Project Appraisal and Public Sector Investment Decision Making

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Project Appraisal and Public Sector Investment
Decision Making
Glenn P. Jenkins Queens University,
Canada Eastern Mediterranean University,
Cyprus Feb 29, 2008
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Overview of Presentation

• International Experience with Public Investment
  Preparation
• MALAYSIA started in 1971
• CANADA started in 1974
• Case study Application of Integrated Project
  Appraisal

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• I- International Experience with Public
  Investment Preparation

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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

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Investment Planning Malaysia

• Brain of system is Economic Planning Unit in the
  Prime Ministers 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 Ministers Department
• Emphasis on results close monitoring of
  implementation plus emphasis on effectiveness of
  investment to meet their high economic growth
  targets.

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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
Inter Agency Planning Group (IAPG)
Secretariat
Proposals
Circulars
Circulars
State Government
Federal Ministries and Agencies
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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.

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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

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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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CHILE
MALAYSIA
CANADA
Cabinet of Ministers
Cabinet of Ministers
Cabinet of Ministers
Strategic Direction
NPC
MOF MED Natl 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
State Governments
Sectoral Ministries
State Governments
Project selection
Project selection
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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 Generals 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 generals 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 governments 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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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 regions 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.

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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
ECONOMIC VALUE

FINANCIAL VALUE


TAX IMPACT

NET BENEFITS TO CONSUMERS
NET LABOUR BENEFITS
FINANCIAL VALUE

TAX IMPACT
NET BENEFITS TO CONSUMERS
NET LABOUR BENEFITS
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• 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 Owners View
Bankers View
Countrys View
Distribution Analysis
Risk Analysis
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Structure of Analysis Figure 1
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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)
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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)
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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)