ECONOMIC ANALYSIS. Table 1: Vehicle Fleet Characteristics Four- Medium Car. Light Bus. Wheel Drive

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1 Western Regional Road Corridor Investment Program (RRP MON 41193) A. Project Costs and Benefits ECONOMIC ANALYSIS 1. Project Costs. The project s capital costs include the costs of the road works, design, supervision, and management. The residual value after 20 years was based on a straight-line depreciation of assets. The new asphalt surfacing will raise road routine maintenance needs and require periodic maintenance in the form of an overlay after 8 10 years. The associated costs were included as an annuity. Financial costs were converted into economic costs by (i) excluding taxes, price contingencies, and financial charges; (ii) using a 0.7 shadow price for low-skilled labor costs; (iii) applying a shadow exchange rate factor of 1.019, calculated according to Mongolia s trade balance; and (iv) converting nominal costs to constant 2010 dollars. 1 The net present value (at a rate of 10%) is $154 million for capital costs and $37 million for maintenance costs, over the project life (assumed to be 20 years after the opening of each section). 2. Vehicle Operating Cost Savings. The vehicle operating costs (VOC) include fuel, lubricants, tires, spare parts, maintenance labor, crew wages, depreciation, and interest. The input values (Table 1) of their economic costs are based on a survey undertaken in 2010 to establish the road asset management system for the Department of Roads (DOR). 2 Economic Unit Costs Table 1: Vehicle Fleet Characteristics Four- Car Wheel Light Bus Bus Heavy Articulated New vehicle cost ($/vehicle) 13, , , , , , , Fuel cost ($/liter) Lubricant cost ($/liter) New tire cost ($/tire) Maintenance labor cost ($/hour) Crew cost ($/hour) Interest rate (%) Utilization and Loading Kilometers driven per year (km) 18,000 30,000 25,000 30,000 30,000 40,000 40,000 Hours driven per year (hours) 500 1,100 2,000 2,000 18,00 2,000 2,000 Service life (years) Passenger occupancy rate (No) Gross vehicle weight (tons) km = kilometer, No = number. 3. The costs of travel were estimated for with- and without-project scenarios using the Highway Design and Management (HDM-IV) equations for six classes of vehicles used in western Mongolia. They relate to the riding quality of the road measured according to the International Roughness Indicator (IRI). The roughness of the existing dirt tracks was assessed through the subjective assessment method. 3 This corresponds to an IRI range of A 2% annual inflation in dollars and 5% annual real exchange rate appreciation of the Mongolian togrog (MNT) was assumed between 2010 and Half of maintenance costs were assumed to be local expenditures. 2 Under ADB Mongolia: Road Database Development Using Geographic Information System. Manila. 3 World Bank Guidelines for Conducting and Calibrating Road Roughness Measurements. Technical Paper No 46. Washington, D.C.

2 2 depending on the sections. This was assumed to drop to an average IRI of 3.5 on the new asphalt concrete surface. The vehicle operating cost (VOC) saving for a four-wheel drive vehicle travelling the entire corridor is estimated to be $193 per trip. The saving for a heavy truck is $334 (Table 2). Overall, VOC savings are estimated at $87 million. Table 2: Vehicle Operating Cost and Time Savings Without-Project Scenario With-Project Scenario Distance (km) IRI Four-Wheel IRI Four-Wheel Vehicle Operating Costs ($) Ulaanbaishint Olgiy Olgiy Khovd Khovd Mankhan Mankhan Altai Altai Bulgan Total a Time (hours, minutes) Ulaanbaishint Olgiy h 06 2h h 15 1h 24 Olgiy Khovd h 16 4h h 32 2h 50 Khovd Mankhan h 13 2h h 05 Mankhan Bulgan h 10 5h h 26 2h 43 Altai Bulgan h 06 1h Total a h 51 16h 14 7h 52 8h 49 h = hours, IRI = International Roughness Indicator, km = kilometer a This does not include sections paved in the 2010s by the Department of Roads between Bulgan and Yarant and north of Olgiy. 4. Time Savings. The faster speeds allowed on the road will generate time savings for passengers and shippers (Table 2). Time savings for passengers were valued at an average rate of $0.9 per hour for jeep travelers and $0.4 per hour for bus passengers. These rates are based on the same DOR survey (footnote 2); they are assumed to grow at the same rate as local real gross domestic product (GDP) per capita. Time savings for cargo were valued at an average of $0.3 per truck hour, based on the saved inventory value. This was computed with an interest rate of 15% 4 and an average commodity value of $1,000 per ton. Time savings are estimated at $72 million. 5. Accident Reduction Benefits. The current poor road condition is a hazard for travel. It causes a significant number of small accidents and technical failures on vehicles. It is unsafe to travel alone on the road in winter, when temperatures often reach -40 C, as a mechanical failure can lead to quick passenger death. The paving of the road will reduce such risks. The increased speeds and higher traffic volumes may, however, increase the number of serious accidents. Overall, it was assumed that the project would lead to a minor net reduction in road accidents. Road safety benefits were valued at an average $20,000 per accident, a rate growing on par with GDP per capita. Road safety benefits are estimated at $4.5 million. 6. Generated and Induced Traffic. Generated and induced traffic benefits were valued as half the VOC and time savings accrued to traffic in the without-project scenario, according to the standard rule-of-half used in transport economics. A special case was made for roadblocks. The project will prevent road failure due to flood or snow. In the current situation, when roadblocks 4 The assumed value is in line with the actual interest rates obtained by private companies from local banks (around 30%) when taking into consideration inflation forecasts (around 15%).

3 occur, travelers sometimes choose alternative, longer routes on some sections. On those sections, diversion benefits, in terms of shorter journey times during roadblocks, were fully accounted for. On other sections, traffic may be totally stopped for several days or weeks. In such cases, it was assumed that the value of removing such roadblocks was equal to half the underlying traffic demand multiplied by the difference between the normal travel costs and a hypothetical travel option that costs twice the norm. 5 Overall, generated and induced traffic benefits were estimated at $45.5 million. B. Cost Benefit Analysis 7. The economic internal rate of return (EIRR) of the project s costs and benefits over 20 years is 11.0%, with a net present value (NPV) of $18.4 million at a discount rate of 10%. A detailed evaluation by road section is in Table 3, while the details of the cost and benefit streams of the project are in Table 6. Table 3: Cost Benefit Analysis Summary, by Road Section Economic Economic Works ADT in ADT in NPV Costs Cost/km Length ($ million) ($ million) ($) EIRR Ulaanbaishint Tsaaganuur , (5.4) 5.3% Olgiy Ulaanbaishint , (1.4) 8.9% Khashaat Pass Olgiy , ,012 (7.0) 8.4% Hovd Khashaat Pass , , % Mankhan Hovd , , % Bulgan Manhkan , (18.0) 8.2% Yarant Bulgan , (2.3) 7.1% Total , % ADT = average daily traffic, EIRR = economic internal rate of return, NPV = net present value. 8. About 90% of the benefits of the project will accrue to Mongolia, and most of the rest to the People s Republic of China (PRC) and Russia (Table 4). Cross-border transport has been dominated by imports for western Mongolia. Reduction in their transport costs will mainly benefit western Mongolia, given the small size of this market. Mining exports to the PRC and Russia were assumed to benefit equally Mongolia and the other partner. For the purpose of the analysis, transit traffic was assumed not to bring significant net benefits to Mongolia. Table 4: Distribution of Benefits Project Benefits Share of Benefits (%) ($ million) Mongolia Russia PRC Local benefits Import/export benefits Mining exports benefits Transit benefits Total ($ million) Share of benefits (%) Source: ADB estimates. 3 5 This method was used in ADB Report and Recommendation of the President to the Board of Directors: Roads for Rural Development in Cambodia. Manila.

4 4 C. Unquantified Benefits 9. It is ADB s practice to consider projects with an EIRR above 10% if they generate significant unquantified economic benefits. 6 Unquantified project economic benefits include: (i) increased accessibility by rural herders to the education and medical facilities at soum (district) centers, as well as the higher-level education and medical facilities located in province centers; (ii) easier mitigation and relief of emergencies (such as dzuds) 7 in rural areas, and (iii) economic benefits arising from scale economies, stronger competition, and agglomeration benefits generated by the gradual integration of goods and job markets in western and central Mongolia, and also by the concentration of the local population in western Mongolia s urban centers. 10. The project is also expected to produce other benefits, particularly poverty relief and improved equity. The project will (i) improve the farm-gate value of the meat, wool, and dairy products sold by herders; (ii) create low-skilled job opportunities during construction and for road maintenance in an area of chronic under-employment; and (iii) offer women new opportunities to generate income. Better accessibility to markets and reduced time spent taking children to school or going to market will allow women herders to create small businesses at road stops, or process some of the products sold by their household to increase their value. More generally, the project will help to redistribute Mongolia s economic activity towards its poorest rural areas. Finally, Mongolian stakeholders anticipate that the project will foster national integration, as well as enhancing western Mongolian s sense of participation in Mongolia s democratic life, which would contribute to the country s long-term stability and development prospects. D. Sensitivity and Risk Analysis 11. Five sensitivity scenarios were tested. Their results are described in Table 5. Overall, the project s viability will depend on whether western Mongolia can capture sufficient spillovers from Mongolia s mining boom and transform this into home-grown growth. The appreciation of the real exchange rate of the Mongolian currency may create financial difficulties. However, from an economic standpoint, it would increase the relative value of local benefits, and impact positively on project viability. The switching value for a cost overrun linked to an increase in quantities is 9.5%. The switching value for a decrease in consumer benefits is 8.2%. A delay in project opening of 3 years (after the capital has been spent) would render the NPV negative. A local GDP growth rate in western Mongolia of 0.5% lower than traffic forecasting assumptions (7% growth in and 8% in ) would have the same effect. 12. The resulting degree of uncertainty of the project s economic analysis is medium to high. Traffic forecasts contained a high degree of uncertainty due to the difficulty of establishing a baseline and reading past trends, and of assessing the impacts on demand and vehicle fleet of such a major reduction in transport costs. The cost analysis contains a medium degree of uncertainty, mainly due to the risks of local-cost and materials inflation (detailed designs exist for the entire corridor). 6 ADB Economic Analysis of Projects. Operations Manual. OM Section G1/OP. Manila. 7 A Mongolian term for an extremely snowy winter in which livestock are unable to find fodder through the snow cover, and large numbers of animals die due to starvation and the cold.

5 5 Table 5: Sensitivity Analysis Main Assumptions Scenario 1 Pure cost overrun of 20% (quantities or price of tradable materials, e.g., Cost overrun fuel, bitumen, concrete) Scenario 2 Pure cost overrun of 10% Cost overrun partly Real appreciation of the MNT at 10% annually until 2020 instead of 5% caused by local Delays of 1 year for works start and implementation inflation Scenario 3 Real appreciation of the MNT at 10% annually until 2020 instead of 5% Dutch disease Local economic growth of 4% annually Scenario 4 No generated cross-border transport No cross-border No transit traffic development No mining development Scenario 5 Local growth at 15% annually during instead of 8% Aggressive growth Real appreciation of the MNT at 10% annually until 2020 IRR = internal rate of return, MNT = Mongolian togrog, NPV = net present value. IRR (%) NPV ($ million) 9.5% (11.3) 9.6% (8.5) 4.6% (78.3) 9.4% (11.2) 18.9% Table 6: Cost Benefit Analysis Summary Year Capital Maintenance Normal Traffic Generated Road Costs Costs VOC Time Traffic Safety Total 2010 (8.16) (8.16) 2011 (6.12) (0.12) (6.24) 2012 (40.63) (0.12) (39.56) 2013 (54.17) (0.12) (52.92) 2014 (57.03) (0.38) (55.83) 2015 (21.87) (0.39) (12.39) 2016 (37.05) (0.54) (26.19) 2017 (25.38) (0.55) (9.07) 2018 (14.17) (0.65) (0.67) (18.19) (0.71) (0.71) (39.03) (0.71) (19.64) (0.71) (11.69) (18.21) (0.71) (0.71) (39.03) (0.71) (19.49) (0.56) (11.54) (0.25) (0.25) (0.0) (0.09) Total ($154.18) ($36.66) $87.15 $72.14 $45.60 $4.36 $18.42 IRR 11.0% VOC = vehicle operating cost.