Project appraisal and public sector investment decision making

Project Appraisal and Public
Sector Investment Decision
Making
Glenn P. Jenkins
Queen’s University, Canada
Eastern Mediterranean University, Cyprus
Feb 29, 2008


Overview of Presentation
International Experience with Public
Investment Preparation

I.




II.

MALAYSIA started in 1971
CANADA started in 1974

Case study: Application of Integrated
Project Appraisal


I- International Experience with
Public Investment Preparation

3

Components of a Good Public
Investment Program


Strategic Direction of Policy



Coordination between central policy ministries and the
line ministries



Investment selection and approval



Monitoring of implementation and assessment of
policy results
4


Investment Planning: Malaysia

• Brain of system is Economic Planning Unit in the Prime Minister’s
Department

coordination of policy by Economic Planning Unit with Line

• Close
Ministries
Ministries and State Governments are responsible for
• Federal
appraisal of projects following methodologies laid down by the
Economic Planning Unit

is driven by the close monitoring of projects by
• System
Implementation and Coordination Unit in the Prime Minister’s
Department

5


Malaysia Development Planning Machinery
Cabinet of Ministers

National Planning Council (NPC)
Draft

Policy

National Development Planning
Committee (NDPC)
Draft
Economic Planning Unit (EPU)
Draft
Secretariat

National
Action
Council
Implementation
and Coordination
Unit

General Framework

Inter Agency Planning Group (IAPG)
Proposals

Circulars
Federal Ministries
and Agencies

Circulars
State
Government
6


Building The Analytical Skills : Malaysia

•
•
•
•

After 4 years of service every member of the Administrative Officer

(Management) cadre receives one year of training at the National
Institute of Public Administration INTAN.

From 1971 to 1990s curriculum included an 8 week course in Project
Planning and Appraisal and a similar course in Project Management.

Emphasis on ex-ante investment appraisal weakened in 1990s by
excessive reliance on strategic planning,- bad projects have resulted.

This weakness has been recognized. In 2008 the government has
contracted to have 100 members of the National and State EPUs
trained in Integrated Investment Appraisal and Project Management.

7


Investment Planning: Canada


The annual budget is the central instrument for maintaining the fiscal
discipline and policy direction of government.



The policy direction is given by the Cabinet Committee on Priorities and
Programs (Prime Minister, Minister of Finance, President of Treasury
Board)



Budget allocations are given to LM by the Department of Finance, the
selection of actual projects is made by the LM.



All major investment expenditures must be appraised by LMs and
approved by Joint Committee of Treasury Board Secretariat and
Department of Finance.



Each Department or Sector Ministry has an Evaluation Branch.



Does both Ex-Ante as well as Ex-Poste Evaluations.



Monitoring of implementation done by sectoral ministries and financial 8
monitoring done by Treasury Board Secretariat with strong Office of
Auditor General


Investment Planning: Canada
 Treasury

Board Secretariat issues guidelines for the
appraisal of investments.

 Sector

specific guidelines for evaluation of almost all
types of projects and programs now available.

 For

example, Canadian Cost Benefit Guidelines:
Regulatory Proposals (Issued October 2007)
9


Canadian Cost-Benefit Analysis Guide:
Regulations


STEP 1 Identifying Issues, Risks and Baseline
Situation



1.1 Incremental Impacts
1.2
Establishing the Baseline Scenario (without
project)



STEP 2 Setting Objectives



STEP 3 Developing Alternative Options
10


Canadian Cost-Benefit Analysis
Guide: Regulations


STEP 4 Assessing Benefits and Costs of Each of Alternative
Options
 4.1
Identification of the Significant Impacts
 4.2
Measurement of Benefits
 4.3
Measurement of Costs
 4.4
Criteria
 4.5
Cost-Effectiveness Analysis
 4.6
Impacts on Stakeholders
 4.7
Discount Rates
 4.7.1
Rational Approaches to Discount Rate
 4.7.2
Discount Rate for Canada

 4.7.3
Annualized Costs and Benefits



STEP 5 Preparing an Accounting Table
 5.1
Cost -Benefit Analysis
 5.2
Stakeholder Analysis

11


Building The Analytical Skills : Canada


Undergraduate and graduate university programs in Canada in
Economics and Public Administration offer one or more courses
in investment appraisal



The Treasury Board Guidelines provide a good set of training
tools for those who wish to undertake a project appraisal.



Private sector consultants often hired to do the appraisals of
public sector investments.



Consultants have a strong incentive to follow the rules set down
by Treasury Board. Furthermore, competition tends to cause the
private sector to improve on the quality of analysis over time.
12


CHILE

CANADA

Cabinet
of Ministers

Cabinet
of Ministers

Implementation

Coordination

Polices

Strategic
Direction

MALAYSIA
Cabinet of

Ministers
NPC
MOF MED
Nat’l Bank

Project selection

Comm. For
Policies
& Programs

NPDC

EPU

Ministry
of Planning

Strict Guidelines
& Fin. ceilings

Sectoral
Ministries

State
Governments

MOF
Budget
Committee

Fin. Ceilings

Sectoral
Ministries
Project
selection

Treasury
Board

Guidelines
Sectoral
Ministries
Project
selection

13


Conclusions from International Experience


A variety of public sector institutional structures, but
to be successful there must be an incentive for the
bureaucracy to do high quality appraisals of project
ideas.



In Malaysia there is the fear of undertaking a bad

project that is difficult to implement. The
Departments do not want to get caught by the ICU
and have the project manager punished. This
system has put too much emphasis on the ability to
implement the project and not necessarily that it
offers good value for money.
14


Conclusions from International Experience


Canada is very decentralized in governmental decision making.



Main sanction against a Ministry engaging in bad project preparation
and appraisal is delaying approval of such investments by the Treasury
Board and the Ministry of Finance.



In Canada the bureaucrats fear is that the project will be a failure and
the Auditor General (AG) will create a great deal of publicity about it.



The Auditor General’s department employs as staff and consultants the
most highly skilled economists and project evaluation experts in the
country. They do post evaluations continuously.



The Auditor General is highly respected. Governments have been
defeated in elections because of evidence of public sector investments
involving large amounts of waste that were uncovered by the AG.



Civil servants may get removed from office or demoted if identified in
auditor general’s report as having done incompetent work.
15


Conclusions from International Experience


A prerequisite for the implementation of an

appraisal system for public sector investments is to
have a core staff of adequately trained analysts,- at
least to be able to properly supervise private
consultants.


The reform process should start with the building of
the skill base of the government’s staff.



Investment appraisal system will usually only be
implemented once policy makers see the benefits
of the application of modern investment appraisal
techniques.



Usually reluctant to implement new systems
without some staff trained to do the work.

16


II- Case study: Application of
Integrated Project Appraisal

17


A Case Example: Manila South Water
Distribution Project
Basic Facts:


The Metropolitan Waterworks and Sewerage System (MWSS), had identified
south Manila as the region with the greatest need for increased access to
potable piped water in the Philippines.



The goal of the project was to bring sufficient amount of quality improved
potable water to 85% of the region’s households, while improving health
problems caused by inadequate clean water supply and sanitation services in
the region.



The Asian Development Bank and other financial institutions financed about
63 per cent of the initial investment cost while the MWSS covered the rest of
the investment cost.



The investment was to be completed by 2004. The project is expected to
operate for 30 years.

18


Manila South Water Distribution Project
Projected Project outcomes:


Estimated total cost: 1,369.5 million 1990 Philippine Pesos.



Financial analysis results: marginally negative NPV of
-77.76 million pesos using a real discount rate of 9 %.
Economic analysis results: positive economic NPV of

2117.87 million pesos using a real discount rate of 10.3%.





The break even price for new expansions is about Ps. 5.2/m 3.

 Project potentially economically attractive but financially weak.
Risk for failure unless possibility of poor financial outcome
mitigated.
Actual Outcome:
Project has failed to deliver the service it promised due to
inadequate financial operating revenues.

19


ECONOMIC VALUE

=

ECONOMIC
VALUE

FINANCIAL
VALUE

=

+

TAX IMPACT

+

NET BENEFITS TO
CONSUMERS

+
NET LABOUR
BENEFITS

FINANCIAL
VALUE

TAX
IMPACT

NET LABOUR
BENEFITS
NET
BENEFITS TO
CONSUMERS

20


Distributive Analysis of Net Benefits
Reconciliation between Economic/Financial and Distributive Analysis:

DISCOUNT RATES
Financial
Economic

9%
10.3%

Econ. NPV @ 10.3%=

%

2,117.87

=

-442.60

=

2,117.87

+

NPV Ext. @10.30%

+

2,560.47

Distribution of Total Net Benefits:
Potentially large benefits to poor.

NPV Exter. @ 10.3%

Government

Non-Paying
Users

Paying
Users

Engineering
Services

Water
Vendors

17.22

740.28

1,921.32

24.38

-142.72
21

SUMMARY OF PROJECT DECISION CRITERIA:

1.

Financial NPV

2.

Financial IRR

3.

Annual DSCRs

4.

DSCRs

5.

Economic NPV

6.

Economic IRR

7.

PV of Impact on Stakeholders

8.

Probability of unacceptable outcome

Project Owner’s View
Banker’s View
Country’s View
Distribution Analysis

for each of indicators above (risk simulation)

Risk Analysis
22


Structure of Analysis
Figure 1:
Project Parameters, and Real Investment Table
(Tables 1a, 1b, 1c, and 1d)
Inflation and Exchange Rate Projections
(Table 2)

Financial Analysis

Production and Sales
(Table 3a, 3b)
3b, 3c and 4)
OperatingWorking
& Maintenance

CapitalExpenses
(Table 5)Capital
and Working
Unit Cost of Production
(Table 4, Table 5)
(End of Table 5)
(Cost of Good Sold)

Loan Schedule
(Table 6)

Tax and Economic
Depreciation
Schedule
No tax depreciation table for
Manila project
as no income tax
(Depreciation

Expense)

(Interest Expense)

Income Tax Statement
(Manila water project does not pay corporate income tax )
(Taxes)
Total Investment Cash Flow (Nominal)
(Table 7)
Total Investment Cash Flow (Real)
(Table 8)

Debt Service Capacity Ratios (Table 9)
Equity Holder’s Cash Flow (Nominal)
(Table 10)
Equity Holder’s Cash Flow (Real)
(Table 11)

(Loan)
(Loan)

23


Figure 2 : Economic Analysis
Step One:

National Economic Parameters:

a. Economic Opportunity Cost of Capital
b. Foreign Exchange Premium (provided by other study for Manila Water Project)

+
Step Two:

Economic Conversion Factors for:
a . Economic Value of water (Table 12)
b. Project Inputs, including
Investments
Operating Expenses
Labor
Working Capital

c. Summary of Conversion Factors (Table 13a-13b)

(Applied to Real Financial Cash Flow Statement)

Statement of Economic Costs and Benefits
(Table 14)

24


Figure 3: Distribution Analysis
A. Economic Real Net Resource Flow
(Table 14)

-

(Minus)
B. Financial Real Net Resource Flow
(Table 8)
(Yields)
C. Net Resource
Flow of
Externalities

D. Distribution
of Externalities
(Present Value)

(Table 15)

(Table 16)

E. Reconciliation
of Economic and
Financial
Analyses:
(Table 17)

25