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close this bookFinancing Cities for Sustainable Development - with Specific Reference to East Africa (HABITAT, 1998, 98 p.)
View the document(introduction...)
View the documentAbbreviations
View the documentForeword
View the document1. Introduction
View the document2. Main Sources of Municipal Revenue
View the document3. Property Tax
View the document4. Income Tax
View the document5. Charging for Urban Services
View the document6. Tax on Provision of Goods and Services (Business Licences and Fees)
View the document7. Income-Generating Enterprises
View the document8. Borrowing
View the document9. Central Government Allocations
View the document10. Summary of Main Findings, Conclusions and Recommendations
View the documentReferences

8. Borrowing

Kenya

Most local authorities do not have financial capability to finance projects aimed at improving services and amenities within their areas of jurisdiction. They, therefore, have to resort to borrowing from external agencies. The law also allows local authorities to issue stocks and bonds to raise revenue. This has, however, been restricted to Nairobi City Council (although Nairobi has not issued new stocks recently, the last stocks issued having matured in 1993).

Two local sources have been very important in providing funds for capital development. These are the Local Government Loans Authority and two national housing agencies, the National Housing Corporation (NHC) and the Housing Finance Company of Kenya (HFCK Ltd.), which have provided loans for housing development.

The Local Government Loans Authority was specifically established as a statutory body under the supervision of the Ministry of Local Government, with responsibility for lending funds to local authorities allocated to it by the central government. It was also meant to utilize surplus funds held by some councils with no immediate use as a source of its loanable resources.

External sources, especially development agencies and multilateral donors, with the World Bank in the lead, have in the 1980s become the leading providers of finance for project development.

Short-term cash flow deficits are resolved by use of bank overdrafts from local commercial banks and financial institutions. The Ministry of Local Government is empowered to regulate the level of overdrafts.

Sources of loans: domestic and international

Overdraft facilities are provided by national banks, such as Kenya Commercial Bank Ltd. and National Bank of Kenya Ltd., which provide banking services to the councils, and also by other financial institutions operating within the cities. Mombasa's current approved overdraft, for example, is Kshs. 40 million.

Domestic loans for capital development were in the period prior to mid-1980s provided largely by the Local Government Loans Authority. These included housing loans, loans for plant and equipment, amenities expansion (road works, sewerage, buildings, drains) and land acquisition finances. This authority is currently incapacitated by lack of both new funds (government grants) as well as revolving funds, due to non-repayment of loans by local authorities.

The National Housing Corporation has provided house loans, commercial building construction loans, house repair loans, as well as limited finances for development of playing fields, water drainage, etc. The Housing Finance Company of Kenya Ltd. has provided mortgage financing for house purchases. For example, municipal schemes in Mombasa that have benefitted from these loans include: Changamwe Estates, Likoni and Kisauni tenant purchase schemes.

International loan sources have been the World Bank, under the Urban Projects, for housing development (through NHC Ltd.), and for expanding amenities, including roads, sewerage, etc; USAID, for tenant purchase scheme development; and the Ford Foundation, for construction of a demonstration centre (in Mombasa). The World Bank is the largest donor among the international lenders. In the 1990s, it has provided funds under the 2nd Urban Project, and currently under the 3rd Urban Project.

There are also internal sources of loan finance, mainly in the form of revenue contribution to capital outlay, which, in the case of Mombasa, include large amounts from service charge revenues.

Loan conditions; duration, security, interest and repayment terms

Most of the loans taken for property development are long-term. The Local Government Loans Authority loans are payable over a period ranging from 10 to 40 years, with an interest rate ranging from 3 per cent (loans taken earlier) to 6.5 per cent. NHC loans are repayable in 20 or 40 years and have an interest range of 3 to 6 per cent. Other loans taken from financial institutions on short-term attract higher interest rates. Nairobi City Council, for example, borrows from the market at interest rates varying between 21 and 26 per cent per annum to meet its short-term cash flow needs.

Loan approval procedures

All loans to the local authorities have to be sanctioned by the Ministry of Local Government, including the size of the overdraft facility. For international loans. Central Government guarantee is normally a pre-requisite. In some cases, loans from international donor agencies are usually made to the central government, which then on-lends them to the local authorities who require the money.

Assessment

In most cases, loans are now taken to undertake projects that are meant to resolve a crises or a long standing problem. They are therefore justified in the sense that there is no money available from the council's sources to undertake them.

If the level of overdrafts taken are an indicator of loan requirements, the medium to long-term sources seem inadequate. Some of the money taken as overdraft, which has surpassed approved levels, could have been borrowed as long-term or medium-term. In 1995/96, Mombasa took double the approved overdraft level.

Table 22 shows the annual balances of stock, local and foreign loans for Nairobi City Council. The local loan balances have been reducing minimally while the foreign loan balances continue to rise.

Table 22. Local and foreign long-term loan balances, Nairobi City Council (KPounds '000 p.a.)

Long Term Loans

1991/92

1992/93

1993/94

1994/95

1995/96

Stocks

14,500

12,500

-

-

-

Local Loans

42,175

40,686

39,127

37,474

35,806

Foreign Loans

221,885

521,199

523,728

573,443

541,670

Source: Nairobi City Council, Abstract of Accounts (Consolidated Balance Sheet)

As illustrated in Table 23, until 1988/89, Nairobi's debt-to-total asset ratio averaged 50 per cent, but this gradually rose to 85 per cent in 1992/93 and slowly fell to 61 per cent in 1995/96. The debt position of the Council has been made worse by its inability to service the loans due. Consequently, it has continued to rely on short-term commercial loans as a temporary solution to its cash flow problems. The major Council creditors are:

Table 23. Leverage, Nairobi City Council

Period

1980

1982

1983

84/85

85/86

86/87

87/88

88/89

89/90

90/91

91/92

92/93

93/94

94/95

95/96

Rate (per cent)

45.7

53.6

52.5

57.7

56.5

51.1

51.0

50.0

70

82

82

85

70

71

61

Source: Nairobi City Council Abstracts of Accounts

· The Central Government, which has been making debt service payments on the Council's foreign loans since June 1990;

· National Housing Corporation and the Local Government Loans Authority, in respect of local loans;

· Interest and redemption proceeds due to NSSF on matured Nairobi City Council stocks;

· Statutory deductions (from staff) not paid to the relevant authorities, including social security, superannuation and provident funds, pay-as-you-earn and national hospital insurance funds;

· Arrears of pay as a result of a large pay award backdated to 1st October 1993 due to staff; and

· Contractors' fees on the Third Nairobi Water Project for work in progress.

Nairobi City Council's poor financial status has resulted in its inability to service the loans since 1990. The Government is, for the time-being, assisting the Council in repayment of foreign loans and the Council is expected to repay the central Government when its financial position improves.

In Mombasa, the loan debt as of 31st December 1980 stood at Kshs. 35.6 million, with about Kshs. 26.6 million being owed to external sources. Loans outstanding had risen to Kshs. 298 million by 30th June 1990. As of 30th June 1997, the council owed Kshs. 675 million to various creditors, out of which Kshs. 391.2 million is mainly long-term loans lent by the Local Government Loans Authority and NHC Ltd.

Thus, debt servicing has become a problem for Mombasa. Like Nairobi, it has had to withhold money collected as statutory deduction to NSSF, Superannuation Fund, PAYE, Co-operatives, etc. to meet its recurrent budget. It also has had to pay only interest on loans, while also delaying payments on general supplies. The last time the Council was able to repay part of its LGLA loans was in 1991. In general, the level of borrowing of Mombasa Municipal Council has increased tremendously over the last 17 years. It has grown by more than tenfold and it is, therefore, not surprising that the Council is having repayment difficulties. The current high level of overdrafts, failure to deliver statutory deductions on time, threats by institutions (such as NHC Ltd.) to take-over municipal property are all pointers to difficulties facing the Municipality. It is also increasingly becoming difficult to raise loan funds.

The United Republic of Tanzania

Local authorities in many parts of the world are body corporates with powers to borrow. With borrowed money, local authorities can invest in expensive infrastructure or can undertake other capital intensive works and pay the money later. Local authorities in the United Republic of Tanzania have powers to borrow, but as is discussed below, borrowing has not been a significant form of financing the activities of local authorities in the country.

Sources of loans

In 1965, the Local Government Loans Board was established to take over from the former Local Councils Board and the Urban Local Authorities Loans Board created before independence, but was disbanded in 1973 along with the abolition of local government in the whole country. The primary object of this Board was to receive, administer and invest funds deposited to it (compulsorily by law) by local authorities; to lend the same to local authorities to undertake major development works and services; and to furnish guarantees and so on. Due to their precarious financial situation, many councils could no longer contribute to this board or qualify for loans. They were not even able to undertake development works by the 1970s.

The current Local Government Loans Board (LGLB) was established under the Local Government Finance Act of 1982. It started operating in 1986 and its functions are to: receive, administer and invest funds deposited by the local authorities (known as the Minimum Compulsory Reserve [MCR]); to lend the same funds to local authorities to finance development programmes and services; to furnish guarantees; and finally to provide and operate central services on behalf of those authorities.

Funds for the Board are derived from:

(a) sums provided by the government for that purpose, and,

(b) sums deposited with the Board by the local governments.

By 1990, the government had given a grant of only Tshs. 204,000.00, and no other formal allocation. The Board has depended on contributions which local governments are compelled to deposit with the MCR, which amount to 10 per cent of a council's total annual revenue. It is a once-and-for-all contribution, that is, the percentage of contribution does not vary unless there is an increase in the annual revenue to be collected, the difference of which must be paid to the MCR to maintain the required levels. Funds are supposed to be used to finance capital works.

Many local authorities have not been able to contribute to this fund due to their own financial problems and, as such, they have not been able to make use of the Fund. The Board requires two conditions in order to sanction a loan:

(a) The council must have made its full contribution to the MCR; and,

(b) The council must satisfy the Board' of its ability to repay the loan. In addition, projects financed must be economically viable and the interest on the loan will be the same as that charged by other financing institutions.

When it started, the Board had an initial capital of Tshs. 24.6 million: Tshs. 12 million from the earlier Board dissolved in 1973 and Tshs. 12.4 million being contributions from the local authorities; and Tshs. 0.204 million being a grant from the Government. This was too little to enable the Board to loan out any meaningful money. In 1990, the government announced its further contribution which enabled the fund to increase to Tshs. 58 million. Yet even this figure is too little.

Information on the operation of the LGLB has been difficult to come by. It would appear that the LGLB exists as a government bureaucracy, but is not an active operator in financing local governments.

Thus, borrowing has not been a form of financing urban governments in the United Republic of Tanzania to any significant degree. The central government does not seem to have been keen to encourage the development of borrowing facilities for local governments since experience with their financial management has not been encouraging. The financial sector in the United Republic of Tanzania is also poorly developed, so that corporate borrowing is still a limited option.

Uganda

As in Kenya and the United Republic of Tanzania, there used to be a Local Authorities Loan Fund in Uganda, which is now defunct, partly due to dramatic exchange rate changes and the change of government in 1971 when Idi Amin took over through a coup d't. It is planned that a revolving fund will replace the LALF and discussions are going on right now.

Borrowing is not common in the local government system in Uganda. One of the main reasons has been lack of confidence in local governments by the commercial banks. Secondly, due to the need for the Central Government to control inflation in the management of wider issues of the macro-economic framework, actual borrowing is restricted for local governments.

Sources of Loans: domestic and international

Locally raised loans are given in the form of over-drafts purely on the basis of negotiation between the bank and local authority. International loans have also been accessed by KCC very recently. A study by Price Water House to establish a Revolving Fund is under way.

The main loan or borrowing in the books of KCC is under the Uganda First Urban Project. KCC has also received grants and loans for rehabilitating roads. The First Urban Project started towards the end of 1980s and is not yet complete. Normally, loan agreements of that nature are between the Uganda Government and the external agency involved, in this case IDA. The amount to be borrowed should not exceed 25 per cent of the locally raised revenue. KCC, which seems to be the only local authority to borrow, mainly invested in rehabilitation of roads and re-building markets.

Assessment

KCC cannot sustain large loans, as sources of revenue to pay back are limited. IDA loans have to be approved by the Central Government. Local banks are not so keen, to lend to local governments, who they consider as likely to have a high rate of default.

International loans are repaid by the Central Government on behalf of any local authority that borrows. In turn, the local authority pays the Central Government. In most cases no cash changes hands for repayment and Central Government ends up writing-off the debts.