ECONOMIC EVALUATION OF IRRIGATION PROJECTS. Pre-Independence- Development of financial policy. Considered as commercial ventures like any other infrastructure projects The feasibility of irrigation projects essentially evolved from the concept of financial soundness of public investment
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Pre-Independence- Development of financial policy • Considered as commercial ventures like any other infrastructure projects • The feasibility of irrigation projects essentially evolved from the concept of financial soundness of public investment • Close of last century with the acceptance of the proposal for construction of irrigation works through loan funds
Pre-Independence- Development of financial policy The Select Committee on Indian Public Works reporting to the House of Commons in 1879 Observed “ The financial results of works of irrigation are in the opinion of your committee, the best test of their utility. A rail road may traverse between certain districts which it does not materially improve, yet the work may on the whole, be beneficial, to the country. However, an irrigation work benefits the immediate locality in which it is placed, it can be of no use to outside districts.”
Pre-Independence- Development of financial policy • The committee further observed that: “ the construction of new works from borrowed money for the future be limited to those schemes alone which upon the responsibility of the Government are estimated to be productive by yielding an annual income equal to the interest in the capital expended on their construction including in such capital interest during construction.” • This recommendation formed the basis for selection of irrigation projects.
Pre-Independence- Development of financial policy First Indian Irrigation Commission (1901-1903) “ An irrigation work is classed as productive and sanctioned against loan funds when it has shown to the satisfaction of the Secretary of state that it is likely to fulfill the conditions of productive public work, that is to yield a net revenue 10 years after completion, sufficient to cover interest charges on the sum at charge at that date. By sum at charge is meant the total direct and indirect capital cost plus the excess, if any, of interest charges to date over the net revenue.”
Productivity rate • The productivity of a scheme was judged with reference to the rate of return earned by it on full development • The criterion for the sanction of irrigation projects was based on financial results
Financial results 1. The capital cost of any work was taken as the sum actually spent on its construction 2. The revenue on account of direct receipt and indirect receipt was estimated 3. The revenue account was debited yearly with • the simple interest on the capital cost of the works at the commencement of the year • The working expenses of the year 4. The revenue account was credited yearly with the direct receipts and the indirect receipts • The difference between 4 and 3 above for any year gives the profit or loss for that year
Productivity rate • The acceptable value of ‘productivity rate’ was linked to prevailing Rate of interest • The productivity rate varied between 4 to 6 percent during 1919 to 1937 • After April, 1937, Government of India prescribed Rate of Return as 6 percent • However, recognising the importance of irrigation to meet the food and fiber requirement of the public at large, most of the Provinces reduced the productivity rate to 4 percent
Productivity rate • The financial viability test was rigidly applied to all irrigation projects • Earlier large irrigation schemes were mostly diversion works and were relatively inexpensive. • During Development of New projects it was felt that the development of irrigation was being held up by the rigid application of the financial criterion • Apart from direct irrigation revenues, other benefits accrued to the Government in the shape of increased revenue from excise duties, income tax, sales tax, transport etc.
Resolution of The Central Board of Irrigation (1936) “ as the expansion of irrigation is seriously handicapped by the restricted view taken of the value of irrigation, an economic survey should be carried out with a view to estimate the direct and indirect financial benefits accruing to the Central and Local Governments from Irrigation Projects”.
Protective Work • A view was taken that if a project did not fulfill the financial criterion, but was still considered necessary in the public interest, it could be sanctioned as a protective work. • Number of irrigation projects which failed to satisfy the financial criterion were accordingly taken up as protective works.
Plan era • A change in the approach to the irrigation projects • These projects were viewed as investment in the development and social benefit where profit was not the sole motive • Rate of return on the capital outlay for classifying a capital work as productive was reduced to 3.75 percent which continued upto the year 1954 • The rate was raised to 4.5 per cent and this rate continued up to March, 1960.
Benefit Cost Ratio • It was felt that irrigation project in an area should not only be viewed as source of income to the Govt. but as a means for increased agricultural produce and economic development of that area and in the process, of the country as a whole. • The Planning Commission in 1958 initiated studies of some of the major projects to assess the overall benefits of the irrigation projects and to find a more appropriate criterion for deciding whether various irrigation projects should be undertaken.
Committee headed by Prof. D.R.Gadgil • Large benefits accrued from irrigation in terms of double cropping, diversification and better quality crops, higher yields, larger income and greater opportunities of employment. • Indirect benefits that accrued were the establishment of processing industries, expansion of consumer industries, retail trade, transport and communications. • Total benefits from irrigation were far larger that the direct financial returns accruing to Government from water rates and betterment levy.
Gadgil Committee • The Committee recommended that in future the concept of benefit cost ratio should be used for assessing the feasibility of new projects instead of the traditional criterion of the direct financial return to the Government. • For simplicity it was considered that the indirect or secondary benefits and cost need not be taken into account.
Gadgil Committee Recommendations • The net annual benefit was to be worked out as the difference between the monetary value of the net agricultural production (total value of produce- cost of cultivation ) ‘before’ and ‘after’ the introduction of irrigation. • The annual cost should be taken to comprise the annual interest on capital, depreciation and expenditure on maintenance and operation.
Recommendations- Contd.. • Gadgil Committee report submitted in 1964 recommend the adoption of economic benefit criterion instead of the financial criterion. • The Government accepted this recommendations and benefit cost ratio criterion has been adopted. • Benefit-Cost Ratio criterion for judging the economic soundness of irrigation projects is in practice till date.
B.C. Ratio • B.C. ratio is obtained by dividing the annual benefits by the annual cost. • Net annual benefit is estimated as the difference in the net value of agricultural produce “before” and “after” irrigation • The annual cost in the denominator comprise • interest on capital cost of the project at the rate of ten percent per annum • depreciation charges at the rate of 1 percent in case of projects having 100 years life say storage scheme and 2% in case life of the project is considered as 50 years • operation and maintenance expenses.
B.C. Ratio • Criteria • Irrigation projects with B.C. ratio greater than 1.5 are considered acceptable from economic point of view. • BC ratio of 1.5 instead of 1.0 was suggested as a prudent precaution against likely increase in cost of the project. • Subsequently, acceptable value of B.C. ratio was reduced to 1.0 for irrigation projects in drought prone areas.
Internal Rate of Return • Reflect the further cost involved in long gestation that takes place during the construction • Obligatory For World Bank aided project • Internal Rate of Return is calculated on the basis of market prices without any adjustment for economic prices because of non availability of national parameters for economic prices
Views of Irrigation Commission (1972) • The economic benefit criterion is more suitable than the financial return criterion. • The rate of return methods is more suited as a basis for making a choice between two investments where financial return is the dominant consideration and no constraints are imposed by national goals • Recommended the continued use of the benefit cost ratio for irrigation projects not only because it is simpler but also because it is used in most countries.
Views of Irrigation Commission (1972) • The application of the benefit-cost-ratio criterion minimises the importance of securing adequate return from investments on irrigation projects • Recommended that at the time of considering project for acceptance that the financial return of the project should also be carefully examined. If the return does not cover working expenses and interest charges on capital, the impact of the project on the irrigation revenues of the State should be examined to see if an upward revision of the water rates in the States, would be necessary.
Review of Criteria • The Fifth Conference of Irrigation State Ministers (1980) • Recommended that whole criteria of B.C. ratio should be reviewed on the basis of actual performance of irrigation system and norms for evaluation of benefits. • Accordingly a Committee under the Chairmanship of Shri Nitin Desai was constituted by Government of India in December, 1981
Nitin Desai- Report • The Committee noted the following methodological deficiencies in the approach • The method of calculation of benefits and the criterion for selection relies on the increment in the net value of agricultural production. This does not reflect the range of objectives which irrigation investments have to subserve. • Irrigation projects take time to implement and, what is important, the time required varies from project to project. The comparison of annualised benefits and annualised costs does not reflect the value of time adequately
Desai Committee Findings • Generally all costs and benefits are evaluated at market prices. Because of the presence of many distorting influences, these market prices may not reflect the true value of these costs and benefits to the economy • Many of the cost parameters are evaluated on the basis of ad hoc norms. For instance, fodder expenses and dung receipts.
Desai Committee- recommendations • Recommendations of Nitin Desai Committee • The committee reviewed the existing norms of evaluating project benefits, cropping patterns, yields, valuation of outputs, cost of cultivation, international prices, concept of opportunity cost adjustment for social cost etc • The present procedure does not take into account the time taken to reach the full benefit • Discounted cash flow (DCF) method must be followed in the benefit-cost analysis of irrigation projects
Review of Existing Criteria • There is no analysis of risk and uncertainty and the extent to which the project will help to reduce the variability of agricultural production, a deficiency which is particularly serious since stabilisation of production is one of the major objectives of irrigation development • There is no systematic attempt at sensitivity analysis to take into account likely variations in yields, costs etc. • The benefit cost analysis is generally “added” on to a project after technical parameter are firmed up. A techno-economic analysis of all available options is seldom attempted
Review of Existing Criteria • Working Group(1999) for updating Existing Guidelines on “Guidelines for preparation of Detailed Project Reports of Irrigation and Multipurpose Project”(1980) • W.G. recommended for continuation of existing practice with the following modifications • Cost of on-farm Development works be worked out separately and two sets of the benefit cost ratio of the project be worked out with and without considering the cost of these works.
WG (1999) recommendations • Benefits due to fisheries, horticulture, catchment area treatment, aforestation, animal husbandry etc. in addition to agricultural production may also be assessed and accounted in benefits • the quantity of water reserved for domestic and industrial water supply may be assigned certain cost in consultation with concerned authority
Recommendations – Contd.. • For modernisation project, the two sets of benefit cost ratio be computed one considering net benefit and net costs and other considering total benefits and total cost. The higher of the two be considered for deciding economic viability of the project. • B.C. ratio limits of 1.5/1.0 (for drought prone areas) and above need to be reviewed in view of landing of the project with so many additional costs and a lower B.C. ratio of 1.0 may be acceptable for determining economic viability of the project.
Where do we Stand Today? • The recommendations of the Nitin Desai Committee not implemented • The Format for estimating Benefit Cost Ration remains the same • The ratio is the sole criteria for acceptance of the project may not give a true pictue of the economics of the project
Issues Unanswered • Sensitivity analysis are rarely performed • Benefits and costs are estimated at the end of the preparation of the project • Such exercise needs to be carried out at planning stage to evaluate various Project alternatives as decision making aid
Concerns • Irrigation systems are largely designed based on inadequate or unreliable data on water resources, irrigation efficiencies, distribution of cropping pattern in the command etc. • The lack of detailed survey & Investigation data
Issues of concerns • In many cases the project is in advanced stage of construction even before it is appraised it is already a fait accomplice • Most econometric models of investments are based on implicit assumption that investment expenditure are reversible. However, most large irrigation projects are irreversible, once started. They can of course be restructured, but not completely shifted
Concerns… • The Planning Commission’s capital cost estimation procedure suffers from many serious limitations. It neglects gestation lag that exists between the time investment is undertaken and the time irrigation potential is created and it fails to recognise that society values investments differently as time passes, among others.
Concerns… • Analysis of 346 M & M irrigation projects show that a fixed period of 12 years between the time investment is made and potential created is representative of most irrigation works.
Other Considerations • The present format deals with static aspects. • The dynamic aspects such as shift in demand and supply post project also needs to be looked into • The costs of inputs such as fertilizers etc have a component of subsidy where as benefits are at market price there is need to look into this aspect as well
Other aspects • Rent of the land ( % of Gross Produce) do not reflect the opportunity cost of the land • Labour cost is only towards hired labours and do not account for the family labours
Benefits /Costs not Accounted • Flood Control • Recreation • Inland fishing • Improvement in life of the people • The flow of funds over long period remains locked and the benefits are delivered ( Partial or full) much later
Recent Developments • Planning Commission constituted a committee to revisit the methodology of computation of BC ratio • Ministry of Water Resources constituted a committee to study the issues related to estimation of BC Ratio (Chawla Committee)
Findings – Planning Commission • Concept of with and without project introduced – Opportunity cost of the project • Intangible benefits recognised but in the absence of procedure to assign monetary value – not proposed to be included in the benefits • Irrigation projects compared with other infrastructure projects such as metro, roads, communication etc.
Planning Commission- report • Need for accounting the factor for deferred irrigation • The valuation of cost & Benefits should reflect preferences for the choices made • Benefits are measured by the market choice • Some measurements of benefits requires valuation of Human Life
Findings of Planning Commission • Projects having BC ratio more than 1 be compared for the NPV • The discount rate be varied for sensitivity analysis of NPV • The present estimation of BC ratio is not on realistic data and do not clearly reflect the contribution of the project to the economic growth
Planning Commission • The data on costs are not based on detailed survey and investigations • There is a need for post facto evaluation of project as a feed back to the appraisal • Discounted cash flow method be used for estimation of BC ratio • Positive and negative social impacts balance each other
Chawla Committee- Findings • Need to do away with BC ratio criteria for water supply projects • Cost towards rent, depreciation on implements, land revenue on %age basis needs modification or to do away with • Benefits towards the flood protection needs to be evaluated and added to the benefits