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

I. International Experience with Public Investment Preparation

MALAYSIA started in 1971 CANADA started in 1974

II. Case study: Application of Integrated Project Appraisal

3

I- International Experience with Public Investment Preparation

4

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

5

Investment Planning: Malaysia

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

Department

• Close coordination of policy by Economic Planning Unit with Line Ministries

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

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

• Emphasis on results – close monitoring of implementation plus emphasis on effectiveness of investment to meet their high economic growth targets.

6

Malaysia Development Planning Machinery

Cabinet of Ministers

National Planning Council (NPC)

National Development Planning Committee (NDPC)

Economic Planning Unit (EPU)

Inter Agency Planning Group (IAPG)

National Action Council

Implementation and

Coordination Unit

Federal Ministries

and Agencies

State Government

Draft

Draft Policy

Draft General Framework

Circulars Circulars

Proposals

Secretariat

7

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.

8

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 monitoring done by Treasury Board Secretariat with strong Office of Auditor General

9

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)

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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

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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

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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.

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Str

ateg

ic

Dir

ecti

on

Po

lice

sC

oo

rdin

atio

nIm

ple

m-

enta

tio

nMALAYSIA

Cabinet of Ministers

MOF MED Nat’l Bank

NPC

NPDC

EPU

SectoralMinistries

State Governments

CHILE

Cabinet of Ministers

Ministry of Planning

Project selection

CANADA

Comm. For Policies

& Programs

Project selection

MOF

Treasury Board

Strict Guidelines& Fin. ceilings

Fin. Ceilings

Budget Committee

Guidelines

Cabinet of Ministers

SectoralMinistries

SectoralMinistries

Project selection

SectoralMinistries

State Governments

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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.

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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.

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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.

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II- Case study: Application of Integrated Project Appraisal

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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.

A Case Example: Manila South Water Distribution Project

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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/m3.

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.

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ECONOMIC VALUE

FINANCIAL VALUE

TAX IMPACT

NET BENEFITS TO CONSUMERS

NET LABOUR BENEFITS

=

+

+

ECONOMIC VALUE

FINANCIAL

VALUE

TAX IMPACT

NET BENEFITS TO CONSUMERS

NET LABOUR BENEFITS

=+

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Distributive Analysis of Net Benefits

Reconciliation between Economic/Financial and Distributive Analysis:

DISCOUNT RATES

Financial 9%

Economic 10.3%

Econ. NPV @ 10.3%= Fin.NPV@10.30% + NPV Ext. @10.30%

2,117.87 = -442.60 + 2,560.47

= 2,117.87

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

GovernmentNon-Paying

UsersPaying Users

Engineering Services

Water Vendors

NPV Exter. @ 10.3% 17.22 740.28 1,921.32 24.38 -142.72

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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

for each of indicators above (risk simulation)

Project Owner’s View

Banker’s View

Country’s View

Distribution Analysis

Risk Analysis

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Project Parameters, and Real Investment Table(Tables 1a, 1b, 1c, and 1d)

Loan Schedule(Table 6)Tax and Economic

Depreciation Schedule

No tax depreciation table for Manila project

as no income tax

Total Investment Cash Flow (Real)(Table 8)

Equity Holder’s Cash Flow (Nominal)(Table 10)

Equity Holder’s Cash Flow (Real)(Table 11)

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

Working Capital(Table 5)

Unit Cost of Production(End of Table 5)

(Interest Expense)(Depreciation Expense)(Cost of Good Sold)

(Taxes)

(Loan)

Financial Analysis

Total Investment Cash Flow (Nominal)(Table 7)

Income Tax Statement(Manila water project does not pay corporate income tax )

Inflation and Exchange Rate Projections(Table 2)

(Loan)Debt Service Capacity Ratios (Table 9)

Project Parameters, and Real Investment Table(Tables 1a, 1b, 1c, and 1d)

Loan Schedule(Table 6)Tax and Economic

Depreciation Schedule

No tax depreciation table for Manila project

as no income tax

Total Investment Cash Flow (Real)(Table 8)

Equity Holder’s Cash Flow (Nominal)(Table 10)

Equity Holder’s Cash Flow (Real)(Table 11)

Production and Sales(Table 3a, 3b)

Operating & Maintenance Expenses and Working Capital

(Table 4, Table 5)

(Interest Expense)(Cost of Good Sold)

(Taxes)

(Loan)

Financial Analysis

Total Investment Cash Flow (Nominal)(Table 7)

Income Tax Statement(Manila water project does not pay corporate income tax )

Inflation and Exchange Rate Projections(Table 2)

(Loan)Debt Service Capacity Ratios (Table 9)

Structure of AnalysisFigure 1:

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Figure 2 : Economic Analysis

Step One: National Economic Parameters:a. Economic Opportunity Cost of Capitalb. 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, includingInvestmentsOperating ExpensesLaborWorking Capitalc. Summary of Conversion Factors (Table 13a-13b)

Statement of Economic Costs and Benefits(Table 14)

(Applied to Real Financial Cash Flow Statement)

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Figure 3: Distribution Analysis

A. Economic Real Net Resource Flow(Table 14)

B. Financial Real Net Resource Flow(Table 8)

C. Net Resource Flow of

Externalities (Table 15)

D. Distribution of Externalities (Present Value)

(Table 16)

E. Reconciliation of Economic and

Financial Analyses:

(Table 17)

- (Minus)

(Yields)

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Figure 4: Risk Analysis

A. Sensitivity Analysis(Tables 18, 19)

B. Risk Variables(Table 20)

C. Results(Table 21, Figure 1 and 2)