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The management and design of economic development projects: A case study of World Bank electricity projects in Egypt

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The management and design of economic development projects: A case study of World Bank electricity projects in Egypt

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Content KEY FACTORS IN APPRAISING DEVELOPMENT PROJECTS IN EGYPT by Salah M. El Sabaa A Thesis Presented to the ( I FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree MASTER OF ARTS (Economics) August 1992 UMI Number: EP44941 All rights reserved INFORMATION TO ALL USERS The quality of this reproduction is dependent upon the quality of the copy submitted. In the unlikely event that the author did not send a complete manuscript and there are missing pages, these will be noted. Also, if material had to be removed, a note will indicate the deletion. Published by ProQuest LLC (2014). Copyright in the Dissertation held by the Author. Dissertation Publishing UMI EP44941 Microform Edition © ProQuest LLC. All rights reserved. This work is protected against unauthorized copying under Title 17, United States Code ProQuest LLC. 789 East Eisenhower Parkway P.O. Box 1346 Ann Arbor, Ml 4 8 1 0 6 -1 3 4 6 U N IV E R S IT Y O F S O U T H E R N C A L IF O R N IA THE GRADUATE SCHOOL UNIVERSITY PARK LOS ANGELES. CALIFORNIA 9 0 0 0 7 This thesis, written by Salah _M_.__E_lSab_aa....................... under the direction of h..Ls~~Thesis Committee, and approved by all its members, has been pre sented to and accepted by the Dean of The Graduate School, in partial fulfillment of the requirements fo r the degree of '12- MB' Dean Aus'ust 13, 1992 THESIS COMMITTEE Chairman ii Acknowledgment s I would like to express my deepest gratitude to our God, the one God we all praise Muslims, Christians, and Jews. Through the often discouraging process of my study, it was ■ my unwavering faith in God which helped me work hard to complete this study in a short period. For Him I am indebted and very grateful. I would like to extend my sincere.appreciation to the ! members of my thesis committee, for their scholarly supervision, guidance, and support. My thesis chairman, the distinguished professor John Elliott, not only helped me during this research, but also throughout my entire program ; i of study at U.S.C. In fact, Professor Elliott's insights, ! personal compassion, and depth of knowledge have been an inspiration to me and my colleagues. Professor Nake Kamrany gave valuable advice, constant guidance, and comments which greatly enriched this study. I am especially indebted to i I Professor Alexander McEachern, whom I owe more, both intellectually and humanly, than I can ever repay. He consistently gave time, encouragement, and advice far more than was his responsibility as a member of my thesis committee. A special word of appreciation goes to all my professors at Harvard University with whom I have had the good fortune to take several courses in project management and iii development economics. Among them I should like particularly to mention my distinguished professors: Glenn Jenkins, John Thomas, Waite Perkins, and Michael Roemer. All of them opened avenues of thought and their views were invaluable for a proper understanding of project evaluation and development economics. A special word of appreciation also goes to all these i individuals in Egypt who generously granted their time, confidential discussions and interviews. Among them are Dr. Ibrahim Helmy Abdul Rahman, former Minister of Planning and ! Director of UNDP, Professor Heba Handoussa, the American University in Cairo, Professor Gouda Abdul Khaleque, Cairo j i University, Dr. Ibrahim Mokhtar, Director of Miser Iran j I Investment Bank, and Dr. Mokhtar Halouda, former Director of CAPMAS. To my host family Debbie, Christy, David, and Don Ludwig, some of the finest people I have ever known, who made my stay in the US meaningful, I extend rny heartfelt thanks. My hope is to maintain communication through future years. Finally, I must thank my wife and life mate, Rawia, for her encouragement and support. It is to her this dissertation is dedicated. Abstract iv This study is concerned with appraising development projects, in particular the efficiency of World Bank projects in Egypt. The study seeks improvements in the methods of appraising public sector projects in Egypt. Project appraisal is employed as a way to assess the economic viability and efficiency of investments. This study shows that the key parameters in evaluating economic viability and efficiency of development projects are: (1) the discount rate (opportunity cost of public funds); (2) the exchange rate; and (3) the cost of major inputs, as approximated by shadow prices of labor, water, electricity, and transportation for development projects. Alternative approaches to estimating the opportunity cost of public funds are made employing the approaches of: Little and Mirlees, Harberger, and Hirshleifer. In practice, the key parameters in evaluating the efficiency of projects have not been accurately estimated in the appraisal stage of the World Bank projects in Egypt. This has resulted in false or misleading information concerning the economic viability and efficiency of the chosen projects. This study presents the basic objectives of institutional development required to lay the ground for V effective assessment of the institutional building aspects of World Bank projects. This is followed by presenting the problems of institutional development in electricity projects in Egypt and the factors that adversely affect their performance. Contents Acknowledgments ii Abstract iv List of Tables viii List of Figures ix Abbreviation X Chapter 1: Introduction 1 1.1 Introduction 1 1.2 Purpose 4 1.3 Hypothesis 5 1.4 Approach 5 1.5 Study Outline 6 1.6 Scope and Limitations 10 Chapter 2s The Appraisal of W.B. Electricity Projects in Egypt 13 2.1 Introduction 13 2.1.1 Demand Forecast 16 2.1.2 Technical and Engineering Aspects 18 2.1.3 Institutional Aspects 18 2.1.4 Financial Aspects 19 2.1.5 Economic Aspects 19 2.1.6 Social Aspects 20 2.2 Electricity Demand Forecast 20 2.3 Analysis of Electricity Demand Forecast 23 2.4 Comments on Demand Forecast 36 Chapter 3: The Economic Analysis of W.B. Electricity Project in Egypt 37 3.1 Methodology 38 3.2 Economic Internal Rate of Return 39 3.3 The Discount Rate as a Key Parameter in Economic Analysis 40 3.3.1 Hirshleifer's Approach 41 3.3.2 Little And Mirelees' Approach 42 3.3.3 Harberger's Approach 45 3.4 The Exchange Rate as a Key Parameter in Economic Analysis 53 vii 3.5 The Shadow Prices as a Key Parameter in Economic Analysis 53 3.6 Conclusion on the Economic Analysis 67 Chapter 4: The Institutional Analysis of W.B. Electricity Project in Egypt 69 4.1 Introduction 69 4.2 The Basic Objective of Institutional Development 70 4.3 The World Bank and Institutional Development in Electricity Project 72 4.4 The World Bank Strategy 76 4.5 Problems of Institutional Development in Electricity Projects in Egypt 76 4.6 Factors That Adversely Affect the j Institutional Development Performance 78 Chapter 5: Conclusions: 83 Bibliography 85 List of Tables 2.1 Real GDP Growth Rates 24 2.2 Per Capita Energy Consumption in Some Developing Countries 27 2.3 Changes in Electricity Per Capita Consumption 28 2.4 Projected Sales and Price Increases Required by the World Bank 3 0 2.5 Sales and Average Prices of Electricity 31 2.6 Population Growth 33 3.1 Development of Interest Rates in Egypt 49 3.2 Changes in Exchange Rate in Egypt 56 3.3 Foreign Currency in the World Bank Projects in Egypt 58 3.4 Exchange Rate Estimation During Appraisal and Implementation of World Bank Projects 61 3.5 The Effect of Changes in the Exchange Rate on EIRR 63 4.1 Project Investment on Training, System Development, and Equipment 74 4.2 World Bank Appraisal Mission Data (Shoubra El Kheima Power Project) 75 4.3 World Bank Appraisal Mission Data (Third Power Project) 75 ix List of Figures 1 Project Management 2 2 Project Appraisal and Areas of Emphasis 7 1 Project Appraisal Phases 17 2 Real GDP Growth Rates 25 3 Per Capita Consumption of Electricity in Egypt 2 9 4 Projected Electricity Sales and Prices Increases 32 5 Population Growth in Egypt 34 1 The Opportunity Cost of Public Funds 48 2 Development of Interest Rate in Egypt 50 3 Development of Exchange Rate in Egypt 57 4 The effect of Changes in the Exchange Rate on EIRR 64 ABBREVIATIONS x ADB African Development Bank CAPMAS The Central Agency for Public Mobilization and Statistics EEA Egyptian Electricity Authority EDC Electricity Distribution Company EIRR Economic Internal Rate of Return GDP Gross Domestic Product IBRD International Bank for Reconstruction and Development IDA International Development Association IFC International Finance Corporation IMF International Monetary Fund IRR Internal Rate of Return LRMC Long Run Marginal Cost of Electricity Supply MEE Ministry of Electricity and Nuclear Energy MOP Ministry of Planning ROR Financial Rate of Return SAL IMF Structural Adjustment Loans SECAL Sectoral Adjustment Loans S&B Stone and Webster UNCTAD United Nations Conference on Trade and Development UNDP United Nations Development Program UNIDO United Nations Industrial Development Organization USAID United Stats Agency for International Development WB The World Bank KCal Kilo-calories KV Kilo-voLt = 1,000 Volt KW Kilo-watt = 1,000 Watt (10 W) MTOE Million Ton of Oil Equivalent MW Mega-watt = 1,000 Kilo-watt (10 W) GW Giga-watt = 1,000 Mega-watt (10 W) KWH Kilo-watt-hour GWH Giga-watt-hour KVA Kilo-volt-amper MVA Mega-volt-amper LE Egyptian pound M Millieme = .0001 LE TOE Tons of Oil Equivalent = 10.415*10 KCal Chapter One 1.1 Introduction: Economic development projects are critical elements of national development in Third World countries. The key to better management of projects lies in the process by which projects are identified, prepared, appraised, and implemented. Strengthening this process should lead to development projects and public investment programs that are more appropriate and more attuned to Egypt's development needs and goals. This study is basically concerned with the appraisal stage of development projects, in particular, World Bank- financed electricity projects in Egypt. As figure (1.1) indicates, the appraisal stage is one stage of the project cycle. This study seeks improvements of the methods of project appraisal of public sector investment program in Egypt. It attempts to bring into focus some of the important practical issues that face development planners in the field of project evaluation. The field of project evaluation is a relatively new branch of economic analysis, and as such is still in its formative stages (Harberger, 1976) . Numerous gaps still exist in the available literature. Alternative approaches to address the different aspects of project evaluation have Project Management 2 t Project Appraisal Project mplementation Project Evaluation Project identification Project Preparation Figure (1.1) 3 been suggested which entail differences of concept that are as yet unresolved, for instance, how we appraise costs and benefits for a development project from a social point of view. These diverge from the purely pecuniary costs and benefits perceived by individuals in the marketplace. In this regard, what is the opportunity cost of public funds? An appropriate discount rate is necessary in order to reach proper decisions on project timing and scale, and is particularly important in reaching valid decisions in years in which investables are either particularly abundant or particularly scarce, relative to existing investment opportunities. In addition, what are the shadow prices of non-traded goods used as inputs to a development project? Moreover, what is the optimum path and appropriate strategy for Egypt, as a developing country, to adopt to promote development ? The above questions have determined the design of this thesis. An attempt has been made here to apply alternative approaches to project appraisal to public investment in Egypt. Egypt, with a relatively fixed amount of usable land and a rapidly growing population, desperately needs development. In Egypt, economic growth and development are significantly related to public sector investments. Productivity growth, a main source of income increases, also depends in part on public sector investments. 4 However, in Egypt the public sector has selected many projects that turned out to be costly to the economy such as investment in intensive-energy technology. An excellent example is the aluminum smelting plant in Upper Egypt. Uneconomical projects, once begun, are difficult to close down, especially when employment or prestige is at stake. The Egyptian economy generally lives with them and subsidizes their inefficiencies. Much remains to be done in Egypt to improve the methods of project appraisal and the implementation of public sector investment programs. 1.2 Purpose: This study adopts a constructive approach, focusing on gaps, weaknesses and unresolved issues in the area of social project appraisal. It is intended to contribute to an improvement of existing procedures, whenever possible. It is designed to apply the theories and techniques of economic and social analysis of project evaluation to describe and assess World Bank electricity projects that are implemented in Egypt. The study will attempt to identify the principal problems and obstacles confronting .the World Bank in implementing its programs in the electricity sector in particular and will outline possible new approaches, 5 policies, and procedures that can to be adopted to improve project performance. The study will look at how projects are institutionalized and evolved and how they are managed. 1.3 Hypothesis: The World Bank projects in the electricity sector in Egypt have not been optimally appraised; this is especially so concerning economic estimations and institutional design. Consequently, project appraisals yield evaluations which provide false or misleading signals concerning the economic viability and desirability of projects. Therefore, resources are not efficiently employed and allocated even within electricity projects and other projects which have been identified. In addition, poor design of institutional aspects affects not only future performance of projects but also the performance of the electricity sector in Egypt. This hypothesis is discussed in chapters two through four. The study shows that projects were inappropriately appraised and designed. 1.4 Approach: From a political economy perspective, using empirical and comparative analysis, the study wi'll evaluate how well development programs and projects have worked in Egypt and how their efficiencies can be improved through better design and management. 6 The institutional setting and evolution are as important as financial and economic factors. As figure (1.2) indicates, the study will cover the factors that affect the project appraisal stage of electricity projects in Egypt. 1.5 Study Outline: Chapter one contains both a general and a detailed introduction to the problems of this study, and presents the proposed hypothesis. Chapters two through four focus on the appraisal stage of the project cycle, and evaluate the stated hypothesis. Chapter two starts with a brief review of the appraisal stage, which lays the ground for further discussion of the different aspects of this important stage in project design. These include demand forecast, technical aspects, financial aspects, economic aspects and institutional aspects. The analysis presented emphasizes economic and institutional aspects of projects. For a better analysis of demand forecasts, the study examines how different factors which affect electricity consumption fit into the economic models developed by the Egyptian Electricity Authority (EEA) and are applied in the demand forecast. It also examines how those factors are represented in the' historical data of electricity sales which are used to project future trends in electricity consumption. 7 Figure (1.2) Data Availability P r o j e c t A p p r a is a l Technical Staff ' W.B. Missions & Proced. Consultant Firms Design Financial J \ Technical institutional Economic Discount Rate Excange Rate This study in chapter three, also presents the ; i i methodology used for conducting economic analyses for the I I I World Bank-financed operations, which is a cost-benefit : analysis developed by I.M.D. Little and Mirrlees. The key ! ! . parameters of economic analysis including the discount rates, exchange rates, and shadow prices, are discussed in 1 detail. ; With regard to the opportunity cost of public funds, 1 i I i j the study reviews the basic alternative approaches employed j to determine the discount rates reflecting the economic cost i of public funds. These include Hirshleifer's, Little and Mirrlee's and Harberger's approaches. In addition, it examines the development of interest rates in Egypt during • ; the last two decades. i The study argues that Harberger's approach is more appropriate for estimating the opportunity cost of public ! t J funds than Hirshleif er' s and Little and Mirrlee's approaches because it presents a more realistic estimation of the i i discount rate for public sector investments in Egypt, which [ I ! is 2 0 per cent. This figure differs from the estimated 6 per cent discount rate used by consultant firms to justify the J i economic viability of electricity projects that will be | implemented in Egypt in the 1990 's. This study also indicates that the shadow prices used in! i economic analysis provide false signals. These shadow prices are based on Page's report "Shadow Prices for Trade Strategy and Investment planning in Egypt" that was developed to be i 1 used in the period from 1980 to 1985, not for projects that j I will be implemented in mid 1990's. ' Further, chapter three shows that for better economic ! [ analysis of development projects in Egypt, we need to' institute a wide-ranging system of economic values that i reflect the real cost and benefits to the Egyptian economy as a whole. This proposed system would provide projectj evaluators and planners with interest rates, exchange rates, and major inputs price of a development project, e.g.,, I labor, electricity, transportation, water.etc. Chapter four presents the basic objectives of; I ( institutional development required to lay the groundwork for assessment of the institution building aspects of World Bank ' i projects. This is followed by presentation of the problems of institutional development in electricity projects in Egypt and the factors that adversely affect their1 performance. Chapter five summarizes the argument of this discussionj and derives certain consequences regarding development i processes. It presents gaps, weaknesses and unresolvedi issues in project evaluation and how they affect the development process in Egypt. It shows how the World Bank can influence the strategies of Egypt, even though the! choice of a strategy and the related policies and programs are finally made by the Egyptian government. I It is hoped that this study will make a contribution to i improvement of existing procedures and provide insights into j the development process. ; 1 i 1.6 Scope and Limitations: j I i J Providing a methodology for optimal allocation of resources is beyond the scope of this study. The study shows j however, that World Bank projects in Egypt are not optimally , appraised and its resources are not optimally allocated. . 1 . . . . i This study also does not claim that investing m electricity or infrastructure constitutes a wrong decision 1 . | or that it does not contribute to development process m any j country. On the contrary, investment in infrastructure, transportation and power constitutes necessary foundations > I on which a strong, viable economy could be built. Needless 1 I i to say, schools, hospitals, small scale industries and development banks cannot exist unless electricity, water and roads are available. I l I This study covers the period from 1975 till 1991. This 1 period was characterized by a influx of foreign aid and ; investments in public sector infrastructure projects. For I | example, the cost of the Cairo-North electrical power station, one of several power stations,' is $ 900 millions ; and the proposed Kuriemat plant exceeds $1300 millions. i 1 The study covers the institutional aspects of the implemented projects. The analysis not only covers the 11 borrowing entity itself, its organization, management, human resources, policies, and procedures, but also the whole array of government policies that condition the environment in which the project is designed to operate. : The study focuses on one major element in the energy ; i i ! sector, specifically, electrical power stations. Energy ! ! projects have beneficial effects on several activities in i ; the Egyptian economy. Experience shows that the availability ! j of electricity affects the nature and scope of economies (or I i diseconomies) of scale in cities and in industrial ! development and location. : I | The study covers projects that are financed by the I i . World Bank as co-sponsor with other international j organizations, mainly USAID. These projects are public sector enterprises that require a large investment. 1 This study is limited, to some extent, by the fact that all studies and documents of the World Bank and other j international aid organization are considered confidential I and for official use only. This has resulted in a great i I difficulty in getting World Bank Staff Appraisal Reports, post evaluation reports, sector reports and IMF reports, and ’ . t the unavailability of some other important reports, e.g. i i Project Completion Reports (PCR). ! Updated shadow prices for non-traded goods are not available. In addition, some important macroeconomic \ parameters are not available, such as elasticity of supply of private-sector saving and elasticity of demand for private sector investment with respect to changes in the rate of interest. ! 13 i Chapter Two The Appraisal of World Bank Electricity Projects in Egypt i 2.1 Introduction: | The appraisal stage of any project cycle provides a | comprehensive review and analysis on a range of issues associated with the potential undertaking and lays the : foundation for implementing the project. Forecasting the j demand and technical appraisal of the project must be ! provided to evaluate its feasibility; the institutional and I j administrative aspects must be fairly assessed; the i financial capability of the project to survive the planned duration of its life must be appraised; the expected economic contribution to the growth and development of the J economy must be measured and evaluated; and finally, an assessment must be made to determine if, and how, this project assists in attaining the social objectives set out for the country. Appraisal of a project brings together project evaluators that include engineers and other technical I ! specialists, financial analysts, and economists. For the World Bank, project appraisal is solely its i responsibility. Appraisal is conducted by bank staff for most projects. However, for big projects like electricity and energy projects, appraisal of projects is based mainly j : on feasibility studies that are conducted by well known j consultant firms, e.g. "Overseas Bechtel", "Stone & Webster : ; ! I Engineering Corporation", and "Sanderson & Porter, Inc". I I These studies are very expensive and their cost may exceed | five or ten millions Dollars. They are usually financed by I ■ ' I an international development organization, e.g. USAID, I UNIDO, or UNDP. I Because of the Bank's close involvement in identification and preparation, project appraisal rarely results in rejection; but it may be extensively modified or ! I redesigned during this process to correct flaws that i otherwise might have led to its rejection. For the Government of Egypt, project appraisal is I conducted within each ministry. For example, the Ministry of Electricity and Energy has a department of studies, research, and development which is in charge of evaluating j j projects. For the Ministry of Irrigation and Water ! Resources, a Regional Irrigation Improvement Program (RIIP) was established in 1984 in the Irrigation Department. The * RIIP is headed by a General Director (Under Secretary of ! j State) and is empowered to carry out field investigation, planning, design, conduct and supervision of projects. For i ! i the Ministry of Agriculture, the Agriculture Research Center I (ARC) is in charge of conducting project evaluation. For the Ministry of Petroleum, a separate consultant firm (ENPI) that belongs to the Ministry is in charge of project I evaluation. i The level of professionalism on the part of analysts varies from one ministry to the other. While the Ministry of | Electricity and the Ministry of Irrigation have a team of ! project evaluators with high analytical skills, the Ministry | of Education lack such skills and caliber. ! In general, project evaluators in each ministry place more emphasis on the technical aspects of projects under investigation and little on the political environment and the social objectives set out for Egypt. In addition, in the I I evaluation of the performance of public sector projects and programs, there is a tendency to examine the financial (or budgetary), economic and distributional impact of the 1 activity as three independent outcomes. However, the three aspects of the overall performance of a public sector project are generally closely inter-related and should be viewed as three parts of an integrated evaluation. Project appraisal is an iterative and integrated process, the information obtained at one stage for one aspect of the study may be essential for the completion of another aspect of the evaluation. For example, if we wish to know the I . . . . . impact of electricity pricing policy on the welfare of a I particular group of people, the information on who the t i customers are and their relative consumption pattern of 16 electricity will eventually be essential in determining the capacity and specifications of a generator in a power I !station. An evaluation of a public sector project that i examines technical and financial variables alone is not very Smeaningful, no matter how accurately it has been carried l out. The appraisal will be more valuable to the public sector decision-makers if the analytical effort covers all important aspects of the project. As figure (2.1) shows, the appraisal phase of a project's i ! development is composed of a series of appraisal and decision points leading to either the project's inception or I I rejection. This process is expected to cover the following 1 areas: i j ;2.1.1 Demand Forecast: i : Here, the demand for electricity, services, and prices or the relative needs of social services are estimated, quantified, and justified. In Egypt, production and I , distribution of electricity is a public sector monopoly, i I where government policies play an important role in determining the demand of the output. For example, extension of electricity to rural areas, the development of industrial \ complexes, and price subsidizing policy will have an impact on the future demand for the electricity in Egypt. Project Appraisal and Areas of Emphasis Demand Forecast Financial Economic Social Insti tutional Technical Figure (2.1) 2.1.2 Technical and Engineering Aspects: Technical appraisal is concerned with questions of J physical scale, layout, and locations of facilities and the technology to be used. This includes types of equipment or I ! processes and their appropriateness to local conditions. So l | the input parameters of the projects are specified in detail j and cost estimates are developed. The technical appraisal ! also reviews proposed procurement arrangements to make sure i that the World Bank's requirements are met. The potential I impact of the project on the human and physical environment is examined to make sure that any adverse effects will be i i controlled or minimized. The World Bank has to ensure that projects are soundly designed, appropriately engineered, and follow accepted I electrical standards. The appraisal team studies technical J alternatives considered, solutions proposed, and expected results. I 2.1.3 Institutional Aspects: Manpower requirements are specified for implementation. ; How the project as an organization will operate and perform efficiently is specified. For a viable "institution", the study should cover not only the electrical power station ; itself, its organization and staffing, but also the i electricity sector in Egypt and the government policies that condition its working environment. 2.1.4 Financial Aspects: Financial expenditures and revenues are evaluated, along with an assessment of alternative methods and sources of financing, to ensure that there are sufficient funds to cover the costs of implementing the project. Also, financial appraisal is concerned with the financial viability of i projects. Will it be able to meet all its financial i obligations, including debt service to the Bank? Will it be able to generate enough funds from internal sources to earn 1 ! a reasonable rate of return on its assets and make a i satisfactory contribution to its capital requirements? The finances of the balance sheet, income statement, and cash i i flow must also be considered. I 2.1.5 Economic Aspects: The objective of the economic appraisal is to examine the project from the point of view of the entire economy to determine whether or not its implementation will improve the economic welfare of the country. It has the same nature as a financial analysis, except that the benefits and costs are ! measured from the point of view of the whole society, while | a financial analysis measures only the benefits and costs ! relevant to the owners and beneficiaries of the project, i.e. the ministry of electricity. 20 j [ 2.1.6 Social Aspects: I Extra-economic impacts of the projects must be t i identified and quantified. These include the impact of a , I j project on the well-being of particular groups in society. 1 i Political factors should be identified as well as the long i run impacts of the project on the community. t I ! 2.2 Electricity Demand Forecast: i ! The electricity demand forecasts are used to draw up plans and to make investments in expanding generation, ! transmission and distribution capacities. It is therefore j important to know the magnitude of the future power load j before investing in the power sector. I I 2.2.1 Factors That affect the Growth of I Electricity Consumption: 1 i The growth in electricity consumption in any country is ' influenced by the following factors (The Economist Intelligence Unit, 1989): : J I - Growth Rate of Gross Domestic Product (GDP). - Change in electricity prices. i i - Rate of population growth. j I - The rate of electricity penetration. - The increase in access to electricity. ' I 1 i - The extent which electricity consumption approaches ; saturation point. 21 2.2.2 Load Forecast for Electricity Projects in Egypt: i For appraisal of electricity projects in Egypt, a demand I forecast is based on the load forecast carried out by the Egyptian Electricity Authority (EEA) . This forecast is based | on previously developed load forecast modeling techniques supplied to EEA by a consultant firm, Stone & Webster Engineering Co. The input data for these models includes available data on population, gross domestic product(GDP) , i industrial production, appliance production and electricity sales. The primary sources of this new data are from EEA and the Central Agency for Public Mobilization and Statistics (CAPMAS) through its document entitled "Population, Housing j and Establishment Census." The load forecast is the ! aggregate of the following sectors: ! I 2.2.2.1 The Residential-Commercial Sector: Energy sales are projected using demographic and j appliance saturation end-use models. The demographic models l I for population projection by the governorate were used to derive estimates of population through the year 2011. The historical average consumption information for the residential-commercial sector was combined with the » I i historical and projected appliance production in the residential average consumption model to project future use per residential-commercial customer. The following model was ' developed (feasibility study for Kuriemat plant, final ' I report, 1989). ! i Ln RES-KWH = 14.425 - 277.876/POP + 0.4045*DUMRES1 I I Where: j I Ln = natural logarithm RES-KWH = Residential/small commercial sales in KWH j i POP = Population DUMRES1 = 1 for 1979 to 1984 and 0 otherwise 2.2.2.2 The Public Utilities Sector: Energy sales are projected using econometric computer ^ models. Historical data are used to forecast future sales. The following model was developed (feasibility study for ' Kureimat plant, final report, 1989). Ln PUB-KWH = 10.39-136.021/POP Where: : I Ln = natural logarithm ! PUB-KWH = electricity sales to public utilities in KWH j i POP = Population in millions j 2 .2.2 . 3 Government Sector: Energy sales are projected using econometric computer models. Historical data are used to forecast future sales. The following equation was developed (feasibility study of i I Kuriemat Plant, final report, 1989). 23 Ln GOV-KWH = 10.867-1298.28/GDPPOP- 1.5437*DUMGOV Where: Ln = natural logarithm GOV-KWH = electricity sales to government in KWH GDPPOP = GDP per capita DUMGOV = 0 through 1978 and 1 thereafter I J 2.2.2.4 The Very High Voltage(VHV)-Industrial I Sector: i Sales are projected using the agreed-on values with the Ministry of Industry from the most recent five-year plan for | the years through 1992. Beyond 1992, VHV electricity sales ; are agreed on with the Ministry of Industry to grow at a 3 per cent annual rate. An estimate of the system losses is made. These losses ' were added to the projections for all sales of energy. These ( values yield the total system energy generation requirements. 2.3 Analysis of Electricity Demand Forecast: For better analysis of demand forecast of an electricity project, we have to examine how different factors which i i j affect electricity consumption fit into the econometric i | models developed by EEA and are applied in demand forecasts. I Also, we have to examine how they are represented in the historical data of electricity sales which is used to ! project future trends in electricity consumption. The j \ I following are the results of the analysis: 2.3.1 Growth Rate of Gross Domestic Product (GDP): Growth of national income is probably one of the most i important factors influencing the growth in electricity consumption (The Economist Intelligence Unit, 1989). The GDP [ rate in Egypt slowed down to 2.2 per cent after the impressive record of a sustained 9 per cent throughout the period 1977 to 1984. Table (2.1) and figure (2.2) indicate ! estimates of the real GDP growth rates. i Table (2.1) Real GDP Growth Rates (in per cent ) Year 1979 1980 1981 1982 1883 1984 GDP Growth Rate(%) 9.2 9.1 9.3 9.1 9.9 8.0 Year 1985 1986 1987 1988 1989 1990 GDP Growth Rate(%) 7.4 4.8 4.2 3.2 3.1 2.2 Sources: . j - Ministry of Planning, 1991. I : This factor is included in the econometeric models developed by EEA and is currently used for estimating demand , forecasts for the World Bank-financed projects in Egypt. ! Year GDP Growth Rates (in %) o —t r\3coji.cno>'>ioo«>o 1979 1980 - 1981 1982 1983 1984 1985 - 1986 - 1987 -- 1988 - 1989 - 1990 Real GDP Growth Rates (in %) (1979-1990) 26 2.3.2. Changes in Electricity Prices: In theory, any increase in electricity price should lead the consumer to curtail demand for power. In the real ■world, electricity pricing has been utilized rather i effectively in several Asian countries to direct or redirect electricity consumption to various sectors and to manage the pattern of power loads, e.g. Japan and South Korea (The jEconomist Intelligence Unit, 1989). Therefore, the impact of I Ipncing policy on the level and shape of electricity demand I has been significant and should be taken into consideration ( t in projecting electricity demand. It is expected that electricity prices in Egypt will be .increased radically for more than one reason as follows: I First, Egyptians are used to consuming more energy than ! jthe average for countries at a similar income level. As The World Bank staff appraisal report (1989) indicates, per ^apita energy consumption in Egypt is approximately 0.538 MTOE, which is 40 per cent higher than the average for [countries at similar income level. Table (2.2) indicates per .capita electricity consumption in Egypt compared to some i other developing countries. 27 Table (2.2) Per Capita Energy Consumption in Some Developing Countries (in KWH) Country GNP Per Capita (1990) (in dollars) Electricity Cons. Per Capita (1989) (in KWH) Egypt 640 720 Tunisia 1, 260 650 Morocco 880 371 Algeria 2,230 630 Jordan 1, 640 704 (1985) Indonesia 500 176 Philippines 710 400 Pakistan 370 250 China 350 420 India 340 260 Africa as Continent 487 Sources: - United Nations Energy Statistical Yearbook, 1990. - World Development Report, 1991. Also, the growth rate of electricity consumption in i Egypt during the last three decades is very high. As table I (2.3) and figure (2.3) indicate, the per capita electricity consumption in Egypt has grown from 50 KWH in the year 1952 to 1000 KWH in the year 1992. 1 Table (2.3) Changes in Electricity Per Capita Consumption (EPCC) in Egypt (in KWH) (1952-1992) Y e a r 1 9 5 2 1 9 6 0 1 9 6 5 1 9 7 5 1 9 8 0 1 9 8 5 1 9 8 9 1 9 9 0 1 9 9 2 E P C C K W H 5 0 1 1 9 1 8 0 1 8 4 4 3 0 6 0 0 7 2 0 8 0 0 1 0 0 0 Sources: - The Ministry of Electricity Achievement Report, 1991. This pattern of electricity consumption is high in Egypt because domestic selling prices for electricity and petroleum product have been kept low for many years by government subsidy, thereby encouraging the growth of domestic consumption. At present, the government subsidy I must be reduced in order that the budget deficit may be lowered. In Egypt, the budget deficit represents 8 per cent i i of GDP (IMF, Economic Development In Egypt Report, 1989). Second, based on the IMF Structure adjustment loans (SAL) (the World Bank aid-memoir, 1991), electricity prices in ! ! Egypt are to be adjusted so as to reach the Long Run | Marginal Cost of electricity supply (LRMC) by the fiscal I j year 1995. The World Bank mission's estimates of electricity ; price increases needed to meet loan conditions are shown in i table (2.4) below: PCCE (in KWH) Figure (2.3) Per Capita Consumption of Electricity (PCCE) in Egypt (in KWH) (1952-1992) 1000 900 800 700 600 500 400 300 .200 100 1992 1990 1989 1985 1980 1975 1965 1960 1952 Year to lO 30 Table (2.4) Projected Sales (in GWH) and Price Increases (in Milliems per KWH) Required by the World Bank (1990-1999) Year 1990 1991 1992 1993 1994 Sales (in GWH) 37 .4 3 9.5 41.7 44 46.3 Ave.Price (M/KWH) 30.5 43 .3 60 .7 83 106 Year 1995 1996 1997 1998 1999 Sales (in GWH) 48.7 51 54 56 59 Ave.Price (M/KWH) 130 151 160 170 180 ! Sources: ] -The World Bank Appraisal Mission Report, Aid-memoir, 1991. According to the World Bank mission's estimates, as indicated in table (2.4), electricity prices are expected to increase from 40 M per KWH in the 1991 to 180 M per KWH in the year 1999. These projected prices can be compared to the average prices in previous years as shown in Table (2.5). I I Table (2.5) Sales and Average Prices of Electricity (GWH and Milliemes per KWH) (1977-1988) year 1977 1978 1979 1980 1981 1982 Sales (in GWH) 11.5 12.6 13 .2 14.3 15.7 17.2 Ave.Pric e (M per KWH) 8.3 8.2 9.5 9.8 10 11 year 1983 1984 1985 1986 1987 1988 Sales (in GWH) 19 .5 22.3 23 .7 25.5 28.5 31 Ave.Price (M per KWH) 12 .4 14.5 17 22 .6 29 30 Sources: - The World Bank Staff Appraisal Report # 2874-EGT, June 1980 - The World Bank Staff Appraisal Report # 8641-EGT, May 1989. Future and past trends in sales and corresponding prices are plotted in figure (2.4) shown below. As shown in figure (2.4), and according to the forecasted demand, electricity prices are to be adjusted so as to reach 180 M per KWH in the year 1999, i.e. six times its value in the year 1991, without adversely affecting the trends in consumption pattern. Projected Sales & Prices (in KWH and milliemes per KWH) ro.uc»cx>oN>-t^o>cx> o o o o o o o o o © 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 * 1988 1 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 •d H o Cl . © o ft © o * M M 0 O fT h N- O iff a CO P. 0 m J r * h- « > © ■ a * o „ © 3 * i j § 2 w a* •d n H- a © a H tt o • I © © a © © H- s 2 sc (2.4) 2.3.3 Rate of Population Growth: Egypt's population has increased from 2 6.085 millions in 1960 to 53.742 millions in 1991, at an annual growth rate of 2.42. Egypt's population is projected to reach 79.007 by 2006 as indicated in table (2.6) and figure (2.5) shown I \ below: Table (2.6) Population Growth (in millions) Y e a r 1 9 6 0 1 9 6 6 1 9 7 6 1 9 8 6 1 9 9 1 1 9 9 6 2 0 0 1 2 0 0 6 T o t a l P o p u . 2 6 . 0 8 3 0 . 0 7 3 6 . 0 6 4 8 . 2 5 3 . 7 4 6 0 . 7 2 6 9 . 6 7 7 9 . 0 0 Sources: - The Central agency for Public Mobilization and Statistics (CAPMAS). This factor is included in the econometric model used by EEA for electricity demand forecast. I 2.3.4 The Rate of Electricity Penetration: This is the rate at which electricity displaces other I I | commercial fuels, e.g. when people replace fossil fuel by electric heaters. Also, this factor is included in the econometric models used by EEA for electricity demand forecast. Historical annual appliance production data from I I the CAPMAS Statistical Year Book are used, along with the newly developed customer account information, to project the I ! average future consumption per customer. Population Growth (in millions) Population Growth In Egypt (in millions) (1960-2006) 80 70 60 50 40 30 20 1960 1966 1976 1986 1991 1996 2001 2006 Year Figure (2.5) £ 35 2.3.5 The Increase in Access to Electricity: For Egypt, a rural electrification policy was adopted in 197 6, and by the year 1990 electricity was provided to a total of 5372 villages which represent 100 per cent of the total rural area in the country {Ministry of Electricity, achievement report, 1990) . In the future, no major rural electrification expansion is expected to take place. In other words, historical data that include increase in electricity consumption due to past expansion in rural areas will not reflect future demand adequately. At present, market saturation in rural and urban areas is apparent. The rate of increase of electricity consumption will not be affected by this factor. 2.3.6 The Extent to Which Electricity Consumption Approaches Saturation Point: Countries with high electricity consumption, e.g. the U.S., Japan, Norway, and Australia- had higher rates of growth in the 1960's, followed by a moderate growth in the 1970's and stagnation in the 1980's. These countries have reached their saturation point in electricity consumption and are expected to have only slight growth in per capita consumption of electricity (the Economist Intelligence Unit, 1989) . Electricity consumption in Egypt has not reached this saturation level that would result in slower growth in 36 electricity use. Electricity consumption is expected to i i continue to experience growth rates that are not affected by saturation. I 1 2.4 Comments on Demand Forecast: Some of the factors that affect growth in electricity consumption are included in the econometeric models used to I project demand of electricity in Egypt. For instance, GDP, ■ rate of population growth, and the rate of electricity , penetration are represented in the model used or in the historical data in the past. On the other hand, some important factors that affect demand are not included in the econometric model, or the past consumption trends, and should be included so that the model would better reflect future demand. For instance, the developed models do not include the expected changes in electricity prices as an explanatory variable to the ; dependent variable,i.e. sales of electricity. In addition, j historical data that include an increase in electricity consumption due to past expansion in rural areas will not reflect future demand adequately, j Consequently, the forecasted demand has been over- i estimated. This is because not all the factors which affect consumption are adequately represented in the econometric model used to forecast demand of electricity in Egypt. Chapter Three The Economic Analysis of World Bank Electricity Projects in Egypt To assess the economic viability of the World Bank projects from the point of view of the entire economy, consultant firms, e.g. Stone and Webster, follow the guidelines for project appraisal using cost-benefit analysis recommended by the World Bank and USAID. The investment criterion used in project appraisal is the Internal Rate of Return (IRR) . This IRR is defined as the rate of return which results in a zero net present value of the net benefit stream. It is that rate of return that equates the discounted costs to the discounted benefits and is obtained by the solution of the following equation: Net Present Value (NPV) = st=n (Bt - Ct )/(l +lRR)t = 0 t = 0 where: Bc = Total benefits from the project pertaining to each year Ct = Total costs of the project. These include: capital outlays, labor, materials, energy and transportation costs, and maintenance and repair expenditures. n equals life time of the project, t equals time period The advantage of the internal rate of. return lies in the fact that it can be calculated on the basis of project data alone, i.e. benefits and costs. 3.1 Methodology: The methodology used for conducting economic analysis for electricity projects in Egypt is based on the following i procedures (Stone and Webster, 1989) : I 1- Benefits from a project are calculated as the net amount of electricity delivered to final users multiplied by its price. 2- Costs are taken from the estimates of projects displaced by year according to the estimated disbursement I schedules. For electricity projects, costs include plant capital, transmission capital, fuel, building and construction, labor, and maintenance cost. ! 3- Terminal or salvage values are considered as credits in the year of the time stream based on the length of the time period of the economic analysis. 4- Costs are subtracted from benefits in each year and a ' net benefit stream is calculated. 5- The resulting rate of return, IRR, is compared to the appropriate discount rate which is the economic opportunity cost of public funds. For Little and Mirrlees, this is the social discount rate, and is defined as the rate at which future consumption ought to 39 be discounted to make it the equivalent, in value of present consumption (Little and Mirlees, 1974) . For 1 Jenkins, this is defined as the discount rate used to I j reflect the value of consumption and investment that is j postponed due to the expansion of the public sector ' I project (Jenkins, 1990) . I 1 6- Sensitivity analyses are conducted to analyze the impact : i ' on the basic result of major uncertainties inherent in project appraisal, for example, the impact of the change ! in exchange rate on the IRR. i I i | All the above costs and benefits are adjusted for economic concepts, by using shadow prices which differ from prices ' l ; observed in the market because of non-competitive behavior, ( I externalities, and distortions introduced by government policy. The shadow price of a given resource is to be determined by the change in economic welfare which occurs as j a result of withdrawing one unit of a good from its existing i employment. 3.2 Economic Internal Rate of Return (EIRR): I t When we adjust cost and benefits to shadow prices in the above mentioned equation we obtain the Economic Internal Rate of Return (EIRR) of the project under investigation. It i i ! is that rate of return for a project that equates the ' discounted costs to the discounted benefits after adjusting prices to reflect the change in economic welfare which occurs as a result of withdrawing or adding one unit of the good from its existing employment in the economy. The economic internal rate of return (EIRR) is a j I product of cost-benefit analysis, designed to measure the i contribution of the investment to the national economy as a whole. Although it is an important indicator of the • I performance of a project, there are some aspects which it l ; does not illuminate. These include the contribution of the ! project to the welfare of particular groups, institution development, and the sustainability of the project in the j long run. Obviously, the economic analysis is based mainly on the estimated values of all costs and benefits. But costs and ’ benefits are based mainly on the estimated values of: the i discount rate, shadow prices, and the exchange rate. For j better evaluation of any project, we need to be sure that ; all calculations are based on appropriate estimations of j these key parameters. I 3.3 The Discount Rate as a Key Parameter in j Economic Analysis: ! The discount rate is a key parameter in the economic ( analysis of development projects. It is a yardstick by which ! 1 ! we measure and compare the economic viability of a project. . We accept or reject a public sector project if its calculated investment criterion (EIRR) is above or below the discount rate which reflects the opportunity cost of public j funds. It is an important indicator which has an influence on decision makers when allocating resources for economic development planning. It plays a powerful role in deciding ;which kinds of investment look best. For instance, the i I decision whether to have nuclear or conventional energy to j generate electricity is sensitive to the discount rate. The i i i former decision uses more capital initially, but saves costs later. Therefore, it requires a relatively low discount rate i to look better than the latter. I There is more than one approach to determine the ! discount rate to be used in economic cost-benefit analysis. | The basic alternative approaches employed to determine the I discount rate reflecting the economic opportunity cost of public funds are as follows: I 3.3.1 Hirshleifer’s Approach: Proponents of this approach argue that public sector i j projects should be discounted by a rate equal to the marginal productivity of capital in the private sector (Hirshleifer, 1960; DeHaven and Miliman, 1960; Baumal, 1968; I and Nicholas, 1969) . The rationale for this choice is based on efficiency grounds, that if the government wants to maximize the country's output, then it should always invest . in the projects which have the highest return. If private 42 | sector projects have a higher expected economic return, then the government should see to it that funds are invested in i the private rather than public projects. ; This approach assumes that if additional funds are invested in the public sector, then no change or movement of I t resources will take place between private investment and I consumption. This approach has a weakness in that it does i I not allow for adjustment m the allocation of funds that ; ] will take place in a reasonably well functioning capital i | market. For instance, Jenkins argues that if people from I their perspective have already allocated their funds between \ investment and consumption optimally, then if the government I is to put more resources into investment we should expect some displacement into consumption (Jenkins, 1991). Allowing , for this displacement effect, the private sector alternative ' return to the public sector investment is not the marginal l ■ | productivity of private investment, but is some mix of the , gross return from private investment and private consumption. : i 3.3.2 Little and Mirrlees' Approach: This approach was first developed by Little and Mirrlees, later refined by Squire and Van der Tak, and is ! currently used in project appraisal of electricity projects ' j in Egypt (Stone and Webster, 1989) . Little and Mirrlees have I j recommended the use of an accounting rate of interest. Their accounting rate of interest (ARI) is the estimated marginal return from public sector projects given the fixed amount of investment funds available to the government (Little and I Mirrlees, 1974) . | In the economic analysis of electricity projects in Egypt, an economic rate of interest of 6 per cent is used, ; as an opportunity cost of public funds, to evaluate the j cost-benefit analysis of projects (Stone and Webster, 1989). This rate is based on Page's report that was developed in 1982, "Shadow Prices for Trade Strategy and Investment j Planning in Egypt" (The World Bank Staff Report, 1982). However, currently, the commercial Bank's interest rate in Egypt exceeds 22 per cent and government bonds yield 19 per ' i i cent annually. In estimating the economic opportunity cost | of public funds, Page followed Little and Mirrlees and Van der Tak and Squire's approach. According to Page: I The marginal product of capital is the net return earned by a marginal unit of public investment when all inputs are valued at border prices. Thus it represents the marginal rate of transformation between present and future foreign exchange; its value reflects both the past history of investment projects within the economy and the likely return to new investments (Page, 1982). So, for Little, Mirrlees, and Page, the accounting rate ofj interest (ARI), which reflects the opportunity cost of public> funds, is essentially a rationing device. It acts to ensure that the best public sector projects are recommended within those funds available in this sector.If more projects look acceptable than the available investable funds, the accounting I i j rate of interest should be adjusted upwards. Also, if too few i projects look promising, the adjustment should go the other way (Little and Mirrlees, 1974). I I Although the methodology employed in the economic analysis of electricity projects (cost-benefit analysis using shadow 1 I prices that was developed by Little and Mirrlees), is an i | appropriate technique for project evaluation, the approach used in estimating the economic opportunity cost of public i funds and shadow prices has some shortcomings. For instance, . ! in estimating the opportunity cost of public funds, the ; I approach only considers the marginal return from public sector projects and neglects the possibility that if public sector i projects are not undertaken then more resources will be; available for allocation among private sector investment and; consumption activities. For Jenkins, seldom, if ever, can the government isolate its investment and current expenditure activities from having an impact on their private sector| j counterparts (Jenkins, 1988). , In Egypt, capital resources are scarce. If the government allocates more funds to public sector investments, the growth of the private sector over the long run will tend to be; 1 slower. Use of a discount rate, which is determined only by' ; the marginal productivity of public sector projects, may lead to the acceptance of projects in a year in which government funds are available which will yield a lower economic return j I : than what Egypt would gain by simply paying some of its debt. ' Harberger's approach in estimating the discount rate is more ■ comprehensive compared to Little's approach, as will be , i ! 1 discussed below. i i 3.3.3 Harberger's Approach: i Harberger argues that the economic cost of government expenditures, simply stated, is the value of production in ! terms of consumption and investment that are postponed by the ! private sector due to the expansion of the government sector, i i plus the cost of additional foreign borrowing which arises because of the expansion of the public sector (Harberger and j Jenkins, 1991) . I The above approach is characterized by a broader view of j I ! the effect of an expansion of the public sector on the rest of I the economy. For example, it does not neglect the impact of i government spending on the private sector. For Jenkins: ; The basic principle which must be fol lowed to ensure that government investment expenditures do not ultimately retard the , level of the country's economic output is that these public investments must produce j a rate of return at least equal to the ! economic output which is now postponed by the other sectors, plus the cost of any ! funds borrowed to finance the public expen- I ditures (Jenkins, 1991). ; 46 As in the estimation of the supply price of .any other good or service, the marginal economic opportunity cost must be i based on the highest cost source of supply which can be i 1 expanded to meet an incremental demand. Currently, the i government of Egypt obtains some of its funds to finance its I budget deficit from the capital market by issuing bonds at a rate of 19 per cent. In supply of funds to the public i I isector projects, e.g. electricity projects, the capital 1 market represents the most common source of incremental funds. i To estimate the economic opportunity cost of public funds, we begin, as shown in the figure (3.1) below, with a j situation where the market rate of interest is i0 , and the :quantity of funds demanded and supplied in the capital | market for equilibrium is Q°. If the government now borrows i an amount equal to G, this causes the economy's total demand for investable funds to shift from I-I to I+G-I+G. The demand for funds by the government will cause market interest rates to increase from iQ to ix , thus inducing I people to save more (postpone consumption) by an amount equals Q° Qs. At the same time, the higher market interest rate will cause people to postpone investments by an amount i I ; Q° Q1. The economic cost of postponing consumption is equal i to the area Q°ABQS, which is the return savers receive from i j their increased savings. This is the area under the S-S j curve and between Q° and Qs. On the other hand, postponed investment has a total economic opportunity, cost which is measured by the area under the I+T-I+T curve and between Q° and Q1. This equals the area Q^CDQ0. It includes the return given up by the private owners of the investments. For Harberger, the economic opportunity cost of capital (ie) can be defined as: ie = (r*es - i*ej *R)/(es - et *R) where: es is the elasticity of supply of private sector saving with respect to changes in the rate of interest rate. e* is the elasticity of demand for private-sector investment with respect to changes in the interest rate. R is the ratio of total private-sector investment to total saving. r is the rate of return received from saving net of income taxes. I is the rate of return on investment. Interest Rate (in %) Figure (3.1) Quantity of Investments and Saving Q1 Q° Qs Opportunity Cost of Public Funds 00 49 4.5.3.4 Changes in Interest Rate in Egypt: Table (3.1) and figure (3.2) indicate the changes in interest rate in Egypt from 1960 to 1992. Table (3.1) Development of Interest Rates in Egypt (1960 - 1992) (in per cent) Y e a r 6 1 6 3 6 5 6 7 6 9 7 1 7 3 7 6 7 7 L e n d i n g R a t e ( % ) 8 CO 00 D i s c o u n t R a t e ( % ) 3 5 5 5 5 5 5 6 7 D e p o s i t R a t e ( % ) 3 4 . 7 Y e a r 7 9 8 1 8 3 8 5 8 7 8 9 9 0 9 1 9 2 L e n d i n g R a t e % 1 2 1 5 1 5 1 5 1 6 . 3 1 8 . 3 1 9 2 2 2 2 D i s c o u n t R a t e ( % ) 9 1 2 1 3 1 3 1 3 1 4 1 4 . D e p o s i t R a t e ( % ) 7 1 0 1 1 1 1 1 1 1 1 . 7 1 2 1 4 1 4 Sources: - International Financial Statistics Yearbook, 1991. According to the IMF stand-by agreement, Egypt has to increase the interest rate over the next few years in order to curb inflation. Therefore, we do not expect low interest rates for the coming years. It is my expectation that the j I current high interest rate will continue for the next three to five years. Interest Rate (in Development of Interest Rate in Egypt (1960-1992) (in %) 2 0 t 18 - 2 - 0 - T- CM V CD 00 o CM V C O CO o CM V C D C O CO CD CD CD CD N- h - N. C O CO CO CO C O CD cn cn cn c n cn <n cn c n cn c n cn cn cn c n Y * “ T— i— Y“ i— T— Y “ T“ * T“ Y™ Y“ 1 — i— Y“ i — Year Discount Rate ( % ) ----------------- Deposit Rate (%) Lending Rate (%) Figure (3.2) c n o 1990 51 Also, in my opinion, it is preferable to use Harberger's approach for estimating the opportunity cost of public funds to evaluate electricity projects in Egypt, and for develop ment projects in general. For instance, we can roughly estimate the discount rate in Egypt by considering the I following: I = 22 per cent, interest charged by commercialJ bank for private investments, r= 14 per cent, net return on saving after tax, es = .3, elasticity of supply of private sector (based on similar cases, Harberger, 1991), et = -1, R = .9, ratio of private-sector investment to total saving. Therefore, the economic opportunity cost of public funds| I (ie) equals: ie = (.14*.3 - [-1]*.22*.9)/( .3 - [-1]*.9) = 20 per cent However, in the economic analysis of electricity projects in Egypt, a 6 per cent discount rate is used to justify thej economic viability of electricity projects that will be I i implemented in the 1990's. This rate differs from the j i estimated 20 per cent, which is a more realistic estimation of the discount rate for public sector projects in Egypt at present. In fact, there is there more than one reason that brought about this difference in estimating the discount rate. First, the discount rate used in the economic analysis of electricity projects in Egypt was based on Little and Mirrlees' approach which is characterized by not having a 52 broader view of the effect of expansion of the public sector projects on the rest of the economy. Second, using 6 per cent as a discount rate is based on Page's report that was developed in 1982 and based on data from the year 1979 (values of commodities and factors of production in terms of 1979 "border Egyptian pounds", Page, 1982). According to Page, it is not appropriate to use his estimates for ; projects after the year 1985. It is stated clearly in the abstract of his report: This paper presents estimates of efficiency and social accounting prices for commodities and factors of production in Egypt which are appropriate for the period 1979-1985 (Page, 1982). , I I 1 Third, for any consultant firm, there is a need to justify I i the effort and time spent in conducting any feasibility study. Indeed, there is a need to justify the worthiness of spending a few years and a two digit figure of millions of dollars on conducting a feasibility study for electricity projects in Egypt. In order to implement any project, there is a need to justify that the project is not only technical- * ly and financially feasible, but also economically feasible. Usually, a consultant firm is an Engineering consultant group, who know well how to conduct the technical aspect of a feasibility study. In addition, technical data is usually ! available, and specifications are standardized and well documented. On the other hand, when it comes to the economic 53 analysis, there is controversy on different economic issues as well as a shortage of updated data on the key economic parameters. For instance, what approach should a consultant firm pursues in estimating a discount rate? And what shadow prices should they apply? Moreover, for any consultant group, there is need to justify the project in order to be implemented in the future and to continue working in the implementation of the project. Needless to say there is a j i motive for a consultant firm to justify the implementation j of any project in which it conducted a feasibility study, j j Naturally, there is a good chance to continue working on the ; ! project and get a piece of the huge cake, which in the case of the El-Kuriemat project, has a value that exceeds 1,300 million dollars. So, it is a mix of different factors that brought about this divergence in the estimated discount rate. These include the application of different economic perspectives and approaches, using non-updated data, and the influence of self-interest motives. 3.4 The Exchange Rate as a Key Parameter in Economic Analysis: For Egypt, as a developing country, foreign currency is a scarce resource. Any analysis of the real cost of a development project requires a knowledge of the strength of the scarcities which not only operate in the Egyptian 54 economy, but also will operate in the future. Therefore, we need to an appropriate estimate of exchange rates in order to evaluate a development project adequately and to estimate j [ I its internal rate of return. In addition, most importantly, future exchange rates need to be predicted, in order to be used for the estimation of those costs and benefits which occur in the future. The relative scarcity of domestic and foreign resources in Egypt may change during the life time of the project, thus leading to a change in the exchange rate.It is customary that the implementation of an electric ity project takes more than four years and its life time may exceed twenty years. Needless to say, an exchange rate is a key parameter in development planning. 3.4.1 Development in Exchange Rates in Egypt: For more than two decades, until early 1990, Egypt had operated a multiple exchange rate system that allowed the Egyptian pound to remain significantly overvalued. Conse quently, the exchange rate did not reflect its real scarcity value in transactions across all sectors of the Egyptian I economy. The following shows how Egypt has had a multiple exchange rate: 55 The Central Bank Pool; j i This pool has rates for official purchases and dedicated ! export proceeds set at levels which subsidized key imports. The pool handed exports of petroleum, cotton, and rice, Suez Canal dues, imports of essential foodstuff, insecticides and fertilizers, and most public sector capital transactions. The Commercial Bank Pool: With rates set by a bank committee, the pool received proceeds of worker remittances, tourism, and exports not going through the Central Bank pool. I The Free Market Pool: This is a quasi-legal parallel market, formally illegal , but officially tolerated, and often subjected to government pressure. This pool shares common sources of supply with I the commercial bank pool {worker remittance and tourism) and satisfies demand by the private sector for exchange for visible and invisible transactions. Table (3.2) and figure (3.3) indicate the development in the multiple exchange rate in Egypt during the period from 1982 to 1992. Transactions in the Central Bank pool were j mainly at the official rate of L.E. 0.7 per dollar. 56 Table (3.2) Changes in Exchange Rate in Egypt (1982 - 1992) (L.'E. per dollar) Pool 1982 1983 1984 1985 1986 1987 Central Bank .7 .7 .7 .7 .7 .7 Commercial Bank (%) .82 1.15 1.2 1.3 1.4 1.5 Free Market (%) 1.1 1.16 1.25 1.5 1.9 2 .27 New Bank Rate (%) - - - - - 2.3 Pool 1988 1989 1990 1991 1992 Central Bank .7 .7 .7 Commercial Bank (%) 2.2 - - - - Free Market (%) 2.35 2.7 3 .19 3 .33 3.36 New Bank Rate (%) 2.3 2.3 3 .18 3.2 3.3 . Sources: - Recent Economic Development in Egypt, IMF Staff Report, 1988. - International Financial Statistics Yearbook, 1991. - Foreign Trends and Their Implications for The United States, The U.S. Embassy, Cairo, 19 91. A new bank foreign exchange market, in which all autho rized commercial banks were permitted to operate, began J ! operations on May 11, 1987. This new market was established | in order to prevent multiple applications for foreign j exchange rates in Egypt as one of the requirements of the IMF stand-by agreement, which centered on both the issues of flexibility and unification of the exchange rate. From May 1987, the exchange rate in the commercial bank pool was Exchange Rate (in Figure (3.3) Development of Exchange Rate in Egypt (in L.E./$) 3.5 5 3 w J 2.5 + 2 1.5 + 1 / 0.5 0 + 1982 1983 1984 1985 1986 1987 Year + 1988 1989 1990 1991 1992 Central B. Pool Commercial B. Free Market New Bank Rate Pool Rate adjusted several times a month by reference to a formula that was initially intended to bring the rate to level of the new bank market rate by end-June 1988. The commercial j bank pool was closed in March 1988. { 4.5.4.2 Exchange Rate and the World Bank-financed Projects: As table (3.3) indicates, a substantial amount of the total cost of the World Bank-financed projects was incurred in foreign currency. Table (3.3) Foreign Currency in World Bank Projects in Egypt (in millions of dollars) Proj ect Foreign Currency Local Currency Total Kuriemat Project % 1,113 .433 81.6 % 255.587 18.4 % 1,386.120 100 % Fourth Power Project % 695.7 82 % 152 .8 18 % 848 .5 100 % Demietta Project % 390.1 84 % 73.7 16 % 463 .8 100 % Mohmoudia Project % 92 .2 77 % 28.3 23 % 120.5 100 % Transmission Project % 78.5 75 % 25.6 25 % 104.1 100 % Technical Assistant % 28 85 % 4.9 15 % 32.9 100 % Total % 2397.83 81.5 % 540.88 18.5 % 2955.92 100 % S our cesr - El Kuriemat Staff Appraisal Report, Aide-Memoir, 1991. - Fourth Project Staff Appraisal Report, 1989. - Third Project Staff Appraisal Report, 1980. 59 l Therefore, an accurate estimation of economic exchange j rate would have a significant impact on project economic analysis. This impact would be further amplified because a large part of the local component of the total cost, although spent in Egypt, would draw down the country's foreign reserve. For instance, the use of construction fuel j i is a local expense but reduces the amount of petroleum j I i available for export. 1 i Therefore, for a World Bank-financed project, one cannot | make a sensible judgement and an adequate economic analysis, specially, for the internal rate of return, without knowing j i the price of the exchange rate and taking into consideration j the likely future change in its value. Indeed, it would be j wrong to use the existing price as a measure of scarcity throughout the life of the project, especially in the case of an electricity project with an estimated life time that exceeds twenty years. For example, Israel is said to have used a shadow rate of exchange in project analysis because \ the reasonable expectation was that foreign exchange would get scarce (little and Mirrllees, 1974, and Bruno, 1967). However, as table (3.4) indicates, the estimation of the exchange rate by World Bank staff appraisal reports does not t reflect the real cost of the scarce resource drawn down from 1 i the Egyptian economy and allocated to electricity projects financed by the World Bank. This occurred for more than one reason. First, for the Third Power project, an exchange rate 60 of .7 L.E. per dollar was based in the year 1980 on the subsidized official rate of the Central Bank pool as indicated in table (3.3). Second, for the Fourth Power project, an exchange rate of L.E 2.4 per dollar was based on the estimated average exchange rate in year 1988 to estimate input costs to a project that would be implemented in the period from 1990 to 1984. Similarly, for The Kuriemat project, an exchange rate of 2.3 L.E. per dollar was estimated in 1989 by a consultant firm, Stone and Webster, and an exchange rate of 3.3 L.E. j per US dollar was estimated in 1991 by the World Bank staff. | I Both estimates reflect input costs to a project that will be | implemented in the period from 1992 to 1996. In all cases, j for both the World Bank and the consultant firm, there is a I i need to justify the project economically in order that the j i project may be implemented. I 61 Table (3*4 ) Exchange Rate Estimation During Appraisal and Implementation of World Bank Projects (L.E.per dollar) P r o j e c t A p p r a i s a l D a t e E x . R a t e f o r A p p r a i L . E . / $ I m p l e m e n t D a t e E x . R a t e f o r I m p l . L . E . / $ E l K u r i e m a t C o n s . f i r m W . B . S t a f f M a y 1 9 8 9 S e p . 1 9 9 1 3 . 3 3 2 . 3 1 9 9 2 - 1 9 9 6 3 . 7 5 * F o u r t h P r o j e c t - W . B . S t a f f M a y 1 9 8 9 2 . 4 1 9 8 9 - 1 9 9 4 3 . 3 T h i r d P r o j e c t - W . B . S t a f f J u n e 1 9 8 0 0 . 7 1 9 8 1 - 1 9 8 5 1 . 4 * A Rough Estimate Sources: - The World Bank, Staff Appraisal Report, El Kuriemat Project, 1991 - El Kuriemat Feasibility Study Final Report, Stone and Webestr, 1989. - The World Bank, Fourth Power Project Staff Appraisal Report, 1989. - The World Bank, Third Power Project Staff Appraisal Report, 1980. 4.5 . 4 . 3 The Exchange Rate and The Economic Internal Rate of Return (EIRR); To examine the sensitivity of EIRR to the exchange rate, it would be better to begin with the formula which is used to estimate of its value. Next, we break down this formula to find the impact of changing the exchange rate on each of them. As mentioned above, the EIRR is the rate of return for a project that equates the discounted costs to the discount ed benefits after adjusting prices to reflect the change in 62 economic welfare which occurs as result of withdrawing or adding one unit of the good from its existing employment in the economy. The following is the equation to determine the EIRR of a project: Net Present Value (NPV) = (Bt - Ct )/(l +EIRR)= 0 t=o Where (Bt) represents the benefits from the project calculated as the net amount of electricity delivered to the final users multiplied by the shadow price of electricity in order to be adjusted to reflect its economic value. (Ct) represents costs, which can be broken down into three main categories as follows: Capital Costs: This is the initial investment on the power plant, which equals to 1.332 billion dollars in case of the Kuriemat project. In this category foreign currency, as table (3.3) indicates, represents 80 per cent of the total investments. Fuel Costs: This component represents a substantial proportion of total project costs. Although fuel is produced domestically in Egypt, it is a tradable good and its costs should be estimated as its opportunity cost in the international market. .... 63 In other words, the total cost of fuel is considered as foreign currency expenditures. Operations and Maintenance Costs: These costs include: spare parts, labor, and adminis tration expenses. The foreign currency represents 61.5 per cent of the total operations and maintenance costs and represents 75.4 per cent of the total costs when we add fuel costs to 0 & M costs (Stone and Webster, 1989). The EIRR is extremely sensitive to change in the costs of 1 I tradable inputs, i.e. fuel, spare parts for operations and maintenance, and capital costs. Table (3.5) and figure (3.4) indicates the effects of changes in the exchange rate on (EIRR) for the Kuriemat project. The graph shows that using the current exchange rate, which is one dollar =3.33 L.E., the Kuriemat project yields an EIRR of 4 per cent, which is, according to my estimates far below the opportuni ty cost of public funds. Table (3.5) The Effect of Changes in the Exchange Rate j (L.E. per dollar) on EIRR (in per cent) ! Exchange Rate L.E.per dollar 2 2.3 2 .75 3 3.3 3.5 EIRR % 16 12 .16 8.712 4 . 016 4.016 2 .71 EIRR (in% Economic internal Rate of Return (EIRR) (in %) and Exchange Rate (in L.E./$) 14 Estimated Yield r 12 10 8 6 Actual Yield 4 . ^ _ !_. Estimated Rate Current Rate 0 2 2.75 2.3 3 3.3 3.5 Excchange Rate (L.E./$) Figure (3.4) cn I | 3.5 Shadow Prices as a Key Parameter in Economic 1 ; Analysis: I I In Egypt, as a development country, government policy i introduces externalities, non-competitive behavior, and j distortions in the prices observed in the market. These ' factors bring about a divergence between market and shadow prices, i.e. the real costs to society. For this reason, i prices observed in the market may provide an inadequate guide for investment development planning and project [ appraisal. Therefore, there is a need for a consistent set ' of prices which reflect the resource costs for a development j project. The shadow prices used in World Bank-financed project ) appraisal are based on a report prepared by John Page, Jr. | "Shadow Prices For Trade Strategy and Development Planning j In Egypt", a World Bank Staff Working Paper no.52. This [ paper was published in 1982 and, as stated earlier in its abstract, presents estimates of efficiency prices for i 1 commodities and factors of production in Egypt which were | appropriate for the period 1979-1985. Therefore, Page's | report is not appropriate for providing an adequate guide I I for project appraisal which may implemented in 1990's. ► j However, the basic principles involved should play an ; integral role in sound project appraisal. 66 3.5.1 Methodology Used by Page to Estimate Shadow Prices in Egypt: Page expresses the shadow prices of any commodity or factor j of production used as an input to a project in terms of a j unit of account which is uncommitted foreign exchange in the hands of the Egyptian government. His assumption is that the social value of commodities is equal to the value at i international prices of delivering them to a representative i ! project. t j For tradable goods, this consists of the world price of i I the commodity plus the value at international prices of the ■ port charges, transportation and handling required to ! ; deliver it to the user. In order to find the equivalent value at international prices of non-tradable, he decomposes costs of production i into tradable inputs, non-tradable inputs and primary | inputs, for example, labor and foreign exchange. Further, he I \ breaks down the non-tradable inputs into their traded, non traded, and primary input cost components. By moving through | several rounds of analysis in this fashion, he reduces the social cost of any commodity to its cost in terms of tradable commodities (foreign exchange) and primary inputs, j This is simply an application of input-out analysis. The I J shadow price of the commodity is then given by the sum of I the shadow value of traded inputs plus the shadow value of I the primary inputs. 3.6 Conclusion on the Economic Analysis: As we have seen from the above analysis, interest rates, exchange rates, and shadow prices are key parameters in economic analysis for a development project. For better j project evaluation of any development project in Egypt, we i need to institute a wide-ranging system of economic prices | ! that reflect the real cost and benefits to society or the j I economy as whole. This system would include economic prices of interest rates, exchange rates, and of major inputs of a development project, e.g., labor, electricity, transporta tion, water.etc. This would not be a simple system and would give rise to quite serious administrative problems and complications. It is these problems which necessitate the institution of an organization whose more limited functions may be adequately exercised under the supervision of another ministry, e.g. the Ministry of Administrative Development or the Ministry of Economy. This proposed organization or team 1 of project evaluators would be the body which would consult j closely with the government of Egypt not only in setting ! economic prices, but also in the choice and selection of the j large development projects, specially those which are I financed by an international organization, e.g., The World 1 Bank or the United States Agency for International Develop ment (USAID) . It would have an important role in determining the policy instruments, the accurate interest rate, exchange rate, shadow prices, and, most importantly, where Egypt should invest in development. Needless to say, it would be i time consuming and inefficient if the appraisal team for t | every project would calculate shadow prices and economic prices for every input of a development project. The organization should establish conversion factors, the factors by which an actual market price is multiplied to give the economic price. It should do this for the main non- I | traded goods and services which are used in almost all I i projects. | Chapter Four i ; Institutional Analysis i I 4.1 Introduction; ! i Of all the aspects of a project, institution building I j and development is perhaps the most difficult to achieve. Mainly, this is because its success depends so much on understanding the cultural environment, and in part on many actions that are within the control of the government and managers. Of seven hundreds World Bank projects reviewed in the late 1980's, only one-third were judged to have substan tially attained the institutional objective of strengthening project-related organizations and agencies (The World Economic Outlook, October, 1991). I ! Obviously, it is easy to ship from the United States to Egypt modern electrical equipments for a power station. However, it is much more difficult to develop and build a j within the power plant a viable and sustainable institution i that is equipped with well developed staff who understand | how to interact with their cultural environment. For Baum: ) ! Institutional building means that the 1 transfer of financial resources and the I construction of physical facilities, howev- ] er valuable in their own right, are less 1 important in the long run than the creation 1 of a sound and viable local "institution", interpreted in its broadest sense to cover I not only the borrowing entity itself, its organization, management, staffing, poli- 70 cies, and procedures, but also the whole array of government policies that condi tions the environment in which the institu tion operates (Baum, 1982). Institutional development should be the new theme of the World Bank projects. The data show that productivity of investments is much higher when the project's institutional development objectives are achieved. Concern for institu tional development as the 1 1 Software" elements of World Bank- financed projects should be increased relative to the concern for "Hardware" elements of projects, which are equipment and physical facilities. 4.2 The Basic Objectives of Institutional Development: The institutional development component in a development project can be thought of as a combination of objectives and elements or tasks in support of the objectives, which are implemented through a range of instruments. The basic objec tives of institutional development are as follows (Samuel, 1990) : 1- To facilitate the project implementation process. 2- To contribute to the sustainability of project benefits (the continuation of benefits beyond the project period). In fact, sustainability, as specified in the articles of the Bret ton Woods agreement, is "to make investment of lasting productive value" 3- To support the development of electricity sector institutions and the linkages among them. I j I Clearly, the first objective has a short-term focus and, i j usually, it is covered in the World Bank electricity | projects in Egypt. This includes consultancy services and the other technical assistance activities that facilitate j project implementation. The second and the third objectives j go beyond project implementation. For electricity projects, these include: better techniques of management, personnel development, management information systems development, adequate accounting procedures, and load management. The mix of elements included in an institutional development component will vary depending on the relative importance i I | given to these objectives in a development project sponsored i | by the World Bank. Needless to say, the scope of mstitu- | tional development will be wider when all the three objec tives are pursued in a balanced way than when it is confined to any one of them, usually the first objective. Institu tional development elements and instruments constitute the i j core of the design of the institution development component. I For the World Bank projects this mix of elements in an 1 | institutional development component is not balanced. This i j mix is designed to further the first objective at the expense of the others. The mix used is dominated by elements 72 that strengthen project implementation and neglect the long term capacity of sector level incentives framework, e.g. compensation, personnel development, and system development. 4.3 The World Bank and Institutional Development in Electricity Project: Since 1977, the World Bank group has been involved in seven operations in Egypt's electricity sector. These operations include: 1- In fiscal year 1977, Regional Electrification, Loan no. 1453-EGT. 2- In fiscal year 1979, Power project II, Shoubra El- Kheima power plant, Loan no. 1733-EGT, credit no. 935-EGT, and special action credit no.20-EGT. 3- In fiscal year 1980, Power project III, Loan no. 1886-EGT, and Credit no.l052-EGT. 4- In fiscal year 1984, Power supplement project, Loan no.1886-1-EGT. 5- in fiscal year 1986, Vocational Training Project, Loan no.2594-EGT. 6- In fiscal year 1989, The Fourth Power Project, Loan no.6641- EGT. 7- In fiscal year 1991, El-Kuriemat Project, Despite the importance and the critical role of the Bank in "institutional development", to date, the Bank has not put enough emphasis and effort for institutional development into the electricity sector in Egypt. Unfortunately, as table (4.1) indicates, the Bank puts more emphasis on transferring financial resources and constructing physical facilities in the electricity sector and less effort and resources on institutional development in this vital sector in Egypt. For example, data from the World Bank Staff Appraisal reports, as table (4.1) indicates, show that for projects whose investment exceeded two billions dollars, the Bank has allocated only an amount of 30 millions for human resources development. For systems development, such as data bank and management information system, the World Bank has allocated only 5.5 million dollars. For consultancy expendi tures, that go to foreign expatriates, the World Bank has allocated an amount of 123 million dollars. This means that the World Bank has allocated only 1.3 per cent, 0.2 per cent, and 4.3 per cent of project investment in human resources, system development, and consultancy services respectively, while the rest, which is 84 per cent, goes to physical facilities and equipments. Table (4.1) Project Investment on Training, System Development, and Equipment (in millions of dollars) P r o j e c t E q u i p . C o n s u l . S e r v i c e s T r a i n i n g S y s t e m D e v e l o p . T o t a l I - E l K u r i e m a t * P o w e r S t . ♦ P i p e l i n e - T r a n s m i s . - T e c h . A s s . S u b t o t a l 1 , 0 2 4 5 1 . 7 1 0 3 . 9 1 , 1 7 9 . 6 4 3 . 3 8 6 . 7 4 4 . 4 4 1 , 2 3 4 I I - F o u r t h P . - D e m i a t t a - M o h m o u d i a - T . L i n e s - T e c h . A s s . S u b t o t a l 4 6 3 . 8 1 2 0 . 4 1 0 4 . 2 6 8 8 . 4 2 9 3 . 5 1 7 2 1 . 9 I l l - T h i r d P . - A s w a n I I - S h o u b r a I I I - D i s t r i b . S u b t o t a l 1 8 0 2 7 6 8 4 5 4 0 2 0 7 . 8 6 . 7 3 4 . 5 5 7 4 . 5 V - V o c a t . T r a i n i n g 1 9 . 3 1 9 . 3 T o t a l % 2 , 4 0 8 9 4 % 1 0 6 . 9 4 . 2 % 2 9 . 5 4 1 . 1 6 % 5 . 4 4 0 . 2 % 2 , 5 4 9 1 0 0 % Sources: - The World Bank Project, Appraisal Mission, Aide- Memoir, July 2-28, 1991. - The World Bank, Staff Appraisal Report, 1989. - The World Bank, Staff Appraisal Report, 1980. Not only does the World Bank not put enough investment and effort into designing the institutional development component of electricity projects in Egypt, but also it does not pay attention to the inclusion of "institution develop ment" as a specialization within its staff appraisal missions. As tables (4.2) and (4.3) indicate, unlike to 75 other areas of specialization, e.g., financial analysis, economic analysis, and engineering analysis, the specializa tion of institutional development is not represented in the World Bank missions. Table (4.2 ) The World Bank Appraisal Mission Data Shoubrah El Kheima Thermal Power Project A c t i v i t y D a t e # o f D a y s # o f P e r s o n s S p e c i a l i z a t i o n R e p r e s e n t e d I d e n t i f i c a t i o n F e b , 1 9 7 8 1 0 2 - E n g i n e e r i n g - F i n a n c i a l A n l . P r e a p p r a i s a l J u l , 1 9 7 8 1 4 3 - E n g i n e e r i n g - F i n a n c i a l A . - E c o n o m i c A . A p p r a i s a l N o v , 1 9 7 8 2 1 5 - E n g i n e e r i n g - F i n a n c i a l A . ( 2 ) - E c o n o m i c A . ( 2 ) P o s t a p p r a i s a l M a r , 1 9 7 9 1 0 2 Table (4.3) The World Bank Appraisal Mission Data Third Power Project and Power Supplement Project A c t i v i t y D a t e # o f D a y s # o f P e r s o n s S p e c i a l i z a t i o n R e p r e s e n t e d I d e n t i f i c a t i o n J u l , 1 9 7 9 1 6 2 - E n g i n e e r i n g - F i n a n c i a l A . A p p r a i s a l N o v , 1 9 7 9 2 3 5 - E n g i n e e r i n g - F i n a n c i a l A . ( 2 ) - E c o n o m i c A . ( 2 ) P r e - n e g o t i a t i o n M a r , 1 9 8 0 5 3 - E n g i n e e r i n g - F i n a n c i a l A . - E c o n o m i c A . F i n a n c i n g M e e t i n g M a r , 1 9 8 0 2 1 Sources: - The World Bank Project Performance Audit Report for: Shoubra El-Khima Thermal Power Project, Third Power Project, and Power Supplement Project, 1990 . 76 Since the consultant firms are usually engineering and : technical groups, e.g. Stone and Webster Engineering Corporation, and Engineering Consultant Group, the more ! complex sector-wide institutional development design and j analysis are being left to the World Bank staff appraisal j mission. But as Tables (4.2) and (4.3) indicate, the skills I and specialization of the World Bank staff mission are often 1 inadequate to deal with these broader institutional develop- . ment issues because they are usually economists, financial analysts or engineers. Therefore, for The World Bank mission, there is a need i I for staff members who can address the institutional develop ment aspects of the project to join other specialists. ! i I 4.4 The World Bank Strategy: j The Bank's strategy in the power subsector has been | j designed to support the development of a rapidly expanding ' | and modern power system. On the other hand, little has been | done to solve the problems that are facing this subsector. | 4.5 Problems of Institutional Development in i Electricity Projects in Egypt: » Despite the long involvement of the World Bank group in Egypt's electricity sector, to date the sector still faces ! serious institutional problems. 77 j | Ironically, these problems were first pointed out in the ! UNDP power sector survey report in 1976, 15 years ago, by a firm of foreign consultants. In general, the power sector in Egypt is dominated by 1 j a single public utility, the Egyptian Electricity Authority I (EEA) . The EEA is a highly centralized organization with cumbersome authority and little coordination between i t | technical and financial staff, especially in planning ! matters. The staff of EEA includes 33,000 employees but is ; characterized by a shortage of qualified and experienced . staff members for certain functions, such as engineers, ! technicians and accountants. At the same time, the subsector is over staffed by clerical and semi-skilled functions (the World Bank Staff Appraisal Report, 1989). t More specifically, the accounting systems of EEA and electricity Distribution Companies suffer from poor property I accounting; improper accrual of revenues and expenses; unsatisfactory cost and budgetary control; delay in account receivable; and deficient management information systems (The World Bank Staff Appraisal reports, 1989 and 1991). A single visit to any branch or office of the Egyptian f Electricity Distribution Company, e.g. Shoubra, Dokki, or , Maadie, will show how badly the electricity sector needs institutional development. ! 78 4.6 Factors That Adversely Affect the Institutional Development Performance of Electricity Projects in Egypt: 1- Although some institutional development work that has occurred primarily with elements and tasks to achieve the first objective of institutional development mentioned above, i.e., to facilitate the project implementation, much less attention is given to the other institutional development objectives that contribute to the sustainability and the long-term strengthening of the project. For instance, the investment in system development and human resources development is much less than the investment in consultancy services that are designed to facilitate project implementation. 2- Electricity sector institutional development strategies are absent; there is no map or long-term perspective to guide the design of the institutional development component of electricity projects in Egypt. 3- There is a clear mismatch between the complexity of institutional development issues needed to be addressed in the World Bank electricity projects and the operational staff appraisal skills available within the World Bank's mission to deal with such issues. There is a need for specialized staff members who are familiar 79 with institutional development issues to join the World Bank staff appraisal mission. Obviously, for the World Bank staff mission, an intimate knowledge of the institutional and organizational behavior of electrici ty sector is as important as knowledge of physical facts and economic aspects. The former, perhaps even more than the latter, is vital to an appreciation of the constraints on development, and therefore of the sector capacity to make progress and to absorb investment. The continuing focus on project implementation weakens the concern given to sector level institutions and their structure and functions. For instance, out of the seven World Bank operations in Egypt, only one project deals with the sector level institutions, which is the “Vocational Training Project". Even this project addresses only a part of one aspect of institutional development, which is training of technicians, as one component of human development. In fact, none of the other World Bank operations have addressed the institutional problems of the financial department, collection system, and distribution companies. The preoccupation is on project implementation. In part, the success of institutional development depends on actions that are within the control of the Egyptian government and the managers in the electricity 80 sector. For instance, changing the ownership of distri bution companies from the public sector to the private sector, redistribution of authority and responsibility within the Ministry of Electricity, staff continuity, redesign of the ministry functions and interministerial linkages, simplification of the administrative system, the modification of the salary system to be competit ive, and the incentive system, are among the factors that are within the control of the Egyptian government. Also, part of the success of institutional development depends on and is influenced by some political factors. For instance, the introduction and implementation of a pricing policy that would ensure financial viability of the electricity project in Egypt is a political issue rather than a technical one because its implementation requires a reduction or elimination of subsidies which have an impact on the vast majority of the Egyptian people. For sustainability of electricity projects, it is essential to pay more attention to the incentive framework necessary for long-term organization performance and inter-organizational collaboration and the issues of authority and centralization. For instance, some of the problems that are facing the Electricity Distribution Companies are improper accrual of revenues and expenses, unsatisfactory cost and 81 budgetary control, a deficient management information system and, most importantly, delays in accounts receivable. To overcome these problems, accountants need to be trained to operate within an incentive framework, and the system should be decentralized. In short, the human components of development projects, rather than merely transferring financial resources and constructing physical facilities, should became a major focus of the World Bank. Chapter Five Conclusions 82 This study has focused on project appraisal of investments in Egypt, notably in electricity. Chapter three identified the key parameters in evaluating economic viability and efficiency of development projects: (1) the discount rate (opportunity cost of public funds); (2) the exchange rate, and (3) the cost of major inputs or shadow prices of labor, electricity, water and transportation. The study reviewed the basic alternative approaches employed to determine the discount rates reflecting the economic cost of public funds. These include Hirshleifer's, Little and Mirrlee's, and Harberger's approaches. The study indicates that Harberger's approach is more appropriate in estimating the opportunity cost of public funds than Hirshleifer's and Little and Mirrlee's approaches because it considers the impact of government expenditures on consumption and investment that are postponed by the private sector. Harberger's approach leads to a more realistic estimation of the discount rate for public sector investments in Egypt, which is 20 per cent. This figure differs from the estimated 6 per cent discount rate used by consultant firms to justify the economic viability of electricity projects that will be implemented 83 in Egypt in the mid 1990's. Therefore, the study shows that key parameters in evaluating the efficiency of projects were not accurately estimated in the appraisal stage of the World Bank projects in Egypt, resulting in false or misleading information concerning the economic viability and efficiency of the chosen projects. v The divergence in the estimated discount rate and economic internal rate of return (EIRR) is due to different factors. These include the application of different economic perspectives and approaches, using non-updated data on shadow prices, and the influence of the self-interest motives of consultant firms. Consultant firms apply Little and Mirrlees' approach in estimating the opportunity cost of public funds, which is not characterized by a broader view of the impact of government spending on the private sector. Chapter four also analyzes institutional aspects of the World Bank projects. It presented the problems and the factors that adversely affect institutional development performance of electricity projects in Egypt. The study shows that for better economic analysis of development projects in Egypt, there are some actions which should be taken by both the Government of Egypt and the World Bank. For the Government of Egypt, there is a need to institute a wide-ranging system of economic prices that 84 reflect the real costs and benefits to society and the economy as a whole. This would include interest rates, exchange rates, and prices of major inputs of development projects, e.g. labor, electricity, transportation, water.etc. This system necessitates establishment of an organization or team of project evaluators whose main function(s) is to consult closely with the Government of Egypt not only in setting economic prices, but also in the selection of large development projects. The proposed system would improve the quality of background information to those who are responsible for planning and managing public sector expenditures. These would include, in addition to economical prices, investment and saving requirements, expected rates of inflation, and exchange rate movements. For the World Bank, better institutional design of project appraisal requires greater expertise in the practicalities of public sector expenditures management than (most) World Bank staff missions possess. In fact, most problems associated with development projects can be traced to institutional deficiencies. Bibliography Abdul Khaleque, Gouda, (1980). P o l i t i c a l E c o n o m y o f F o r e i g n A i d , Polwel Printing Press, Dacca. ! Adams, Walter (1990) . H o w B e a u t i f u l i s S m a l l ? S c a l e , j C o n t r o l a n d S u c c e s s i n K e n y a I r r i g a t i o n , World | Development, Washington D.C. ; Adelman, Irma and Thorbecke, E. (19 66) . 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Asset Metadata

Creator El Sabaa, Salah M. (author)

Core Title The management and design of economic development projects: A case study of World Bank electricity projects in Egypt

Degree Master of Arts

Degree Program Economics

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag economics, general,Energy,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

Advisor Elliott, John M. (committee chair), Kamrany, Nake M. (committee member), McEachern, Alexander W. (committee member)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-466237

Unique identifier UC11264078

Identifier EP44941.pdf (filename),usctheses-c20-466237 (legacy record id)

Legacy Identifier EP44941.pdf

Dmrecord 466237

Document Type Thesis

Rights El Sabaa, Salah M.

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA