare in thecoming few months, jointly with private sector, District ActionPlans for promotion of scientific and environmentally safefertilizer use duly supported by activities like soil testing andtraining to fertiliser retailers and farmers. These steps wouldconsiderably improve the environment for the expansion offertiliser use through private sector initiatives. Based onthese proposals, fertiliser related data base will be expandedfrom the district level upwards and arrangements will be made forflow of relevant information from the district throuqh toheadquarters.

22. Soil acidity is emerging as an issue in the limited areas ofmedium to high potential agricultural lands in Kenya. A studywill be mounted in 1990/91 in order to establish the currentstatus of the soils, and to initiate ameliorative steps as earlyas possible. Depending upon the outcome of such a study, thegovernment would initiate well focused research programmes todevelop site specific ameliorative measures.

IV. PUBLIC BMXpNDITURU

23. Public Investment and Dudgeting: Considerable progress hasbeen made in recent years to improve the efficiency of publicresource allocation and use within the agricultural and livestocksectors. Under the Government's Budget Rationalization Program(BRP) a forward budget and planning process is now well-established in both ministries which has improved allocativeefficiency. The BRP has also established guidelines for projectselection. Administrative reforms such as computerization of thebudget estimates have also been firmly established.Institutional reforms have also been achieved including theestablishment of a project monitoring and evaluation unit in eachministry. Listed below are the actions to be undertaken duringASAO I1 to improve the ministries' financial management.

- 49 -

ANNEX 1Page 9 of 15

24. Maintaining Levels of Financial Support. Despite publicxpenditure cutbacks, support to the agricultural sector has

remained constant in real terms for the past five years (at 10%of total public expenditure). In the Ministry of Agriculture andthe Ministry of Livestock Development (which form part of thesector) the composition of financial support in terms of theratio of operating and maintenance expenditures (O&M) to salaryexpenditure has deteriorated. The deterioration in O&Mexpenditures is one of the most significant factors reducing theperformance of the two ministries. For Fiscal Year 1991/92, theMinistry of Agriculture will be allocated in real terms anadditional 4.4 percent of its 1990/91 net recurrent estimates andthe Ministry of Livestock Development will be allocated in realterms an additional 6.3 percent of its 1990/91 net recurrentestimate. Further allocations would be made in the 1992/93estimates to compensate for the shortfall in the recurrent budgetof the two ministries.

25. Rationalization of the Investment Portfolio. Experiencehas shown that the financial resources and ministerial staff arespread too thinly to ensure prompt and effective implementationof projects. During the ASAO II, the portfolio of projects willbe rationalized to ensure more rapid completion and adequatefollow-on recurrent cost support. Appropriate criteria forproject selection will be developed and a core set of projectswill be identified for full funding to ensure promptimplementation. The ministries will also establish a projectsecretariat to ensure that the portfolio is rationalized.

26. Improved Budgeting of Recurrent Costs. The ministries willdevelop and adopt budgeting norms to ensure that operating andmaintenance (0&X) costs are adequately funded. A budgetsecretariat will be established to ensure allocative efficiency,with particular attention to recurrent costs.

27. Development of Staffing Norms. Both ministries will developexplicit staffing norms by service which will guide therecruitment and deployment of personnel. The norms thusdeveloped will help determine Treasury salary ceilings and non-salary (O&M) recurrent cost budget allocations.

28. Improved Financial Monitoring. To more effectively managefinancial resources, the ministries will budget on the basis ofcost centres. At the same time, expenditure reporting will beimproved by developing a computerized financial informationsystem in the two ministries which tracks district levelexpenditures. Particular emphasis will be given to the promptrecording of direct donor payments.

29. Improved Projeot Management. Project management will beimproved by the expansion and strengthening of the ministries'current Project Monitoring and Evaluation Units. These units

-50 - ANNEX 1Page 10 of 15

will be given a managerial role and will serve as backstoppersfor projects. All administrative, evaluative, and financial dataconcerning a project will flow into the units thus providing acentral source for project Informatior.. A computerized ProjectPerformance Reporting System (PPRS) for timely monitoring ofprojects will be developed. Project management will be furtherstrengthened by the establishment of a ministerial projectsecretariat which will review periodically progress of projectsusing the PPRS.

30. Privatization and User Pess. Several initiatives have beenmade in recent years to privatise various services in the twoministries. Under ASAO II the services of the two ministrieswill be reviewed further to determine their potential forprivatization and the financial impact of such changes. Theministries will also review services which presently charge userfees or could potentially charge fees to determine appropriatecharges.

V. WOOD BECURITY

31. The central objective of national policy is to addresspoverty through agricultural and economic growth which reachesthe poorer groups. This will be achieved by creating conditionsfor faster development of the agricultural sector which encouragethe participation of the smallest farmers, and by creatingproductive employment opportunities outside agriculture,especially in rural areas. To accelerate the growth ofsmallholder agriculture, the Government will give high priorityto agricultural research which addresses the constraints faced bysuch farmers, take steps to increase the uptake of fertilisers,and improve incentives through accelerating the payment offarmers and continuing with the liberalisation of markets,especially by progressively removing controls on cerealsmarketing. To accelerate growth of employment opportunities, theGovernment will increase investments, especially in rural areas,in the basic infrastructure of roads and transport services,electric power, water supply and communications. As a furthercontribution to the generation of employment opportunities,especially for low income groups, an increasing proportion ofthis basic infrastructure will be put in place through programmesof public works using labour-intensive construction techniques.

32. A policy paper on food security prepared by the Ministriesof Agriculture and Livestock Development has been completed andcommented upon by other ministries. The paper entitled "HouseholdFood Security and Nutrition Policy" covers, inter alia, actionsrelating to the management of food security during and afterperiods of drought. It also makes recommendations for thecoordination and allocation of responsibilities within theGovernment for food security. Also under preparation is a systemfor monitoring the impact of grain marketing reforms currently

- 51. -ANNEX 1

Page 11 of 15

being developed by the Ministry of Supplies and Marketingtogether with NCPB. The Ministry of Planning and NationalDevelopment will be responsible for a broader monitoringprograme aimed at isolating the impact of economic reformmeasures, particularly on vulnerable low income groups. Actionplans for assisting groups at risk will be developed in moredetail with responsibilities being allocated in accordance withthe institutional framework agreed on the basis of the HouseholdFood Security and Nutrition Paper. A drought contingency planwill form part of the new system of food security management.

VI. DAIRY 8BD8BCTOR

33. The Government's objectives in the dairy subsector areprimarily to increase milk production in order to meet growingdomestic demand and to promote a more efficient and competitivedairy industry, particularly in milk collection, processing andmarketing. The main strategies to be implemented are: to promoteproductivity increases especially among smallholders; and toreform the milk pricing and marketing systems in a phased mannerwhich, (i) revises the role of Kenya Cooperatives Creameries,(KCC); (ii) makes the KCC more efficient through its ownershipand management and a revised role in providing adequate pricestability; (iii) increases competition in milk processing andmarketing; and (iv) increases flexibility in the pricing systemto respond to domestic market forces within the bounds set byparity prices, with the eventual goal of price decontrol.

34. The Government, in 1989, initiated steps to streamline theoperations of the KCC, and in early 1990, the Dairy MasterplanStudy was launched. The first phase of the study, which focuseson improved strategies, policies and institutional reforms hasbeen completed. The second phase of the study, which is expectedto end in December 1990, focuses on the formulation of detailedimplementation plans of the policy reforms and a dairy investmentprogramme over the next 10 to 15 years.

35. Government would prepare a Dairy Development policy paper byMarch which would outline the revised policies and keysupporting actions for restructuring Kenya's dairy industry.Government would also formulate the supporting action plans byearly May 1991, including a timetable for implementing thesepolicies. It is expected that these would include the followingkey actions over the next five years.

36. Increased Vroduction: Implementation of an action plan tointensify milk production in smallholder farms with an emphasison improved dairy research, breeding programmes, extension andanimal health programmes, including the expanded role of privateveterinary and A.I services. These action plans and the timetablewould be finalised by May 1991.

- 52 -ANNEX 1

Page 12 of 15

37. Iun1ug.JaZ *crss Government's long term target is torestructure the processing industry into a series of producer-based cooperatives and private ventures which eventually would becompeting for the growing milk market. This structure would bereached by key short and long term actions which will involve therevision of KCC's role and structure, promotion of competitionand proper sequencing of pricing and marketing reforms.

38. Pricin VA Ete: In reviewing the milk price, Governmentwould improve the criteria of milk pricing, which would be basedon improved data collection, analysis of market conditions andtake account of parity prices. These improvements would bereflected in the price analysis and announcement for the 1991price review, with further improvements in subsequent years.

39. &MI&&= zLZX hanajs: The Government will review therelevant legislation involving the dairy industry to removerestrictions on the establishment of new processing plants,subject to the maintenance of hygienic standards. Initially, theGovernment plans to remove such restrictions in 1991 for allareas outside Nairobi and Mombasa. The role of the Kenya DairyBoard will be revised to support the effective implementation ofthe new policies with emphasis on ensuring the maintenance ofhygienic standards, and monitoring the implementation of therevised policies of the dairy industry.

vII * A PLIO? m BLATIO

40. It is the policy of the Government that the land rights ofagricultural producers should be secured and protected by thestate. Furthermore that the conduct of land use should reflectsound principles of management and environmental sustainability.Consequently, the Government will: (i) promulgate a moreauthoritative and precise statement on land policy for thecountry; by March 1991 (ii) speed up the process of bringing boththe large and smallholder sector farms under the same propertysystem; (iii) remove all impediments to land market operations,including allocations and speedy processing of disputes; (iv)ensure that sufficient resources are available through training,the procurement of equipment and expansion of physical facilitiesfor all fiold staff of ministries, particularly the Ministry ofLands and Housing and Physical Planning directly engaged in thedevelopment of land resources; and, (v) make available moreinfrastructural support, credit and farm extension advice tosmallholder farmers through channels and mechanisms that do notcompromise their land rights security such as mortgages and othercharges.

41. In the long run the Government will aim to: (i) developcomprehensive land use guidelines, including an indicative landuse plan for the country for adoption and modifications, asnecessary, in particular local contexts; (ii) develop a national

- 53- ANNEXI

Page 13 of 15

enviromental action plan and a broad legislative framework forits implementation throughout the country; (iii) undertake astudy of the impact of current land legislation on agriculturaldevelopment, preliminary to a general review, rationalization andsimplification of those laws and the structure of landadministration they have created; (iv) investigate new ways andlegal mechanisms that would stimulate more productive use of landin units of economic size; and, (v) establish and operate aneffective Land Resource Inventory and information system for usein national development planning. The Government will develop anaction plan and time-table in the next few months, indicating howand when these measures will be taken and the resources neededfor that purpose.

VIll. COFFs SURAROM

42 The Government is committed to the improvement of the coffeesubsector through improved institutional arrangements and promptpayment to farmers. Key actions in this subsector will include:implementation of an improved smallholder coffee payment systemthrough cooperatives with the aim of restoring the confidence offarmers and encouraging the intensitication of production andclarification of the roles of the KPCU and the Coffee Board in amanner which promotes efficiency in the subsector.

Ix. COTTO supJxC =

43. In 1987, the Government investigated the processing andmarketing of cotton with the aim of identifying the main reasonsfor the poor performance of the subsector. Government also passeda new cotton Act in August 1988 whose aim thrust is to divest theexisting Cotton Lint and Seed Marketing Board (CLSMB) of itscotton marketing and processing functions and to assign it theimportant role of regulatory agency.

44. The Government is carrying out a study aimed at formulatingdetailed operational procedures for the marketing of cotton lintand seed based on an auction system, and to develop anappropriate and operationally sound payment system to farmerswhich ensures prompt receipt. The Government aims at implementingappropriate recommendations of the study.

45. The study will examine the organisational and staffingstructure of the Cotton Lint and Seed Marketing Board (CLSMB)with a view to enhancing its capability to undertake efficientlyits new role under the Cotton Act. It will also examine thecurrent cotton ginning arrangements and capacity utilisation anddevelop an appropriate ginnery rationalisation and rehabilitationprogramme, taking account of the potential for growing cotton indifferent agro-ecological zones of the country.

- 54 -ANNEX 1

Page 14 of 15

X. SGAR lionBESECO

46. The sugar subsector has made a major contribution toagricultural growth since independence and has continued to be asignificant area for public investment. With the country'snatural advantages in producing rainfed cane, the steady flow ofinvestment funds has meant that approximate self sufficiency hasbeen possible despite the rapid growth of domestic demand.Nevertheless, the industry has experienced problems relating tothe organization of cane production, harvesting and transport andthe efficiency of cane processing. Being aware of this, theGovernment commissioned a study of the sugar subsector in 1989.The study has yet to be finalized, but the Government willendeavour to ensure that it is completed by the end of 1990 andwill draw up an action plan based on recommendations acceptableto Government within three months of completion. This processmay require further analysis to resolve outstanding policyissues.

47. The Government's principal policy objective for thesubsector is the retention of domestic self-sufficiency. Effortswill be made to increase cane productivity through improvedresearch and extension. The factories will be subject toperformance targets to improve efficiency. Marketing anddistribution will also be reviewed with the aim of increasingefficiency. In the event of shortfalls resulting from poorgrowing conditions or other natural causes, imports will be madeby the Government or its agent using competitive tendering.

48. In future, the Government will attempt to encourage theprivate sector to invest in new sugar processing capacity.Towards this end, sugar prices will be reviewed regularly toensure that both cane production and processing remainsufficiently profitable to attract the required level of newinvestment.

XI. ARID AND SENI-ARID LANDS MAL)

49. The main Government objective in the development of ASAL isthe exploitation of its potential in ways consistent with thereclamation and protection of fragile ecologies and withsustained improvements in the quality of life of the inhabitants.The Ministry for Reclamation and Development of Arid Lands andWastelands, (MRDASLW), Sessional Paper to be submitted toParliament. The Paper will set out detailed policies andinstitutional arrangements which will indicate: (i) specificobjectives and actions required for their achievement; (ii) broadpriorities for investment, research and policy reforms; (iii)environmental and other guidelines for the selection andstructuring of projects; and (iv) appropriate institutionalarrangements and responsibilities. A key element of policies andinstitutional arrangements will be the ASAL Environmental ActionPlan due to be completed by June, 1992.

- 55 -

ANNEX IPage 15 of 15

XII e*QDp^XB

50. Due to the importance attached to wildlife conservation,Government has created a new parastatal, Kenya Wildlife Service,(KWS), to oversee the sector. It replaces the WildlifeConservation and Management Department which had hitherto provedineffective. The new parastatal has been staffed with a strongmanagement team that has now brought poaching under control. Withassistance from the donor community, including the World Bank,the KWS is now developing a comprehensive policy framework andfive-year investment programme for wildlife conservation anddevelopment, which will form the basis for preparing newlegislation and a Sessional Paper, as well as specifying thenature and extent of donor support.

XIII. FORESTRY

51. Environmental conservation through management of naturalresources, particularly forests, is an important Governmentobjective. The Kenya Forestry Development Project, though notformally linked with ASAO II, is designed to include severalrelated structural adjustment elements with particular actionscomprising of: (i) formulation and adoption of a new and improvedforestry policy; (ii) increased participation of smallholderfarmers and the private commercial sector in forestry activities;(iii) reduced disincentives for producing forest products in theprivate sector; (iv) improved efficiency and composition ofpublic sector expenditures; and (v) institutionalizingsubsectoral planning as part of the decision making process.

Yours sincerely,

Prof. George|SaiVice Preside t & ster for Finance

- 57 -Appendix to Annex IPage 1 of 6

S,~~~~~ a

0~~~~~~1

i

1~~~1 1 I

IL~ Il

St g * V.

hi l

! .

Appendix to Annex IPage 2 of 8

KENYA

ASAO II POLICY MATRIX

MAIZE

OBJECTIVES STRATEGIES ACTIONS AND TIMINGUnder ASAO I Under ASAD :------…Achiovod --- --- -- Proposed---

Before RNesotiation Board Presentation Second Tranche

Improve NCPB Improve NCP8 Completod major Draft Performance Govornmont/NCPB Goovrnment/NCPBperformanco, prooto efficiency by: study on maize Contract (PC) 3/ finalized PC for finalize PC forcompetition and (1) clearly defining marketing reforms; submitted to IDA. 1991/92 to 1993/94 1992/93 to 1994/96sinisizo budgetry its rolo and restructuring of acceptable to IDA, acceptable to IDAcosts of NCPM maizo functions; NCP begun: write- and signed for and sign formarketing (Ti) segregating Its off of NCP8 debts. 1991/92. 1992/93.operations. comerclial

operations from Ito Reserve stocksprice stabilization funded in 1989/10 Minor crops removed Beans removed fromand food security budget, but from NCPB scheduled NCPB schedulod list.functions and Inodequately. list.providing fullbudget subsidy for Direct role of NCPBlosses ariing from in primary market Number and coverage unthes non-commrcial reduced by increased of private local °°functiono; number and covorage buying agento(iii) expooing It to of private local Increased,competition from tho buying agent. acceptable to IDA.private sector Insecondary markets NCPB's assured shareand transterring to In secondary market Further reduction Inthe privato sector reduced from 100$ to NCPB's assured shareprimary marketing 80% in regard to in secondary market,activities; supplies to sifted to 6O.(iv) improving its millers.decision-makingcapacity with regardto reserve stocklevel managementInvolving imports, Qexports and domesatic CD sales.

o x

1/ The PC incorporates: (i) government's policy otatement on NCPB's role and responsibilities in regord to maize trading and on the cn 0principles governing budgetary support to NCPB; (ii) accounting reforms to reflect tho true financial coat o eoach of NCPB'soperations, with officiency norma; (iii) reservc stock target tovelo, guidelines for thoir Danaegmant and turnover, and decision rulesfor price stabilization; (iv) Government budgetary allocationo to compensate MCPB fully for leases incurred on food security and prico stabilization operations; and (v) monitorable NCPB performanco targets.

- 59 -Appendix to Annex IPage 3 of 6

46 ~ ~ ~ ~ ~ ~ -

MO~~~~~~~~~~~~~~~~~~~~~4

,0 0*-.zusj

j ; t-"~~4~ -@134.1

Ci *jo. 1t 1' i ' -

I I -1

Appendix to Annex IPae 4 of 6

KENYA

ASAO It tOLICY MATRIX

PUBLIC INVESTMENTS/EXPENDITURES

OBJECTIES STATEGIES ACTIONS AND TIMINGUnder ASAO I Under ASAO II:---- ---- Achiev"d--------- ---PrODOsod--

Boro Neslotiatlon Board Presentation Second Tranche

Inerease .llocative Apply ob;ective Annusl PolIey Economi e ndefficieney of pubile economic and Statement. prepered environmentalInvestment resoureas environmental on Investment criteria acceptableto enhance eclterli to project priorittes. to IDA adopted.agricultural growth. solection.

Review existing Portfolio review 'Core investment Annual Estimates ofportfolio using progressed, program' agreed, and 19M/93 and Forwardabove criteria, to satisfactory to IDA. adequatoly funded In Budget of 1992/98-solect 'core Forward Budget for 1994/95 reflectlnvestment progr 1991/92-198/94. 'core Investmentof high priority program.projects.

Implemnt project Project RegIstry Projoct Performncemanagement *systm to designed. Reporting Systemmonitor performance RS) establisheand provide input for all projects,Into Forward Budget along with Projectpreparaton. Review Coaittee to

carry out annualreview.

Improve operational Improve balance Establishment and MOA and MOLD staff RevIew of staffIng Finalzoe staff Ingefficiency of public between stff costs Complement counts and norma by grades, and norms and beginrecurrent and non-salary Registries prepared reconciliation with estimation of non- lmpleomntation of an 0 3expenditurox so expenditure, to to enumerate stff complement control salary operating action p!an to °Qenhance agricultural raise productivity and describe ond payroll records expenditures In key achieve rovisd growth. of operational deployment patterns. completed, service commenced. staffing norm s staff. (including lntako of o x

training Ntinstitutes), and os oagre adequatebudgetary provision.Incre_s cost Review of user Compl tu ;recovery from ur chargs, en of eIn Imlentton

charge, aN privet. sector ot ct10n plan.Identify opportunitiesopportunities tor commenced.privet. sectorparticipation inselected services.

Appendix to Annex IPag 5 of O

KENYA

ASAO I POLICy MATRIX

PUBLC INVEST S/EPErTmES

CSJCTVE STRATEGIES ACTION AMD TIMMNUnder ASAO I Under ASAG 1t:------Ach;i ved-- SeconoTen-

Before Neaotlation Board Preseatto-n Second TranChe

Zmprov, Budgeting Strnogthen Budget and Project Admintstrativo Dovelopment of an Evalute pertorm nce

and Disbueromnt lnstltutional Secretariat arrangeent. and Improved cash flow In 1991 of Improved

System to ensure arrn e r estab blished to systms for Improved management system budget and paymnt

rea IIoti budget prparing and oversee preparation monitoring of ad personnel syatos and exchonge

eatimotes and tiewly monitoring budget of Draft Estimates oxpenditure lnfonmation system viets with IDA on

flow of funds to expenditures. and Forward Budget. specifitd. coemenced. findings.

project.Ensure timely Allocations under - sm as above -

releae of budgeted direct payenttunds. system nncrea d,

and procedurs foraccessing donorfunds revised.

0' 0Io

Appendix to Annex IPage 6 of 0

KENYA

ASAO II POLICY MATRIX

STEPS TOWARD ASSISTDNG VULNERABLE GROUPS

OBJECTIVES STRATEGIES ACTIONS AND TIMINCUnder ASAO I Under AAO I:---A chlovod-oned-

Before Negotlation Board Presentation Second Trnnche

Devlop and toet Action plans for Hono. OK Food Securtty Food and nutrition Adopt action plantargeted Meosuee to lnomo support, Study cosploted. action plon end begpnmis t low lncoom Improving nutrition prepared. tmplomeetation.

group vulnerable to and droughteconoitc or physical preparednessshocks.

Full-time officer to Finalize plon andprepare a drought begincontinpency plan implemwAstion.appointed;preparation of plan

baspoeeility i tfor Stdy of impact of Adept action planassessing progress graln mrkeig sad beintIn poverty reducWtio reform, and Impl_mtati on.

sad m.aitocingporepeation of,effects of _esosomic action pvie toreesprora adldres Problmem

wipd o_to WU"b. coemeed. Compte bow_lIme

-0~~~~~orw I_p --1 -0 tkeftl Of mosltrilla b.ibidsmitorlmg

Ufelsod oad

"Woles saW fieldBevels assigned.

f*1

- 63 -

ANNEX IIPage 1 of 2

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPEPATION

SUPPLEMENTARY DATA SHEET

I. TIHBTABLE OF REY EVENTS

(a) Time taken to prepare the project 21 months (September1988 to June 1990)

(b) Project prepared by GOK with assistance fromIDA

{c) Identification mission September, 1988

jd) Appraisal commenced June, 1990

(a) negotiations November 15, 1990

(f) Planned date of effectiveness March, 1991

II. SPECIAL INBN?ATION ACTIONS

103

IIl. SPECIAL CONDITIONS

Conditions of Effectiveness

N03

Conditions of Second Tranche Release

WMee

(a) malie protucer prices adjusted based on revised methodology;

(b) maize movement permit floor raised to 8 tons (90 bags); adate during 1992 for removal of all controls on domesticmeize movement agreed with IDA;

(c) GovernmentjNCPB finalize PC for 1992193 to 1994/95acceptable to IDA, and sign for 1992193;

(d) further reduction in NCPB's assured share in the secondarymarket, to 601;

(s) rone beans froa NCPB scheduled list;

- 64 -

ANNEX IIPage 2 of 2

Fertilizers

(a) MOA finalizes the policy paper on "in-kind* fertilizer aid,and exchanges views with IDA on proposed measures;

(b) complete the study on private sector mechanismsto lower the costs of fertilizer imports, andreview findings with IDA;

(c) adopt action plans for soil testing, training,and fertilizer promotion, for all majorfertilizer consuming Districts, agreed with theFertilizer Development Committee;

Public Expenditures

(a) annual estimates of 1992193 and Forward Budgetof 1992193-1994195 reflect the core investmentprogram";

(b) finalize staffing norms, and beginimplementation of an action plan to achieverevised staffing norms (including intake oftraining institutes), and agree adequatebudgetary provision for non-salary operatingexpenditures in key services;

(c) complete studies on user charges and private sectorparticipation in selected services, and begin implementationof an action plan;

(d) evaluate performance in 1991 of the improved budget andpayment system, and exchange views with IDA on findings;

Steps Toward Assisting Vulnerable Groups

(a) adopt and begin implementation of action plans for food andnutrition, drought contingency, and addressing any problemsarising from grain marketing reforms;

(b) complete baseline survey, and implement household monitoringsurvey.

- 65 -

ANNEX III

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

PERFORMANCE CONTRACT BETWEENNCPB AND THE TREASURY

Outline

1. Government Statement of Maize Policy. Includess policy onmaize pricing, maize movement controls (their phased abolition), de-scheduling of other crops (in which NCPB would no longer trade), andliberalization of the secondary market; a re-statement of the roles ofNCPB; Government guidelines on NCPB's staff reductions, depot closings,handling of surplus stores, handling reserve stocks, and introducingmanagment incentives; and an outline of other market developmentactivities to be undertaken by Government.

2. Government Subventions. Elaborates the new accountingframework for allocating expenditures of various operations of NCPB, theformula for Government budgetary provisions for NCPB's food security andprice stabilization operations, and, in the annual contract, the actualbudgetary provisions arising from applying the formula to theforthcoming year of the rolling financial plan.

3. NCPB's Performance Targets. The various steps which NCPBcontracts to undertake to achieve significant cuts in the costs of itsoperations are outlined and agreed. These include: measures ofeffectiveness in attaining targets for price stabilization,liberalization of the secondary market, and handling of reserve stocks;measures of efficiency as expressed in depot costs, staff costs,transport costs, and management overheads per unit of throughput; andmeasures of the impact of NCPB's improved performance on reductions inthe subventions required from the public budget.

4. Monitoring and Evaluation. The procedures for NCPB'ssubmission of semi-annual performance reports, and their discussionamong NCPB, the Ministry of Supplies and Marketing and the Ministry ofFinance have been agreed, along with the process by which results ofthese discussions will be fed back into NCPB's corporate planningprocess, and how the effects of external factors (such as changes inGovernment policy, inflation, exchange rates, and market prices) vill bereflected in agreements reached.

- 67 -

ANNEX IVPage 1 of 2

XENYA

SECOND AGRtCULTURAL SECTOR ADJUSTMENT OPERATION

INDICATORS FOR THE AGRICULTURAL SECTOR

A. STRUCTURAL INDICATORS

INDICATOR 1980 1985 1989

Agriculture as Z of GDP 30.3 29.6 28.5

Production Index5DP 91.7 108.3 131.6Agriculture 90.1 103.9 127.1

Agricultural Exports as X Total 44.2 63.4 65.5Coffee as I Total 22.2 29.4 20.4Tea as I Total 11.9 24.4 27.2

Agricultural Terms of Trade 108.4 93.5 97.7

Fixed Capital Formation in Agriculture 61.9 50.8 47.7(Xi million, Gross, 1982 prices)

As 2 of Total 7.0 8.5 6.1

Fertilizer Availability ('000 tons) 169.8 373.4 274.8

Fertilizer Used ('000 tons) 129.1 271.6 219.0

Credit to Agriculture 14.4 18.5 18.0(as _ of domestic credit)

Price Index for Consumer Goods PurchasedIn Rural Sector 69.9 154.8 184.0

- 68 -

AqNEX IVPage 2 of 2

B. GROWTH RATES al(t per year)

INDICATOR 1980-89 1980-85 1986-89

Value Added - GDP 4.4 3.9 5.1- Agriculture 3.0 2.5 4.1

Capital Formation - Total -0.1 -7.5 5.2- Agriculture -0.7 -7.0 -3.7

Fertilizer Availability 6.5 9.8 -4.6

Fertilizer Use 8.4 14.7 0.7

Production of Main Commodities:Maize 2.9 -1.3 4.9Milk 2.8 1.9 4.7Coffee 2.5 4.2 3.3Tea 9.1 10.2 10.9'Wheat 0.7 -4.3 -0.2Sugar 2.2 -1.9 6.8

Real Prices of Main Commodities (farm):Maize 1.3 3.6 -0.8Milk 1.2 3.8 1.7Coffee -2.7 -3.2 -8.6Tea -3.6 10.3 -13.9Wheat 0.9 2.5 4.5Sugar 4.1 6.1 1.9

a/ Calculated by fitting a trend line using least squares

- 69 -

ANNEX VTable 1

EXTERNAL FINANCINA REqUJRES AND SOURCES(In *illione of US dollare)

P R 0 J E C T E D1980 1990 1991 1992

Exztrnal Financing Requiresents 119 1261 1160 1135

Current Account(excluding off cial transfer.) 716 681 s5a 587

Amortizetion 1/ 241 415 4B8 447World Bank/IDA (79) (96) (101) (102)

EIF Repurchase 182 100 40 61Chnge in Reearve. 110 66 120 70

Disburemntes 1106 1174 1189 1102Grants 280 176 1B2 160Loans rem -Official Creditors 84 719 603 724World Dank/IDA (244) (213) (228) (146)

Private Creditor. 1/ 107 46 156 187IMF-ESAF 108 lOS 106 0Otber Capital (not) 825 126 21 81

Gap 2/ 0 87 41 83

Source: 13D, Debtor Reporting System end staff estimates.

Notes The Government of Kenya Is currently ditcusaing with the IMF appropriatemasures neede to close the gap In 1900.This Baw Scenario is subject to rvisions basd on occurences in the Gulf.

1/ Includes private non-guaranteed debt.2/ Expected di abursment. from cofinanctng and aditi onal umtI lateral

assistanco.

- 70 -

ANNEX VTable 2

KEY INDICATORS

ProjectionsActual Prelim. ---- -------------------

1988 1089 1990 1991 1992

GDP Growth Rate 6.0 4.6 4.8 6.0 5.1GNP Growth Rate 6.6 4.8 6.6 6.2 6.1GNP/Capita Growth Rate 1.6 0.6 1.7 1.5 1.3Consumption/Capita Growth Rate 2.1 -6.8 -1.4 1.7 2.7

Total DOD (in US$) 5780.7 5700.6 5908.8 6540.9 6948.3DOD/IOS 218.8 201.7 190.2 190.1 201.2DOD/CDP 68.3 69.1 65.8 65.8 63.4Debt Service-LT (in US$) 686.1 594.0 779.8 775.8 887.6Debt S.rvice/IGS 28.7 21.0 25.2 28.7 24.8Debt Service/GDP 7.6 7.2 8.6 7.8 7.7Total Interest/IGS 8.8 7.8 8.6 9.1 9.1Interest/GDP 2.8 2.7 3.0 3.0 2.9

Gross Inveotm.nt/GDY 25.8 26.4 24.2 28.1 22.4Domestic Savings/GODY 20.7 19.7 19.8 19.7 20.0National Savings/ODY 17.6 16.5 16.7 17.8 17.4Marginal Savings Rate 0.00 0.02 0.22 0.27 0.21

Gov't Revenuos/GDP 23.4 28.4 23.9 23.7 23.6Gov't Expenditures/GOP 1/ 28.t 80.4 80.4 29.9 29.8Fiscal Deficit/GDP 2/ -6.5 -7.1 -6.5 -6.1 -5.7

Export Growth Rats -8.1 1.6 7.6 6.0 8.0Exports/GDP 12.7 12.4 12.7 12.8 12.9Import Growth Rate 10.8 2.2 -8.8 1.1 6.0Imports/GDP 21.5 21.0 19.8 18.6 18.7Current Account (in mill.USS) -659.2 -716.2 -680.8 -682.9 -657.0Current Account/GDP -7.9 -8.7 -7.5 -5.9 -4.9TormS of Trade Index (1982=100) 88.4 78.4 74.0 78.8 79.3

MEMO:DS Ratio (Incl.IMF A ST) 8/ 32.9 29.6 83.7 30.0 80.0

Note: Fiscal data are for the fiscal year ending on June 80.Fiscal year GDP Is calculated as a simple average of calendar year data.Trade date are In real prie..

1/ Numerator Includes net lnding.2/ Numerator Include adjustment to cash.8/ Denominator Is exports of goods and services.

- 71 -

STATUS OF OANK Ci OPERATIONS tN KENYA ANNEX VIPage 1 of 2

A. STATMEN OF BANX LOANS AMS IDA CEDm(no of September 30, 1900)

- -41S8l Il toon---Amunt (Lees Cancel lotions)

Loan or Fiscal Undbo-Credit No. Year Borroer Purpoe sank IDA bursd

Forty-four (44) Loons and forty-three (43) credits fully dibursed 20.82 702.11Of which SECALs, SAL. ad Progran Loene/Credltst a/

Cr.A021-0 1086 Kenya Agriculture Sector 0.00 40.00Cr.1717-0 1to6 Kenya Agriculture Sector 0.00 20.00Cr.AO38-0 106 Kenya Induatrial Sector Operation 0.00 10.00Cr.1927-0 1088 Kenya Industrial Soctor Operatlon 102.00Cr.1927-1 180 Kenya Industrial Sector Operation SJ.70Cr.2049-1 1908 Kenya Financtal Secor Operation 44.00 -

0.00 269.70 0.00

Cr.2049-0 e 1089 Kenya Financiol Sector Operation 120.00 12.39Cr.1107 1981 Kenya Fifth Education 40.00 6.98Cr.1237 1962 Kenya Cotton Proc. a Marketing 20.53 0.74Cr.123# 1902 Kenya Integrated Rural Health &

Family Planning 28.00 2.90Cr.13S7 196 Konya National Extenaion 15.00 0.41Cr.1390 19" Kenya Secondary Towns 22.00 12.26Ln.2359 1064 Kenya Kiambere Hydroelectric 60.00 2.06Ln.2409 194 KeyaY Second Highway Sector 5.00 3.31Cr.FO1? 1964 Kenya Second Highway Sector 40.00 33.16Cr.1548 166 Kenya Water Engineorlng 6.00 0.33Cr.186? 196 . Kenya Sixth Educetion 37.50 32.59Cr.1675 196 Kenya Petroleum Explor. Tech. Assist. 8.00 2.86Cr.1718 1906 Kyo Agric. Sector Management 11.50 4.26Cr.1738 1987 Kenya KIE 2nd Small Scale lndutry 8.00 6.03Cr.17568 1907 Kny Animal NIth Service 15.00 13.47Cr.1820 107 Kenya Second Rallwoy 26.00 13.20Cr.1840 1966 Kya Agriculture Reearch 19.60 19.6Cr.1904 196 Konya Population III 12.20 10.#5Cr.1973 1989 Kya Getheral Devolopasat 40.70 29.26Cr.1974 169 Kenya Rural Services 20.80 17.44Cr.20S8 1960 Kenya TA 5.00 4.76Cr.2060 160 Kenya Third Nairobi Water Suppi. ProJ 64.60 61.31Cr.2062 100 Kenya Coff*e It 40.60 46.42Cr.2111 1660 Ken Population IV 35.00 36.59Cr.2147 160 Konya TA-OFI Res/Exp. Prm 6.00 6.54

Total 911.82 1843.56 366.76of which repld 369.38 20.41

Total held by Bank & IDA 42.44 1323.17_ -

Amont sold 11.74of which reaid 11.74

Total undlsbursd 366.76

1/ Approved after FY80o SAL, SECAL or Progrea Loan/Credit(kesledl .wtl 11.12.90)

- 72 -

ANNEX VI- - ~~~~~~Pa..,. 2

S. STATEMENT F WC INESTWM IN KNA(a. .t sepeme 80, 109)

Amount In USS MillionFiscalYear Obligor Tpe of Susiness Loan Equity Totoa

197,190S, Kony HoIe Proportlee Houel 6.2 0.7 5.0and 1978

1970,1974 Pan African Paper M1 III Pulp and Paper 40.7 6.8 47.01977,197919o1, is..,and 19001972 Tourism Promotion Servics Hotle 2.4 -1/ 2.41970 Rift Valley Texti le Ltd. Text) lee 6.8 2.6 9.119t7 Kenya Commrcial Bank Ltd. Capitol arket 2.0 - 2.0190,1984 Developmet Finance Development Fina1c 6.1 1.8 6.4

Comny of Kenya Ltd.1961 Kenya Com_rcial Finance money A Capital IMakt 5.0 - 5.01962 Bamburl Portland Cemet and Constrt. 4.4 - 4.4

cemnt Co., Ltd. Materil1902 Dimond -Trust of Moe A Capital IMrket - 0.6 0.9

K'npa Limited1962.1907 Induatrial Promotion Mone a Capitol Mbrket - 2.0 2.0

Service (Kenys) Ltd.1968 Tatra Palk Converters Pulp & Paper Product 2.2 0.4 2.6

Limited1964 Leather Industries of TenIql 2.1 0.6 2.7

Kenya Limited1066 sdu Paper Intrnationl Polp a Pape Product 87.1 2.0 89.1

Limited1066 Equatorial beech Tourim 5.6 - 5.6

* Properties1996 011I Crop Devlopment Ltd. 0.7 1.4 11.1

Total Gras Commitment 127.6 16.$ 146.1Low: repeymente, cancellations,

exChu adjustente,termInation. aN sales 94.0 0.0 103.0

Total Comel tbmest mw bold by IFC 88.5 0.8 48.1Totl UndieWrsd 0.0 1.2 1.2

1/ 844,987

kee2edl .wi11.9.00

- 73 -

ANNE VIIPage 1 of 4

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERIATION

Supervision Plan and Implementation Schedule

IDA Supervision Input

1. It is envisaged that about 20 SW per year vill be requiredfor supervision. Of these, routine activities (review of progressreports, procurement actions, correspondence, donor discussions, and soon), will take about four SW per year for the first two years while thequick disbursing part of the Credit is being disbursed, and three SW peryear for the latter three years, until the training and technicalassistance component is completed. For non-routine supervision,staffing needs are indicated in the table below. The project isexpected to become effective about March 1, 1991, and the closing dateis December 31, 1995.

Borrower's Contribution To Supervision

2. The Steering Committee chaired by the Ministry of Financewill submit semi-annual reports to IDA on progress of the AdjustmentProgram, on August 1 and February 1 each year until February 1, 1993.These reports will cover the areas laid out in the Government's Letterof Sectoral Policy, namely Incentives and Marketing, Fertilizers, PublicExpenditures in Agriculture, Food Security, the Dairy Subsector, LandPolicy and Legislation, the Coffee, Cotton and Sugar Subsectors, Aridand Semi-Arid Lands, Wildlife, and Forestry. The detailed format forthis report will be finalized during the first supervision mission.

3. The implementing ministries will submit semi-annual progressreports on the progress of training and technical assistance, by August1 and February 1 each year until February 1, 1996. These reports willcover capacity building activities in the Ministries of Agriculture,Livestock Development, Supplies and Marketing, Planning, and Finance,following a format agreed during the first supervision mission.

Organization of Review Missions

4. While the adjustment component is under implementation, IDAreview missions will be staffed to review implementation of both theadjustment and capacity building components. Review missions will beled by the ASAO II Task Manager (Economist), and will include staffand/or consultants in areas of price policy and marketing, generaleconomic policy, fertilizers, public expenditure management, monitoringand evaluation, and training, with other specialties where needed.

5. Because of the linkages between the Adjustment Operation andstabilization policy, a macro-economlst from IDA's Country OperationsDivision will be invited to participate in the review missions leadingup to release of second tranche. Close coordination will also bemaintained with the IMF, and with the Bank's disbursement unit inNairobi, to ensure fast disbursements.

KENYA ANNEX VIISECOND AURXCULlURAL SUM ADaUTMENT OPATON Page 2 of 4

Splementatlon ScheduleA. Adjustment CoM2nt

Composeat/Tash Couplet- AgewcyIon Date -

(a) Maize produeer prlce to be reviewed and re-adjusted using the new methodology. 2/91 IOf

(b) Maiz movement controls to be relaxed further to permit transortation of up to 8 twn (90begs) of maiz without a pemit; a date during Im for removing I I controls on domeeticmaize movement to be agreed with IDA; NCPB s guaranteed shere of the econdary (i fted MOF/MSMmIIlIrs) demand for maisz to be reduced to OX; beans to be d-scheduled. 11,91 Cabinet

(e) The Prrformanc Contract, aeemptable to IDA, to be finalized for the year 1992/93 to MOF/USM1994/95 and slnred for 190/93. 11/91 NCPB

FeftilIers

(n) The solocted Institutiosl mech anim to lower the coase of fortilizer Imports and atime table to mak It operational to be gareed with IDA. 11/91 MOA

(6) The policy paper on donor In-kindO fertilizer aid to be finalized, and an *xchange ofviews to take place with IDA on proposed easure. 11/91 O

(c) Action plans for sell teting, fertilizer promotion, and training to be finalizedfor all Distetets following review by the Fertilizer Development Comittes (FOC). 11/91 MOA/ FOC

Public Exienditore

(a) A Project Perforanc Rportilng System and a Project Review Comittee In MCA endMOLD to be established; the MOA and MOLD core invesetmnt proram In the 1992/93Annual Budget to be fully fitnnced and included In the estimates In the1992/93-1994/9S Forward Budaet. 11/91 MOA/A04

(b) Staffing norms to be finals zed, and lmplementation to be coemm_ced of staffing andnon-salary operstin expendIture norm In key activIttes, with consequentialadjustents to the intak, of training institutions. 11/91 W

(c) Implentation of an action plan to incr"ea collection of er charges would be c_mmeeced. 11/91 MOA/MILD(d) Prtormance In 1991 of the Improved budget and paymet system woud be evoluated,

and vies exchanged with IDA on the fIndings. 11/91 MOAW LDM

Assistance to Vulnerable Groups OP

Implemettion of action plans to be cooanced for: drought contingency, food/nutrition, CBSddressing possible advers impacts of graln marketing reforme, and household monitoring. 11/91 MCOA 4

AIEX vIIPage 8 of 4

KENYASECOND ARICULTURAL SM ADJUSTMENT OPERATION

S. Trainron A TA Cospon nt

Ccmpoo rt/Ta.k Completion Date Aonoy Rosponl-

Capseity Buildins In oAaicultur_

Procurement of transport and office equlpsont 6/91 WOA/MOWL/tSM/R.crultmtnt of technical Asistanee Personnel 6/91 MPND/MOfFln.llzation of 4-y.t. trutaing program and detbaled annual progrm 6,91 1/962

5/93, 5/94l Iplementation of eah annual training progrm 6/92, 6/,

_____________________________________________________6/94, 6/u ______

O-

ANNEX VIIKEWA ~~~~~~Pe 4 of 4KENYA '

SECOND AORICULTLRAL SUMYf ADJUSTMENT OPERATION

IDA Supervision Inet Into Key Activities

Dtesli/ Activity Skills Needed Staff Week.

FY91

2/91 Focus on disbursement, ostablishment of Special Aecounts, progreso on Task Manager 2.0actlons for meeting second trancho conditions, finalizing formats for Economist 1.0semi-annual reporttng on adjutment and capacity building compononts, Financiol Analyst 1.0and recruitment of technical assistance. Fertilizor Spec. 1.0

5/91 Review of progress on all econd tranche activities, wlth special Task Manager 2.0focus on establishing the monitorlng activities, and food oscurity Economist 3.0actions. Flnancial Analyst 3.0

Fertilizer Spec. 8.0

FY92

11/91 Second Tranche Review Mission; -jview of progreos towards meeting all Task Manoger 2.0second trenche conditione. Economist 3.0

Financlol Analyst 2.0Fort. Spec. 2.0Macro-Economist 1.0

4/92 Revlow of progreso on finalizing dieburseoments for adjustment Task Manager 2.0component; review of progres on capacity building component, Economist 1.0especially establishment of the training program. Financial Analyst 1.0

Troining Spec. 2.0 _

FY98

10/92 Beginning preparation of PCR on adjustment component; review of Task Manager 2.0capacity building component. Economist 2.0

Financial Analyst 2.0M A E Spec. 2.0Training Spec. 2.0

8/98 Review capacity building component Toak Manager 2.0Economist 2.0Training Spec. 2.0

FY94 Two missions to reviow capacity building component Task Manager 8.0Other specs. 7.0 0

FY9S Two missions to review capacity building componont, and begin Task Monagor 8.0 o Hpreparing PCR on the latter. Other specs. 7.0 . . .h

/ While dates for forml miesions have been specified, most of the supervision of the operation will be by staff working inNairobi, who will work on specific elements of the operation whenever neoded.

- 77 -

ANNEX VIIIPage 1 of 10

XENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

CAPACITY-BUILDING COMPONENT

I. IMPROVED AGRICULTURAL POLICY ANALYSIS

Background

1. Since the mid-1980s, improvements in agricultural policy analysisin the Ministries of Agriculture and Livestock Development have not beensustained because the data base has deteriorated, trained andexperienced professionals have moved out to the private sector, andtechnical assistance has been greatly reduced.

The Program

2. The main objective of the program is to strengthen theGovernment's capacity to carry out agricultural policy analysis throughan integrated program of technical assistance and training. Major areasof improvement will include analysis of agricultural prices and marketstructures, macro-economic and sectoral linkages, projects andinvestments. The program comprises four elements:

(a) Improved Data: More comprehensive collection will be undertakenof data on agricultural outputs and inputs (especiallyfertilizer), household consumption expenditures, and marketprices, with priority policy analysis of these variables. Thiselement will be coordinated with actions under a recently approvedmarket information system project financed by USAID, and fundedunder a recently launched project on monitoring and evaluation ofagricultural strategies and policies being supported by IDA andUNDP;

(b) Training: Training will be offered in two packages: non-degreeand in-country training in policy analysis (approximately eighttraining modules would be offered 1-2 times per year); and limiteddegree training at the Masters level (two in Kenya and two in aforeign institution);

(c) Technical Assistance: Provision will be made for a team ofadvisers which includes a team leader and a training coordinator.The team leader will coordinate training and technical assistance,oversee administrative aspects of the program, and provideanalytical support to the Development Planning Division (DPD) inthe Ministry of Agriculture. The training coordinator willdevelop course content (including relevant case study material) onpriority modules in close liaison with the trainers and will beresponsible for implementing the non-degree training program. Theremaining advisers will be distributed in the Ministry ofAgriculture, Ministry of Livestock Development, Ministry of

- 78 -

ANNEX VIIIPage 2 of 10

Supplies and Marketing and Monopolies and Prices Commission of theMinistry of Finance; the advisers will assist in improvingquantitative policy analysis, emphasising on-the-job training oflocal counterpart planning officers, help to develop an improvedagricultural data bank, and monitor the effectiveness of theshort-term training.

(d) Support facilitiess These will include microcomputers andcomputer software, operating funds for field visits by planningofficers, and essential office equipment.

Implementation

3. The overall program will be coordinated by the Ministry ofAgriculture/DPD. Government will recruit an international institution(which will be encouraged to use local inputs to the extent possible)with relevant experience in SubSaharan Africa. The program will bemanaged from a Technical Asistance and Training Unit to be establishedin MOA/DPD. It is expected that the local participation will establisha capacity within Kenya to provide non-degree training in agriculturalpolicy analysis on a sustainable basis. Among others, local inputs areexpected from the University of Nairobi (Department of AgriculturalEconomics and Institute of Development Studies) and Egerton University.Precise arrangements for the local participation will be worked out asproposals are finalized.

4. The program would be supervised by an interministerial committee,chaired by the Head of the DPD/MOA. The other members would be theHeads of the Planning Divisions of the participating Ministries. Theteam leader will report to the steering committee, and, in liaison withthe respective Head of Planning Unit and adviser, will review and updatethe Planning Units' and advisers' work programs to reflect priorityneeds of improved policy analysis. The training coordinator will reportto the team leader, while the other advisers will report to therespective Heads of their planning units and, periodically, to the TeamLeader, especially regarding the effectiveness of the non-degreetraining courses.

5. The program will span a period of four years starting July 1991,and is estimated to cost about US$3.8 million equivalent. IDA and theAfrican Development Bank will cofinance the program on a joint basis(approximately US$2.0 million and US$1.8 million, respectively).

Cost Estimates

6. The cost estimates are as follows (USS million equivalent):

Equipment: 0.4Trainings 1.6Consultants: 1.6Non-Salary Operating Fundst 0.2

TOTAL: US$ 3.8 M

- 79 -

ANNEX VIIIPage 3 of 10

Tne agricultural data component will be funded by the Monitoring andEvaluation Project, using IDA funds to be channelled to the CentralBureau of Statistics and MOA.

7. The following actions will be taken in order to start the programby July 1991:

- Short listing of international institutions, and invitation forthem to submit proposals (February 15, 1991);

- Selection of the institution (April 15, 1991);

- Mobilization (July 1, 1991);

II. LAND POLICY AND ADMINISTRATION

Bac round

8. The Department of Lands of the Ministry of Lands and Housing has ac tral role in addressing land policy and administration issues, and inc rrying out land-related proposals under ASAO II (Letter of Sectorolicy, paras 40-42). A recent evaluation of the Department of Landsdicates that it has serious constraints involving its staff, land

administration procedures and supporting facilities. If theseconstraints are not overcome, this will affect adversely theimplementation of improved land policies aimed at promoting increasedagricultural production through a more efficient, renumerative use ofgood quality land. It is therefore imperative that the Department ofLands be strengthened as an institution in order better to perform itsi functions in land administration, valuation, registration, and titling,and to develop land information systems and inventories.

The Program

9. The program will provide:

(a) short-term non-degree and in-country training for the Department'sstaff in both Headquarters and Districts;

(b) short-term technical assistance (10 months) to assist thedepartment formulate and implement its training program and actionplan for improved land policy and administration; and

(c) essential equipment and operating funds to support implementationof the action plan.

Implementation

10. The above activities will be carried out by senior staff from theDepartment of Lands over a 3-year period, begining nA later than July,1991. The Deputy Commissioner of Lands till be responsible for theimplementation of the overall program, in close coordination with the

- 80 -

ANNEX VIIIPage 4 of 10

Permanent Secretary and Commissioner of Lands. The day-to-dayresponsibility will be under a Senior Assistant Commissioner of Landswho will coordinate closely with the District offices and reportdirectly to the Deputy Commissioner of Lands.

Cost Estimates

11. A total of US$300,000 has been made available under ASAO II tosupport the above program. This represents the first phase of anexpanded program to be supported in the future from other sources yet tobe found. The first phase program will focus on improving land policiesand land administration procedures in the high potential agriculturalareas.

12. These funds will cover the costs oft short-term consultancies, aprogram to computerize essential land information (to be complemented byan expanded land information system which will be financed separately);short-term training courses in-country (including courses in use ofcomputers for data collation and management at both Headquarters andDistrict levels), microcomputers, vehicles, transport operating costs(fuel and repairs), land registration and valuation stationery andequipment, typewriters and photocopiers, plan printing machines anddrawing materials.

III. PUBLIC EXPENDITURE MANAGEMENT

A. PROJECT MONITORING AND EVALUATION

Background

13. The Ministries of Agriculture (MOA) and Livestock Development(MOLD) place a major emphasis on development activities. Currently,over 502 of the total budgetary expenditures of the two ministries isfor direct investment projects and programs. The GOK is keen to ensurethat the effectiveness of both ongoing and new projects and programs isenhanced. To do this it is critical to operate an efficient projectmonitoring system that instills accountability and allows the periodicreallocation of resources, when and where necessary. The existingproject monitoring systems in the two ministries has proved to begrossly inadequate. Very little information exists on projectperformance, and it is almost impossible to make an objective assessmentof project impact on the ministries' development activities.

14. MOA. The current functional responsibilities of various divisionsin the MOA, with regard to different phases of the project cycle, aredefined within the framework of the Project Management system (PMS).The PMS was established in both the MOA & MOLD in 1984. According tothe existing allocation of responsibilities in MOA, the ProjectDevelopment and Monitoring Division (PDMD) is mainly, but notexclusively, responsible for project monitoring. The other divisionwhich shares this responsibility with PDMD is the Development PlanningDivision (DPD) which is administratively responsible to the Permanent

- 81 -

ANNEX VIIIPage 5 of 10

Secretary. The shared responsibility of both divisions in projectmanagement in fact overlaps over the entire project cycle beginning withproject identification/preparation and concluding with final impactevaluation. To date the overlapping functions between the twoministerial units has substantially weakened the functioning of thereporting system.

15. Aside from the overlapping functional responsibilities for M&E themajor factors underlying the poor performance of the project managementsystem in the MOA and HOLD are that:

(a) the current system for obtaining project implementationinformation through technical divisions or project coordinators isgeared to describing annual activities without any indication ofquantitative outputs; therefore as a priority there is a need tomodify the existing reporting formats in order to make them moremanagement-oriented;

(b) the existing reporting mechanism continues to be geared to singleproject monitoring with no system for national level aggregationor analysis; the Project Performance Reporting System should bedeveloped into a centralized system, to be supported withtechnical assistance; and

(c) the PDMD's and PMU's mandate to monitor a large number of projectsis not supported by commensurate increase in manpower or otherresources; it is important that under ASAO II the system changesin M&E be accompanied by a program to strengthen the institutionalcapacity for this task.

16. MOLD. The monitoring and evaluation of about 21 projects in thelivestock subsector is currently the responsibility of an exclusiveProject Management Unit (PMU). The shared responsibility of PMU and DPDin various phases of the project cycle has more or less the samenegative implications as discussed in the case of MOA above.Furthermore, a review of the database in the MOLD's Project Registryrevealed that only outdated and quite unreliable data of a historicalnature is available. In fact the regular reports generated by projectofficers and DLPOs for livestock projects are less in number andprepared with less regularity than in the case of MOA projects.However, the factors that have prevented the system from becoming fullyoperational are the same as indicated for MOA above.

The Program

17. MOA. As the lead Division responsible for project M&E, the PDMDneeds to be adequately staffed with technically qualified personnel withsupporting equipment and facilities. Presently, the Division has 13professional staff at headquarters including 8 assigned to "ProjectDevelopment" work. This activity is henceforth to be refocussed oninitial project identification. The strengthened PDMD will have 9professional staff at headquarters, and 21 at provincial level (one M&Eofficer plus two professionals in each province), in addition to 6

- 82 -

ANNEX VIIIPage 6 of 10

Technical Assistants (TA.) per province responsible mainly for fieldwork. The proposed T.A. program will help PDMD establish an effectivepresence in the field. At present most of the PDMD technical officershave not been exposed to adequate training in their respective tasks.In view of the high turnover of MOA trained staff, however, thetechnical assistance and training component caters for functional shortterm training both within Kenya and overseas.

18. MOLD. The MOLD has already recomended to the Director ofPersonnel Management (DPM) in the Office of the President that the PMUbe elevated to divisional status. While the unit has currently anauthorized establishment of only 5 professional staff including theAssistnt Director of Livestock Production as head, it is proposed thatthe authorized establishment be expanded by a further 25 professionalstaff mainly to support decentralization of M&E activities at the fieldlevel. As much as possible, staff training seminars and vorkshops inM&E will be conducted jointly for MOA and MOLD in order to ensure cost-effective use of the available limited resources. It is howeverrecognized that MOLD may indentify some training needs separate fromthose considered to be common between the two ministries. Therefore,some 700 days of short courses (about 28 days for each professionalstaff) have been provided for use by the PHU in HOLD in each of theproject years.

19. System Design. The conceptual framework of the existingonitoring system in MOA and MOLD as contained in the PMS does recognize

most of the essential features of project monitoring. However,currently several types of project implementation reports are generatedto serve the needs of several users, including donors. In fact, mostdonors require periodic monitoring as part of project design and theyhave introduced special monitoring reports. The real problem is thatthe existing reports are unsuitable for a centralized managementinformation system, which can signal to management the keyimplementation problems for quick remedial action. The existing PMSreporting framework needs to be translated into standard operationalguidelines and performance indicators applicable to all projects. As afirst priority, therefore, the PDMD in Agriculture, and PHU in Livestockwill, in collaboration with the respective technical divisions,undertake a thorough review of all the existing reporting formats.

B. BUDGET MANAGEMENT

Background

20. In 1986 the Government of Kenya (GOK) initiated bold measures toimprove financial management of sectoral ministries as part of itsBudget Rationalization Program (BRP). Nonetheless, there are stillareas which need to be effectively audressed. There are for instanceweaknesses in systems of funds flow, accounting and procurement, causingdelays which exacerbate the problems and constraints in the managementof projects and programs. It is in this context that this technicalassistance package has been developed.

- 83 -

ANNEX VIIIPage 7 of 10

The Program.

21. Changes in the existing accounting and funds flow systems areimportant in the following three areass

(a) improving the timeliness and reliability of the monthlyexpenditure statements related to Authority to Incur Expenditures(AIEs) by: overcoming the current problems in ensuring completereporting on direct donor payments; ensuring timely submission ofreliable monthly expenditure returns by each AIE holder, andplacing the primary responsibility of preparing the returns on theAIE holders themselves, rather than on District Accountants vhoare outside the administrative control of MOA and MOLD; improvingthe data coding and software currently in use in the processing ofthe monthly expenditure returns; and training accounts personnelin the use of PCs so that they can take over the responsibilityfor the processing of the returns from the finance division staff;

(b) developing a standard system for the operation of advance depositaccounts (special accounts) where donors can place their funds foruse under the AIE/reimbursement system of funds flow; and

(c) strengthening the performance of the accounting divisions in MOAand MOLD through introduction of microcomputers and training, sothat they can carry out all their functions, including those stillcarried out manually, or even undertaken by the finance divisionsbecause the latter have had the computer technology and skills.

22. To help accomplish improvements in the aforementioned areas theASAO II Credit will support technical assistance for systemsdevelopment, staff training, and computerization of accounting systems.Most tasks will be accomplished under the direction of an expatriatebudget advisor financed by another ongoing IDA project. It is expectedthat all accounting routines at H.Q. will be computerized.

Cost Estimates

23. The program for strengthening public expenditure management andmonitoring is estimated to cost US$3 million equivalent over a four yearperiod, including physical contingencies and allowances for priceescalation. The costs include an estimated US$0.95 million for the PDMDin the MOA, US$0.83 million for the PHLU in MOLD, and US$1.2 million forbudget management. The base costs include US$0.67 million for vehiclesand motorcycles, US$0.42 million for office equipment, US$1.03 millionfor training, and US$0.51 million for technical assistance.

IV. FERTILIZER DEVELOPMENT

Background

24. The recent (1989) Bank study on Kenya's agricultural growthprospects concluded that over 85 percent of future increase in the

- 84 -

ANNEX VIIIPage 8 of 10

country's value added in agriculture would come from smallholders, whocultivate 66Z of the cropped area but currently achieve yield levelsabout half of those realized by the largeholders. The low productivityof Kenya's smallholders is to a large extent explained by sub-optimalapplication of the necessary farm inputs, especially fertilizers. Thesmallholders' share in country's annual fertilizer consumption does notexceed 402 (on 662 of cultivated land) and much of it goes to cash cropslike tea and coffee, leaving only a small percentage for use on cerealcrops. Furthermore, more than 702 of the smallholders still use nofertilizer or negligible quantities. As a result, the national averagefertilizer use is only about one third of the estimated potential. Onthe other hand, fertilizer use needs to increase at an estimated 112 peryear to sustain the Goverrment's objective of achieving an annualagricultural growth rate of 4.5Z.

25. The goal of ASAO II (Fertilizer Component) is to promote anincreased and more efficient use of fertilizers, particularly bysmallholders, in a liberalized and competitive marketing environmentthrough a program of institutional strengthening and policy reform.Past experience shows that such a program would have poor chances ofsuccess, unless it is accompanied by a strategy to build up effectivelythe institutional capacity associated with program implementation. Thisis the goal of the technical assistance and training program.

The Program

26. MOA: The Inputs Unit, currently managed by two full-timeofficers, will be expanded to an Inputs Branch, whose tasks willincludet (a) integrating commercial and donor fertilizer imports; (b)developing a data base on the fertilizer subsector covering, inter alia,-the international and domestic fertilizer market situation, pricetrends, ocean freight rates, fertilizer demand estimation by seasons andlocations, information on crop areas and recommended fertilizer doses;(c) promoting quality control; (d) assisting Government in designingpolicies to promote fertilizer use through private fertilizer trade; and(e) keeping abreast of all developments in the fertilizer sector. TheTA and Training Component is designed to help the Inputs Branch developappropriate systems to oversee the fertilizer subsector, train key staffin their respective job responsibilities, provide necessary equipmentsuch as microcomputers to assist in storage, retrieval and analysis ofdata, as well as a few vehicles to improve staff mobility, and establishand run an efficient management information system (HIS). Provision hasalso been made for short study tours of senior government officials aswell as members of the National and District Fertilizer Committees(which are being set up under ASAO II to improve the consultativeprocess between the private sector and the Government), to assist themto keep current with the trends and fertilizer sector managementpractices in and outside the country.

27. District Extension Staff: The provincial and district extensionstaff, particularly the newly appointed District Soils and Fertilizerofficers, will be trained in practical ways of handling soil and

- 85 -

ANNEX VIIIPage 9 of 10

fertilizer related subjects in the field through workshops, seminars,training courses, and study tours.

28. Fertilizer Dealers: Fertilizer dealers (wholesale and retail) inthe private and cooperative sectors will be assisted with short (2 day)training programs to improve their knowledge about the role of varioustypes of fertilizer in their specific crop and soil situations, andfertilizer promotion and marketing techniques including environmentallysafe fertilizer handling, storage and application methods. Somefertilizer promotion material will also be provided to the privatetraders. Similar training, specially tailored to meet their needs, willalso be provided to agencies handling fertilizer importation anddistribution.

29. Farmers' Training: Training focussed on soil-fertilizer-croprelationship and economies of fertilizer use will be provided toselected farm leaders to overcome the reluctance to make optimum use offertilizers.

30. Other Technical Assistance and Training: Since the Farm InputsBranch has yet to develop adequate technical capacity, short-termconsultants' services will be provided to supports (a) the design andorganization of the training courses outlined in above; (b) the designand implementation of systems for monitoring fertilizer use; (c) areview of the currently prescribed fertilizer standards to ensurerelevance for the Kenyan farmer; (d) the definition of fertilizerquality control regulations and their operating framework; (e) a rapidsurvey to determine the soil acidity status in different agro-ecologicalzones of the country and development of an action program, pendingfurther research (over 301 of the Keynian soils are already affected bysoil acidity); (f) development of district action plans; (g) thedevelopment of guidelines for operating soil testing laboratories; and(h) a mid-term review of the policy and institutional reforms.

Cost Estimates

31. The total costs of the TA and Training measures outlined above areestimated at US$2.7 million, including provision for physicalcontingencies and price escalation, respectively at 102 and 4.92 perannum beginning 1991. All these costs are non-recurrent and will befunded 1002 from the IDA Credit for ASAO II. The incremental annualrecurrent costs for the program are estimated at US$0.56 million,equivalent to about 172 of total costs for the three year period. Therecurrent costs will be funded by GOK.

SUMMARY COST ESTIMATES

32. The total costs of the Capacity Building Component are estimatedto be US$9.86 million, including physical contingencies, and allowancesfor price escalation. The component will be cofinanced by IDA (US$8million) and the African Development Bank (US$1.86 million). Thebreakdown of the estimated costs is presented in the following table.

- 86 -

ANNEX VIIIPage 10 of 10

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

CAPACITY-BUILDING COMPONENT

Table 1. COST ESTIMATES BY CATEGORY(US$ million, including all contingencies)

Component Vehicles Office Training Tech. TOTALSEquip't Asstce.

Policy 0.00 0.40 1.60 1.60 3.80"Analysis __l

Land 0.06 0.02 0.02 0.20 0.30Administration

Public 0.77 0.49 1.19 0.59 3.04ExpenditureFertilizer 0.06 0.03 2.27 0.36 2.72

TOTALS 0.89 0.94 5.08 2.95 9.86"

aj Includes US$0.16 million in non-salary operating costs

- 87 -

ANNEX IXPage 1 of 2

KENYA

SECOND AGRICULTURAL SECTOR ADJUSTMENT OPERATION

DOCUMENTS IN THE PROJECT FILE

Cereals Sector

1. Ministry of Finance, Mlnistry of Supplies and Marketing, andNational Cereals and Produce Board. Performance Contract for theperiod 1990/91 to 1992193. December, 1990.

2. National Cereals and Produce Board. 'Liberalisation Under theCereals Sector Reform Programmes An Evaluation.' July, 1990.

3. National Cereals and Produce Board. 'Meeting the Challenge of theNineteen Nineties. NCPB Corporate Strategy 1990/91 to 1992/93.'Discussion Draft, August, 1990.

4. National Cereals and Produce Board. 'Establishment of PerformanceTargets.* A report by Githongo and Associates (Africa) Ltd. andOxford Research Ltd. November, 1990.

Fertilizer

5. A Consultancy Report for the World Bank on Fertilizer Developmentin Kenya. April, 1990.

6. Ministry of Agriculture. Fertilizer Action Plans for Bungoma,Kisii, Machakos, Murang'a, and Nandi Districts. November, 1990.

Public Expenditure

7. Recurrent Cost Issues in the Ministry of Agriculture and theMinistry of Livestock Development. A Draft Report by S.B.Peterson and Kithinji Kiragu. May 25, 1990.

Poverty Alleviation

8. Ministry of Agriculture and Ministry of Livestock Development.Household Food Security and Nutrition Policy. Draft Report, 1988,released October, 1990.

Capacity Building

9. Institutional Capacity Building for the Development PlanningDivisions in the Ministries of Agriculture and LivestockDevelopment. May, 1990.

- 88 -

ANNEX IXPage 2 of 2

10. Ministry of Lands, Housing and Physical Planning. 'Land Policyand Legislation Issues in Kenya's Agricultural AdjustmentOperation II*. A report by H.W.O. Okoth-Ogendo. August, 1990.

11. Fertilizer Component: A Program of Technical Assistance andTraining to Promote Institutional and Infrastructural Development.A Consultant's Report. September, 1990.

12. Ministries of Agriculture and Livestock Development.Institutional Strengthening and Technical Assistance Under thePublic Expenditure Component. A Report by Javed Masud and K.Kiragu. October 2, 1990.

Other

13. Ministry of Livestock Development. 'Kenya Dairy Master Plan tothe Year 2000: Enhanced Policies and KCC Efficiency.' A DraftInterim Report by Carl Bro International. July, 1990.

14. A Suggested Framework for the Monitoring and Evaluation of theAgricultural Sector Adjustment Program. A Draft Discussion Paperby K. Altemeier. July 2, 1990.

15. Other working papers to be added.

MAP SECTION

S U D A N

o/'/ t-=ti''' .3 ''5 ~K E N Y ASUA

'"_( l* s E T H I O P I Atn I-J j? s._ ,,_ t Ba& N/

1 E gosl b A p I o ' .

U ~ GI T N\D A % ' )v' - E A T E R N

UGANDA W.*~~~~~~~~~~~~~~~~~~~~~~~~~~INI

v k L L E Y ,jSO Al

TADADD AtD A CTS O A NN OJ R t H

rG-.S( TLR £ 1 { \ *v~~X_ \ / A.

, I ;; > zw 5 S MrX < -t 7

_ <5/ = D z T t~~~~~ ~ R N \%s

AADAIAAPTAO SC ,DT D AAf A . | .1 1 ' f A' ) kCE

A.oV A D L I C A

-- D- 4-M -. BP I; bi /TAA

M%lr0 PllODA0N OtATTIAT bOAdDOATi-A

tA*iT4S~~~~~~ INT -1 er'O\>w