On the way: A look at Kenya's new Road Annuity Programme

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Overview of the Kenyan Road Infrastructure Sector

In recent years, the Government of Kenya has expended a large part of its budget on road infrastructure. This effort has been in fulfilment of the country’s economic growth strategy under Kenya’s Vision 2030 initiative (the country’s development blueprint). Currently, the sector relies heavily on the Treasury and proceeds from the Roads
Maintenance Levy Fund (RMLF) to build new roads and maintain existing road networks. Despite this, huge gaps remain in financing. For instance, in the 2014/2015 financial year, only KES 27.3 billion (USD 273 million) was available for the annual roads programme. This is less than 50% of what was required for road maintenance, rehabilitation and development of new roads.

As a result of these gaps, it is estimated that the Ministry of Transport, Infrastructre, Housing and Urban Development owed contractors KES 25.3 billion (USD 253 million) in outstanding payments for projects that had yet to be completed, as well as for those which had been certified as complete as at 31st December, 2013. Moreover, private road contractors were owed an estimated KES 88.3 billion (USD 883 million) for commitments yet to be billed and certified as at 31st December, 2013. This necessitated government initiatives to plug the funding gap, and key amongst these initiatives was the Road Annuity Programme (RAP)

The Road Annuity Programme: Objectives and Expected Outcomes

In June 2014, President Uhuru Kenyatta launched RAP, which was subsequently approved by the Cabinet on 10th March, 2015. Pursuant to RAP, the Government shall:

(a) identify a maximum of 10,000 kilometre (km) priority roads distributed across the country;
(b) procure long term contracts for design, finance, construction and maintenance of identified roads under a public private partnership arrangement within the meaning of the Public Private Partnership Act, 2013 (the PPP Act), with payments linked to the completion of roads and performance based maintenance; and
(c) pay for the services delivered by the private contractors through the normal budget process.

The Roads Annuity Fund (the Fund) was established under the Public Finance Management (Roads Annuity Fund) Regulations, 2015 (the Annuity Regulations). The Fund was established for the purposes of providing capital to meet the national Government’s annuity payment obligations for the development and maintenance of roads under RAP. The Annuity Regulations provide that withdrawals from the Fund shall only be made for the purpose of payment of approved annuity payment obligations and operational expenditures.

RAP aims to transform the country into a low-cost investment and trading destination and bring Kenya closer to the realisation of Vision 2030 and attainment of middle income economy status. RAP also aspires to build the capacity of local firms with a view to enabling them to take up the development of all infrastructure projects in the country and to generate adequate employment opportunities for graduates, amid high unemployment rates among the growing youth population.

Additionally, the new road network will promote national integration and improve security as a result of connectivity of regions and communities. It is reported that in urban areas such as Nairobi, RAP is expected to reduce pollution and traffic jams, which are estimated to cost KES 57.8 million (USD 578,000) per day in lost productivity. RAP will also create more arteries in and out of cities thus decongesting traffic and reducing travel time.

The Government’s initial plan was to complete 2,000 km of small roads within the 2014/2015 financial year, followed by 3,000 km in 2015/2016 made up of 80% small roads and 20% highways and 5,000 km in 2016/2017. Once completed, RAP would have nearly doubled the number of Kenya’s asphalt surface roads from the current 14,000 km, equivalent to 8.8% of the 161,451 km of classified roads, to 24,000 km.

However, RAP almost collapsed in late 2015 amid concerns of inflated construction costs, with contractors quoting twice more than the Government’s budget for building a km of road. The Government had expected to spend about KES 25 million (USD 250,000) for every km of rural roads and between KES 50 million to KES 80 million (USD 500,000 to USD 800,000) for each km of urban and trunk roads.

Significantly, lenders also differed with the Government on the rate of interest to be charged on loans issued to shortlisted contractors amid a volatile forex environment, soaring lending rates, rising inflation and a high risk of default among borrowers. The Government had proposed a uniform rate of 12% to 13%, which commercial banks rejected arguing that contractors were borrowers like any other and would therefore be assessed based on their respective risk profiles. (Previously , the prevailing commercial bank interest rate was on average approximately 20% but is now capped at 4% above the Central Bank of Kenya’s base rate). The stalemate on the interest rates applicable led to widespread perception that the RAP had collapsed.

However, in April 2016, the National Treasury Cabinet Secretary, Henry Rotich, clarified that contrary to earlier statements, RAP had not reached a dead end. Around the same time, it was reported that the Government had negotiated a KES 150 billion (USD 1.5 billion) concessionary loan from the World Bank’s private wing, the International Finance Corporation (IFC), to revamp RAP by enabling local contractors to access funds at affordable interest rates. These funds would be disbursed by local banks at interest rates of between 5% and 6%.

The Annuity Road Financing Model (ARFM) represents a major shift from the traditional road development financing models such as the Engineering, Procurement and Construction (EPC) model the Build, Operate and Transfer (BOT)-Toll model. Under the EPC model, which had traditionally been used in Kenya, the Government would invite bids for engineering knowledge from private players and meet all procurement costs. The private sector’s participation was therefore limited to the provision of engineering expertise while the Government bore the whole risk of the project.

In the BOT-Toll model, the developer has to construct and maintain the road and thereafter recover the construction costs by collecting toll proceeds. There is, however, an additional traffic risk that the developer has to bear.

The Annuity Road Financing Model Explained

The ARFM was introduced in Kenya to help the road sector overcome its financing constraints while ensuring faster turnaround in execution of road construction. The Government is using this model for roads that may not be viable for conventional tolling which is more suitable for heavy traffic roads whose users can generate sufficient revenue to offset construction and maintenance costs. According to the Kenya Private Sector Alliance, the model has been tried in road construction in other countries with success and Kenya will be the first African country to use this model.

Under the ARFM, contractors will design, finance and construct the roads within a stipulated time not exceeding three (3) years and guarantee construction quality. The successful bidders will be required to raise at least 70% of the total cost of a project, before they are awarded a contract. Contractors will also maintain the roads post-construction for a maximum of eight (8) years, based on fixed annual payments by the Government, which will be extended after construction. The role of the Government will involve negotiating loans with banks based on a payment modality to be agreed upon by the Government, the contractor and the bank, giving guarantees to local banks in the form of letters of comfort and certifying the works upon completion. The Government, which would have provided 30% of the funds, will then repay the loans at a uniform rate in equal instalments (annuity) over an agreed period from the time a given road is completed.

The Various Regulators
RAP will be implemented by the Ministry of Transport and Infrastructure, Housing and Urban Development through the Kenya National Highways Authority, Kenya Rural Roads Authority and Kenya Urban Roads Authority.

It is hoped that RAP will benefit from a new dispensation and strengthened institutions. Case in point, the Engineer’s Act, 2011 established the Engineers Board of Kenya (EBK) which is mandated to register engineers to ensure that they carry out their duties in accordance with the EBK’s Code of Conduct. In addition, the National Construction Authority is responsible for regulating the construction industry and ensuring contractors provide quality services. Both these bodies can caution, censure, suspend or remove registered persons from the register.

The Public Private Partnership Committee established under the PPP Act is mandated to, among other things, ensure each project agreement is consistent with the provisions of the PPP Act. The Public Private Partnerships Node also established under the PPP Act is mandated to, among other things, identify, screen and prioritise projects, based on guidelines issued by the Public Private Partnerships Committee.

The Indian Perspective
The National Highways Authority of India recently launched a new financing model, which is a mix between the ARFM and the EPC Model. Under this hybrid annuity model, the government contributes 40% of the project cost in the first five (5) years through annual payments (annuity). The remaining 60% is paid as a variable annuity amount based on the value of the assets created and the performance of the developer. This means that during the construction stage, the developer has to raise the remaining 60% in the form of equity or 6loans. Under this model, revenue collection is the responsibility of the National Highways Authority of India. The National Highways

Authority of India will collect toll and refund the developer in equal instalments over a ten (10) to twenty (20) year period. The Indian Government’s policy is that this model will only be used in stalled projects where other models are not applicable.

Benefits of the Annuity Road Financing Model

Notably, under RAP, the contractor has the assurance that payment for work done will be made on time in contrast with past experiences of non-payment. The Annuity Regulations provide that the contracting authority shall process and submit a request for payment to the officer administering the Fund within ten (10) days of receipt and that the officer shall settle applications for payment within twenty one (21) days of receipt. The ARFM also gives the Government the opportunity to offload the risk associated with construction of roads to the consortiums which will help reduce the cost of building and maintaining roads. Paying contractors for roads built and certified as complete will also help eliminate poor workmanship. The Annuity Regulations provide that a contracting authority shall only request for payments from the Fund once an independent engineer has certified that the contractor has met all obligations for which payment is claimed under the project agreement.

Conclusion

There is no doubt that once fully implemented, RAP will improve access to markets and facilitate the uplifting of the socio-economic condition of the entire nation due to increased connectivity across the country. RAP will also help build local capacity, facilitate job creation, improve national integration, boost trade, economic growth and security. In that sense, the RAP addresses a number of the socio-economic development patterns envisioned under the new Constitution and under Vision 2030.