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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 MALAYSIA started in 1971

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Project Appraisal and Public Sector Investment Decision Making

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

  2. Overview of Presentation • International Experience with Public Investment Preparation • MALAYSIA started in 1971 • CANADA started in 1974 • 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 Action Council National Planning Council (NPC) Draft Policy National Development Planning Committee (NDPC) Implementation and Coordination Unit Draft Economic Planning Unit (EPU) Draft General Framework Secretariat Inter Agency Planning Group (IAPG) Proposals Circulars Circulars State Government Federal Ministries and Agencies

  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)

  10. 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

  11. 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

  12. 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.

  13. CHILE MALAYSIA CANADA Cabinet of Ministers Cabinet of Ministers Cabinet of Ministers Strategic Direction NPC MOF MED Nat’l Bank Comm. For Policies & Programs Treasury Board Polices NPDC MOF Ministry of Planning Coordination EPU Budget Committee Project selection Guidelines Strict Guidelines & Fin. ceilings Fin. Ceilings Sectoral Ministries Sectoral Ministries Implem-entation Sectoral Ministries Sectoral Ministries State Governments State Governments Project selection Project selection

  14. 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.

  15. 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.

  16. 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.

  17. II- Case study: Application of Integrated Project Appraisal

  18. 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.

  19. 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.

  20. ECONOMIC VALUE ECONOMIC VALUE = FINANCIAL VALUE = + TAX IMPACT + NET BENEFITS TO CONSUMERS NET LABOUR BENEFITS FINANCIAL VALUE + TAX IMPACT NET BENEFITS TO CONSUMERS NET LABOUR BENEFITS

  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 for each of indicators above (risk simulation) Project Owner’s View Banker’s View Country’s View Distribution Analysis Risk Analysis

  22. Project Parameters, and Real Investment Table Project Parameters, and Real Investment Table (Tables 1a, 1b, 1c, and 1d) (Tables 1a, 1b, 1c, and 1d) Inflation and Exchange Rate Projections Inflation and Exchange Rate Projections Financial Analysis Financial Analysis (Table 2) (Table 2) Production and Sales Production and Sales (Table 3a, 3b, 3c and 4) (Table 3a, 3b) Loan Schedule Loan Schedule (Table 6) (Table 6) Tax and Economic Tax and Economic Depreciation Depreciation Operating & Maintenance Expenses and Working Capital Working Capital Schedule Schedule (Table 5) No tax depreciation table for No tax depreciation table for Unit Cost of Production (Table 4, Table 5) Manila project Manila project (End of Table 5) as no income tax as no income tax (Interest Expense) (Interest Expense) (Cost of Good Sold) (Cost of Good Sold) (Depreciation Expense) Income Tax Statement Income Tax Statement (Manila water project does not pay corporate income tax ) (Manila water project does not pay corporate income tax ) (Taxes) (Taxes) Total Investment Cash Flow (Nominal) Total Investment Cash Flow (Nominal) (Table 7) (Table 7) Total Investment Cash Flow (Real) Total Investment Cash Flow (Real) (Table 8) (Table 8) (Loan) (Loan) Debt Service Capacity Ratios (Table 9) Debt Service Capacity Ratios (Table 9) (Loan) (Loan) Equity Holder’s Cash Flow (Nominal) Equity Holder’s Cash Flow (Nominal) (Table 10) (Table 10) Equity Holder’s Cash Flow (Real) Equity Holder’s Cash Flow (Real) (Table 11) (Table 11) Structure of Analysis Figure 1:

  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 (Table 15) D. Distribution of Externalities (Present Value) (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 1 and 2)

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