Document of

The World Bank RE ' TO

FOR OFFICIAL USE ONLY

Report No. 2253a-KE

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KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

STAFF APPRAISAL REPORT

May 10, 1979

Eastern Africa RegionCentral Agriculture Division

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

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CURRENCY EQUIVALENTS

Currency Units - Kenya Shillings (K Sh) /1US$1.00 - K Sh 8.0K Sh 1.00 - US$0.125

WEIGHTS AND MEASURES

Metric British/US Equivalents

1 meter (m) - 3.28 feet1 hectare (ha) - 2.47 acres

1 kilometer (km) 2 - 0.62 mile1 square kilometer (km ) - 0.39 square mile (sq mi)1 kilogram (kg) - 2.2 pounds (lb)1 liter (1) - 0.26 US gallon (gal)

- 0.22 British gallon (imp. gal)1 metric ton (m ton) - 2,205 pounds (lb)1 long ton - 2,240 pounds (lb)

ABBREVIATIONS

AFC - Agricultural Finance CorporationCBD - Coffee Berry DiseaseCBK - Co-operative Bank of KenyaCBOK - Coffee Board of KenyaCPCS - Co-operative Production Credit SchemeCRF - Coffee Research FoundationCSS - Co-operative Savings SchemeDAO - District Agricultural OfficerFTC - Farmer Training CenterIADP - Integrated Agricultural Development ProgrammeIADP I - First Integrated Agricultural Development ProjectICO - International Coffee OrganizationKFA - Kenya Farmers Association (Co-operative) Ltd.KNFC - Kenya National Federation of Co-operatives LimitedKPCU - Kenya Planters' Co-operative Union Ltd.MOA - Ministry of AgricultureMOCD - Ministry of Co-operative DevelopmentPDA - Provincial Director of AgricultureSCIP - Smallholder Coffee Improvement Project

FISCAL YEAR

Government - July 1 to June 30CBK - October 1 to September 30CBOK - July 1 to June 30CRF - October 1 to September 30KPCU - July 1 to June 30

/1 Since October 1975 the Kenya Shilling has been pegged to the SDR at a rateof SDR = K Sh 9.36; the rate vis-a-vis the US dollar has fluctuated sincethat time.

FOR OFFICIAL USE ONLY

KENYA

APPRAISAL OF THE SMALLHOLDER COFFEE IMPROVEMENT PROJECT

TABLE OF CONTENTS

Page No.

I. BACKGROUND ................................................ 1

A. Project Background ................................... 1B. The Agricultural Sector .... .......................... 1

C. Government Services .................................. 5

D. Agricultural Credit .................................. 7

E. Commercial Services . .................................. 9

II. COFFEE SUB-SECTOR ......................................... 10

A. Background ........................................... 10

B. Kenyan Coffee Markets and Prices .................. ... 10C. Production ........................................... 12D. Processing ........................................... 14

III. THE PROJECT ............................................... 15

A. General Description . ....................... ............ 15

B. Detailed Features . . ................................. . 16

C. Project Costs . . ............... 18D. Financing .................. 20

E. Procurement .................. 21

F. Disbursements .................. 22G. Accounts and Audit ............. ...................... 23

H. Environmental Impact ... .............................. 23

IV. ORGANIZATION AND MANAGEMENT .............. ................. 24

A. Project Organization and Staffing .. .................. 24B. Training ................................ *. 27C. Monitoring and Evaluation ............. ............... 27D. Project Implementation .............. ................. 28

V. COFFEE PRODUCTION AND PROCESSING ........................... 29

A. Production - Technical Features ..... ................. 29B. Production - Farmers Benefits . ........................ 32C. Production - Estimates ........ ....................... 33

This Report is based on the findings of a IBRD appraisal mission whichvisited Kenya in May-June, 1978, composed of J. Wijnand, F.-M. Patorni(IDA) and D. Gardiner, A. Gibson and H. Seuster (Consultants).

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.

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Page No.

D. Processing - Constraints ..... ....................... 33E. Processing - Modifications ............... ........... 34F. Processing - Benefits .......... .. ...................... . 35

VI. MARKETS AND PRICES ........ ................................ 35

VII. BENEFITS AND JUSTIFICATION ................................ 38

A. Economic Evaluation .................................. 38

B. Financial Evaluation ........ .... .................... 40

VIII. SUMMARY OF AGREEMENTS REACHED ON CREDIT CONDITIONS ........ 41

SUPPORTING TABLES, CHARTS, MAP AND DESIGNS

TABLE 1 - Project Costs SummaryTABLE 2 - Detailed Financing PlanTABLE 3 - Co-operative Bank of Kenya Ltd. - Project Cash FlowTABLE 4 - Government Cash FlowTABLE 5 - Estimated Schedule of DisbursementsTable 6 - Economic Rate of Return CalculationTABLE 7 - Economic Rate of Return and Sensitivity Analysis

Table of Contents of Volume II

CHART 1 - Ministry of Agriculture2 - Department of Co-operative Development

MAP

Kenya-Coffee Areas IBRD 13743

KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

I. BACKGROUND

A. Project Background

1.01 In March 1978, the Government of Kenya requested that the Bankconsider financing a coffee rehabilitation program for the smallholdercoffee sector. The loan application was prepared by the Development PlanningDivision of the Kenya Ministry of Agriculture (MOA). The potential for aproject was identified during the 1973 Agricultural Sector Survey. At thattime, coffee prices were showing the first upward trend since the earlysixties. However no rapid follow-up took place because, in 1974, pricesdropped again as a result of good production prospects linked with a lowerdemand from the importing countries. The project preparation team workedclosely with district coffee working groups and the provincial and districtauthorities. The Bank's Regional Mission in East Africa (RMEA) was consultedregularly during preparation by MOA. This report is based on the findings ofa Bank appraisal mission which visited Kenya in May-June, 1978, composed ofMessrs. J. Wijnand, F.M. Patorni (IDA), A. Gibson, H. Seuster and D. Gardiner(Consultants). The objective of the Project is to (a) improve the qualityof coffee produced by the country's cooperative processing facilities; (b)rehabilitate about 15,000 ha of coffee plantings which are owned by small-holder farmers who do not have access to sufficient input supplies; and (c) toprovide incentives for smallholder farmers, who achieved higher yields becauseof the recent boom in coffee prices, to maintain those yields despite lowercoffee prices forecast for the next four years. All smallholder coffeeproducing areas are included in the proposal and the Project would rely onexisting coffee bushes. Coffee production is established as the most importantcash crop in Kenya's small-scale farm sector and the proposed Project is anintegral part of the Government's policy for encouraging greater productivityin the small-scale farm sector. Development of smallholder coffee wouldextend Bank assistance to the Kenya coffee industry presently given to coffeeestates through the Group Farm Rehabilitation Project (Credit 537-KE, Loan1093-KE) which was initiated in 1975.

B. The Agricultural Sector

General

1.02 Kenya has a total area of 583,000 km and it is a country of enor-mous contrasts in topography, climate and soils. The climate varies withthe altitude which ranges from sea level to over 5,000 meters. Conditionsrange from very dry, in the marginal areas of the north to high rainfall in

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the forests of the south-western highlands. Almost half the total area is

near desert, with very limited agricultural potential, while the plateaus in

Central Kenya include some of the most fertile soils in Africa. Kenya's

population is estimated at 14.2 million (mid-1977) and is growing at the rate

of about 3.5% annually. About 90% of the population is classified as rural

and is mainly dependent on agriculture for its livelihood. Kenya's 1977 GDP

in current prices, and at factor cost, was about K Sh 32.4 billion, or K Sh

2,280 (US$285) per capita. The average annual income per capita of those

living in rural areas is estimated at K Sh 580 (US$70). Population densities

vary widely from region to regi 2n. In most heavily populated areas, there areabout 150 to 200 persons per km and the average holding is one hectare.

There are many areas with much lower densities, even in localities of high and

medium potential. Extreme variations in population density are explained by

the fact that in most areas land is regarded as the exclusive domain of a

particular tribe; in addition, the colonial heritage has influenced population

(and agricultural) patterns, as much land was appropriated for large-scale

expatriate farms or set aside as Government land.

1.03 Kenya's agricultural sector is characterized by a wide varietyin systems of production which reflects the differences between ecologicalzones and the patterns of land tenure and population distribution. A broad

distinction can be made between the large farming sector, including Govern-

ment farms, and the smallholder sector which employs the great majority of the

rural population. The Government defines small farms as 20 ha and below.

There are about 1.5 million smallholdings in Kenya, of which about 50% are

less than 2 ha, and occupy less than 4% of cultivable land. Most small-

holdings are farmed by their owners. About 20% are considered experienced

commercial farmers, another 20% are in a transitional stage between sub-

sistence and commercial production, and the balance of some 60% are sub-

sistence farmers. Hiaize is the staple crop but smallholders also produce

beans, coffee, tea, pyrethrum, cotton, oilseeds, livestock, milk, potatoes

and fruit. Large- and medium-scale farms are larger than 20 ha, and they

occupy about 2.7 million ha (compared with 3.5 million ha occupied by small

farms). There are about 1,000 large farms with holdings in excess of 400

ha each, and just over 2,000 medium-scale farms of 20-400 ha each. Virtually

all production systems for these farms are oriented to commercial markets

and involve a wide range of crops. Wheat, sisal and maize are the dominant

crops.

1.04 The share of the agricultural sector in total GDP has been declin-

ing, from 40% in 1964 to 28% in 1977. This resulted principally from fast

expansion in other sectors, notably the manufacturing and supply industries.

Recent growth in agriculture as a whole remained below the 1964-73 rates of

4.5% per annum, notwithstanding Government efforts to develop this sector.

This is in large part explained by unfavorable weather conditions from 1973/74

to 1975/76. The trend in agriculture's contribution to total GDP for the last

six years is as follows:

K Sh million (constant 1972 prices)

% Increase1972 1973 1974 1975 1976 1977* 72-77

Total GDP 13,172 14,066 14,382 14,523 15,405 16,536 25.5

Agriculture

Non-Monetary 2,134 2,306 2,376 2,329 2,329 2,406 12.7Monetary 1,888 1,934 1,922 1,924 2,001 2,246 19.0Total Agriculture 4,022 4,240 4,298 4,253 4,330 4,652Percentage of Total 31.9 30.1 29.9 29.7 28.1 28.1

* Provisional.

The encouraging growth of the monetary contribution to agriculture, estimatedat 19% between 1972 and 1977, was complemented by a somewhat slower expan-sion in non-monetary production (13%). Between 1976 and 1977 the totalcontribution from agriculture to GDP rose by 7% (constant 1972 prices),to K Sh 4,652 million (US$581 million). There was a 12% increase in thegrowth rate of monetary production and a 3% contribution from the non-monetary sector. At current prices, the value of marketed farm producerose from K Sh 5,000 million (US$625 million) in 1976 to K Sh 8,302 million(US$1,038 million) in 1977. The small and large farm sectors contributed tothis growth in roughly equal amounts.

1.05 Quantitatively over the period 1974-77 output from cereal productionrose 11%, output from temporary industrial crops rose 12%, while outputfrom permanent crops rose 35%. In comparison, production from livestockincreased by 11%. The price indices showed increases of 15% for crops,compared to 33% for livestock produce.

1.06 Agricultural exports, always the single most important sectoralcontributor to total exports, increased by 101% in 1977 to total K Sh 6,336million (US$792 million); rising coffee prices having the dominant effect(1977 = +80%). These data reflect a good agricultural year in 1977,and show the tremendous impact of international demand for Kenya's coffee andtea crops.

Livestock

1.07 The estimated total numbers of cattle, sheep and goats in Kenyaare 9.7 million, 5.5 million and 6.3 million, respectively. Of these,approximately 1.9 million cattle and 0.5 million sheep are grade animals.Livestock development schemes have been designed to provide veterinary,upgrading (by artificial insemination), and marketing (meat/milk) facilities,particularly for cattle and for high potential areas. Mfore recently, range

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areas have been receiving greater attention, and sheep and goat improvementcenters are also being developed, especially for marginal areas. To improvelivestock health further, the Department of Veterinary Services is currentlytaking over direct responsibility for the construction and operation of dipsthroughout the country. The Government has also initiated a national projectfor poultry improvement. The objectives of these policies are to improvedomestic meat/produce supplies and to develop the potential for meat exports.

Forestry and Natural Resources

1.08 Of Kenya's total area (583,000 km ), 520,500 km is categorized aspotentially agricultural, 13% being regarded as "high", 6% "medium" nd81% "low". The 5 emainder is mainly categ2rized as forest (17,000 k ),water (13,500 km ), game parks (28,500 km ) and townships (3,500 km ). Withlittle high potential land remaining uncultivated, the growing population ispressing development of lesser potential areas and forests, making actionfor effective resource conservation imperative. To achieve this, the Govern-ment is now emphasizing appropriate soil conservation measures, especially insmall farm areas, linked to reafforestation; long term development planningfor marginal areas; and specific schemes for ensuring the further developmentof high potential land by appropriate farming systems.

Development Strategy

1.09 Government's development objectives for agriculture are (a) toachieve self-sufficiency in agricultural products, (b) to increase both theoutput and productivity of export commodities, (c) to diversify output tospread out the effects of price fluctuation, and (d) to develop the social andphysical infrastructure in integrated programs for both cash and food crops,thereby raising incomes and living standards in the poorer parts of the country.The reduction of rural-urban disparities and general inequalities in incomesis a complementary long-term objective of the Government. Since the agricul-tural sector offers the best prospects for increasing production with rela-tively low capital inputs, its growth can significantly contribute towardsachieving these stated objectives.

1.10 The development strategy for agriculture addresses the problemsof both the large and small farm sectors; it is clear that both will continueto play a significant role in contributing to the rational growth of foodproduction. Services and projects thus aim to support the development needof both sectors to realize the full potential from mixed farms in highpotential areas. The Integrated Agricultural Development Program (IADP)was introduced as the main vehicle for supporting small farm development,especially those farms outside the cash economy. For more advanced farmersthe Third Agricultural Credit Project financed by IDA is designed for bothsmall- and medium-scale farms; multi-owner farmers can benefit from the GroupFarms Rehabilitation Project. The Narok Agricultural Development Projectaims to foster the development of mixed farms in the middle range (20-100 ha)

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in a district of high, and largely unexploited, potential. Coffee is animportant enterprise for specific encouragement within the developmentstrategy, because of its importance as a cash crop, its significance toexports, and because productivity has been declining in recent years.

1.11 The central policy of Government for self-sufficiency in essentialfood crops is being emphasized by the Ministry of Agriculture. Notably, thepricing policy and small farm development projects since 1974 have encouragedsurplus maize production, ensuring strategic reserve (now 180,000 tons)and developing export capacity (1975-76: 200,000 tons, 1976-77: 500,000tons). In 1975, sugar and wheat were also selected for self-sufficiencyprograms. In addition, in 1977 it was decided to speed up the drive forself-sufficiency in cotton, tobacco and edible oils.

C. Government Services

1.12 Government services to agriculture are delivered through fiveministries and 15 statutory production boards. The Ministry of Agriculturehas the primary responsibility for agricultural development and farmerservices. The Ministry of Cooperative Development (MOCD) supervises co-operative organizations and provides them with management advice. TheMinistry of Lands and Settlement is responsible for land adjudication,legal division and consolidation of all farm land. The Ministry of Worksand the Ministry of Water Development provide and supervise crop extrac-tion roads and rural water supplies, respectively. The statutory boardsinvolved in agriculture are either general, as is the Maize and Produce Board,which trades in most food crops, or crop-specific, e.g., the Coffee Boardof Kenya (CBOK). The initiation and implementation of development projectsis being decentralized through the increased use of the District DevelopmentCommittee which approves and monitors all development projects at the districtlevel.

1.13 The Ministry of Agriculture comprises three departments: theDepartment of Agriculture, the Department of Veterinary Services and theAdministrative Services Department, which includes the Development PlanningDivision. Chiefs are directly responsible to the Permanent Secretary. TheDepartment of Agriculture is responsible for implementing policy and promot-ing agricultural production throughout Kenya. The Department of VeterinaryServices concentrates on the provision of health and breeding facilities forlivestock. The Development Planning Division is a supporting organizationfor both of these technical divisions; it acts as the main link with theMinistry of Finance and Planning, and is responsible for all economic anddevelopment planning matters related to agriculture. The Department of Agri-culture includes eight technical divisions; each division head is responsibleto the Director of Agriculture for the specific aspects of agriculture forwhich the division is concerned. The eight divisions are: (i) IndustrialCrops Production, (ii) Food Crop Production, (iii) Horticultural Crop Produc-tion, (iv) Animal Production, (v) Range Management, (vi) Livestock Marketing,

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(vii) Land and Farm Management, and (viii) Scientific Research. A DeputyDirector of Agriculture was appointed in April 1976 to be responsible forplanning and organization of extension services and training. He liaisesdirectly with the Provincial Directors of Agriculture (PDA's), who have prin-cipal responsibility for extension services in their area of jurisdiction.

1.14 Agricultural Extension Services. Agricultural extension workinvolves most of the Ministry's technical divisions. Ministry headquartersis responsible for overall policy decisions and administration, but fieldoperations are directed from a provincial level and are organized and co-ordinated on a district basis, under the District Agricultural Officer (DAO).Within limits set by Government policy, provincial extension services havea high degree of autonomy. The Land and Farm Management Division is sup-posed to act as a coordinator of extension efforts. Most extension staffhave in the past specialized in crop production. However, services werereorganized in 1976 and extension agents at farmer level now act as gene-ralists; the emphasis is on improved management of the farm as a whole.Current extension staff for crop development number about 7,000, and theaverage number of holdings per officer is about 230. The principal problemsof extension services in the past have been poor communications, notablytransport, an unbalanced mix of specialist skills, lack of in-service training,and limited continuity due to frequent transfers of personnel. The 1976reorganization of extension services and several on-going development projectsaim to address these problems and to make extension services a more effectivevehicle for providing support and supervision of farmers. Specifically, theGovernment aims to increase extension coverage in key development areas, toprovide better transportation and allowances and to improve housing facilitiesin remote areas for extension officers, to provide more information to farmersin support of extension work, and to strengthen in-service training programsfor extension staff.

1.15 Staff Training is provided by a network of colleges and traininginstitutions. Senior agricultural staff are now mainly trained to universitydegree level at the University of Nairobi. Intermediate level staff aretrained to diploma standard at the Egerton College, while junior staff obtaintheir training (to certificate level) either at Embu or Bukura Institutesof Agriculture. In 1972, MOA initiated a training scheme designed to updatethe training of all extension officers, particularly in the technologicalaspects of crop and animal production. In the same year the Ministry createdthe Land and Farm Management Division which has emphasized improvement offarm management standards. Assisted by the Fourth Education Project (IDA),MOA now intends to expand the Faculty of Agriculture (to 180 B.Sc. graduatesper year) and Bukura and Embu Institutes of Agriculture (to 350 certificateholders each per year). The numbers of trained staff for agricultural ser-vices is still far from adequate, and is likely to remain so for the fore-seeable future; however, several active programs are underway to expand thecapacity of training institutions and to make their programs more effectivein support of national development efforts.

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1.16 Farmer Training Centers (FTCs). FTCs are designed to introducefarmers to modern agriculture techniques through short residential courses;FTCs also offer in-service training for extension staff. There are twolarge-scale FTCs at Eldoret and Nyahururu, which concentrate on trainingfarmers, managers, and extension staff for large farms, and 31 smallerFTCs, 18 of which are operated directly by the MOA and 13 by the NationalChristian Council of Kenya. The Government hopes to establish FTCs in each ofKenya's 42 districts. Capacity of FTCs ranges from 35-100 people per course.Each FTC has, in addition to farm employees, about eight teaching and admini-strative staff. Each has a demonstration farm varying in size from 25 to1,000 hectares to assist with training courses. FTCs also work through modernfarms and demonstration plots in their district. FTCs each offer 30-50courses annually, reaching a maximum of about 5,000 farmers and extensionstaff. In-service training for extension workers is provided on a regularbasis to update knowledge of animal and crop extension and farm management;courses normally last two months.

1.17 Agricultural research is the responsibility of a specific divisionof MOA and is mainly conducted at 24 research stations situated throughoutthe country and generally reflecting priority production of the area concerned.Past research has emphasized crop production, e.g. the development of hybridmaize varieties and adaptation of wheat varieties at the National PlantBreeding Station, Njoro, and has thus played a significant role in increasingfood production since Independence.

D. Agricultural Credit

1.18 Agricultural credit in Kenya is available through a number ofinstitutions in the organized credit market and individuals operating inan informal market. Five types of credit institutions can be distinguished:(a) commercial banks which provide working capital and development creditchanneled largely through medium- or large-scale farmers; (b) the Agricul-tural Finance Corporation (AFC) which gives loans to large as well as small-scale farmers; (c) the Co-operative Bank of Kenya (CBK) which providesdevelopment and seasonal loans to cooperative societies; (d) parastatalorganizations such as crop or produce boards which provide seasonal loansor medium term loans mainly for the development of cash crops; and (e) othercredit institutions which provide suppliers credit through institutions suchas the Kenya Farmers' Association and Kenyan Breweries Ltd.

1.19 The Central Bank of Kenya controls the banking system which includesa large commercial banking sector, and two principal parastatal organizations,AFC and the CBK, both of which are also operated on commercial lines. TheCentral Bank sets the prime interest rate (currently 8% per annum) and theminimum interest rates and volume of credit with which commercial banks canlend for specific purposes. Of the total estimated credit of K Sh 820 millionavailable for agricultural production in 1975-76, over 50% was supplied bycommercial banks and nearly 10% by input suppliers mainly for large farm

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operations. Approximately 20% each is supplied by AFC and the Co-operativeBank of Kenya, the latter principally to small farmers. These credit fundsrepresent loans to 180,000 farm businesses or approximately 15% of the totalfarms in Kenya.

1.20 Commercial banking is dominated by three large institutions linkedto British overseas banking groups: the Kenya Commercial Bank, the BarclaysBank International, and the Standard Bank (Kenya) Ltd. These banks providebroad coverage through a network of branch offices in important towns.The bulk of commercial bank lending to agriculture is channeled to large-scale farms and farming companies, and to corporations engaged in agro-industrial activities. Commercial banks also handle, however, an estimated10-12,000 loans to medium- and small-scale farmers; small-scale loans arenormally short-term and are largely for on-farm developments rather thanworking capital. Normally these loans take the form of a line of credit;banks seldom perform analysis of farm development proposals and there isvirtually no follow-up of farm developments. The principal constraints toincreased commercial bank lending for small and medium size farms are thehigh cost of making small loans and the lack of dependable farm managementservices. At the end of 1977, total commercial bank lending to the agricul-tural sector was K Sh 1,088 million.

1.21 The Co-operative Bank of Kenya was established in 1968 to providemedium and seasonal finance to cooperative societies and to act as an outletfor societies' funds and members' savings. It does not deal with individualsbut lends to unions or societies who make loans to their members. The majorlending system of the Co-operative Bank is the Co-operative Production CreditScheme (CPCS) through which approximately 240,000 loans have been made since1970. It is Government policy to emphasize small farm loans through theIntegrated Agricultural Development Program (IADP). The first phase aims atreaching 56,000 members by 1980 in all parts of the country. This programis concentrated on developing systems for assisting less progressive smallfarmers. Crop and produce boards provide seasonal credit and some medium-termloans for specific crops. The Wheat Board, for example, finances wheatproduction, and in 1976/77, financed 722 growers, for a total amount of aboutK Sh 37 million; funds for these programs are normally lines of credit fromcommercial banks. The KFA provides services to farmers through its paymentterms, which are 60 to 90 days for members; since KFA markets wheat, theyoften serve as collection agents for the Wheat Board. The Kenya Breweriesextends seasonal credit for barley production and is considering a programof tractor loans for barley growers.

1.22 GMR Scheme. The Guaranteed Minimum Return (GMR) scheme provides

crop insurance to growers of maize and/or wheat with a minimum of 6 hectaresunder either crop. GMR was introduced in 1942 as a war-time measure toencourage large-scale crop production, and until 1966 it applied only to plotsof at least 40 hectares under specified crops. The program has gradually beenreduced in scope for crops covered, but has been expanded by lowering theminimum holding size eligible for participation. Under GMR, the Governmentapproves planting of a certain acreage; this planting order entitles thefarmer to compensation in case of crop failure; the security provided by GMR

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creates the basis for seasonal credit in the form of advances on GMR. AFCacts as agent for the disbursement and collection of GMR funds. Since1975/76, AFC, acting as the Government's agent, has raised funds for GMRthrough the sale of promissory notes by the Central Bank. GMR providescrop insurance and seasonal credit up to a maximum of K Sh 500 per hectare;interest is charged at 10% a year. The GMR program has substantial arrearsand operates inefficiently; AFC is seeking to phase it out.

1.23 The Agricultural Finance Corporation is a statutory board which wasestablished in 1963 to assist in the development of agriculture by makingloans to individual farmers, cooperative societies or companies. Althoughmainly providing medium- and long-term credit, AFC also provides seasonalcredit to its borrowers. AFC loans are generally secured over land. It isGovernment's policy to expand loan activities through AFC particularly tomore progressive small farmers, in addition to its services to the medium-

and large-scale farming sectors. The small-scale lending programs are mainlyassisted by IDA lines of credits. One of the large-scale lending programs,Group Farms Rehabilitation Project, was initiated in 1975 and is being partly

financed by the Bank Group.

E. Commercial Services

Agricultural Inputs

1.24 Most agricultural inputs are obtained by farmers through severalcommercial organizations. Of these Kenya Farmers Association (Co-operative)Ltd., (KFA) is the largest, with 33 branches and 2,212 stockists throughoutthe country. In addition, the Kenya National Federation of Co-operatives(KNFC) initiated a merchandizing organization in 1975 to complement and expandthe national coverage of input supplies to farmers through the cooperativenetwork. In 1975 Government assumed responsibility for importing and distri-buting fertilizers to the existing retail outlets; it also introduced uniformfertilizer prices throughout the country. An agreement was signed in 1975 for

the construction of a fertilizer factory to satisfy the national demand; this

factory was due to commence production in 1979 but recent financial managementproblems have resulted in the project start-up date being put back till early

1980.

1.25 The national seed requirements are mainly supplied by the Kenya SeedCompany, in which the Government is a major shareholder. Spray chemicalsrequired for crop production are supplied by several commercial companiesthrough existing retail outlets (mainly KFA). Building materials and otheritems required by the agricultural sector are generally manufactured in Kenya,and are available through KFA and other suppliers. A range of farm machineryis imported, assembled or manufactured by a variety of commercial companiesand retailed through outlets in strategic centers.

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II. COFFEE SUB-SECTOR

A. Background

2.01 Coffee growing was introduced in Kenya around 1900 and has gonethrough various ups and downs. The industry initially developed along estatelines and by 1935 about 42,000 ha were planted with Arabica coffee, producingapproximately 22,000 tons of washed coffee. From 1935 till 1950 the hectarageunder coffee declined steadily to 24,000 hectares, mainly due to poor prices.The sharp rise in prices from 1950 onwards was responsible for the thirdphase in coffee development in Kenya and by 1955 production overtook the 1935level to reach 23,000 tons. During this third phase the first major diversi-fication of coffee production to smallholders occurred. However, the processwas slow and it was not until 1960 that production became really significant,both as regards quantity or quality. By 1964, smallholding mature hectaragesurpassed the estate hectarage and smallholding production overtook estateproduction in 1965-66. Today production from the smallholder sector is aboutthe same as the production from the estate sector, although the average yieldsof the smallholder sector are well below the estate sector.

2.02 Coffee is the most important single agricultural commodity in termsof its contribution to the gross marketed value of agricultural produce and inearning foreign exchange. The share of coffee in total annual export earningshas consistently been more than 14% since 1972. In 1976 the share increasedto 27.8% and in 1977 to a record 42.6%. Coffee is also important in terms ofemployment opportunities. Out of about 900,000 people in regular wage employ-ment in the monetary sector in Kenya during 1977, approximately 87,000 wereengaged as permanent workers in the various parts of the coffee industry.An additional unknown number is involved in casual employment, particularlyduring the picking season.

2.03 Notwithstanding its economic importance, coffee contributes onlya minor share to direct Government revenue. This small provision contrastssharply with that in most other producing countries. An export tax wasimposed on coffee in 1963 at a relatively moderate rate of K Sh 400 (US$50) aton which represented approximately 5% of value. The tax was halved in 1967and discontinued after 1973. In June 1977 an ad valorem export tax wasintroduced and set at 15% of the value of auction sales proceeds aboveK Sh 20,000 (US$2,500) a ton.

B. Kenyan Coffee Markets and Prices

2.04 The marketing structure is centralized through the Coffee Board ofKenya (CBOK) which controls the planting of coffee through a licensing system,takes delivery of all coffee produced and sells it for export by auction.Its main intermediate agent is the Kenya Planters Co-operative Union Limited

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(KPCU) which receives parchment coffee from the estates and from smallholdersthrough the local cooperative societies for hulling, grading and cleaning.All final processing and grading takes place in Nairobi where facilities existfor storage throughout the year. Auctions are normally held every week inNairobi at which sales are made to private exporters. A complex system ofgrading by appearance and cup taste is carried out and sampl2s are sent tobuyers all over the world before the coffee is auctioned. The participa-tion of the CBOK in the marketing process ceases after the auction.

2.05 The share of Kenya in total world exportable production of coffee in1974/75 was just under 2%. However, Kenya is an important supplier to certaincountries notably West Germany, Netherlands, USA and Sweden. The volume ofexports has risen from 53,725 tons in 1970 to 94,344 tons in 1977.

Table 1: QUANTITIES AND TOTAL VALUE OF COFFEE EXPORTS 1969-1977

Quantity Value Domestic Export Prices (f.o.b.)Year tons K Sh (million) K Sh per kg

1970 53,725 445 8.281971 56,426 391 6.921972 63,142 495 7.841973 75,317 716 9.501974 71,680 767 10.701975 67,728 704 10.401976 77,586 1,867 24.061977 94,344 4,087 43.33

2.06 The trend in producer prices for the period 1965-1977 are asfollows:

Table 2: TRENDS IN PRODUCER PRICES, 1965 - 1977 /1

Payment to Grower Payment to GrowerYear K Sh per kg Year K Sh per kg

Current Prices 1977 Prices Current Prices 1977 Prices

1965 6.40 15.40 1971 5.70 12.101966 6.00 13.70 1972 7.00 14.001967 5.30 11.90 1973 8.70 15.901968 6.00 13.40 1974 9.80 15.251969 5.60 12.60 1975 9.40 12.251970 7.40 16.25 1976 22.30 25.60

1977 39.60 39.60

/1 1977 constant prices derived by using Kenya's Consumer Price Index(IMF International Statistics).

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2.07 The year 1975/76 represented a dramatic year with price records beingset and broken almost weekly. By the end of June 1976 some 62,000 tons hadbeen sold, in itself a record, and prices had reached a level of K Sh 28,000per ton. At the end of 1976, 77,586 tons had been exported at an averageprice of K Sh 24,060 per ton. Exports of Kenya coffee earned the countryan equivalent of K Sh 1,860 million in foreign currency that year. In 1977prices rose even further to an unprecedented average of K Sh 43,330 a ton and94,344 tons were exported resulting in an equivalent of K Sh 4,087 million inforeign currency.

2.08 The quality of Kenya coffee is reflected in the high prices whichit commands on the export markets. The information below confirms its highvalue particularly during the recent period of tight supply.

Table 3: PRICES (K Sh per ton FOB)

Year Kenya All Exporting Countries

1974 10,700 9,2201975 10,420 9,0401976 24,060 19,7601977 43,340 33,600

2.09 The behavior of the international coffee market was a directresult of the changing supply situation. Prices in real terms reached a peakin 1977 and a gradual decline is expected during the next four years as thesupply situation eases.

C. Production

2.10 Coffee is grown in all of the six main agricultural provinces,generally being restricted to altitudes of 4,500 to 7,000 feet. With theexception of an area of about 100 hectares of Robusta in Western Kenya,Arabica is the variety of coffee grown in Kenya and considerable effort hasbeen given to produce optimum varieties which has resulted in Kenya's cropbeing highly regarded for quality on the world market. A permanent coffeebreeding unit as part of the Coffee Research Foundation (CRF) in Ruiru hasbeen established which is the sole supplier of coffee planting material withinthe country. Central Province has always dominated coffee production, withEastern, Rift Valley, Western, and Nyanza Provinces following in order of areaplanted. Coast coffee is grown only on a limited scale in Taita.

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2.11 The main coffee areas within each province are situated in regionsreceiving an average of 1,000 mm to 1,800 mm annual rainfall. Serious, longlasting droughts occur periodically and can suddenly reduce the overall pro-duction capacity of the coffee tree. The limitations of water supply lead tomethods of farming for coffee in Kenya which are considerably different fromthose of Central and South America. Soil depths of 2 to 3 m are considerednecessary to provide sufficient water storage capacity between wet seasons.The majority of soils on which coffee is grown in Kenya are of volcanic origin,low in nitrogen and phosphorous, but usually well supplied with potassiumand minor elements. However, some coffee is also grown on non-volcanic soilswhich are deficient in many nutrients and have a wide diversity of character-istics. Shade trees are generally not grown in the main coffee areas, althoughat the upper and lower altitude margins, they are used to moderate diurnaltemperature fluctuations. Coffee tree populations of 1,300 to 1,400 perhectare are usual, although where irrigation is possible, it appears that theoptimum density may be about 2,200 trees per ha. Irrigation is graduallybecoming more common on estates and about 25% of this coffee growing areareceives some supplementary irrigation. On smallholdings, it appears almostimpossible to design economical irrigation schemes for the crop because theblocks of coffee are small and are situated on steep, terraced land high abovethe water-courses. Fortunately the small-scale coffee farms are generally inhigher rainfall areas than the coffee estates.

2.12 During the past decade there has been a decrease in the coffeegrowing areas, although in the last few years it has remained static ataround the 86,800 ha recorded in 1977. The decline was attributed to (i)management problems associated with the transfer of production from estatesto smallholders, (ii) coincidental rise in incidence of Coffee Berry Disease(CBD), seriously reducing yields and earnings, (iii) restrictions on newplantings under the International Coffee Agreement, which ended in 1973.In 1977 the relative areas grown by estates and smallholders were 27,800(32%) and 59,000 (68%) hectares. Approximately 270,000 farmers are registeredas coffee growers. The remaining registered coffee estates (731 in 1977),have each an average productive area of 40 hectares.

2.13 The decline in production from 1973 till 1975 can be attributedspecifically to: (i) poor rainfall: many coffee growing areas suffereddrought in 1973, (ii) escalation in input costs, leading to low fertilizerand spray applications and consequential yield reduction and disease recur-rence, (iii) increasing problems with labor and handling and (iv) compara-tively better prices and payment systems for alternative crops. The greatestscope for increasing output from existing bushes is within the smallholdercoffee sector where average yields are well below potential. Average yieldsof washed coffee on smallholdings have so far reached less than 50% of thatachieved by estates. Productivity in smallholdings was 760 kg per hectareon average compared with 1,790 kg per hectare on estates in 1977. Howeverproduction in the smallholder industry does produce mean average yields of upto 1,450 kg per hectare per year. The low average productivity is attributedto the 23,000 hectares of neglected coffee holdings. KPCU and the CPCS schemeprovide only credit worthy coffee farmers with agricultural supplies on credit.The criteria for these loans are directly linked with past production perform-ances. It is clear that the neglected holdings therefore do not qualify for

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access to sufficient input supplies because of low production levels in thepast. A major aim of the Government is, therefore to reduce this imbalanceand raise coffee earnings of smallholders with neglected holdings. To achievethese aims it is necessary to analyze the reasons for the poor performance offarmers who own the neglected holdings. One of the main reasons appears tobe farmers dissatisfaction with the services supplied by coffee factories,societies and unions. Poor management of societies has frequently resulted inlow payment rates for coffee delivered because of high overhead costs. Thecapacity of the machinery in coffee factories is often not capable of handlingthe crop which results in either lower quality of coffee produced or farmersbeing turned away when trying to sell their coffee crop. The same results arealso noticed when factory management is poor. In both cases this results in alower pay-out rate for coffee delivered by the smallholder coffee farmers. Inthe end the farmer often decides to neglect his coffee and spend more time onalternative crops.

D. Processing

Handling System

2.14 The majority of Kenya coffee is processed according to the "wet"method. However, at the end of each season the few remaining fruit arestripped off the trees and dried in the sun. The product of this "dry" methodis known locally as "mbuni". Small growers deliver their cherry to the nearestco-operate coffee factories which are collectively owned by the farmers andrun by societies, membership of which is compulsory for the coffee farmers.The pulping machinery is under cover, fermenting tanks are of concrete, dryingis done on wire-bottomed tables raised above the ground. On delivery of thecherry the grower receives a weight receipt, if the cherry is accepted at thefactory. If it is rejected, the farmer dries it into "mbuni" and sells itto his respective society. The societies and factories in each district areorganized into a District Co-operative Union. The Co-operative Union under-takes the transport of the pulped and dried parchment by lorry to the nearestrailhead or direct to the milling agents (KPCU) of the CBOK, who hull, gradeand prepare the coffee for sale at the weekly public auction in Nairobi.The mill normally treats each society's deliveries separately and the ratiocherry/clean coffee is fixed by the Union on the basis of the outturn Reportfor each delivery. Payouts are made three or four times a year to the socie-ties which, in turn, pay their members on the basis of the cherry weightreceipts. Final prices are calculated at the close of each crop year when,after the deduction of various marketing costs, taxes and commissions bythe CBOK, KPCU, the cooperative unions and the local cooperative societies,the balance is paid to the growers.

2.15 The coffee grower's Co-operative Societies are well establishedthroughout the country. There is however sufficient evidence that inefficientmanagement of a number of societies is resulting in a lower payout to thesmall farmers, thus diminishing the incentive to improve production. Thesector has also had problems of deteriorating quality in recent years becauseof undercapacity and poor management of the cooperatively owned processingfactories. There exists a wide range in the efficiency of committees and

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staff of the societies. Individual growers are often inclined to associate

themselves only with the most efficient societies. This trend can only be

halted by ensuring the administrative efficiency of cooperative organizations

and by improving the facilities and capacity of the co-operative factories.

III. THE PROJECT

A. General Description

3.01 The proposed Project would, over a four year period (1979 - 1982),

assist and rehabilitate the cooperative coffee industry. The Project activi-

ties would aim to (i) improve the quality of coffee produced by the country's

cooperative processing facilities; (ii) rehabilitate about 15,000 out of

23,000 ha of neglected coffee plantings which are owned by smallholder farmers

who do not have access to sufficient input supplies; and (iii) provide incen-

tives for farmers, who achieved higher yields because of the recent boom in

coffee prices, to maintain those yields despite lower coffee prices forecast

for the next four years. All smallholder coffee producing areas would be

included in the proposal. Within this four-year period the target of the

Project would be the active participation of approximately 70,000 registered

coffee growers through the provision and coordination of essential services

to the cooperative coffee sector. The Project would comprise the following

components:

(a) The rehabilitation of 400 existing factories, the

construction of 14 new factories, the construction of

50 mechanical dryers and provision of improved training

facilities;

(b) Provision of medium-term development loans to farmers

for the rehabilitation of their holdings;

(c) Strengthening of the Coffee Research Foundation;

(d) Development of improved coffee extension servicesand training;

(e) Strengthening of the Department of CooperativeDevelopment services, improved training facilitiesfor staff; and

(f) Incremental staff and facilities for the Co-operativeBank of Kenya Ltd, to provide improved credit facilities

in areas under rehabilitation.

3.02 The Project would be managed by the existing coordinating unit

for the Integrated Agricultural Development Program (IADP) within the Ministry

of Agriculture as strengthened under the Project, and the Department of

Co-operative Development. The Head of the IADP program would be assisted

by a Coffee Project Manager who would be responsible for managing the

implementation of the Project as a component of the overall IADP program.

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3.03 Agricultural development in Kenya is now largely planned on a wholefarm basis, encouraging production through simple, area-specific packages ofenterprises. The IADP is the vehicle chosen for effecting this development.Coffee is an important enterprise for specific encouragement within thisprogram, because of its importance as a cash crop, its significance to exportsand because productivity has been declining in recent years. The proposedProject would incorporate three of the Government's major objectives, namely:(i) it would be a national program which offers considerable potential forincreasing productivity and exports; (ii) it would provide specific assistanceto smallholders; and (iii) it would create additional employment opportunities.

B. Detailed Features

Factory Construction and Rehabilitation

3.04 The percentage of top quality coffees in Kenya has steadily declinedsince 1960, and this can be directly attributed to the constraints experiencedby the smallholder producer. Traditionally, the highest qualities of Kenyacoffee have been produced by the smallholder cooperative sector and not by theestates. Major contributing factors in the observed decline in quality havebeen the inadequacy of both the factory management and the physical facilitiesprovided at the coffee processing factories.

The Project would aim to remove these major constraints by providingfunds for the construction of 14 new 3-disc factories and the rehabilitationof a further 400 factories. Total rehabilitation will be carried out onapproximately 50 of these factories by resiting and rebuilding, extensiverehabilitation will be necessary on approximately 170 factories, and partialrehabilitation would be carried out on the remaining factories. The Projectwould provide for 314 new 1,000 bag stores, 451 extra pulper discs, 171 extrapulpers and 1,600 units of 1,000 ft. of extra drying table space. In thoseareas where climate and space availability are evident constraints, the Proj-ect would provide 50 mechanical drying facilities. All factories under theProject would be provided with facilities which will enable them to complywith the Kenya Water Act (Chap. 372). This would consist of approximately 236complete recirculation systems and 314 recirculation pumps. The entiresmallholder coffee industry would benefit from these investments rather thanjust the Project participants. Correct utilization of the physical facilitiesprovided under the Project would be implemented under an extensive factory-management training program, which would reach 1,180 coffee factory managersand 560 factory clerks and produce recorders. Under the Project, CRF wouldtrain 26 coffee factory technicians. Arrangements for the maintenanceof the factories both during and after the Project period were discussedduring negotiations and assurances obtained that appropriate provisionsbe made through the regular budgetary procedures of the coffee societieswhich are under the control of MOCD. One of the major reasons for farmersto neglect these holdings has been the low pay-out rates because of poorand inefficient factory performances. The above training and rehabilitationmeasures will contribute significantly to creating better incentives forfarmers to maximize their production levels.

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Medium-Term Development Loans

3.05 An estimated 70,000 smallholder coffee farmers would obtain medium-term development loans from the Co-operative Bank of Kenya to enable them torehabilitate their holdings. Rehabilitation would include clearing of over-grown plantings, establishing proper weed control regimes, pruning, soil con-servation measures, improved nutrition practices, pest and disease control andinfilling of vacancies (approx. 5% equalling 750 ha). The Project would aimfor these holdings to be brought back into optimum production which is aprocess which could take up to four years. At the end of the rehabilitationperiod, the growers would have established proven production levels whichwould ent-itle them to participate in existing credit schemes. The adminis-tration of these loans would be similar to that of CPCS (para 1.21). Thefunds would be lent to farmers for a period of up to four years, repayableduring the following three years. The interest rate paid by the farmers wouldbe not less than 10% p.a. (para 3.14). Arrangements to provide adequatesecurity, and in particular the possibility of securing the loans by a chargeover land owned by the loanee, were discussed at negotiations.

Coffee Research Foundation

3.06 The Coffee Research Foundation (CRF) would be strengthened withadditional research facilities and a number (6) of newly appointed researchersand support staff (25), to increase research into varieties, cultural methodsand crop treatment. In addition, suitable training programs for coffeeextension officers and the factory managers would be set up to transmitresearch findings rapidly into field practice. To do so, the Project wouldsupport the improvement of the existing training facilities at the JacarandaFarm of the Foundation. The proposals are the major part of the Foundation'sDevelopment program for 1978-1983 which covers areas outside their regularresearch programs.

Extension Services and Training

3.07 The Project would aim to strengthen the coffee extension servicesof the MOA through the provision of training, office equipment, vehiclesand staff. This would be effected as an adjunct of the existing extensionservices at provincial and district level, which are, at present, restrictedin number and facilities and not sufficiently trained to give the best adviceto coffee farmers. The Project would be implemented under the Government'sIntegrated Agricultural Development Program. A Senior Agricultural Officerwould be responsible to Head IADP for all aspects of project coordination.At present there are three provincial coffee officers, but two more seniorofficers would be appointed under the Project, to ensure thorough fieldcoordination of the specialist aspects of the Project in all areas. Theseofficers would work under the Provincial Directors of Agriculture (PDA's) inclose coordination with the provincial IADP coordinators. Similarly, nineadditional district coffee officers would be appointed to ensure thoroughcoordination of the Project requirements at farmer level. These officerswould be responsible to the DAOs (District Agricultural Officers) and wouldwork in close coordination with the District IADP coordinators through

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divisional extension agents. Specific Project-oriented in-service trainingprograms would be provided for coffee extension staff and specialized coffeeofficers in all aspects of coffee production by CRF. Coffee farmer trainingwould be undertaken through field courses and demonstrations.

Department of Cooperative Development

3.08 The Project would provide office equipment, vehicles and staffnecessary to expand and strengthen the Department of Cooperative Development(MOCD). A total of 11 additional officers plus support staff (50) would beemployed to implement the Project efficiently. The main areas of activity tobe strengthened are MOCD's responsibilities for education, accounting, creditand savings, planning and management. One of the best incentives to raisefarmers' interest would be to maximize the pay-outs to farmers. At presentthis pay-out level averages 75% of the auction price with considerable varia-tions from as low as 30% to as high as 85%. However, the expected fall incoffee prices linked with the present overhead cost by unions and societies,would result in a decreased pay-out to farmers equal to about 60% of auctionprices. MOCD has responsibility for improving the operational activities ofunions and societies and it is in this area that the greatest contributionfrom MOCD can be made. A direct reduction in overhead costs both in theunion/societies and the coffee factories would result in a direct increase inpay-out levels to farmers. The proposed improvements in MOCD's supervisorycapabilities would aim to maintain the pay-out level at approximately 75% ofauction prices.

Co-operative Bank

3.09 CBK credit services in the coffee areas would be strengthenedand expanded, in order to serve better the needs of the farmers who aregoing to participate in the Project. Both additional (field) staff andvehicles would be provided for in the Project proposals.

C. Project Costs

3.10 Total Project costs, including taxes and duties (US$5.0 millionequivalent), are estimated at K Sh 497.5 million (US$62.2 million), the foreignexchange component of which is about K Sh 215.8 million (US$27 million) orabout 43%. All estimates are based on prices expected as of March 1979. Aphysical contingency of 10% was applied to all Project items. Price contin-gencies were applied using inflation rates of 9% in year 1 and 8% thereafterand amount to 16% of the total Project costs.

3.11 Details of the Project costs are summarized below:

Foreign

K Sh Million --- ---- US$ Million ---- Exchange % of

Local Foreign Total Local Foreign Total ( Base Cost

Factory DevelopmentConstruction and Rehabilitation 87.1 77.3 164.4 10.9 9.7 20.6 47 43Recirculation Systems 18.7 16.6 35.3 2.3 2.1 4.4 47 9Working Capital 25.9 6.5 32.4 3.3 0.8 4.1 20 8

Farm Inputs 50.3 56.7 107.0 6.3 7.0 13.3 53 28

Coffee Research FoundationResearch 6.5 2.6 9.1 0.8 0.3 1.1 29 2.5Training 3.4 0.5 3.9 0.4 0.1 0.5 14 1

Ministry of AgricultureExtension Services 8.4 3.5 11.9 1.1 0.4 1.5 29 3Training 5.4 - 5.4 0.7 - 0.7 - 1.5Monitoring 1.8 - 1.8 0.2 - 0.2 - 0.5

Ministry of Coop. DevelopmentProject Implementation 7.0 3.0 10.0 0.9 0.4 1.3 30 2.5Training 1.5 - 1.5 0.2 - 0.2 - 0.5

Co-operative Bank 0.8 0.2 1.0 0.09 0.01 0.1 23 0.5

Total Base Cost 216.8 166.9 383.7 27.2 2 48.0 43 100

Physical Contingencies 21.9 16.5 38.4 2.7 2.1 4.8 43 10Price Contingencies 43.0 32.4 75.4 5.3 4.1 9.4 43 21

Total Project Cost 281.7 215.8 497.5 35.2 27.0 62.2 43 131

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D. Financing

3.12 Financing of the Project costs would be shared in the followingamounts and proportions by the Cooperative Societies, Government, IDA and theCommonwealth Development Corporation (CDC), UK (for detailed financing plansee Table 2):

FINANCING PLAN

FARM INPUTS FOR 70,00 0 FARMERS - CONSTRUCTION/RE14ABILITATION OF 414 FACTORIES

(US$ Million)

Co, Soi-eties _overnment IDA CDC

Amt. 7 Ant. I Amt. X Amt. X TOTAL

Factory Development:Civil works and Euijnment 4.8 20 2.1 8 6.5 26 11.6 46 25.0*.Xorkinr Canital 4.1 100 - - - - _ 4.1

-nr- lnuts - -0.7 5 12.6 95 - -- 13.3

Coffee Pesearch Foundation(Pesearch & Training) 1.0 62 0.6 38 - - 1.6

Ministry of Agriculture(Extension Services, Train-ing, Monitoring) _ _ 1.6 66 0.8 34 - - 2.4

Ministry of Cooperative Dlevt.(Project Implementation &

Training) _ _ 1.0 73 0.5 27 - - 1.5

Cooperative Bank _ _ 0.09 90 0.01 10 - - 0.1

Sub-Total 8.9 18 6.5 15 21.0 43 11.6 24 48.0

Contingencies 2.6 18 2.2 15 6.0 43 3.4 24 14.2

Total, including taxes 11.5 18 8.7 15 27.0 43 15.0 24 62.2

Taxes 1.5 30 3.5 70 - _ - - 5.0

Total, net of taxes 10.0 18 5.2 9 27.0 47 15.0 26 57.2

3.13 The proposed IDA Credit of US$27 million would finance about 47%of the total project cost net of taxes. It is recommended that retroactivefinancing of US$0.45 million be approved from September 1, 1978 to meet pre-liminary Project costs. The IDA credit would be made to Government on stand-ard terms. An additional US$15 million of external financing by CDC is beingarranged to provide a total of US$42 million from foreign sources, or about73% of the total Project cost, net of taxes. The CDC loan would be for 15years, including 5 years of grace at 7% interest rate per annum. The fulfill-ment of all conditions precedent to the effectiveness of the CDC loan wouldbe a condition of credit effectiveness. Farmers' would contribute throughcooperative societies, to the financing of factory rehabilitation and construc-tion, and of incremental working capital for factory operation. Governmentwould finance the local currency component of the remaining costs.

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3.14 The funds for credit (factories and farm inputs) would be onlentby Government to CBK at an annual interest rate of 7%. Funds for factoryconstruction and rehabilitation would be in turn onlent by CBK to co-operativesocieties (both directly and through co-operative unions) for up to 10 years,including up to 18 months of grace, with interest to co-operative societies atnot less than 10% per annum. CBK would also provide medium-term loans tofarmers through co-operative unions and societies; loans to farmers would befor up to 7 years, including 4 years of grace, with interest at not less than10% per annum. The interest rates to be charged would permit a margin of 2%for CBK, and 1% for the co-operative unions in those cases where funds arechannelled through unions and 3% for CBK if funds are lent directly to theco-operative societies. These rates are in line with existing medium termagricultural lending rates in Kenya. Repayments made to CBK by the co-operativeunions and societies would be credited to a revolving fund and would be usedto give additional loans for the improvement of coffee factories and farms andfor repayment of the loan to the Government. Government and IDA funds would berepaid by CBK after a 10 year grace period, but the proceeds of the CDC loanwould be repaid in ten equal installments beginning in 1985. Any future modi-fications to general interest rates for agricultural loans arising from reviewby Government of interest rates in Kenya and discussions with the Bank Groupwould be applied to this project. Assurances on the above lending terms andconditions were obtained during negotiations and the execution of a SubsidiaryLoan Agreement, satisfactory to IDA, would be a condition of effectiveness.

3.15 Funds, amounting to about US$0.8 million, from the IDA Credit forassistance to CRF and vehicles for CBK would be passed on to those agencies onsuch terms as the Government may determine.

E. Procurement

3.16 Most of the items to be financed under the Project would not besuitable for bulk procurement under international competitive bidding.However, there is adequate competition, both international and national, inoffering goods through the normal supply channels. All the costs quoted inthis paragraph include physical and price contingencies. Fertilizers andchemicals for the Project, estimated to cost about US$10 million and toolsfor farmers estimated at about US$2.3 million, would represent a small frac-tion (about 10%) of the whole coffee sector requirements; as it would notbe practical to establish special procurement channels for the limited re-quirements under the Project, they would continue to be procured by thecooperative unions and societies mainly from commercial firms; supplies aresatisfactory and prices competitive. Most of the equipment and civil works forfactory construction and rehabilitation, estimated to cost US$33 million wouldbe procured by the cooperative unions following local competitive biddingprocedures. Civil works would be too small in scale and too scattered (414construction sites) to attract international contractors, and major equipmentsuppliers are represented in Kenya. Civil works not costing more than US$10,000equivalent per factory may be carried out on force account by the cooperativesocieties. Such works would include, inter alia, the installation of sun-dryingtables and the preparation of construction sites. Miscellaneous supplieswould also be purchased by the cooperative societies through commercialchannels to carry out these works. The aggregate value of these works andequipment is estimated at about US$1 million. For the construction of housing

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and offices, estimated to cost about US$1 million, local contractors would beemployed by the appropriate institutions following local competitive bidding.Office equipment for MOA and MOCD (US$15,000) and research equipment for CRF(US$13,000) would be purchased following local competitive bidding procedures.The procurement of a total of about 50 vehicles, estimated to cost US$1million, would follow international competitive bidding procedures, except incases under which purchases could not be made through bulk contracts for 10 ormore vehicles; in the latter case, vehicles would be purchased following localcompetitive bidding procedures. The balance of US$14.9 million consists ofthe costs of farm labor (US$3.5 million), transportation of coffee, cherriesand farm inputs between the farm and the factory (US$1 million), and incre-mental staff and operating costs (US$10.4 million). Assurances as to theabove arrangements were obtained at negotiations.

F. Disbursements

3.17 The proceeds of the Credit would be disbursed over 4 years on thefollowing basis:

US$ Million

(a) 32% of the amounts disbursed by theCooperative Bank for loans for factory con-struction and rehabilitation including factorybuildings and for the purchase of factoryequipment; 6.5

(b) 95% of the amounts disbursed by the Co-operative Bank for loans for farm inputs; 12.6

(c) 40% of the total expenditures for theconstruction of buildings (excludingfactory buildings); 0.3

(d) 70% of the total expenditures for vehiclesand equipment (excluding factory equipment); 0.7

(e) 70% of the total expenditures for Project-related training; and 0.9

(f) an unallocated amount representing a partof price contingencies on the above categoriesand transferable to them as appropriate. 6.0

Total Credit 27.0

Disbursements against (a) and (b) would be made against statements of expendi-ture certified by the Co-operative Bank, the documentation for which wouldbe retained by the Co-operative Bank for review by Bank supervision missions.Disbursements against (c), (d), and (e) would be fully documented. An esti-mated schedule of disbursements is given in Table 5.

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G. Accounts and Audit

3.18 Separate Project accounts would be maintained by each of the executingentities under the Project as follows: (i) by the Financial Controller in theIADP Unit for the loan proceeds for all the components of the Project includingProject funds handled under the credit components; (ii) by the Project Accountantin the Department of Co-operative Development for activities under the Projectand training of factory staff; and (iii) by the Co-operative Bank, the Co-operativeUnions and Societies involved in the Project, and the Coffee Research Foundation andMAO for their activities pertaining to the Project. Assurances were obtained atnegotiations that (i) the above accounting records would be established and maintained;(ii) the accounts of all the above institutions would continue to be audited by in-dependent auditors acceptable to the Association; and that (iii) the audited accountsprepared by the IADP Unit would be forwarded to the Association, with the auditor'sreport, not later than six months following the end of the financial year to whichthey relate.

3.19 The present auditing arrangements of the institutions involved inthe Project are satisfactory. The responsibility for auditing MOA's andMOCD's accounts, as in the case of all Government entities, rests with theAuditor General. The accounts of cooperative unions and societies are auditedby the Audits and Accounts Division of the Department of Co-operative Develop-ment. The accounts of the other institutions involved in the Project areaudited by independent private auditing firms established in Nairobi andthey are satisfactory.

H. Environmental Impact

Soil Conservation

3.20 Through the Soil Conservation Services of the Land and Farm Manage-ment Division of the MOA, appropriate conservation measures would be encour-aged and enforced for all coffee land under rehabilitation. This componentwould follow the existing policy for emphasizing soil conservation throughmajor extension efforts, supported by specific labor intensive and mechanizedprojects. In addition, soil conservation training would be incorporated inthe Project-oriented training programs.

Water Pollution

3.21 In 1976 new legislation was enacted with regard to water conserva-tion. Prior legislation was concerned primarily with conserving water quan-tity whereas the new legislation is equally concerned with conserving waterquality. Indiscriminate disposal of the effluent from coffee processing

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factories has caused considerable pollution of rivers to the detriment ofdomestic, agricultural and industrial usage. It is now illegal to returnany coffee factory effluent to the rivers. The Project would facilitatecompliance with this new regulation through the provision of suitable waterrecirculation/disposal systems for coffee factories.

IV. ORGANIZATION AND MANAGEMENT

A. Project Organization and Staffing

4.01 The Ministry of Agriculture is now implementing the First IntegratedAgricultural Development Project (IADP I) as the major vehicle for encourag-ing smallholder development throughout the country. IADP is coordinated bya Management unit at MOA and MOCD headquarters, supported by coordinatorsat both the provincial and district level. Coffee being one of the mostimportant smallholder crops grown, IADP has been selected by the Governmentas the vehicle through which the Project will be managed and implemented.Thus, the Ministry of Agriculture would have overall responsibility forimplementing the Project. However, under this overall direction, thoseaspects of the Project involving the Co-operative Bank, cooperative unionsand societies would be carried out by the Ministry of Cooperative Development.

4.02 The Management unit in MOA for IADP consists of the IADP Coordinator,Deputy Coordinator, an Evaluation Officer and Financial Controller. Thesefour officers in turn are supported by four senior agricultural officers whoare looking after the specific disciplines required within IADP projects,i.e. Crop Production, Animal Production, Land and Farm Management and Veteri-nary Services. These technical coordinators are responsible for the necessaryliaison and coordination to remove constraints and promote production withinsmallholder "farm packages".

4.03 The eight technical divisions of the Department of Agriculture areresponsible for policy recommendations and formulating technical guidelinesfor their specialized fields. For the Project the Head of the IndustrialCrop Division would be responsible for advising on all technical mattersrelating to coffee production and factory development. Because of the detailand extensive scope of the Project, a senior agricultural officer with wideexperience in all aspects of coffee production, would be appointed as Manager -

Smallholder Coffee Improvement Project (SCIP). He would be working as amember of the IADP Coordinating Committee and be responsible to the Head IADPfor full implementation of the Project. He would work in close consultationwith the IADP Crop Production Coordinator and the Head of the Industrial CropsDivision; the Manager - SCIP participated in the credit negotiations.

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4.04 Equally important, the SCIP Manager would be responsible for liaising

with relevant departments and organizations outside the Department of Agricul-

ture. This liaison would especially concern the officer responsible for the

Project in MOCD and also in the Coffee Board of Kenya, KNFC for inputs, CRF,

CBOK for credit, and the Department of Water Development for pollution

elimination.

4.05 At provincial and district level the present IADP coordinators

would be responsible for ensuring the smooth implementation of SCIP. They

would be assisted by specialist coffee officers at both the provincial and

district level. Some of these specialists are already in place and the

Project would provide funds to bring the number of provincial coffee officers

up to 5, and the number of district officers up to 11. The implementation of

the Project at farm level would be achieved through normal extension services

dealing with groups of farmers at sub-location level. To assist in this work

approximately 40 of the existing agricultural assistants would receive special

training to orientate them to the objectives of the Project. These assistants

would then be reassigned throughout the coffee growing areas.

4.06 The assistants would be required to liaise closely with the coffee

inspectors of the Coffee Board of Kenya and the Coffee Working Groups which

exist in most districts. These groups are made up of growers and represen-

tatives of the various relevant organizations.

4.07 To ensure proper coordination of the Project at the highest level,

representatives of the coffee industry would be appointed to the already

established Interministerial Coordinating Committee for IADP under the chair-

manship of the Permanent Secretary of the Ministry of Agriculture. The Coffee

Board of Kenya and the Kenya Planters Cooperative Union would be represented

by the general managers of those institutions while the Coffee Research Founda-

tion will be represented by its Director. These representatives would attend

Coordinating Committee meetings when relevant.

4.08 As with the current operations of the IADP, the development of

the Project would be effected through annual work plans. The first plan

would be submitted to IDA for review and comments by April 30, 1979, and

subsequent plans would be submitted by March 15 of each year during Project

implementation. Subsequently, analysis of the Project's achievements would

be undertaken through the ongoing monitoring and evaluation system which was

introduced and is being expanded under the IADP.

4.09 The annual review and work plans would form the basis for specific

Project implementation programs. The preparation of the work plan would be

the responsibility of the Manager-SCIP. The Plan would incorporate detailedproposals for the coming twelve months for factory improvements, farmersparticipation, credit requirements, input requirements, infrastructural

support activities, training activities, monitoring/evaluation requirements

and research activities. The full cooperation and assistance from the various

- 26 -

participating institutions and Ministries would be obtained. The Plan wouldbe reviewed by the IADP Interministerial Coordinating Committee under thechairmanship of the Permanent Secretary of MOA. Assurances were obtainedduring negotiations that the work program for each year would be submitted tothe Bank for review and comments not later than March 15 of each year. Thework plans for 1979 have been submitted since negotiations.

4.10 At field level the district would be the basic management unitand a committee consisting of the DAO, the District Coffee Officer, the IADPDistrict Coordinator, the District Cooperative Officer, the District Develop-ment Officer, the Cooperative Union Manager and the CBK field representativewould prepare district work plans and review progress.

4.11 Those aspects of the Project which involve CBK, unions and societieswould be carried out by the Department of Co-operative Development. MOCDcontrols the district cooperative unions at the national level. It promotesdevelopment through assistance in management, implementation of accountingsystems, credit schemes and training programs. A major function is to auditthe accounts of unions (and in some cases, societies). It is envisaged thatan Assistant Commissioner at headquarters will be appointed to coordinateall coffee matters within MOCD; the officer should participate in the creditnegotiations. As the number of loanees is expected to be substantial, hewill be assisted by one Senior Cooperative Officer and an Accountant. Addi-tional staff will be posted to both the district and provinces to facilitateboth the additional loan processing and auditing functions which will berequired under the Project. The Project would provide for credit through theCo-operative Bank of Kenya. In order to ensure proper supervision of theProject's loans, the field services of the CBK would be strengthened.

4.12 Staffing - The Project would require the following incrementalstaff:

Senior Staff-/Junior Staff Total

Ministry of Agriculture 34 50 84Department of Cooperative Development 11 50 61Cooperative Bank of Kenya 3 3 6Coffee Research Foundation 14 17 31

Total 62 120 182

1/ Job Group J and above.

Assurances were obtained from Government at negotiations that (i) Governmentwould assign staff to the Project in line with the provisions under thevarious components proposals, (ii) terms of reference for key Project staffbe agreed with the Association and that (iii) Government would ensure at alltimes that there are appointed to the positions of Project Manager within theIADP Unit and of Project Coordinator within the MOCD, persons with appropriate

- 27 -

qualifications and experience. Detailed lists of incremental staff posts and

job descriptions for the senior project positions are in Annexes 5, 6, and 7.

Planning for the appointments of the senior staff required has already started

and no difficulty is envisaged in recruiting the staff set out above.

B. Training

4.13 Serious constraints are being encountered in the field with trying

to improve the effectiveness of the coffee extension services and coffee

factory management. The four most important constraints are: (a) the inade-

quate technical background of coffee extension staff, society managers, factory

managers, committee members and coffee growers, (b) lack of coffee extension

supervisory staff, (c) inadequate recurrent budgetary support for the extension

staff and (d) the lack of clear incentives to encourage coffee extension staff

to a better performance.

4.14 The Government has already started to address the problems outlined

in (c) and (d) in anticipation of Project start-up. The Project would aim to

alleviate the constraints mentioned under (a) and (b); firstly by providing

for field training courses and demonstrations for coffee farmers and in-service

training programs for coffee extension staff, factory managers, committee

members and society managers; and secondly by providing for the appointment of

additional coffee extension supervisory staff both at the provincial and

district level. These training programs would not replace the present general

staff training programs undertaken by both MOA and MOCD but would supplement

them and be Project orientated. The proposed training programs for the

various staff involved in implementing the Project would be conducted in joint

cooperation by MOA, MOCD and CRF.

C. Monitoring and Evaluation

4.15 The monitoring and evaluation needs of the Project would be the

responsibility of the Monitoring and Evaluation Section within the IADP Unit.

A recent special supervision mission dealing with the performance of this

unit concluded that the monitoring and evaluation system which has been set

up is generally well conceived although there are some significant ways in

which it could be improved. A detailed schedule on steps and timing for

improving the unit has been discussed with the Ministry of Agriculture and

assurances were obtained at negotiations that the full implementation of

the recommendation would be completed by July 1, 1979 or a later date to be

agreed with the Association.

4.16 The additional workload for the unit to monitor and evaluate this

Project would require provisions for the employment of five additional super-

visors and 20 enumerators. The proforma side of the monitoring and evaluation

system would assist in obtaining information from the agencies and ministries

- 28 -

involved in the Project; this in turn would assist management in (a) collect-ing statistics on project inputs and outputs for further evaluation andreporting needs, (b) observing and assessing progress and the fulfillment ofset targets and operations as laid down in the respective work plans, (c)identifying problems and shortcomings of the Project for timely adjustmentsand re-orientation of the Project, and (d) managing the Project effectivelyand efficiently at all levels.

4.17 In addition to the proforma reporting system, farm surveys wouldbe designed to (i) determine the Project's effect on project beneficiaries,(ii) provide early indication of project constraints, and (iii) indicateareas where services to the smallholder coffee farmers should be adaptedor changed, i.e. extension, training, input supply, marketing system andother cooperative services. In addition, the farm surveys would serve asguidance to the Planning Division in MOA in the annual preparation of workplans.

4.18 The Government should prepare a completion report summarizing per-formance under the Project and evaluating its successes and problems. Thisshould be submitted to the Association not later than six months after theexpected closing date (i.e. September 30, 1984), and assurances on thissubject were obtained during negotiations.

D. Project Implementation

4.19 The Project would be implemented over a period of four years,beginning July 1979. The Government was encouraged during negotiations tobegin preparing the first work plans and plan start-up activities to avoidsubsequent implementation delays. The Project Implementation Schedule issummarized below and was also discussed during negotiations.

- 29 -?UJkLI LWLkLMENIAI IIIUN SlKEDOULE

Project Year (July 1- June 30) 0 1 2 3 4 5

1978/79 1979/80 1980/81 1981/82 1982/83 1983/84

Project Staffin;

Appointment of Manager - SCIP + HQ Staff !NOACoordinator - MOCD + HQ Staff MOCDProv. and District MDA StaffProv. and District MDCD StaffCBK StaffCRF Staff

Project Planning

Terms of Referetice Key Staff 5District Submissions for Year (1) Activities _Yearly Work Plan and BudgetsSubmissions from CRF and CBK

Project Implementation

Factory Construction, Improvement & TrainingExtension and Training, Monitoring & Evaluation _

CUK Loans

CRFMOCD and Training

Annual Project Review _ -Governmrent Completion Report Sept. 84

T iRD

AppraisalNiegotiationsBoard Approval nEffectivenessAnnual Workplans Approval U * *Completion June 30Closing '83 * Mar. 84

V. COFFEE PRODUCTION AND PROCESSING

A. Production - Technical Features

5.01 Coffee is grown on approximately 86,800 ha, of which 59,000 ha arecultivated by small-scale farmers. It is grown in all of the six main agricul-tural provinces, generally being restricted to altitudes of 1,400 to 2,100meters. The following Table shows the area planted to coffee covering theperiod 1963-1977:

HectaresCrop Year Estates Smallholders Total

1963/64 32,600 20,000 52,6001966/67 31,800 42,900 74,7001970/71 29,900 53,800 83,7001974/75 28,600 57,800 86,4001975/76 28,600 56,600 85,2001976/77 26,900 59,900 86,800

- 30 -

The reduction in estate planting is mainly due to the policy of transferringestates from expatriate ownership. A considerable growth in smallholdingarea took place between 1963 and the early 1970's. The changes between theearly 1970's and 1976 are probably mainly as a result of an improvement inthe statistical procedures because, according to CBK, the smallholder areasmight have been under-estimated originally.

5.02 Mainly Arabica coffee is grown in Kenya and this variety requiresa stress factor to break its inherent dormancy and produce high yields. Itis generally accepted that this stress is supplied by the dry season whichis much more pronounced East of the Rift Valley than it is in Western Kenya.The coffee areas of Central and Eastern provinces have therefore a higheryield potential than those West of the Rift Valley. Despite similar naturalconditions and production techniques small-scale farmers harvest much lesscoffee (1977-average 760 kg/ha) than large-scale producers (1977-1,790 kg/ha). In the early sixties yields on smallholdings were much higher due tothe fact that at that time many of the trees were relatively young and thesoil in which they were planted was highly fertile. In the following yearsyields fell sharply due to the effect of Coffee Berry Disease on the one handand the expansion of smallholdings without technical supervision on the otherhand. The Table below shows the trend of yields for the period 1963-1977in kg/ha.

Kg/haCrop Year Estates Smallholdings

1963/64-1965/66 (average) 768 9951966/67-1970/71 (average) 753 4951971/72-1974/75 (average) 1,153 6211975/76 1,317 6381976/77 1,786 761

Yields of smallholder coffee started to rise again in the early seventieswhich was mainly due to improved extension services and increased pay-outs byKPCU.

5.03 Research on the ways and means of increasing yields is carried outby the Coffee Research Foundation at Ruiru. Both the Research Institute andthe Coffee Board of Kenya confirm that mean average yields of 1,000 kg/ha arewell within the capabilities of the Kenyan small-scale coffee farmers. Manyprogressive coffee farmers are achieving these yields and better. Out of58,900 ha of small-scale coffee plantings, approximately 23,000 ha have beenidentified as either neglected or not worked to their full potential. Theaverage yields for this area are approximately 220 kg/ha only, compared tothe average yield of 1,100 kg/ha achieved by farmers (about 60% of thesmall-scale farmers) who do not need support through the Project.

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5.04 Under the Project an improvement strategy would be followed whichhas been outlined in paras 3.04-3.09. These investments, except the provision

of medium-term development loans which are made to project farmers only, wouldbenefit the entire small-scale coffee industry. Although approximately 23,000

hectares have been classified as neglected by the GOK and CBOK, it is antici-pated that only 15,000 hectares of this will be affected by the Project provi-

sions. Farmers acceptance of the provisions is expected to build up slowlywith about 3,000 ha of the target group joining in year 1, 6,000 ha in year 2,

and 3,000 ha in both year 3 and 4. For the farmers joining, the Project pro-

visions would eliminate genuine constraints which are facing them. Not all

the farmers with neglected holdings face these constraints. Out of 23,000 ha,

approximately 8,000 ha are owned by farmers which belong to the low end of theproduction scale for reasons ranging from non-interest to old age. Project

provisions do not allow for their participation. Identification of potentialparticipants will be carried out at the farm level by a team of people con-sisting of the local extension agent, the local Coffee Board inspector andrepresentatives of the Department of Cooperative Development. It is antici-

pated that higher uptake rates will emerge from areas East of Rift comparedto areas West of Rift.

5.05 The farm models described below are indicative of the farmingpractices likely to be adopted by those who obtain loans under the Project.

These models are particularly important for analysis of what is happening on

the present neglected holdings compared to those of progressive farmers.Although there are differences between the 19 districts covered under theProject, it was necessary to contain the number of models. The models there-

fore give an order of magnitude of what can be achieved rather than predictingprecise output figures. The models consist of three parts: (a) gross margin

calculations per hectare for coffee; (b) the significant farming system for anumber of districts with the corresponding farm budget and (c) the resulting

cash flow for the farming system described. Model 1 is typical for the target

coffee growing areas in Machakos and Muranga and represents approximately 4%

of the total coffee smallholding areas. There are few alternative cash cropsand the farms often depend entirely on the cash return from coffee. Atpresent, progressive farmers in these areas achieve the highest yields

in the country. Proper use of inputs would enable the farmer to increasegreatly his productivity with a corresponding increase in the creation of

employment opportunities and income. Model II covers the growing areas in

Nyeri, Meru and Kirinyaga. It represents approximately 15% of smallholdercoffee growing areas. Food crops like maize and beans are produced mainly forhome consumption and the major other cash crop is potatoes. Model III is based

on Kisii coffee farmers and it represents an average view of the coffee farmactivities in that district. The model is also representative for South

Nyanza and the major part of Kisumu and Siaya. The well distributed rainfallin these districts does not stimulate top yields from Arabica coffee. Howeverit is clear again that with proper husbandry methods and access to sufficientinputs the farmer is well positioned to increase his productivity. Model IV

is representative of the larger farms in Baringo, West Pokot, Kajiado, Kerichoand Nandi. This zone is suitable for Arabica coffee and it would bring areliable income into the district. Large tracts of some of the districts were

- 32 -

newly settled after Independence in 1963 and the incoming farmer - often a

pastoralist concentrated on cattle and maize first. Therefore considerable

efforts by the extension services would be required to upgrade production

techniques. The yields' forecasts (350 kg/ha in Year 4) are well below the

potential as the rehabilitation of these areas will take longer than the

Project period.

5.06 Estimates of yield increases may be summarized as follows:

Yields (kg/ha)ProgressiveNon-Project

Project Year Without 1 2 3 4 Farms

Model I 450 560 760 960 1,160 1,400-1,450

Model II 265 390 550 710 880 1,050-1,100

Model III 135 305 475 645 815 815

Model IV 95 160 225 290 350 300-350

Yield increases are expected to arise largely from husbandry improvements:

(a) increased input use, particularly fertilizers and pesticides, (b) better

weed control measures, (c) planned pruning cycles, (d) employment of casual

labor during peak labor times. Improved extension activities and training

facilities will play a major role in achieving the projected yield increases.

Progressive non-Project farmers achieve the mean annual yields indicated

above already. Annual yields would vary of course with the stage of pruning.

For models I and II, conservative estimates have been used to allow for occa-

sional droughts and other yield limiting factors. Over the four-year Project

period a gradual uptake by farmers is expected resulting in having by Year 4

approximately 15,000 ha under rehabilitation. The majority of these farmers

are expected to apply for medium-term development loans.

B. Production - Farmers Benefits

5.07 Although all smallholder coffee farmers would benefit from upgraded

factory facilities and improved extension services, an estimated 70,000 farmers

are expected to benefit directly from the Project's credit component over four

years. Almost 90% of Project cost correspond to factory rehabilitation and

farm credit and would be recovered from the beneficiaries through loan repay-

ments; the remaining 10% corresponds to institution-building expenditures

which would be recovered through the existing taxes levied on incremental

production. For farm credit, only those farmers who cannot obtain sufficient

input supplies through present credit schemes would qualify for participation.

At full development (farm year 4) net incomes of farmers who obtained the

medium-term development credit, based on the farm models described above, are

estimated as follows:

- 33 -

Model I Model II Model III Model IVImprovements

Area to be rehabilitated(ha) 2,865 9,550 2,250 115

Net farm income withoutProject 3,587 5,578 4,530 5,112Subsistence 3,587 3,636 3,786 3,346Cash income withoutProject - 1,942 744 1,766

Net farm income withProject (farm year 4) 6,619 8,901 7,015 5,669Subsistence 3,736 3,636 3,786 3,346Cash income with Project 2,883 5,265 3,265 2,323

The projected increases for Models I, II and III are substantial and resultmainly from increased inputs and the ability to employ casual laborers. Theyare realistic projections which are already being exceeded by the progressivefarmers. Model IV shows an acceptable increase in cash income which is ex-pected to improve beyond the Project period. Model IV is expected to showa slower take up than farmers in other areas and this will result in moreextension work to be put in.

C. Production - Estimates

5.08 Production estimates are based on yield projections for each indi-vidual district using farm budget analysis. The production estimates arerealistic as the yield projections used are already being surpassed by themore progressive farmers in the districts. In Year 7, incremental produc-tion is estimated at about 9,500 tons of clean coffee. The increment wouldrepresent an increase of about 9.5% on the 1976/77 national production ofabout 100,000 tons. The national production rose sharply in 1976/77 and it isexpected that the 1977/78 crop will only be about 90,000 tons due to adverseweather conditions particularly in the Eastern and Central provinces.

D. Processing - Constraints

5.09 Physical Facilities - The Co-operative societies have been unable toprocess the cooperative crop efficiently because of a general lack in both thequantity and quality of physical factory facilities. Specific shortcomingsare (a) antiquated pulpers of unsuitable design or the use of underdimensionedpulpers, (b) the absence of suitable pregrading equipment, (c) insufficientnumbers of fermentation tanks for the present cherry input, (d) the absence of

- 34 -

underwater soak tanks, (e) inadequate skin drying and table drying capacity,(f) insufficient parchment storage capacity and (g) final washing and gradingchannels which are too short. In addition, only a few society coffee factorieshave any recirculation equipment which would enable them to comply with the1976 Water Act.

5.10 Coffee Factory Management - The major constraint is the lack ofsuitably trained, job-oriented personnel in charge of factory management.The incorrect use of factory equipment and facilities is the largest singlecause of coffee quality decline. At a lower level of administration, themain obstacles are the shortage of numbers and quality of clerks and account-ing staff. These shortages have led to delays and inaccuracies in paymentto the individual farmers and this in turn has resulted in loss of faithin the Society by the coffee farmer.

5.11 Coffee Factory Engineering Staff - There is an almost completeabsence of qualified engineering staff within the co-operative coffee sectorindustry. This has resulted in a serious lack of maintenance and againincorrect use of machinery. These staff shortages have also been responsiblefor the present diversity in factory design and modification recommendations.

E. Processing - Modifications

5.12 The Project would remove the present physical shortcomings byconstructing 14 new factories and rehabilitating 400 of the 568 existingfactories. Although 506 factories were identified as needing rehabilitation,it is anticipated that only 400 factories will be affected by the Projectprovisions. The remaining factories would not be rehabilitated under theProject because the respective societies would not be interested for variousreasons or will obtain funds elsewhere. Improvements to the 400 factoriescan be divided into four basic types. This division is primarily determinedby the age of the factory. For Type I classified improvements, the Projectproposals would allow for resiting and rebuilding 50 factories which by virtueof site location and available space cannot be considered for rehabilitationin the conventional sense. Type II factories number 170 and they wouldrequire extensive modifications to existing structures. Constraints due tothe relative siting of the major factory components and the adjacent riverwould be overcome by hydraulically pumping parchment coffee to a higherelevation within the factory area. Type III improvements to 140 factories andType IV improvements to 40 factories would mainly provide additional pulpingcapacity, additional drying table capacity and additional storage facilities.

5.13 The Project would make provisions for the installation of all nec-essary recirculation equipment at individual society processing units tocomply with the Water Act of 1976. The Project would also provide for theintroduction of suitable mechanical drying units in those districts whereclimatic conditions and size of site produce drying constraints which cannotbe solved by conventional sun-drying systems. Subject to the submission of a

- 35 -

detailed area evaluation, the Project would provide for 50 such units, 20 inNyeri and Muranga District of Central Province, 20 in Meru and Embu Districtsin Eastern Province and 10 in Kakamega and Bungoma Districts of WesternDistrict.

5.14 The Project would include provision for training programs for 1,180coffee Factory Managers and Assistant Managers, and 560 factory clerks andproduce recorders. The Project proposes to eliminate constraints due to lackof engineering skills by recruiting 4 additional provincial coffee factoryengineers and 16 additional coffee factory technicians.

F. Processing - Benefits

5.15 The Factory Improvement program would specifically attempt toimprove the quality benefits. The optimum quality of any coffee is determinedat the moment the cherry is picked from the coffee tree. Achievement of theoptimum quality of any given consignment of coffee is then greatly dependenton the efficiency of the subsequent processing steps to which the cherrycoffee is subjected. Significant declines in quality are incurred through theuse of incorrect pulpers, shortage of drying space, poor storage facilities,the use of polluted factory water, and the absence of under-water soak tanks.In addition delayed pulping, non-selective cherry sorting, poor skin dryingand sun drying, incorrect pulper setting are all managerial aspects whichnecessarily affect the final quality gradings. It is anticipated that follow-ing completion of the Project proposals, type I and II factories should becapable of improving their present quality standards by at least 3 classesand type III and IV factories by 1 class, resulting in increases of cleancoffee prices ranging from 5% to 10%.

VI. MARKETS AND PRICES

Demand

6.01 About 20% of world coffee production is consumed in producing coun-tries. Of the supplies entering international markets, almost 90% are importedby the US, Canada and European countries. The US absorbs more than one-thirdof world coffee imports; Western Europe takes approximately one-half of totalimports. Major importing countries in Europe are West Germany (10% of worldimports), France (8%), and Italy (6%). The demand for coffee is primarilydetermined by established habits, per capita income and population. In mostcountries, the demand for coffee is highly inelastic with respect to changesin prices and incomes. Consumption in coffee producing countries is expectedto grow by 4.5% a year until 1980, by 3.8% between 1980 and 1985, and by 2.5%in the remaining years up to 1990. World import demand is projected to growat an average rate of 2.7% a year up to 1990.

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6.02 The market for Kenya coffee, however, differs significantly fromthe above averages, because of Kenya coffee's high quality (see para 2.05).It is expected that the demand for Kenya coffee will continue to grow at afaster rate than the global demand for coffee, and that the Kenya coffeeindustry will be able to continue selling the totality of its production athigh prices in the future (see para 6.04).

Supply

6.03 The largest coffee producer is Brazil (on average 25% of the world'sproduction), followed by Columbia (12%), Ivory Coast (6%), Uganda (5%), Mexico(5%), Guatemala (3.5%), and Indonesia (3.5%). Kenya's share of the worldmarket is about 2%. World coffee production is projected to expand at anaverage annual rate of 3% from about 4 million tons in 1974 to about 7 mil-lion tons in 1990.

6.04 The potential expansion of Kenya's coffee production is of the sameorder of magnitude as this average world production annual rate of expansionof 3%. It is estimated that, besides the 9,500 tons generated by the pro-posed project after a 7-year period through the rehabilitation of small-holder's farms, the maximum potential expansion of the area under coffee(this is not part of the proposed project) is up to about 40,000 hectares. 1/At an assumed average yield of 1,000 kg per ha, such an expansion of areaswould result in an additional production of 40,000 tons. The Government ofKenya, however, has no firm plans to embark on such expansion. In any event,the maximum foreseeable expansion of Kenya coffee production would thereforebe of about 50,000 tons above the some 100,000 tons achieved at present.This represents an average 3% annual increase over a 15-year period. Therate of growth of production resulting from the project itself would averageabout 2.5% over the project period.

Prices

6.05 High coffee prices during the mid-1950s triggered an expansion ofcoffee plantings in almost all producing countries, which led to an increasein production and to growing stocks during the early 1960s. Producer stocksreached their peak of 90 million bags (5.4 million tons), equal to 2 yearsof world import demand, in 1966. In the following years, crops fell contin-uously short of consumption, and stocks were gradually drawn down. Becauseof the high stock levels during the early 1960s, prices reacted only slowlyto the changing market situation. It was not until the early 1970s thatprices again approached their level of the 1950s. When the commodity boomof 1973/74 started, coffee prices joined the upward trend, reaching US$0.72/lb,where they remained until the Brazilian frost of July 1975. Steep priceincreases followed, reaching a peak of US$3.29/lb in April 1977. During 1978,auction prices for Kenyan coffees have averaged $1.67/lb.

1/ Source: Coffee Board of Kenya.

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6.06 Prices are expected to decline from their present higher level toreach a forecasted low of $0.98/lbs (1979 constant) by 1981/82; this declinein prices is expected to slow the rate of coffee plantings which will resultin a strengthening of coffee markets during the second half of the 1980s.

6.07 As already stated, Kenya coffee commands prices about 20% higherthan the coffee from most other exporting members, because it is a high qualityarabica coffee used for blending with lower quality coffees. However, per-centage variations of the prices of Kenya coffee are close to those of othertypes of coffees. For price projections under the proposed Project, theactual series of Nairobi auction prices have been extrapolated using the priceindex for Guatemala Prime Washed as calculated by the Bank's Commodities andExport Projections Division.

International Coffee Agreement

6.08 The six-year International Coffee Agreement which entered intoforce on October 1, 1976 provides for the introduction of export quotas whenprices fall below specified levels (at present US$0.775/lbs). This referenceprice refers to a "composite indicator price" (the arithmetic mean of a groupof indicator prices for Other Milds and Robustas) published by the InternationalCoffee Organization (ICO). Export quotas would come into effect when thisindicator price falls, for 20 consecutive market days, below the referenceprice of US$0.775 cents. Article 33.3 of the 1976 International Coffee Agree-ment provided for a review and possible revision of the reference price bythe Council before September 30, 1978, and again in 1980. The September 1978Review Meeting did not decide on a new reference price. It decided that itwould convene another meeting if and when the composite indicator price fallsfor 20 consecutive trading days to a level which is 15% below an average priceto be calculated on the results of the 20 marketing days before September 30,and the 20 marketing days after September 30, 1978. On present indications,this would mean that another meeting be held if and when the price falls toapproximately $1.25/lbs. Kenya's quota is presently 65,000 tons, which issignificantly below its present production of nearly 100,000 tons. However,a possible triggering of the International Coffee Agreement quotas would noteffect Kenya's exports significantly, because the new quotas to be establishedwould be based on the past two years volume of exports, and the productivebuild-up under the Project would be progressive (see para. 7.10).

6.09 The International Coffee Organization has been advised of theProject and has not raised objections, as firstly the Project provisions donot include new plantings and secondly the rate of production resulting fromthe Project is commensurate with the anticipated rate of growth of demand forcoffee.

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VII. BENEFITS AND JUSTIFICATION

A. Economic Evaluation

Summary Economic Benefits and Justification

7.01 The proposed Project would be of major importance to Kenya as itwould contribute to increased production and quality of coffee, the country'smain source of export earnings. The agricultural credit, extension and train-ing components would assist up to about 70,000 farmers to increase their pro-ductivity, and the factory construction and rehabilitation component wouldimprove coffee quality and reduce river pollution (para 7.11). These twocomponents would contribute to increasing smallholder's income (para 5.07)and Kenya's foreign exchange earnings though the production of an additional9,500 tons of clean coffee and a quality improvement resulting in an averageprice increase of 6% in 1990 (in constant terms). Incremental employmentcreated for farm labor would be equivalent to about 6,500 full-time annualjobs. The research component would continue the Government efforts to ensurethe long-term growth of the coffee industry.

7.02 The ERR measuring incremental benefits of the project as a wholeis estimated at 21%. The Project's benefits are derived from two separatelyidentifiable sources: (i) the incremental production by the Project farmers,and (ii) the improvement of the quality of coffee processed in the factories,due to improved processing practices. Separate benefit streams correspondingto these benefits are in Table 6. The ERR on the agricultural productioncomponent alone (i.e. excluding the costs and benefits of improved coffeequality) would be 20.5%. The ERR on the factory component alone would be22%. The cost savings arising from the improvement of co-operative societies'management, although high, have not been taken into account in the economicanalysis (the ERR would be over 40% if these benefits were taken into account).

7.03 In the calculation of the above rates of return, foreign exchangewas shadow priced. 1/ The cost of hired labor was valued at its actual mar-ket rate, which was also used to value farmers' families' labor. If foreignexchange were not shadow priced, the ERR would decrease by about 6 percentagepoints to 15%. Detailed calculations of rates of return, prices and sensitivityanalyses are at Tables 6 and 7.

Basic Assumptions

7.04 The economic life of the project is assumed to be 25 years. Therate of return analysis includes all expenditures for capital investments,replacements, operation and maintenance costs related to all the project

1/ Shadow foreign exchange rate KSh 11.0/US$1.0 compared to current rateof KSh 8.0/US$1.

- 39 -

components. Costs do not include price contingencies, taxes and duties.Physical contingencies (representing 10% of project base cost), however, areincluded in the calculation of rates of return. Coffee prices have beenprojected in accordance with the latest Bank forecasts.

Sensitivity Analysis

7.05 The ERR of the Project as a whole is moderately sensitive tovariations of costs or benefits. If all costs are increased by 20%, or ifall benefits are decreased by 20%, the ERR would decrease by 6 percentagepoints from 21% to 15%.

7.06 The sensitivity of the ERR of the agricultural production compo-nent (base estimate 20.5%) was tested against variations of:

(a) production costs (resulting from changes ofinput prices and/or physical requirements);

(b) value of incremental production (resulting fromchanges in coffee prices and/or quantities ofcoffee produced); and of

(c) the number of farmers participating in the program.

A 20% increase of production costs would decrease the ERR on the productioncomponent by 6.5 percentage points from 20.5% to 14%; a 20% decrease ofproduction benefits would decrease the ERR by 10.5 percentage points from20.5% to 10%; a decrease of the number of project participants to half of thebase estimate would reduce the ERR by 4.5 percentage points from 20.5% to 16%.

7.07 The sensitivity of the ERR of the factory construction and rehabil-itation component (base estimate 22%) was tested against variations of:

(a) capital and operating costs;

(b) capacity level of factory utilization;

(c) coffee prices;

(d) quality of the factories' output; and

(e) 1 year delay in factories' start-up.

A detailed sensitivity analysis was conducted for each type of factory. TheERR would still be above 15% if any one of the above parameters varied by upto 20%.

Risks

7.08 Risks associated with rainfall and other natural conditions havebeen taken into account in estimating the Project benefits. To minimize the

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risk that Project institutions might fail to reach the expected number of

farmers with services and inputs, Project implementation would be governedby Annual Work Plans (para 4.09). Another risk is that farmers may adopt therecommended input packages less rapidly than anticipated. This, however, would

not significantly affect the rate of return since most expenditures would be

reduced by an amount commensurate with the loss of incremental benefits. As

an illustration, if only 50% of the farmers expected to participate actually

participated in the Project, the ERR on the production component would decrease

from 20% to 16%.

7.09 Technical risks regarding factory design and operations and risksof substantial delays of construction are low since (i) coffee factory tech-

nology is well known in Kenya, (ii) the projections of the factories' per-

formance is based on the actual performance of coffee factories operating

in Kenya at present, and (iii) the project provides for training of factory

personnel. Risks of unsatisfactory management are further minimized by thefact that the factories would be operated independently.

7.10 The commercial risks are low, because forecasts of coffee prices have

been based on all expected world coffee production increases; unforeseeabledevelopments of the coffee market would be likely to reflect a lower-than-expected world production (thus pushing prices up) rather than an underestima-

tion of future coffee production. The possible triggering of InternationalCoffee Agreement quotas (para 6.08) would not affect significantly Kenya's

exports, because the above quotas are based on the past two years volume of

exports, and the production build-up under the Project would be progressive.

Environmental Impact

7.11 One of the major benefits of the Project, although not quantifiedin the present analysis, would be the elimination of heavy river pollution

by coffee factory effluents, through the provision of water recirculationsystems and appropriate waste disposal. Another environmental benefit would

be the prevention of soil erosion on rehabilitated farms through small scaleon-farm conservation works.

B. Financial Evaluation

Forecasts of Factory Operations

7.12 The assumptions regarding capital costs for factory constructionand rehabilitation, and recurrent costs, are detailed in Annex 3 for eachfactory type. These costs are based on the actual conditions of coffee pro-

cessing in Kenya. In the base case, it was assumed that factories wouldoperate at 100% capacity. This assumption is realistic, as coffee factoriesin Kenya usually operate above their nominal capacity.

7.13 Detailed financial projections for the new factories and for thefour types of factory rehabilitation works, and sensitivity analyses, havebeen carried out. Depending on the type of improvement carried out, the

- 41 -

financial rate of return (FRR) on investment, including the investment in therecirculation system which does not yield direct benefits, would range between12% and 32% (FRR calculated in constant prices). Sensitivity analyses showthat the FRR, for any factory type would be over 14% (if the cost of therecirculation system is excluded) and in most cases over 10% (if the costof the recirculation system is included) in the following circumstances:(i) factories operating at 80% of capacity, (ii) incremental benefits fromimproved quality decreasing by 20%, (iii) operating costs increasing by 20%and (iv) capital costs increase by 20%.

7.14 Under the Project, the cooperative societies would borrow 100% ofthe cost of the recirculation system and 75% of the other factory investments,at 10% interest rate per annum, repayable over 5 years including one yearof grace. These terms would ensure a satisfactory payout to farmers duringthe early years of the project and thereafter.

Co-operative Bank and Government Cash Flows, and Foreign Exchange Benefits

7.15 The Co-operative Bank's Project cash flow (Table 3) would be positiveduring the first 10 years and allow for additional investments in the coffeesector. Repayments in subsequent years would be readily met from earlier surpluses.The Government cash (Table 4) would be negative during the first 2 years and reacha deficit of about US$2.0 million. Thereafter, annual cash flows would be positive,the cumulative cash flow would become positive in project year 4. The projectforeign exchange receipts would always exceed foreign exchange expenditure. Atfull development in about year 10, the project's net annual foreign exchange earn-ings would be about US$18 million (in 1979 prices).

VIII. SUMMARY OF AGREEMENTS REACHED ON CREDIT CONDITIONS

8.01 The following issues were discussed during negotiations:

(i) the proposed Project Implementation schedule as outlinedin para 4.19.

(ii) arrangements for the maintenance of the factories followingthe Project period (para 3.04).

(iii) arrangements to provide adequate security for farmers' loans,and in particular the possibility of securing the loans bya charge over the land owned by the loanee (para 3.05).

8.02 During negotiations, assurances were obtained on the followingissues:

(a) Financing arrangements for the Project (para 3.12);

(b) Procurement arrangements for the Project (para 3.16);

- 42

(c) Establishment and/or maintenance of separate projectaccounts (para 3.18) by

(i) the Financial Controller in the IADP Unit, which wouldcover the loan proceeds for all components;

(ii) the Department of Co-operative for their activitiespertaining to the project;

(iii) the Co-operative Bank, Co-operative Unions and Societiesfor project activities;

(iv) the Coffee Research Foundation for their activitiespertaining to the Project; and

(v) MOA for their extension training and monitoringactivities pertaining to the Project.

(d) That accounts of all the above institutions continue to beaudited by independent auditors acceptable to the Bank(para 3.18);

(e) That audited accounts be forwarded by Government to theBank, with the auditor's report, not later than six monthsfollowing the end of the financial year to which theyrelated (para 3.18);

(f) That annual work programs be prepared and submitted to theBank for review and comments not later than April 30, 1979,(subsequently received) and thereafter not later than March 15of each year (para 4.09);

(g) That the Government apply modifications to interest ratesresulting from the general review on interest rates to thesub-loans subsequently approved under the Project (para 3.14);

(h) That Government assign staff to the Project in line withthe provisions under the various component proposals (para4.12);

(i) That terms of reference for key Project staff be agreed withthe Association (para 4.12);

(j) That the Government ensure at all times that there are appointedto the positions of Project Manager within the IADP Unit and ofProject Coordinator within the MOCD, persons with appropriatequalifications and experience (para 4.12);

(k) That the Government prepare a draft completion report onthe Project and submit it to the Government not later thanSeptember 30, 1984 (para 4.18);

- 43 -

(1) that the Government complete the implementation of recom-mended changes to the Monitoring and Evaluation Section ofthe IADP Unit by July 1, 1979 or at a later date to beagreed with the Association (para 4.15); and

(m) that both administrative and financial provisions be made forthe maintenance of the factories during and after the Projectperiod (para 3.04).

8.03 Conditions of Credit effectiveness would be that (i) all conditionsprecedent to the effectiveness of the CDC loan have been fulfilled (para 3.13)and that (ii) a Subsidiary Loan Agreement, satisfactory to the Association,has been executed on behalf of the Borrower and CBK (para 3.14).

8.04 Subject to the above conditions, the proposed Project would besuitable for an IDA credit of US$27.0 million to the Government of Kenyaon standard terms.

- 44 -

Table 1

KENYA

SMALLHOLDER COFFEE IMPROVEMENT RROJECT

PrOject Coat Summary I'(I Sh'OOO)

Foreign Taxes andExchange Duties

Year 1 Year 2 Year 3 Year 4 Total ( (

I. FACTORY DEVELOPMENT

Capital Cost 64,390 80,980 52,990 1,360 199,720 47 14

Working Capital - 10,850 13,320 8,200 32,370 20 10

Sub-Total 64,390 91,830 66,310 9,560 232,090 43 13

II. FARM INPUTS -/

Fertilizers and Pesticides 4,137 14,584 19,726 24,785 63,232 76 3

Tools 2,025 4,769 3,720 3,903 14,417 60 3

Hired Labor 1,752 5,525 7,176 8,200 22,653 - 10

Transport 412 1,429 2,150 2,724 6,715 - -

Sub-Total 8,326 26,307 32,772 39,612 107,017 53 3

III. COFFEE RESEARCH FOUNDATION

Research: Capital 5,098 - - - 5,098 44 11

Recurrent 998 998 998 998 3,992 10 4

Total 6,096 998 998 998 9,090 29 8

Training 1,340 890 B35 835 3,900 14 7

Sub-Total 7,436 1,888 1,833 1,833 12,990 24 8

IV. MINISTRY OF AGRICULTURE

Extension Service: Capital 2,690 - - - 2,690 70 20

Recurrent 2,304 2,304 2,304 2,304 9,216 17 6Total 4,994 2,304 2,304 2,304 11,906 29 9

Training 1,350 1,350 1,350 1,350 5,400 - -

Monitoring 452 452 452 452 1,808 2 1

Sub-Total 6,796 4,106 4,106 4,106 19,114 18 6

V. MINISTRY OF CO-OPERATIVE DEVELOPMENT

Project Implementation: Capital 2,450 - - - 2,450 70 20

Recurrent 1,885 1,885 1,885 1,885 7,540 17 6Total 4,335 1,885 1,885 1,885 9,990 30 10

Training 390 390 370 370 1,520 - -

Sub-Total 4,725 2,275 2,255 2,255 11,510 26 9

VI. CO-OPERATIVE BANK

Capital 165 - - - 165 70 20

Recurrent 201 201 201 201 804 13 4

Sub-Total 366 201 201 201 969 23 7

TOTAL BASE COST 92,039 126,607 107,477 57,567 383,690 43 8

Physical Contingenci7 - 9,204 12,661 10,748 5,757 38,370 43 8

Price Contingencies - 6,075 19,500 28,374 21,530 75,479 43 8

TOTAL PROJECT COST 107,318 158,768 146,599 84,854 497,539 43 8

1/ Base costs in March 1979 constant prices. Year 1 ccrresponds to financialyear starting July 1, 1979.

2/ Net credit requirements.3/ lOX on all items.T/ Inflation rates 9Z in Year 1, 8X thereafter.

December 28, 1978

KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

Detailed Financing Plan(K Sh Million)

1/ ForeignCoop. Societies Government IDA CDC Exchange

Amount % Amount % Amount % Amount % Total (

1. Factory Development

Construction - Rehabilitation 39.8 25 12.6 7 40.4 24 71.6 44 164.4 47

Recirculation Systems - - 3.5 10 11.5 23 20.3 57 35.3 47

Sub-Total 39.8 20 16.1 8 51.9 26 91.9 46 199.7 47

Working Capital 32.4 100 - - - - - - 32.4 20

2. Farm Inputs 2/ - - 5.5 5 101.5 95 - - 107.0 53

3. Coffee Research Foundation

Buildings - - 2.9 60 2.0 40 - - 4.9 40

Vehicles and Equipment - - 0.2 30 0.5 70 - - 0.7 70

Training Expenses - - 1.0 30 2.4 70 - - 3.4 15

Other Recurrent Costs - - 4.0 100 - - - - 4.0 10

4. Ministry of Agriculture

Vehicles and Equipment - - 0.8 30 1.9 70 - - 2.7 70

Training Expenses - - 1.6 30 3.8 70 - - 5.4 -

Other Recurrent Costs - - 11.0 100 - - - - 11.0 15

5. Ministry of Coop.Development

Vehicles and Equipment - - 0.7 30 1.8 70 - - 2.5 70

Training Expenses - - 0.5 30 1.0 70 - - 1.5 -

Other Recurrent Costs - - 7.5 100 - - - - 7.5 30

6. Co-operative Bank

Vehicles - - 0.1 30 0.1 70 - - 0.2 70

Recurrent Costs - - 0.8 100 - - - - 0.8 13

Sub-Total 72.2 18 52.7 15 166.9 43 91.9 24 383.7 43

7. Contingencies 20.7 18 17.5 15 48.4 43 27.2 24 113.8 43

Total. Including Taxes 92.9 18 70.2 15 215.3 43 119.1 24 497.5 43

Taxes- 11.7 30 27.7 70 - - - - 39.4 -

Total. Net of Taxes 81.2 18 42.5 9 215.3 47 119.1 26 458.1 47

1/ Commonwealth Development Corporation (UK)

2/ Net credit requirements.

3/ Information provided to show IDA's and CDC's contribution to project financing

on a without tax basis. However, all goods procured under the project would be

subject to the usual tax laws of Kenya

March 7, 1979

KENYA

SMALLhOLDER COFFEE IMPROVEMENT PROJECT

Co-operative Bank of Kenya Ltd. - Project Cash Flow 1/(K Sh million)

YearsYear 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 Year 12 Year 13 Year 14 Year 15 16-20

Sources of Fund

Loans frm Government 2/ 69.3 113.6 105.3 55.5 -- -- -- -- -- -- -- -- -- -- -_ -

Repayments 3/Factory Loans: Interest 1.3 7.2 13.5 16.2 14.3 12.2 10.1 8.0 5.9 3.7 1.8 1.2 0.5 -- -- --

Principal -- 0.4 5.4 13.8 20.9 23.6 23.6 23.6 23.5 23.4 21.8 16.0 13.9 -- -- --

Famers' Credit: Interest 0.2 1.4 4.1 8.1 12.8 11.6 10.2 8.1 4.6 1.8 -- -- -- -- -- --

Principal -- -- -- -- 6.1 16.5 25.5 39.0 32.4 18.5 -- -- -- -- -- --

Less Doubtful Debts 4/ -- -- -- -- (0.3) (1.3) (2.4) (2.6) (2.0) (1.0) -- -_ __ -_ __ __

Carried from Previous Year -- -- -- -- _- -- __ __ -_ -_ __ __ -_ __ __ __

Total Sources of Funds 70.8 122.6 128.3 93.6 53.8 62.6 67.0 76.1 64.4 46.4 23.6 17.2 14.4 -- -- --

Uses of Funds

Loans to Co-operative Unions 69.3 113.6 105.3 55.5 -- -- -- -- -- -- -- -- -- -- -- --

Interest 2/ 1.3 5.0 13.2 20.0 22.5 15.4 15.4 15.4 15.4 15.4 -- -- -- -- -- --

Annuity 2/ __ _ __ __ __ 14.3 14.3 14.3 14.3 14.3 48.8 48.8 48.8 48.8 48.8 33.4

Total Uses of Funds 70.6 118.6 118.5 75.5 22.5 29.7 29.7 29.7 29.7 29.7 48.8 48.8 48.8 48.8 48.8 33.4

Cash Flow (available for newinvestments) 5/ 0.2 4.0 9.8 18.1 31.3 32.9 37.3 46.4 34.7 16.7 (25.2) (31.6) (34.4) (48.8) (48.8) (33.4)

1/ In current terms.2/ At 7% interest per annum with 5 years of grace for principal payments for funds from CDC and 10 years of grace for

principal payments from Bank and Government funds. Principal repaid over 10 years in each case.3/ Factory loans: repaid by co-operative societies at 9% interest rate p.a. over 10 years including 18 months of grace.

Farmers' loans: repaid by co-operative unions at 9% over a maximum of 7 years including 4 years of grace forprincipal repayments. Interest rate paid by ultimate beneficiaries is not less than 10%. a

4/ Five percent of farmers' credit.5/ Surplus funds if reinvested would cover deficits in later years.

May 9, 1979

-47-

KENYA Table 4

SMALLHOLDER COFFEE IMPROVEMENT PROJECTl/

Government Cash Flow(K Sh Million)

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

SOURCES OF FUNDS2/

Taxes and Import Duties 9.2 15.2 14.4 8.0 7.0 7.0 7.0 7.0 7.0 7.0

County Council Cess - 0.2 1.0 2.0 3.6 5.1 5.9 6.3 6.6 7.24/

Export Taxes - - - - - 6.1 7.9 8.9 9.8 11.3

Interest and Principal-/ 1.3 5.0 13.2 20.0 22.5 29.7 29.7 29.7 29.7 29.7

External SourcesIDA Credit 44.2 67.4 64.0 40.6 - - - - - -CDC Loan 24.5 37.4 35.6 22.6 - - - - - -

Total Sources of Funds 79.2 125.2 128.2 93.2 33.1 47.9 50.5 51.9 53.1 55.2

USES OF FUNDS

Project Expenditures:

Co-operative Bank Loans 69.3 113.6 105.3 55.5

Coffee Research Foundation:

Capital Costs 6.0 - - -Recurrent Costs 1.2 1.3 1.4 1.5 1.5 1.5 1.5 1.5 1.5 1.5Training 1.6 1.1 1.1 1.2 1.2 1.2 1.2 1.2 1.2 1.2

Sub-Total 8.8 2.4 2.5 2.7 2.7 2.7 2.7 2.7 2.7 2.7

Ministry of Agriculture:

Vehicles and Equipment 3.2 - - - - - - - - -Training 1.6 1.7 1.8 2.0 2.0 2.0 2.0 2.0 2.0 2.0Recurrent Costs 3.2 3,5 3.8 4.1 4.1 4.1 4.1 4.1 4.1 4.1

Sub-Total 8.0 5.2 5.6 6.1 6.1 6.1 6.1 6.1 6.1 6.1

Ministry of Co-op. Development!

Vehicles and Equipment 2.9 - - - - - - - - -Training 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.5Recurrent Costs 2.2 2.4 2.6 2.8 2.8 2.8 2.8 2.8 2.8 2.8

Sub-Total 5.6 2.9 3.1 3.3 3.3 3.3 3.3 3.3 3.3 3.3

Co-operative Bank:

Vehicles 0.2 - - - - - - - - -Recurrent Costs 0.2 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

Sub-Total 0.4 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3

Total Project Expenditure 92.1 124.4 107.8 48.9 12.4 12.4 12.4 12.4 12.4 12.4

Debt Service:6/

IDA Credit - Service Charge 0.1 0.6 1.1 1.5 1.6 1.6 1.6 1.6 1.6 1.6IDA Credit - Repayments - - - - - - - - - -

7/CDC Loan - Interest 0.9 3.0 5.6 7.6 8.4 8.4 7.6 6.7 5.9 5.0CDC Loan - Repayments - - - - - 12.0 12.0 12.0 12.0 12.0

Total Uses of Funds 93.1 128.0 1.23. 77.0 22.4 34.4 33.6 32.7 31.9 31.0

Net Cash Flow (13.9) (2L. 4.7 16.2 10.7 13.5 16.9 19.2 21.2 24.2

1/ Year 1 corresponds to financial year starting July 1, 1979. Current prices are used foryears I to 4. Inflation rates used are 9% for year 1, 8%/. for e ars 2 to 4, t8. thereafter.

2/ Taxes and duties are 8% of project-related expenditures.3/ 3% of auction value of coffee (see Annex 1, Table 14). Incremental production and quality

improvement are shown in Annex 1, Table 18.4/ 15% of sales above K Sh 20/kg.5/ Interests paid by Co-operative Bank at 71 p.a. on funds lent for credit. Repayments on CDC commence year 6.6/ Standard IDA terms.7/ Fifteen years repayment of which five years of grace; 7% interest rate per annum.

May 9, 1979

- 48 -

Table 5

KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

Estimated Schedule of Disbursements 1/(us$ Million)

IDA Fiscal Year Quarterly Cumulative Disbursementsand Quarter Disbursements at End of Quarter

1979/80September 30, 1979December 31, 1979 --

March 31, 1980 0.2 0.2June 30, 1980 0.2 o.4

1980/81September 30, 1980 1.4 1.8December 31, 1980 1.8 3.6March 31, 1981 1.8 5.4June 30, 1981 1.8 7.2

1981/82September 30, 1981 1.8 9.0December 31, 1981 1.8 10.8March 31, 1982 1.8 12.6June 30, 1982 1.8 14.4

1982/83September 30, 1982 1.8 16.2December 31, 1982 1.8 18.0March 31, 1983 1.8 19.8June 30, 1983 1.8 21.6

1983/84September 30, 1983 1.8 23.4December 31, 1983 1.8 25.2March 31, 1984 1.8 27.0June 30, 1984

1/ A 12 month lag between physical investments and disbursements by theIDA is assumed. Disbursements in 1979/80 correspond to initialexpenses being financed retroactively.

March 5, 1979

KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

Economic Rate of Return Calculation

(K Sh Million)

Yeara Accounting

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Year 11 12-25 Factor

COSTS

1. FactorY Development

Construction/Rehabilitation 53.1 66.3 43.7 1.4 - - - _ _ _ _ _ 1.04

Recirculation Systems 11.3 14.7 9.3 - - - - _ - - _ _ 1.04

2. Incremental Farm Inputs 3/

Fertilizers, Pesticides, Tools, Transport 7.7 24.5 33.1 37.0 41.0 45.0 46.4 46.4 46.4 46.4 46.4 46.4 1.21

Hired Labor 1.4 5.7 8.2 11.2 12.7 13.4 13.8 13.8 13.8 13.8 13.8 13.8 1.0

Family Labor _/ 3.3 10.5 15.3 20.8 23.0 24.1 24.7 24.7 24.7 24.7 24.7 24.7 1.0

3. Research - 6.1 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.03

4. Training and Monitoring 6/ 3.5 3.1 3.1 3.1 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.5 1.0

5. Other Services 7/ 9.7 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 1.01

6. Thysical Contingencies (10%) 9.6 13.1 11.8 7.9 8.4 8.9 9.2 9.2 9.2 9.2 9.2 9.2 1.09

BENEFITS

1. Incremental Production

Quantity (ton 0o9) -' - 0.4 1.6 3.5 5.9 8.0 9.0 9.5 9.5 9.5 9.5 9.5

Price (K Sh/kg) - - 14.3 12.6 11.2 12.1 12.7 13.2 13.5 13.8 14.1 14.5 14.9 4

Value - 5.7 20.2 39.2 71.4 101.6 118.8 128.3 131.1 134.0 137.8 141.6 1.37

2. Quality Improvement IO/

Factories Throughput (ton '000) -/ - - 19.2 44.3 61.7 61.7 61.7 61.7 61.7 61.7 61.7 61.7

Quality Premium (K Sh/kg) 12 _ - - 0.2 0.4 0.6 0.7 0.8 0.9 1.1 1.2 1.3

Value - - - 8.9 24.7 37.0 43.2 49.4 55.5 57.9 74,0 80.2 1.37

1/ In March 1979 prices.2/ From Annex 1, Table 2. Incremental recurrent costs are not shown, as they were

deducted from farmers' price. They amount to K Sh 0.5/kg.

3/ From Annex 1, Table 3.2/ From Annex 1, Table 3.

Valued at Hired Labor prices.

5/ From Annex 1, Table 4, less Training component.

6/ Items under Training and Monitoring in Annex 1, Table 1. After Project completion,

requirements for training and monitoring would be halved.

7/ Extension services, MOCD, Co-op. Bank costs.

8/ From Annex 2, Table 28, shifted by one year.

9/ Using prices paid to farmers in the without project situation (Annex 1, Table 14) to

avoid double-counting of factory benefits (quality improvement). Taxes and cesses

have been added back as they do not represent economic costs.

10/ Due to higher standard of processing.

11/ See implementation schedule in Annex 3, Table 5.12/ See Annex 1, Table 14. Difference in farmers' price for the with project and a,

without project situation. Taxes and cesses have been added back. s

-50 - Table 7

KENYA

SMALLHOLDER COFFEE IMPROVEMENT PROJECT

Economic Rate of Return and Sensitivity Analysis

ERR (%)

A. All Project Components 1/

Base ERR 21All costs increased by 20% 15All benefits decreased by 20% 15

B. Agricultural Production

Base ERR 20.5All production costs, except family labor, 14increased by 20%

All production benefits decreased by 20% 10Farmers' participation at 50% of base estimate 16Family labor valued at zero 33

C. Factory Component 2/

Base ERR 22

1/ For the economic analysis, two components have been consideredindividually: (i) agricultural production resulting in increasingthe quantity of coffee produced, and (ii) factory construction/rehabilitation resulting in improving coffee quality. Correspondingbenefits streams are in Annex 1, Table 18.

2/ See detailed analysis per type of factory in Annex 1, Table 16.

January 2, 1979

- 51 -

KENYA

APPRAISAL OF THE SMALLHOLDER COFFEE IMPROVEMENT PROJECT

TABLE OF CONTENTS - VOLUME II

ANNEXES

1. Cost Tables and Rate of Return Calculation

Table 1. Project Cost SummaryTable 2. Factory Construction and Rehabilitation - Project Costs

Table 3. Cost of Incremental Farm Inputs and Credit Requirements

Table 4. Coffee Research Foundation - Project CostsTable 5. Ministry of Agriculture - Project CostsTable 6. Department of Co-operative Development - Project Costs

Table 7. Co-operative Bank of Kenya Ltd. - Project CostsTable 8. Cost of Fertilizers as of June 1978Table 9. Price Projections of Fertilizers and ChemicalTable 10. Actual and Projected Coffee Prices - Guatemalan Primed Washed

Table 11. Distribution of Kenya Coffee ExportTable 12. Actual and Projected Prices of Average Kenya Coffee Mix

Table 13. Distribution of Project's Cooperative Produced Coffee,

per Class GroupTable 14. Projected Financial Coffee Prices to FarmersTable 15. Improvement of Coffee Quality, per Type of Factor Improvement

Table 16. Factories: Summary of Financial Rates of Return

Table 17. Analysis of Factory Investments (5 pages)

Table 18. Rate of Return CalculationTable 19. Economic Rate of Return and Sensitivity Analysis

Table 20. Co-operative Bank of Kenya Ltd. - Project Cash Flow

Table 21. Government Cash Flow

2. Farm Budgets and Production Estimates

Table 1A. Smallholder Coffee Hectares, Yields and Production (1977)

Table 1B. Smallholder Coffee Areas - Project AreasTable 2. Gross Margin from Cofee - Machakos District

Table 3. Farm Budgets - Machakos DistrictTable 4. Cash Flow - Machakos DistrictTable 5. Gross Margin from Coffee - Embu District

Table 6. Farm Budgets - Embu District

Table 7. Cash Flow - Embu DistrictTable 8. Gross Margin from Coffee - Kisii District

Table 9. Farm Budgets - Kisii District

Table 10. Cash Flow - Kisii DistristTable 11. Gross Margin from Coffee - Baringo Distrist

Table 12. Farm Budgets - Baringo DistrictTable 13. Cash Flow - Baringo DistrictTable 14. Expected Yields - Project Farmers

- 52 -

VOLUME II

ANNEXES (Continued)

2. Farm Budgets and Production Estimates (Continued)

Table 15. Typical Farming Systems in Project Area

Table 16. Total Labor Requirements for Picking Coffee for Project Farmers

Table 17. Total Labor Requirements for All Coffee Activities of Project

FarmersTable 18. Distribution of Labor Requirements and Costs for

Casual Labor for Project FarmersTable 19. Fertilizer RequirementsTable 20. Average Pesticide Recommendations per Hectare by District

Table 21. Total Fertilizer RequirementsTable 22. Pesticide RequirementsTable 23. Credit Requirements for ToolsTable 24. Hired Labor RequirementsTable 25. Transport RequirementsTable 26. Farmers Own Input ContributionTable 27. Total Medium-Term Credit RequirementsTable 28. Total Production Estimates

3. The Coffee Processing Improvement Program

Appendix 1. Model Descriptions of Factory Types and Criteria for

Complete RehabilitationAppendix 2. Mechanical Coffee Driers

Appendix 3. Job Description and Salary Scales for ProvincialCoffee Factory Engineers and Coffee Factory Technicians

Appendix 4. Factory Staff Houses

Chart 1. Recirculation System Flow Chart

Chart 2. Quality Decline by Class and Type of Factory

(Mecahnical Facilities only)Chart 3. Quality Decline by Class and Type of Factory

(Management Aspects only)

Table 1. A Proposed Program for the Establishment of NewFactories at Society Level

Table 2. List of Factories Scheduled for Improvement (13 pages)Table 3. Summary of Coffee Factory Improvement by Province and

DistrictTable 4. Unit Costs for New Factories and of Rehabilitation

of Existing FactoriesTable 5. Investment Costs of New Factories and of Rehabilitation

of Existing FactoriesTable 6. Operating Costs Three-disc Factory

Design 1. Designs for New Factories and Types I, III and IV

RehabilitationDesign 2. Designs for Type II Rehabilitation

- 53 -

VOLUME II

ANNEXES (Continued)

4. Agricultural Credit and the Co-operative Bank

Table 1. New Agriculture Credit Issued by Type of Farmer1973/74 - 1976/77

Table 2. Co-operative Bank of Kenya Ltd. - Balance SheetsTable 3. Co-operative Bank of Kenya Ltd. - Income and

Expenditure AccountsTable 4. Co-operative Bank of Kenya Ltd. - Funds Flow StatementTable 5. Co-operative Bank of Kenya Ltd. - Indicators of Financial

and Operational PerformanceTable 6. Co-operative Bank: Delinquency Rates as at April 30, 1978Table 7. Loan Agreement Blank FormTable 8. Loan Application Blank Form

5. Coffee Research Foundation

Table 1. Coffee Research Foundation - Project CostsTable 2. Coffee Research Foundation - Allocation of Project Items

6. Ministry of Agriculture

7. The Role of Cooperatives in Coffee Production

8. Training

Appendix 1. Course Guide for Coffee Factory M4anagers (7 pages)Appendix 2. Cooperative College of Kenya - The Centre for

Cooperative Education (10 pages)

9. Kenya Planters' Cooperative Union Limited

Appendix 1. Different Grades of Coffee (2 pages)Appendix 2. Coffee Classifications (5 pages)

10. The Coffee Board of Kenya

11. Selected Documents and Data Available in the Project File

KENYASMALLHOLDER COFFEE IMPROVEMENT PROJECT

Ministry of Agriculture Organization

Minister of Agriculture

Permar'en Sec etary

Head Development Deputy Secretary 1 Depu y Secretary ~~~~~~Principal FinanceiJj[jmnDpuyScrtr Deuy ere yand Establish-

Plnning Division Development Adiitrtin etOfficer

Diretorof Agtric e

Dpulty retor of Research

Livestock Range Land and Far Anima dustra HorculaMar g Management Management [rod [on [oCp Food Crops

Provincial Director |j of Agriculture

IADP MANAGEMENT UNIT

Head - IADP FDistrict Agricultural Officer

_ 0 Dep. Heasd IAOP P FarmerTnainingCeFr n t_ _ Ecaleation Officesr

Fi-_ .1 Cont,oil.r Division Agricultural Officer

_Financial Controller

Crap Animal Lan & Farm I Veterinar ManagerPraducti P tion Management Services S I i.p Field Extension StaffCoordintdr Codinator Coardinator Coordinator

| Farmer

a/ Technical Divisions Represented at Provincial and District Levels.World Bank - 1 8992

KENYASMALLHOLDER COFFEE IMPROVEMENT PROJECT

ORGANIZATION CHART OF THE DEPARTMENTOF CO-OPERATE DEVELOPMENT

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S.A (CO-OP) Seniorm t Adrtr

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