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 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 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 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 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 Building The Analytical Skills : Malaysia • • • • After 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 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 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 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) Canadian Cost-Benefit Analysis Guide: Regulations  STEP Identifying Issues, Risks and Baseline Situation   1.1 Incremental Impacts 1.2 Establishing the Baseline Scenario (without project)  STEP Setting Objectives  STEP Developing Alternative Options 10 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 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 high quality appraisals of project ideas  In Malaysia there is the fear of undertaking a bad project that is difficult to implement The Departments 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 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 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 % 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  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%= Fin.NPV@10.30% 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: Financial NPV Financial IRR Annual DSCRs DSCRs Economic NPV Economic IRR PV of Impact on Stakeholders 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 : 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 Figure 4: Risk Analysis A Sensitivity Analysis (Tables 18, 19) B Risk Variables (Table 20) C Results (Table 21, Figure and 2) 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Public Administration INTAN From 1971 to 1990s curriculum included an week course in Project Planning and Appraisal and a similar course in Project Management Emphasis on ex-ante investment appraisal. .. 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. .. 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