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p. 60 of 74 BACK | NEXT I. Introduction II. Background III. The Economic Rationale of A Project IV. Macroeconomic and Sectoral Context V. An Integrated Approach To Economic Analysis VI. Identification and Quantification of Costs and Benefits VII. Valuation of Economic Costs and Benefits VIII. Large Projects, Linkages, and National Affordability IX. Least-Cost and Cost-Effective Analysis X. Investment Criteria: Economic Viability XI. Discount Rate XII. Uncertainty: Sensitivity and Risk Analysis XIII. Sustainability of Project Effects XIV. Distribution of Project Effects XV. Projects and Policies XVI. Appendices Appendix 1: Key Questions For The Economic Analysis of Projects Appendix 2: Project Economic Rationale: Market and Nonmarket Failures Appendix 3: The Project Framework Appendix 4: Identification and Measurement of Consumer Surplus Appendix 5: Treatment of Working Capital Appendix 6: Depletion Premium Appendix 7: The Use of Constant Prices In The Economic Analysis of Projects Appendix 8: General Methodology For Building Up Project Statements Appendix 9: Economic Evaluation of Project Output and Input Appendix 10: Economic Price of Traded Goods and Services Appendix 11: Valuation of Nontraded Outputs and Inputs Appendix 12: Shadow Wage Rate and The Shadow Water Rate Factor Appendix 13: The Economic Price of Land Appendix 14: Treatment of Resettlement Components of Projects Appendix 15: Calculating Economic Prices At The Domestic Market Price Or World Market Price Levels Appendix 16: Estimating The Shadow Exchange Rate Factor and The Standard (Or Average) Conversion Factor Appendix 17: Example of An Economic Rate of Return: An Irrigation Rehabilitation Project Appendix 18: Effect On Net Foreign Exchange and Budget Flows: An Example Appendix 19: Least-Cost Analysis and Choosing Between Alternatives Appendix 20: Estimating The Economic Opportunity Cost of Capital Appendix 21: The Treatment of Uncertainty In The Economic Analysis of Projects: Sensitivity and Risk Analysis Appendix 22: User Charges, Cost Recovery, and Demand Management: An Example For Piped Water Appendix 23: Financial Returns To Project Participants: An Illustration Appendix 24: Economic Evaluation of Environmental Impacts Appendix 25: Distribution of Project Effects Appendix 26: Impact On Poverty Reduction Appendix 27: Difference Between Economic and Financial Prices Appendix 28: Use of Economic Prices In Measuring Effective Protection Appendix 29: Exchange Rate Issues In Project Analysis XVII. Others

Guidelines for the Economic Analysis of Projects : XVI. Appendices

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Appendix 18 : Effect on Net Foreign Exchange and Budget Flows : An Example

1. Some projects are sufficiently large to have a significant impact on the countrys foreign exchange flows and on the governments budget. This applies particularly in small countries where a major project can impact on foreign and domestic currency flows. It can also apply in the case of large projects, in relatively large countries, especially where there is a persistent foreign or budgetary deficit. In such cases, it is useful to have a statement of the direct impact of a project on foreign exchange and government revenue and expenditure flows.

I. Net Foreign Exhange Flows

2. The project resource flow at economic prices measures the total foreign exchange effect on the national economy. Some of these effects are indirect, such as the opportunity cost of local labor or the foreign exchange component of nontraded goods, while some of them are direct. A project will have a direct effect on the availability of foreign exchange through foreign exchange earned or saved as a result of incremental output, and as a result of the foreign exchange used in the provision of project inputs.

3. The irrigation rehabilitation example of Appendix 17 can be used to illustrate a projects direct foreign exchange effect. That project used irrigation and incremental agricultural inputs to produce more rice and less vegetables. The incremental rice production has a direct foreign exchange effect in the form of savings of imported rice. The direct foreign exchange costs of the project are the proportions of project input costs that are foreign exchange expenditures, given in the cost breakdowns at Table 2 of Appendix 17. These include the foreign exchange component of investment costs, institutional support, operations and maintenance (O&M) with the project, and incremental fertilizer imports. The direct foreign exchange generated by the project includes the savings of incremental rice imports and the foreign exchange component of O&M without the project. These direct foreign exchange flows of the project are given in Table 1.

4. The net direct foreign exchange flows are initially negative while investment is ongoing, and then become very large and positive as the incremental rice production substitutes for imports. The accumulated effect on net foreign exchange shows an accumulated negative effect at first, which turns positive as soon as the fifth year of the project. Overall, this irrigation rehabilitation project has a substantial and positive effect in terms of direct foreign exchange. The only problem consists of the large amounts of foreign exchange needed during the investment phase.

5. The direct foreign exchange flows can be amended to allow for the effects of foreign borrowing. A loan is being provided by the Bank to cover the direct foreign costs of the investment costs and institutional support. It involves the usual ordinary capital resources (OCR) repayment terms consisting of a grace period corresponding to the investment period, a commitment fee of a proportion of undisbursed amounts during the investment period, and loan payments over the life of the project. The inflation adjusted real interest rate is almost 4 percent. The loan can be added as a foreign exchange inflow, the loan payments can be added as foreign exchange outflows.

6. The loan reduces the initial foreign exchange outflows by meeting the foreign exchange component of initial costs; the initial outflows are reduced just to the annual interest and commitment charges. There is then a very rapid accumulation of foreign exchange from the first year of incremental production. At the end of the project life, after 25 operating years, there is a large accumulation of foreign exchange.

II. Government Budget Effects

7. The irrigation rehabilitation project has a very positive impact overall on direct foreign exchange flows for the country. However it also involves a very substantial increase in budget expenditures. The project effect on the government budget depends on the project institutional structure. The government will be responsible for meeting initial investment and institutional support costs of the project. It will save the without project O&M costs. In addition, the project is designed so that the with project O&M costs are met by the farmers, both in kind for undertaking some maintenance activities and through an irrigation charge that covers the financial O&M costs. Hence with project O&M will become a financial contribution of the farmers and no longer draw on the government budget. In return for the initial investment expenditures, however, the government will receive very little in the way of tax revenue. Tax revenue will come in the form of the tax component of project costs (indicated in Appendix 17, Table 1), which includes a small tax on investment goods and a relatively small tax on imported fertilizers. (It has been calculated separately that the average farmer, even at the higher cropping intensities and yields with the project, will not be subject to income tax.)

8. The net effect on the government budget is given in Table 2. There will be substantial budget expenditures for investment. These expenditures should be compared with the total government development budget and scheduled into the governments overall public investment program. They may be a large proportion of investment expenditures for the whole government or for the sector. The small amount of annual tax revenue can also be compared with the total government recurrent budget. It is expected to represent only a small increase in total government revenues. Table 2 also shows the accumulative effect on the government budget. The accumulative effect builds up as a negative amount during the investment period, and remains negative even beyond the end of the project.

9. The large negative impact on the government budget is ameliorated by the foreign loan in the investment period. However, the loan meets only the foreign exchange component of investment: there are still substantial budget net expenditures at the beginning of the project. When incremental outputs commence so also do loan payments. The loan payments exceed annual incremental tax revenues, and so the negative effect on the budget grows over time. (The accumulated negative budget effect at the end of the project is larger with the loan than without because of the loan charges.)

III. Conclusions

10. Taken together, these two statements of direct foreign exchange flows and net government budget flows provide further light on the project and its funding than is simply given by the EIRR. They demonstrate that the project will generate a substantial amount of net savings of foreign exchange, but, within the planned institutional structure, through substantial budgetary support of irrigation expenditures. The current design allows for meeting only irrigation O&M costs through irrigation charges on farmers; the question arises as to whether a proportion of the irrigation capital costs could also be passed on to the farmers to relieve the negative accumulative impact on the government budget. This question should be addressed in the context of a financial analysis of the incremental net incomes for farming households.

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