Lessons Learned : Conducting Pre-feasibility Studies at Municipal Level

Key Lessons: Conducting pre-feasibility studies at the municipal level to mobilise resources Context It is estimated that Kenya needs USD 2-2.5 billion per year for basic urban infrastructure investments and another USD 1-1.5 billion per year for investments into urban housing.i In addition, strategic investments into high-potential value chains are critical to ensure that urbanisation leads to sustainable and inclusive economic development.

However, the budgetary allocation to county governments and municipalities often is far below the necessary funding threshold and few municipalities have yet to build the capacity to generate revenue. For example, currently, municipalities are receiving donor support for urban infrastructure , as such by utilising those funds municipal budgets can only fund about 10-20% of the projects outlined in the urban economic plans (UEPs)1 even assuming the full municipal budget was dedicated towards these plans.

This financing gap necessitates municipalities to improve own-source revenue collection as well as attracting new forms of capital such as private financing into commercially viable opportunities. Private finance can be attracted specifically by identifying and designing investments well suited for the private sector, by creating a strong enabling environment where private sector is properly incentivised, sufficiently protected, well regulated, and by interfacing and engaging with potential investors. The financing gap also requires municipalities to be able to effectively unlock funding from other development partners/donors such as the World Bank. As a programme, we have seen funds “left on the table” by municipalities due to lack of capacity to meet disbursement requirements in good time. Ultimately, the financing gap requires municipalities and their respective counties to ensure that they are investing their resources in projects that will most effectively drive towards municipal development objectives, by avoiding unutilised investments.

Improving the investment attraction ability by municipalities is key to close funding gaps that exist for municipal investments and ultimately achieving the goal of more resilient municipalities. To do so, programmes should weave into their support, capacity building to ensure that the work they do is sustainable beyond the programmes support.

From the urban planning process in the first set of Sustainable Urban Economic Development Programme (SUED) municipalities – Isiolo, Kitui, and Malindi – a long list of projects emerged that are needed to enable the municipalities to realise their vision2. Planning documents, such as the UEPs and the County Integrated Development Plans are extremely important to provide directional guidance to government entities at all levels as to where to expend their limited resources. However, to ultimately mobilise internal and external resources for prioritised projects and move to implementation, additional project validation and design through pre-feasibility studies are needed. Over the last six months, SUED has developed nine pre-feasibility studies for these municipalities. These studies assessed the value chain and infrastructure projects that the municipalities, in partnership with SUED, selected from their planning documents to receive investment attraction technical assistance. This lessons learned document aims to highlight the approach taken and key learnings from developing pre-feasibility studies to support the mobilisation of resources for municipal projects.

Approach SUED developed pre-feasibility studies to take the concepts presented in the UEP and build out the project plans by testing and identifying the most viable project design to achieve the objectives of market-driven, inclusive growth.

These studies were decision-based documents to provide an answer as to whether the project is feasible and will achieve the results needed to be worth the investment costs (both financial and technical). The pre-feasibility analysis was critical in assessing viability and ensuring public resources for project design and development are well targeted towards projects that are most likely to be successful and sustainable.

1

Urban Economic Plans are advisory documents that the Sustainable Urban Economic Development Programme has helped select municipalities develop. They provide a focused urban and economic development strategy that will guide future development.

2 The Urban Economic Plans can be accessed here: https://www.suedkenya.org/urban-economic-plans

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Specifically, SUED utilised the eight criteria explained in the table below to assess each prioritised project. This was done through a mix of desk research, consultations with key stakeholders and sector experts, and financial modelling.

Each of the eight criteria provides a different lens against which the project is assessed, focusing on the motivation for the project (market size and need), the way the project would be structured and implemented (project operations), how the project interacts with the broader policy and regulatory context (enabling environment), the impact potential (economic empowerment, environmental, and gender and social inclusion), and the economics and readiness of the project to take on investment (project economics and investment readiness). Each of the eight criteria are extremely important for assessing viability and a deep dive in each enables decision makers (project owners, government entities, and investors) to weigh trade-offs that exist. For example, a project that may have stronger project economics with regards to generating more profit, may have lower impact potential with regards to the number or quality of jobs created if the project is focused on keeping the labour force small in order to keep operational costs low. While determining if this is a trade-off the decision maker is willing to make, is dependent on their goals, the analysis along each dimension allows for informed decision making.

Table 1: Criteria used to assess projects

From SUED’s work on these documents, numerous aspects of our approach were validated such as the importance of:1)climate change and gender and social inclusion assessments to ensure mainstreaming of these critical issues, 2) capacity building of municipalities to either carry out pre-feasibility studies or have enough of the fundamental knowledge to oversee the development of studies by consultants, and; 3)utilising an ‘investor lens’ throughout the process to ensure ultimate outputs answer the questions investors will want to know.

In this document, we want to highlight three learnings which emerged that can help inform future pre-feasibility studies carried out on municipal projects, and government projects more broadly. These learnings highlight what SUED found to be the most crucial and often overlooked elements and questions that need to be answered to provide sufficient information to potential investors.

Lesson 1: The market assessment is a critical first step For a project to bring about the type of transformational change that municipalities are targeting, it must address the fundamental bottleneck that is currently constraining economic growth; this is true both for value chain and infrastructure projects. To be able to identify these bottlenecks or market failures in value chains, it is necessary to first take a step back and evaluate the market opportunity and value chain operations considering: •

Does demand outpace supply? Is it a market gap that is likely to continue growing?

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What is the competitive advantage of this municipality to address the market gap?

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What are potential constraints in the value chain that has limited actors in addressing the gap? In particular, what has stopped current private sector players from fulfilling unmet demand?

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On infrastructure projects, the critical questions are around the problem the investment is trying to address specifically: •

What and how great are the economic losses that would be averted by this infrastructure (e.g., destruction of property, lost productive time for workers)?

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What and how great are the economic gains that could be achieved (e.g., greater access to market, increased tourism).

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Importantly, do the costs of the investment justify the potential gains and averted losses?

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Does the county and municipality have the financial capacity to implement the programme or co-finance it?

For both types of projects it is critical to think through how addressing the bottleneck or gap will improve (or hinder) climate change mitigation and adaptation as well as how it might differentially affect special interest groups such as women, youth and people with disabilities.

Too often municipal projects, while well meaning, do not address market assessment which ultimately means they will not provide sustainable solutions to serve the people. Additionally, sometimes projects overlook the fundamental question of if there is sufficient market demand and if the municipality has a competitive advantage to capture that market demand. By starting with a market assessment that includes an understanding of the different value chain actors, municipal constraints to growth, and market potential, projects can be better targeted for catalytic change. For example, in Kitui, SUED’s assessment showed that there is a large amount of underutilised honey processing capacity; therefore rather than additional investments in processing, investments in increasing honey production can help improve utilisation of existing infrastructure with positive externalities for the value chain. There is the added climate change resiliency benefit of honey production that investments in increased production can provide alternative livelihoods to those who relied on charcoal production prior to the charcoal ban. Similarly, our market assessment and value chain review for fruit processing in Malindi highlighted that despite significant production of mangos and high demand, linkages from the farmer to the processor and from the processor to large-scale off-takers were key challenges. Therefore, while processing of fruit in Malindi presents an attractive opportunity to leverage the area’s resources for value addition, investment into additional processing capacity is not viable without interventions targeted at improved market linkages. Ultimately, investments to address market linkage challenges are what can drive additional capital expansion of processing capabilities in the medium- to long-term.

Lesson 2: Defining appropriate role of the private and public sectors is key A key question the pre-feasibility study must answer is who is best placed to own and execute the project. In all the municipality projects, SUED typically looked at three main types of models: •

Privatisation –can the private sector own and operate the project with the public sector role being limited to creating a conducive enabling environment,

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Public implementation – can the public sector own and operate the project fully, and

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Public-Private collaboration – this ranged from public ownership with procurement for a private operator to a full Public Private Partnership (PPP). While there are numerous shapes these types of agreements can take, the defining feature is that there is shared risk for both parties and each ‘brings something to the table.’ For example, the government may lease land to the private company, the company may bring financing to build and operate an asset, or the government may hire a company to provide a service.

Too often when the government identifies a project needed in the municipality, the default assumption is that they will be closely involved in owning and/or operating the project. However, in many cases the municipality does not have the capacity to operate these projects. On top of that, the municipality can have an outsized impact for their residents by creating the enabling environment to attract private companies and investors to projects that are well suited to private involvement. Determining the appropriate structure is dependent on several factors but most critically: •

Is the project part of the devolved functions of the county and municipality? If so, public involvement in the project is important. For example, since waste management is part of the devolved functions, the county government/municipality should be the key driver of this function to ensure service provision is equitably provided even if pieces of the process can include private involvement (for example managing waste collection or recycling operations). In addition, the county and municipality should strengthen both their

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institutional systems and staff capacity to manage the project. Further the county and municipality should prioritise the project and ensure it’s included in the county planning system to ensure that funds are availed for it.

•

Is the risk of success and the potential impact high? If so, public involvement could help to de-risk the investment provided there is a sufficient impact case for the government to get involved. For example, the Malindi boat leasing project for fishermen has the potential to be commercially viable and have significant impact potential of increasing fisherman income by 2.25 times , but given there are a number of untested variables repayment rates by fishermen, is potentially a risky venture for an investment for the private sector at this stage. Therefore, having the public sector incubate the idea can help to de-risk the project by providing a proof of concept to the private sector.

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Will the public involvement actually increase the risk profile of the project? In some cases, the private sector sees government involvement – particularly in areas outside core government functions – as introducing more risk. This includes operating projects that require high levels of organisational efficiency, like running an abattoir, which typically the private sector is better at delivering given incentive structures. In these cases, considering how to decrease public involvement can help enable greater investment.

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Does the municipality have the capacity to effectively manage the project? The key question here is ‘can’ the government do it? Municipalities were constituted just recently and still are significantly under resourced with regards to financing and capacity. Critical here is if the municipality has the know-how and capacity to take on and run the project effectively.

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Are the project economics attractive to the private sector? Specifically, do the financial investment costs justify the economic returns? If so, the private sector is likely to be incentivised to operate the project. In cases where the project might not be justified by economic returns alone, but are based on the social returns, there is a stronger case for the public sector to step in to help facilitate the execution of the project.

This is part of the reason the environmental and social impact assessments are a critical aspect of prefeasibility since assessing returns to municipal investments must look at both financial and impact returns.

While the most feasible project structure with respect to operations and ownership is a combination of several factors, these rules of thumb can help provide guidance on the appropriate role of the public and private sector. For example, Isiolo County is currently in the process of operationalising an abattoir, owned by the County with the support of the World Bank. For the greenfield meat processing facility which is envisioned to further add value to the carcasses from the abattoir, the county government has determined, as a result of the pre-feasibility, that the project is best positioned as a fully private operation. The meat processing opportunity and economic returns are attractive to private operators and therefore Isiolo has identified it as a prime project for which to leverage private sector capital. This means the county government’s role importantly is focused solely on creating the enabling environment to facilitate a private operator to establish the facility adjacent to the abattoir. Ultimately, the Municipality will reap the impact benefits of this project without needing to inject its own, limited financial resources. Deciding the project ownership structure will also help to determine the appropriate type of resources to mobilise. Specifically, it can inform if it is a project that can be funded fully through commercial capital, requires public or grant funding, or needs a blend of the two. Further municipalities and the counties need to strategically utilise funds that they receive from the national government to cater for urban services. They must define their priorities and link them to the potential they have to attract investors.

Lesson 3: Pre-feasibility conclusions typically include a nuanced set of conditionalities against which the project could be feasible Given the complexity of municipal projects, the feasibility findings typically provide insight into the dependencies or key risks that need to be addressed to ensure feasibility. Based on SUED’s work the most common types of conditionalities are: •

Dependency on a project in other parts of the value chain – for example, the meat processing facility is feasible but conditional on assured supply from the abattoir which has yet to be operationalised. Similarly, a waste to value plant in Malindi, requires integration into the faecal sludge treatment plant designs that are being developed.

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•

Dependency on improvements in other parts of the value chain – for example, fruit processing in Malindi is feasible but conditional on improved market and farmer linkages. Similarly, the feasibility of Kitui’s significant installed honey processing capacity is dependent on increasing honey production to ensure sufficient raw material.

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Dependency on proof of concept at scale – for example, a boat leasing project that has been started in Kilifi County has currently only bought three boats. A scale-up of this project could present a commercially viable opportunity but feasibility is conditional on testing incentive structures and key assumptions at greater scale.

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Dependency on potentially politically sensitive actions – for example, multiple projects require resettlement of populations which can be particularly challenging to do given the political sensitivities around the process.

With these dependencies identified, the critical next step for municipalities is putting into place a detailed implementation plan for addressing the conditionalities such that a pathway to feasibility can be cleared.

The significant financing gap that municipalities face to implement critical value chain and infrastructure projects requires them to draw in additional external funding. Private sector financing presents an exciting opportunity for municipalities to leverage their limited resources for broader impact, assuming the project fits financiers’ requirements. Fundamental to that is project feasibility: can the project be viable based on the way it is designed? The pre-feasibility process – conducting a deep-dive analysis on the eight feasibility criteria – helps to answer that question, provide guidance on next steps, and ultimately supply the information that is critical to attract investors.

i UN Habitat (2014), cited in DASUDA (2014) Kenya Market Study, p.9.

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