Project appraisal and public sector investment decision making

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Project Appraisal and Public Sector Investment Decision

Making

Glenn P Jenkins Queen’s University, Canada Eastern Mediterranean University, Cyprus

Feb 29, 2008

I- International Experience with

Public Investment Preparation

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

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

Economic Planning Unit (EPU)

Inter Agency Planning Group (IAPG)

National Action Council

Implementatio

n and Coordination

Unit

Federal Ministries

and Agencies

State Government

Draft Draft Policy

Draft General

Framework

Circulars Circulars

Proposals Secretariat

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

 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

Joint Committee of Treasury Board Secretariat and Department of Finance

 Monitoring of implementation done by sectoral ministries and financial 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)

 STEP 2 Setting Objectives

 STEP 3 Developing Alternative Options

Canadian Cost-Benefit Analysis

 4.7.1 Rational Approaches to Discount Rate

 4.7.2 Discount Rate for Canada

 4.7.3 Annualized Costs and Benefits

 5.1 Cost -Benefit Analysis

Building The Analytical Skills : Canada

Economics and Public Administration offer one or more courses

in investment appraisal

tools for those who wish to undertake a project appraisal.

public sector investments

by Treasury Board Furthermore, competition tends to cause the private sector to improve on the quality of analysis over time.

MOF MED Nat’l Bank

& Programs

Project selection

MOF

Treasury Board

Strict Guidelines

& Fin ceilings Fin Ceilings

Budget Committee

Guidelines

Cabinet

of Ministers

Sectoral Ministries

Sectoral Ministries

Project

Sectoral State

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.

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

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.

II- Case study: Application of

Integrated Project Appraisal

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

Manila South Water Distribution Project

Projected Project outcomes:

 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%.

 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

ECONOMIC VALUE

FINANCIAL

VALUE TAX IMPACT

ECONOMIC VALUE

FINANCIAL VALUE

TAX IMPACT

NET BENEFITS TO CONSUMERS

NET LABOUR BENEFITS

= +

Distributive Analysis of Net Benefits

Reconciliation between Economic/Financial and Distributive Analysis:

Distribution of Total Net Benefits:

Potentially large benefits to poor.

Government

Non-Paying Users

Paying Users

Engineering Services

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

for each of indicators above (risk simulation)

Project Owner’s View Banker’s View

Country’s View Distribution Analysis

Risk Analysis

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

Production and Sales

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

(Cost of Good Sold)

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

Operating & Maintenance Expenses

and Working Capital

(Table 4, Table 5)

(Interest Expense) (Cost of Good Sold)

Structure of Analysis

Figure 1:

Figure 2 : Economic Analysis

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)

Statement of Economic Costs and Benefits

(Table 14)

(Applied to Real Financial Cash Flow Statement)

Figure 3: Distribution Analysis

A Economic Real Net Resource Flow

(Table 16)

E Reconciliation

of Economic and

Financial Analyses:

- (Minus)

(Yields)