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8/13/2019 S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo
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Capital Budgeting
Kuben Naidoo
South Africa
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8/13/2019 S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo
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What well cover
Why is capital different?
Should we budget for capital differently?
Modalities of budgeting for capital
Getting value for money from capitalspending
Policy issues to consider
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What is investment? Spending that improves public services in the
long-term: expects a long term return, creates
public assets In laymans terms, spending on durable goods
that will contribute to the provision of publicservices over a number of years
E.g. Building Hospitals, buying IT systems
Not e.g. training teachers, redundancy costs
Why not?
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Where capital fits in?
Capital
baseline
Public
asset
base
PUBLIC
SERVICES
Current
spending
(wages)depreciation
New investment
capital
budget
Conventionally, we think that recurrent spending plus capital
spending delivers a service
This is wrong
Public asset base plus recurrent spending delivers service
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8/13/2019 S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo
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Theoretical issues to consider Think of a continuum of spending to impact
If I hire a teacher, I get an output immediately
If I budget to build a school I get a school in say two years time
If I budget to build a power plant, I get power in seven years time
If I under-maintain an asset, I see a deterioration in public services
in ten to fifteen years time
This introduces an inherent bias against
capital spending Benefits not visible immediately
or costs of not investing only visible in the long term
Tougher to cut recurrent spending
Easier to cut maintenance spending than fire teachers
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Should you budget separately for
capital? Case for
It counters the bias against capital spending It allows government to direct the increase in the
capital base towards priorities
It allows for more robust cost-benefit analysis
Case against Returns to capital not always the same
Links between capital and the related recurrent costsare harder to secure
What about different policy options: More police or close circuit TV cameras
More police or more vehicles
Surely these decisions cannot be taken centrally
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Modalities of capital budgeting Centralised
Treasury appraises all capital projects and decides
which ones to spend on Advantage: high benefit projects are favoured
Disadvantage: not easy to measure benefits and wellorganised departments capture too much resources
Decentralised Allocate money to for capital to police
They decide which police station to build
Advantage: closer alignment between allocations andpriorities and between need and spend
Disadvantage: departments may do high profile lowbenefit projects
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Measures of performance People generally look at spending numbers
Must shift focus to look at outputs Houses built, new electricity connections, kms of roadsbuilt or resurfaced
Also look at outcomes
Capacity constraints, congestion
Most importantly, but not easy to do objectively
Focus on the state of the stock Tension between need to maintain infrastructure
(which is often in richer areas) and build new
capacity in poorer areas
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Its the state of the stock that mattersState of bus stock
7
8
9
10
11
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
Years
70
72
74
76
78
80
82
Vehicles
'000
Average age of bus fleet
Size of vehicle stock
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Its the state of the stock that matters(road defects index)
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Capital budgeting in South Africa We generally have a decentralised system
Police, education, health, roads agency receive abudget
They decide which project to implement
Treasury tries to raise the bar on cost benefit analysis
For large projects over R1.2 billion, treasury
does evaluation and allocates money directly
95% of capital spending is done through
conventional budgeting
5% through PPPs
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How does PPP or PFI work? Government specifies exactly what we want
Private sector raises capital, builds and thenmaintains
Government pays a unitary charge consisting ofcapital portion and maintenance portion
Key thing is to pass some risk onto the privatesector
Do they work?
If the specs are good and the department has thecapacity to manage the contract, then we get value formoney
If not, its often more costly
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Optimism bias Departments under-budget for costs because they think
that if they are honest with the costs, money will not be
allocated Project overruns are a nightmare for spending control, yet
they are endemic in the public sector
Outturn Cost % of Expected Cost100%
No of
Projects
Expected Cost
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Examples of optimism bias
Green point
stadium budget:
R1.7 bil lion
Revised
estimate:
R3 billion
Freedom park
budget:
R400 million
Revised estimate:
R1 billion
Automated
fingerprint IDsystem
Budget:
R700 mill ion
Outturn:
R2 billion
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Under-spending on capital
0
5
10
15
20
25
30
98-99
99-00
00-01
'01-02
'02-03
'03-04
'04-05
'05-06
'06-07
'07-08
Outturn (at Budget)
Plans
Why? Failure to cascade 3 year budgeting
Longer lead times for complex procurements
No capacity and expertise to deliver
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What might be happening?
Why the underspending?
Some ideas:
Failure to cascade 3 year budgeting
Longer lead times for complexprocurements
No capacity and expertise to deliver
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Infrastructure bunching Typical scenario
Commodity prices rise, exchange rate appreciates,
interest rates fall Domestic demand increases
Higher domestic investment in non-tradables E.g. telecomms, retail space, housing, banking
Construction boom Prices rise due to capacity constraints
Imports rise, current account deficit widens
Interest rates rise Boom turns to bust
It is critical for the public sector to avoid bunching
Rather save and smooth infrastructure spending growth
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Gross fixed capital formation
10
12
14
16
18
20
22
24
26
28
30
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
per
centofGDP
Strong investment will increase domestic capacity and raise potentialgrowth in the economy, but pressures on inflation and current accountmust be managed
This is where we
want to be
This is where we are
and we already have a
current account problem
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Any questions?