Project Analysis in Developing Countries

Project Analysis in Developing Countries

Project Analysis in Developing Countries Steve Curry Senior ProjectEconomist Asian Development Bank Manila, Philippines and John Weiss Professor o( Development Economics University of Bradford Second Ed ition palgrave macmillan

* Steve Curry and John Weiss 1993,2000 All. rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisionsof the Copyright, Designsand Patents Act 1988, or under the terms of any licehce perrnitting Ilrrrltedcopying issued by the Copyright Licensing Agency, Saffron Housel6-10 Kirby Street, LondonEC1 N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civilclaims for damages. The authors have asserted their rights to be identifiedas the authors of this work in accordance with the Copyright,Designsand Patents Act 198B. First published 1993 Reprinted several ti rnes Second edition 2000 First published 1993 by PALGRAVE MACMILLAN Palgrave Macrnillah in the UK is an lmprint of MacrniUah PublishersLimited, registered in England, company number 785998, of Houndrnllls, Basingstoke, Hampshire RG2.1 6XS. Palgrave Macmillan in the USis a divisionof St Martin's Press LLC I 1.75 FifthAvenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave and MacmiUan are registered trademarks in the United States, the United Kingdorn, Europeand other countries. ISBN 978-0-333-79292-6 DOI-l0.1057/978-0-230-37511-6 ISBN 978-0-230-37511-6(eBook) This book is printed on paper suitable for recyclingand rnade from fully rnanaged and sustained forest sources. togglrtg; pulping and rnanufacturlng processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this bookis available from the BritishLibrary.

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Contents List offigures List oftables Preface to the Second Edition Introduction viii ix xiii 2 Main features of Projects, Project Resource Statements and Financial Statements 8 3 Project Criteria 41 4 National Economic Returns and the Use of Economic Prices 71 5 The World Price System of Economic Analysis 101 6 The Domestic Price System of Economic Analysis 137 7 Non-traded Output and Benefit Valuation 167 8 financial Analysis of Projects 202 9 Uncertainty 225 10 Projects and Environmental Effects 238 11 Income Distribution Effects of Projects 265 12 National Economic Parameters 300 13 Limitations and Conclusions 323 Bibliography Index 344 349 vii

List of Figures 2.1 2.2 2.3 2.4 2.5 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 5.1 6.1 7.1 7.2 7.3 7.4 7.5 7.6 12.1 Project benefits and costs: different types of project Project life: technical, market and economic life Economic life of a project Op erating costs Project resource profiles BCR NPV curves NPV curves: different points of view NPV curves: project alternatives Incremental resource flow Project cost alternatives Incr emental resource cost flow Output effects: competitive market Output effects: regulated market Input effects: competitive market Input effects: regulated market Traded project output Traded project input Exported output Impor table output Conflicting decision: financial and economic price calculations (case 3) Financial and economic pr ice calculations Transport and distribution elem ent in border parity pricing Equivalence of world and domestic pri ce systems Increa se in supply cau sing price fall Original producers fully displaced by a new project Willingness to pay (WTP) Identificati on of two price- consumption points without and with project Two separate demand lines for different products Demand for transport SIO table: direct coefficients 13 18 19 21 26 44 45 51 54 59 61 64 72 74 75 76 80 81 85 86 95 96 106 145 168 169 171 173 175 180 302 vii i

List of Tables 2.1 Project perspectives and statements 10 2.2 Project investment costs 16 2.3 Working capital calculation 22 2.4 Carton project: resource flow statement 25 2.5 Project financial statement 30 2.6 Applying a discount factor as a weight 33 2.7 Discounting a net benefit stream 33 2.8 Discounted resource statement :H 2.9 Discounting a constant annual amount 35 2.10 Discounting and time profiles 37 3.1 Resource statement: project criteria 43 3.2 Resource flow with more than one JRR 48 3.3 Textile plant: different points of view 50 3.4 Resource statements: project alternatives 53 3.5 Comparison of NPV and BCR criteria 56 3.6 Inconsistent results: NPV and JRR 56 3.7 Incremental resource statement 57 3.8 Least cost analysis: pipeline alternatives cost statements 60 3.9 Incremental resource cost statement 63 :3. ]() Cost effectiveness analysis: accounting skills 65 3.11 Resource statements and investment constraint 67 3.12 Project criteria: investment fund constraint 68 3.13 Project criteria: adjusted discount rate 69 4.1 Economic price of exportable output: timber 86 4.2 Economic price of import substitute output: pumps 87 4.3 Economic price of power input supplies 89 4.4 Application of conversion factors 92 4.5 Alternative numeraires for economic price values 94 4.6 Decision combinations at financial and economic prices 96 5.1 Conversion factor for non-traded activity: electricity 110 5.2 Estimated returns to land at world prices 121 5.3 Use of world prices 124 5A.1 Financial returns to Water Authority 126 5A.2 Financial analysis, costs and benefits to farmers 127 5A.3 Fanners' costs 129 5A.4 Price data 129 ix

x List oftables SA.S Economic analysis, costs, world price system 130 5A.6 Border parity prices 133 5A.7 Economic analysis, benefits, world price system 134 6.1 CF for foreign exchange 140 6.2 Numerical example in world and domestic price systems 143 6.3 Electricity conversion factor : domestic price system 148 M.1 Financial analysis, costs and benefits to farmers 155 6A.2 Economic analysis, costs, domestic price system 1S7 6A.3 Economic analysis, benefits, domestic price system 160 6A.4 DRC irrigation: illustration 166 7.1 Willingness to pay (WTP) in water supply 176 7.2 Average cost savings without project traffic 181 7.3 Education project: life time worker income without and with project 184 7.4 Education project: benefits and costs in present values at 10 per cent 185 7.5 Health pro ject: cost effectiveness 186 7A.1 Fin ancial analysis (case 1 tariff = O&M costs) 190 7A.2 Economic analysis (case 1 tariff = O&M costs), domestic price system 195 7A.3 Economic analysis (case 1 tariff = O&M costs), world price system 197 7A.4 Financial analysis (case 2 tariff = O&M costs + 40 per cent) 198 7A.5 Economic analysis (case 2 tariff = O&M costs + 40 per cent), domestic price system 199 7A.6 Economic analysis (case 2 tariff = O&M costs + 40 per cent), world price system 200 8.1 FinanciallRR: railway project 204 8.2. Comparators for financial indicators 205 8.3 Financial cost of initial capital (FCIC) 206 8.4 Financial IRR: railway corporation 208 8.5 Return on equity 210 8.6 Average incremental cost 216 8. 7 Project cash flow (current prices) 221 9.1 Resource flow: best estimates 227 9.2 Percentage cost breakdown and conversion factors 229 9.3 Switching values 230 9.4 Risk analysis: basic data 232 9.5 Results of risk analysis 235 10.1 Economic value of gas 250

List of Tables xi 10.2 Valuation of environmental effects 251 10.3 Project A: mining project 259 10.4 Project B: power rehabilitation 261 10.5 Project C: national park 263 11.1 Financial analysis: telecommunications project 269 11.2 Economic analysis in domestic prices 275 11.3 Distribution analysis: divergence between economic and financial values 276 11.4 Summary distribution effect 277 11.5 Alternative measures of poverty impact: telecommunications example 279 11.6 Distributional analysis: divergence between economic and financial values with foreign financing 283 11.7 Distributional analysis: divergence between economic and financial values using world prices 287 11.8 Summary distribution effect: world price analysis 288 11.9 Income weights 290 11.10 Re-valuation of telecommunications project with income weights 291 111\.1 Water example distributional effects 295 11A.2 Distributional effect: case 1 295 111\.3 Water example: distributional effects with higher tariff 297 11A.4 Distributional effect: case 2 298 l1a.5 Ranking poverty-oriented programmes 299 12.1 SIO table: direct coefficients 305 12.2 Total primary factors of output in productive sectors 306 12.3 Full CF results 309 12.4 Indonesia discount rate, 1992 315 12.5 Results of NEP studies 316

Preface to the Second Edition Project analysis has grown up in the last 40 years and has been widely adopted, particularly in the process of external funding of public sector projects. Project analyses are undertaken from different points of view, and the scope of the analysis varies in different applications. The focus of this book is on the economic analysis of projects in developing countries, which we see as complementary to financial, environmental, or social analyses. This emphasis on the economic impact of projects remains relevant, partly because of the major change in the portfolio of aid-funded projects, which are now predominantly from infrastructure and social sectors, for which financial appraisals will either be inappropriate or will be seriously misleading as a guide to project worth. Project analysis has been facilitated greatly by the development of microcomputing, so what were once relatively complex manual calculations can be carried out rapidly using spreadsheet packages. The ways in which microcomputing techniques can be used for the analysis of projects is a subject in its own right and the application of spreadsheets to project decisions is not discussed here. Since the first edition of this book was published in 1993 several other texts on project analysis have become available, such as Perkins (1994), Dinwiddy and Teal (1995) and AnB (1997). We would like to think that our text complements these, particularly that of Dinwiddy and Teall which is a rigorous survey of the theory of the subject. Here we have tried to combine the application of project analysis methods with their theoretical underpinnings. Multilateral financing institutions have also renewed their interest in the economic analysis of projects (ADB,1997; World Bank, 1998). The applications in this second edition are consistent with the practise of these institutions. Apart from the use of different project examples, illustrations and references the new edition contains two new chapters, Chapter 8 on the link between economic and financial analysis and Chapter 10 on the economic effects of environmental impact. These have become more important in recent years. In addition, Chapter 4 which introduces the issue of economic value, Chapter 7 on non-traded goods and Chapter 11 on income distribution have been completely rewritten. xiii

xiv Preface to the Second Edition The authors take this opportunity to acknowledge the excellent work of Jean Hill who once again helped us in producing the manuscript despite her other responsibilities. STEVE CURRY JO HN WEIS S