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Key factors in appraising development project in Egypt

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Key factors in appraising development project in Egypt

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Content THE MANAGEMENT AND DESIGN OF ECONOMIC DEVELOPMENT PROJECTS: A CASE STUDY OF WORLD BANK ELECTRIC-ITY PROJECTS IN EGYPT by Salah M. El Sabaa A Dissertation Presented to the FACULTY OF THE GRADUATE SCHOOL UNIVERSITY OF SOUTHERN CALIFORNIA In Partial Fulfillment of the Requirements for the Degree DOCTOR OF PHILOSOPHY (Political Economy and Public Policy) July 1992 Copyright 1992 Salah M. El Sabaa UMI Number: DP23386 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. Dissertation Publishing UMI DP23386 Published by ProQuest LLC (2014). Copyright in the Dissertation held by the Author. 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 - 1346 UNIVERSITY OF SOUTHERN CALIFORNIA THE GRADUATE SCHOOL UNIVERSITY PARK LOS ANGELES, CALIFORNIA 90007 This dissertation, written by Salah M. El Sabaa under the direction of h..is Dissertation Committee, and approved by all its members, has been presented to and accepted by The Graduate School, in partial fulfillm ent of re quirements for the degree of ^Z j p . 4^ 37 <fi? A J . f 3 D O C T O R O F P H IL O S O P H Y Dean of Graduate Studies Date DISSERTATION COMMITTEE ... Chairperson Acknowledgment s ii I I would like to express my deepest gratitude to our God, the one God we all praise .. Muslims, Christians, and Jews. Throughout the often discouraging process of my research, it was my unwavering faith in God which helped me work hard to complete this study in short period. For him I am indebted and deeply grateful. I would like to extend my sincere appreciation to the members of my dissertation committee, for their scholarly I ! supervision, guidance, and support. My committee chairman, Professor Nake Kamrany gave valuable advice, constant guidance, and comments which greatly enriched this study. I I Distinguished Professor John Elliott not only helped me i during this research, but also throughout my entire program of study at U.S.C. Professor Elliott's insights, personal kindness , and depth of knowledge have been an inspiration to me. Professor Richard H. Dekmejian commented extensively on several drafts and opened many avenues of thought. I am especially indebted to Professor Alexander McEachern, whom ! I owe more, both intellectually and humanly, than I can ever repay. Professor McEachern not only consistently gave time, ; encouragement, and advice, but also provided me with I insights into how relationships between a professor and his students should be structured, a lesson to which I attach a great value. To all members of my dissertation committee I Jowe a debt and gratitude. iii I am indebted also to Professor Omar El Sawy whose contribution went beyond his responsibility as a member of my guidance committee. In fact, he provided academic and moral support beyond description. A special word of appreciation goes to all my professors at Harvard University with whom I have had the good fortune of taking several courses in project management and development economics. Among them I would like particularly to mention my distinguished professors: Glenn Jenkins, John Thomas, Dwight 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 individuals in Egypt who generously granted their time in confidential discussions and interviews. Among them are Dr. Ibrahim Helmy Abdel Rahman, former Minister of Planning and Director of UNDP, Professor Heba Handoussa of the American University in Cairo, Professor Gouda Abdul Khaleque of Cairo University, Dr. Ibrahim Mokhtar, Director of Misr Iran Investment Bank, and Dr. Mokhtar Halouda, former Director of CAPMAS. I cannot refrain from mentioning Dr. David Nygaard, the Ford Foundation Representative for the Middle East and North Africa, who provided financial support to me during my initial year of study at U.S.C. Words cannot begin to describe his remarkable support during my study at Harvard University and U.S.C. 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 my heartfelt thanks. My hope is to maintain communications with them in the future. Finally, I must thank my wife and life mate, Rawia, for her encouragement and support. It is to her, therefore, this dissertation is dedicated. V Abstract This study is concerned with the evaluation of development projects, in particular the efficiency of World Bank projects in Egypt. The study seeks improvements in the methods of evaluating public sector projects in Egypt. Two approaches are employed in this study: (1) project identification as a way to optimally allocate Egypt's and World Bank's resources; (2) project appraisal as a way to assess the economic viability and efficiency of investments. Project Identification: The electricity sector is compared with the agriculture sector as a means of employing project identification for priority ordering of investment for development in Egypt. The key criteria for evaluation are the impacts of developments of each sector upon Egypt's national objectives and needs. These include employment opportunities, growth, alleviation of poverty, cross comparison of per capita consumption in each sector, economic rate of return, national security, balance of payments and foreign debt. This study shows that the allocation of scarce investments would have been more efficient in agriculture than in electricity in terms of meeting Egypt's national objectives and needs. However, World Bank lending programs vi in Egypt reveal a priority ordering of electricity over agriculture and rural development. It follows that World Bank development projects in Egypt have not been optimally identified, and its programs have not followed an optimal path of development or an efficient allocation of World Bank's and Egypt's resources. Project appraisal: This study shows that the key parameters in evaluating economic viability and efficiency of development projects are: (1) the discount rate (the 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. 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. Contents vii Acknowledgments ii Abstract V List of Tables X List of Figures xi Abbreviation xii Chapter 1: Introduction 1 1.1 Introduction 1 1.2 Purpose 3 1.3 Hypotheses 4 1.4 Approach 5 1.5 Study Outline 8 1.6 Scope and Limitations 14 Chapter 2: Egypt and the World Bank: 17 2.1 Purpose 17 2.2 The Origin and Nature of the World Bank 17 2.3 The World Bank Evolution 19 2.3.1 Reconstruction Period 19 2.3.2 Growth as Path for Development 20 2.3.3 Industrialization as a Path to Development 23 2.3.4 Growth and Social Equity as a Path to Development 24 2.3.5 Growth and Free Market as a Path to Development 27 2.3.6 Stabilization and Structural Reform as a Path to Development 29 2.4 The Operational Procedure of World Bank Aid Program in Egypt 31 2.4.1 The IMF Economic Reform Program 31 2.5. The Effect of The IMF Economic Reform Program on Appraisal of Electricity Projects in Egypt 41 2.6 Assessment of World Bank Operation in Egypt 42 2.6.1 Methodology 42 2.6.2 Egypt's National Objectives and Problems 45 2.6.3 Potential Areas of Development in Egypt 49 2.6.4 Agriculture and Rural Development in Egypt 49 2.7 Conclusions 61 ■ • * Vlll Chapter 3: Electricity Sector in Egypt 63 3.1 Purpose 63 3.2 Introduction 63 3.3 Institutional Framework 64 3.4 Organization 66 3.5 Production of Energy 68 3.6 Consumption of Electricity and its Pattern 70 3.6.1 Geographical Pattern of Energy Consumption 72 3.7 Electricity Pricing in Egypt 80 3.8 Electricity Tariff Structure in Egypt 81 3.9 Volume of Subsidy and its Impact 83 3.10 Import Substitution and Sustained Development 85 3.10.1 World Bank and EEA Investments in Imported Goods 85 3.10.2 The Potential of Producing Electrical Equipment in Egypt 85 3.10.3 World Bank and Electricity Sector Investments in Electrical Equipment Industry 86 3.11 Conclusions 88 Chapter 4: The Appraisal Of Electricity Projects In Egypt 90 4.1 Introduction 90 4.1.1 Demand Forecast 93 4.1.2 Technical and Engineering Aspects 95 4.1.3 Institutional Aspects 95 4.1.4 Financial Aspects 96 4.1.5 Economic Aspects 96 4.1.6 Social Aspects 97 4.2 Electricity Demand Forecast 97 4.3 Analysis of Electricity Demand Forecast 100 4.4 Comments on Demand Forecast 103 4.5 Economic Analysis 114 4.5.1 Methodology 115 4.5.2 Economic Internal Rate of Return 116 4.5.3 The Discount Rate as a Key Parameter in Economic Analysis 117 4.5.3.1 Hirshleifer's Approach 118 4.5.3.2 Little And Mirelees' Approach 119 4.5.3.3 Harberger's Approach 122 4.5.4 The Exchange Rate as a Key Parameter in Economic Analysis 130 4.5.5 Shadow Prices as Key Parameters in Economic Analysis 142 4.5.6 Conclusions on Economic Analysis 144 4.6 Institutional Analysis 145 IX 4.6.1 Introduction 145 4.6.2 The Basic Objective of Institutional Development 146 4.6.3 The World Bank and Institutional Development in Electricity Project■ 148 4.6.4 The World Bank Strategy 153 4.6.5 Problems of Institutional Development in Electricity Projects in Egypt 153 4.6.6 Factors That Adversely Affect the Institutional Development Performance 154 Chapter 5: Conclusions: 158 Glossary 166 Bibliography 168 X 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4 .10 4.11 4.12 4.13 4.14 List of Tables Increases in Unemployment Rates in Egypt 47 Agriculture Sector Development: Some Key Indicators 50 Total Investments in Agriculture and Land Reclamation Versus Investments in Electricity Sector 54 World Bank Investments in Electricity Sector in Egypt 55 World Bank Investments in the Land reclamation Sector in Egypt 56 Development of Land Reclamation in Egypt 57 World Bank Cumulative Lending Operations to Countries Versus Cumulative Lending Operations to Egypt 59 The Impact of Development in the Electricity Sector Versus the Impact of Development in the Rural Sector in Egypt 60 Development of Generating Power in Egypt 70 Consumption of Electricity in Egypt by Zones 73 Pattern of Electricity Consumption in Cairo and Upper Egypt by Sector 75 Actual Electricity Consumption of Residential and Industrial Sectors 7 8 Projected Electricity consumption of Residential and Industrial Sectors 7 8 Changes in Average Electricity Prices 81 Electricity Sector Investments in Electrical Industry in Egypt 87 Real GDP Growth Rates 101 P,er Capita Energy Consumption in Some Developing Countries 104 Changes in Electricity Per Capita Consumption 105 Projected Sales and Price Increases Required by the World Bank 107 Sales and Average Prices of Electricity 108 Population Growth Development of Interest Rates in Egypt 126 Changes in Exchange Rate in Egypt 133 Foreign Currency in the World Bank Projects in Egypt 135 Exchange Rate Estimation During Appraisal and Implementation of World Bank Projects 138 The Effect of Changes in the Exchange Rate on EIRR 140 Project Investment on Training, System Development, and Equipment 150 World Bank Appraisal Mission Data (Shoubra El Kheima Power Project) 151 World Bank Appraisal Mission Data (Third Power Project) 152 List of Figures xi 1.1 Project Cycle and Areas of Emphasis 7 1.2 World Bank Operational Procedures 10 2.1 Project Identification 43 2.2 Impact of Development on Egypt's National Objectives and Problems 44 2.3 Polices Interactions 46 2.4 Development of Unemployment Rate in Egypt 48 2.5 Development of Land Reclamation in Egypt 58 3.1 Development of Generating Power in Egypt 71 3.2 Pattern of Electricity Consumption in Egypt 74 3.3 Pattern of Electricity Consumption in Cairo and Upper Egypt by Sector 76 3.4 Actual and Projected Electricity Consumption of Residential and Industrial Sectors 79 4.1 Project Appraisal and Areas of Emphasis 94 4.2 Real GDP Growth Rates 102 4.3 Per Capita Consumption of Electricity in Egypt 106 4.4 Projected Electricity Sales and Prices Increases 109 4.5 Population Growth in Egypt 111 4.6 Opportunity Cost of Public Funds 125 4.7 Development of Interest Rate in Egypt 127 4.8 Changes in Exchange Rate in Egypt 134 4.9 The effect of Changes in the Exchange Rate on EIRR 141 xii ABBREVIATIONS 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 1 Chapter One 1.1 Introduction: This study is basically concerned with the evaluation of development projects, but since projects are the building blocks of any investment plan it is inevitably also a study about economic planning, in particular, the optimum allocations of foreign investment. All investments are planned by someone or government organization; electricity and agriculture projects do not just happen. The plan cannot be good if its constituent parts are faulty. The study seeks improvements of the methods of project identification and project appraisal of public sector investment programs in Egypt. Projects are a critical element of national development in the Third World countries. However, 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 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 pecuniary costs and benefits perceived by individuals in the marketplace. In this regard, what is the opportunity cost of public funds and 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? Does investing in agriculture promote development more than investing in infrastructure? Indeed, project identification is an issue of optimum resource allocation, which is a main theme in the discipline of economics. The above questions have determined the design of this thesis. An attempt has been made here to apply different alternative approaches to project evaluation to public sector investment in the country of 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. 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. One 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. Therefore, much remains to be done in Egypt to improve I the methods of project identification, project appraisal, and the implementation of public sector investment programs. 1.2 Purpose; This study aims at taking a constructive approach, focusing on gaps, weaknesses and unresolved issues in the area of social project evaluation. And 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 the World Bank electricity projects that are implemented in Egypt. This study will look at the World Bank's long-term relationship with Egypt, evaluating projects in the context of the lending program, and the role played by The Bank as a source of finance and of advice on policy issues. It will look at how the project fund was created, what the role of other donors, e.g. the United States Agency For International Development (USAID) and the African Development Bank, and whether the projects were properly financed or not. The study, will also aim at identifying the principal problems and obstacles the World Bank confronted in implementing its program in general and in the electricity sector in particular and will outline possible new approaches, policies, and procedures that can to be adopted to improve project performance in the future. The study will examine how project ideas are first created, and conceptualized . In addition, it will look at how projects are institutionalized and evolved and how they are managed. 1.3 Hypotheses: This study considers two hypotheses: 1.3.1 The First Hypothesis: World Bank development projects in Egypt were not optimally identified, and its aid program may not be the optimal path to development or to allocate both the World Bank's and Egypt's resources. Consequently, resources are not efficiently employed and allocated among productive sectors in the economy. Benefits relative to costs in investment in areas other than electricity projects may be larger. Therefore, the development process would be better promoted to greater extent by investing more resources in other productive sectors in the economy. This is not an either/or proposition; it is a matter of to what extent projects are to be identified from electricity and infrastructure sectors versus other areas of the economy. This hypothesis is addressed in chapter two. The study shows that Egypt has over-invested in electricity and under- invested in agriculture. 1.3.2 The Second Hypothesis: The World Bank projects in the electricity sector in Egypt were not optimally appraised; this is especially so concerning economic estimations and institutional design. Consequently, project appraisal yields 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 chapter 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 will evaluate how well development programs and projects have worked in Egypt and how their efficiencies can be improved through better design and management. The institutional setting and evolution are as important as financial and economic factors. The study will also emphasize the political factors that shape and influence the decision making process in identifying and implementing development projects in Egypt. The study will follow a top-down approach by first analyzing The World Bank's policy framework and how well it fits into the Egyptian economic environment, then examining Egypt's national objectives and the development strategy of Egypt, in so far as one exists. As figure (1.1) indicates, the study begins by analyzing how projects are identified, prepared, appraised, negotiated, implemented and finally followed up and evaluated. As figure (1.1) also indicates, the study emphasizes project identification and project appraisal phases as well as the factors affecting each of them. Project Cycle and Areas of Emphasis Egypt's Problems Five Years Plan Political Environment In Egypt Contemporary Theories Of Economic Devlopment Project Identification Human Res. Agriculture ^ T ^ W o rld Bank Policies & Leadership International Environment US Foreign Policy Dev. Banks Electricity Project Preparation Institutional Capacity. Data Availability Technical Staff Project Appraisal Alternative Approaches To Dev. g W.B. Missions & Proced. Financial Design Institutional f Economic ___ ] I___ Consultant Firms Technical Project Implementation J Discount Rate Excange Rate Project Evaluation Figure (1.1) 1.5 Study Outline: Chapter one contains both a general and a detailed introduction to the problems of this study, and presents the hypotheses proposed. Chapter two contains an assessment of the Egypt-World Bank relationship. First, it provides an introduction to the World Bank: its origin, nature, and purpose, in order to establish the setting in which the institution operates. Second, the study examines the World Bank in historical perspective by analyzing its evolution and its lending policies since its inception in Bretton Woods in 1946. It shows how the World Bank has been profoundly affected by prevailing development theories and strategies. In addition, it illustrates how the World Bank has been affected by its leadership visions about development, e.g. R. McNamara, partly in response to changes in the international environment, e.g. the world debt crisis, and partly by the economists who had worked for the World Bank, e.g. Hollis Chenery and Anne Kruger. Moreover, it shows how the World Bank has been affected by U.S. foreign policy. Third, the study examines World Bank policies and operations in Egypt. Furthermore, as figure (1.2) indicates, chapter two illustrates in global context the operational procedures of the World Bank aid program in Egypt. In addition, it illustrates how the World Bank aid program is realized, negotiated, and approved, and the role of the 9 International Monetary Fund (IMF) and other international donor organizations, e.g. USAID, in formulating the World Bank aid program in Egypt. This is a very important economic planning stage, where projects are identified. Usually, aid programs consist of many more or less inter-related projects. Indeed, this is a stage where a substantial amount of Egypt's scarce resources, including foreign . aid, is allocated. Obviously, proper project identification requires optimum allocation of resources, the main theme of economics. At the end of chapter two, the study places in perspective the results of the World Bank lending program in Egypt and illustrates how it has contributed to Egypt's development objectives and needs. Furthermore, it asks whether World Bank policies in Egypt are consistent with its evolution and with the prevailing development theories or not. World Bank Operational Procedures 10 INTERNATIONAL ENVIROMENT (DEBT CRISIS) HUGE FOREIGN DEBT US FOREIGN POUCY BALANCE OF PAYMENT DEFICIT — BUDGET DEFICIT INFLATION GREEN LIGHT Standby Agreement FIVE YEARS PLAN UNEMPLOMENT DEBT FORGIVNESS \7 DEBT RESCHEDULE GREEN LIGHT US FOREIGN POLICY A.DEVELOP. BANK GREEN LIGHT USAID AID PROGRAMS Figure (1.2) Electricity EDUCATION AGRICULTURE S A L LOANS PROJECT LOANS PARIS CLUB Eur. Com. GOVERNMENT OF EGYPT WORLD BANK AID PROGRAM FOR DEVELOPMENT ECONOMIC REFORM PROGRAM IMF STANDBY AGREEMENT 11 Chapter three examines the electricity sector in Egypt. It provides a brief survey of the electricity sector organization, generating plant, and distribution systems. Next, it examines the pattern of electricity consumption, which includes past and projected growth. Further, this chapter displays the historical price trend and the structure of tariffs and sales which indicate that from the viewpoint of the economic cost of electricity, nearly all consumer groups are subsidized. Moreover, the data indicate that the structure rate gives a strong subsidy to large state enterprises. The study indicates that such a pricing policy has led to an inefficient process of investment in other production sectors in the Egyptian economy. In fact, the pricing policy led the ministry of industry to act as if energy resources were not scarce, leading to a lowered efficiency of investment. This is clear and evident from the investing and installation of more energy-intensive technology plants such as the Kima fertilizer plant. This is one example of how all production sectors in the economy are inter-related. Obviously, a decision made in one sector has an impact on decisions and allocation of resources in other sectors of the economy. Chapter three argues the need for the formulation of a pricing strategy that is based upon the marginal cost structure with a proposed adjustment of tariffs to incorporate social and financial considerations. Chapter four focuses on the appraisal stage of the project cycle, and evaluates the second hypothesis. It 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 in this chapter emphasizes economic and institutional aspects of projects. For 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. Next, this chapter presents the methodology used for conducting economic analyses for the World Bank-financed operations, which is a cost-benefit analysis developed by I.M.D. Little and Mirrlees. The key parameters of economic analysis are discussed in detail. These include the discount rates, exchange rates, and shadow prices. Regarding the opportunity cost of public funds, the study reviews the basic alternative approaches employed to determine the discount rates reflecting the economic cost of public funds. These include Hirshleifer's approach, Little 13 , and Mirrlee's approach and Harberger's approach. Moreover, it examines the development of interest rates in Egypt during the last two decades. The study argues 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 presents 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 in Egypt in the 1990's. This study also indicates that the shadow prices used in economic analysis give false signals. This is because these prices are based on Page's report "Shadow prices For Trade Strategy and Investment planning In Egypt" that was developed to be used in the period from 1980 to 1985, not for projects that will be implemented in 1990's. Further, chapter four shows that for better economic analysis of development projects in Egypt, we need to institute a wide-ranging system of economic values that reflect the real cost and benefits to the Egyptian economy as a whole. This proposed system would provide project evaluators and planners with interest rates, exchange rates, and major inputs prices of a development project, e.g., labor, electricity, transportation, water.etc. 14 At the end of Chapter four, the study presents the basic objectives of institutional development to lay the ground for assessment of the institution 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. Chapter five summarizes the argument of this discussion and derives certain consequences regarding development processes. It presents gaps, weaknesses and unresolved 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. It is hoped that this study will make a contribution to improvement of existing procedures and provide insights into the development process. 1.6 Scope and Limitations: Providing a methodology for optimal allocation of resources is beyond the scope of this study. The study shows however that the World Bank projects in Egypt are not optimally identified and its resources are not optimally allocated. This study also does not claim that investing in electricity or infrastructure is a wrong decision or does 15 not contribute to development process in any country. Obviously, investment in infrastructure, transportation and power constitutes the necessary foundation on which a strong, viable economy could be built. Needless to say, schools, hospitals, small scale industries and development banks cannot exist unless electricity, water and roads are available. This study covers the period from 1975 till 1991. This period was characterized by a influx of foreign aid and investments in public sector infrastructure projects. For example, the cost of the Cairo-North electrical power station, one of several power stations, is $ 900 millions and the proposed Kuriemate plant exceeds $13 00 millions. As figure (1.2) indicates, the study emphasizes project loans and sector loans, specifically electricity sector loans, although some emphasis is placed on structural adjustment loans that cut across several sectors and deal with such broad problems as management of a government's investment budget or its external debt. The study covers the institutional aspects of the implemented projects. The analysis not only covers the 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. 16 The study focuses on one element in the energy sector, specifically, electrical power stations. Energy projects have beneficial effects on several activities in the Egyptian economy. Experience shows that the availability of electricity affects the nature and scope of economies (or diseconomies) of scale in cities and in industrial development and location. The study covers projects that are financed by The World Bank as co-sponsor with other international organizations, mainly USAID. These projects are public sector enterprises that require a large investment. This study is limited to some extent by the fact that all studies and documents of the World Bank and other international aid organization are considered confidential and for official use only. This resulted in a great difficulty in getting World Bank Staff Appraisal Reports, post evaluation reports, sector reports and IMF reports, and the unavailability of some other important reports, e.g. 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. 17 Chapter Two Egypt and the World Bank 2.1 Purpose: The purpose of this chapter is to assess the nature and extent of World Bank policies and operations and how they affect Egypt's long-term development. It seeks to address the issue of optimum resources allocation among the different sectors in the economy in order to promote economic development and to put in place viable structural changes for long-term growth in Egypt. 2.2 The Origin and Nature of the World Bank: Early in World War II, the economic and financial experts of the allied nations began to consider what plans could be made to help meet the economic problems of the post-war period. They recognized that attention would have to be given not only to the immediate relief and physical reconstruction of economies disrupted by the war but also to the expansion, by appropriate international and domestic measures, of production, employment, and the exchange and consumption of goods which are the material foundations of the liberty and welfare of all peoples. From deliberations on these plans, the outlines of two complementary financial institutions emerged. 18 The first institution, the International Monetary Fund (IMF), was to promote international currency stability by helping to finance temporary balance of payments deficits and by providing for progressive elimination of exchange restriction and the observance of accepted rules of international financial conduct. The second institution, the International Bank For Reconstruction and Development (IBRD) , was, as its name implies, to help finance the construction and development of its member countries. By the spring of 1944, the proposal for these two organizations had reached an advanced stage. A United Nations Monetary and Financial Conference was accordingly convened. On July 1944, the representatives of 44 nations assembled at Bretton Woods, New Hampshire, completed final drafts of articles of agreement for the Fund and the Bank for submission to the participating governments. Participants at the Bretton Woods conference felt that development problems could be best solved by the creation of a new type of international investment institution which would be authorized to make or guarantee loans for productive reconstruction and development projects, both with its own capital funds and through the mobilization of private capital, and which would be provided with a financial structure under which risk of such investment would be shared by all member countries roughly in 19 accordance with their economic strength. This is the solution which was embodied in the World Bank's Articles of Agreement. The Articles establish the World Bank as an inter governmental institution, corporate in form, all its capital stocks being owned by its member governments. The World Bank group is a family of institutions of which the International Bank for Reconstruction and Development (IBRD) and the International Development Finance Cooperation (IFC) are the best known. 2.3 The World Bank Evolution: 2.3.1 T h e Early Years: Reconstruction Period: The Bank officially opened in June, 1946. The first loan went to Europe for relief and physical reconstruction of economies disrupted by World War II. As stated in Article 1 of its Articles of Agreement, it was given primary responsibility for providing reconstruction capital to countries devastated by the war, largely by guaranteeing private international loans (Leslie, 1987). With the announcement of the Marshall Plan, the external financing of European reconstruction was assumed directly by the United States. The European countries preferred the Marshall Plan because of its easier terms compared to the World Bank loans. Under the president of the World Bank John McClay, the World Bank redirected its attention to promoting the development of its members. As McClay put it "The 20 reconstruction phase was over and that of development underway" (Leslie, 1987). 2.3.2 "Growth" as a Path for Development: Project Approach With Emphasis on Infrastructure: Eugene Black Era (1949-1962): During the Eugene Black era, 1949-1963, the World Bank redirected its loans and efforts from Europe to the less developed countries and chose to concentrate on investments in traditional sectors such as infrastructure, transportation, and energy. Two thirds of the Bank's lending went to those sectors.. According to a World Bank Operation Evaluation Study: The Bank's lending of the 1950's and 1960's had concentrated on physical infrastructure, so as to provide some of the inputs required for growth (the World Bank, 1989). World Bank strategies were a response to major developments in the international system as well as the influence of prevailing development theories. Regarding the major development in the international system, during the 1950's, many less developed countries in Africa and Asia gained their independence and became members of the international system. They demanded that their needs be systematically addressed by 21 the World Bank. Using their influence in the United Nations General Assembly, a comprehensive agenda was formulated to promote Third World development. Regarding the influence of prevailing development theories, during 1950 's, theorists such as Kuznets, Rostow, Rosenstein- Roden, and Arthur Lewis, saw Third World development as being inhibited by weakness in the structure of production and the economy as a whole in these countries (Kuznets, 1951) . Paul Rosenstein-Roden maintained that the production structure of developing countries was decidedly different from that of the more, advanced nations. Economic development in developing countries was inhibited by obstacles, bottlenecks, and structural constraints, such as high rates of population growth and low levels of savings and investments. Thus, massive infusions of short-term capital investment and technical assistance into developing countries, would be needed to foster development (Leslie, 1987). Therefore, those theorists advocated industrialization and capitalization as the path to development. During Black's tenure, in the 1950's, the World Bank adopted the above views and chose the project approach as the vehicle to implement them in developing countries. The Bank emphasized the correlation between underdevelopment and the lack of infrastructure, productive facilities and energy in developing countries. During the period 1947-1952, loans for electric power accounted for almost half total project 22 lending, claiming 3 91 million dollars out of a total of 885 million dollars. The purpose of the Bank is to finance sound economic projects to correct these imbalances. This would attract foreign private investment to lay the foundations for growth. Proponents of the project approach see it as the most effective way of guaranteeing economic institution-building in developing countries and ensuring donor control over contributed funds. These views are clearly reflected in the lending policies of the Bank during this period (The World Bank Development Report, 1981). The project approach is probably the most effective way of ensuring donor control over contributed funds, but, it is not necessarily the most effective means to economic institution-building. Black viewed the market as a better guide to the allocation of resources than government controls. This reflected the laissez-faire view of Rosenstein-Roden about the development process that formed the cornerstone of Bank thinking at that time. It was felt that government's role ought to be limited to providing the institutional framework that would facilitate the proper functioning of economy based on private enterprise (Adler, 1972). During Black's tenure, the Bank became an aid coordinator, acting as an intermediary between aid-giving and aid receiving states via devices known as the consultative Group and the Consortium. Also, during the Black's tenure, The Bank began to 23 play the political role of diplomatic agent, turning down Egypt's request for financing the High Dam as a viable development project for Egypt, and offering its good offices in the settlement of claims arising from the Suez Canal nationalization (Shapiro, 1967). 2.3.3 Industrialization as a Path to Development: George Woods Period (1963-1968): During George Woods' tenure as president, the Bank continued Black's project approach to development. In addition, the Bank recognized that sustained development required a skilled labor force. In 1963, the World Bank established an Educational Project Division to fund activities for training. The emphasis was on preparing manpower as an input to the production system. Woods, as an investment banker, with vast experience in the problem of industrial financing, made World Bank assistance to industry his leading priority. During his tenure, lending to development finance companies reached 100 million dollars and in 1966 rose to 159 million dollars (The World Bank Development Report, 1978) . The Woods' administration was responsible for a large increase in the volume of industrial financing. By the early 1970's, economists came to a broader view of development than Simon Kuznets' view, who saw income inequalities as decreasing with progressive industrialization. Economists came to emphasize not only economic growth as the 24 path to development but also welfare and distributive justice, as will be discussed below. 2.3.4 Growth and Social Equity as a Path to Development: Robert McNamara Period (1968-1981): Robert McNamara was a man of great humanitarian vision who emphasized increasingly the recognition of the social dimensions of the development process. He claimed that development is clearly not simply economic progress measured in terms of gross national product, but is something more basic that includes equity and human needs. According to Naylor: McNamara brought to the World Bank the conviction of the Kennedy years that growth and redistribution within the rules of operation of capitalist market economies were fully compatible; and he brought it to the Bank just at the beginning of the series of financial crises that would ultimately lead to the overthrow of the Keynsian paradigm and its redistrubutive ethic inside the United States (Naylor, 1982). During McNamara's tenure, the quality of human resources began to be seen as an even more important determinant of growth than physical infrastructure. He expanded the narrow orientation of the World Bank lending that prevailed in the late 1950's and 1960's, that focused on infrastructure, into 25 areas such as agriculture, rural development, education, family planning, and health services. McNamara believed that the Bank should be in the forefront of the development effort. He stipulated that the Bank would double its lending in the 1968-1973 period as compared to the previous five years. A larger percentage of loans were extended to the long- neglected regions of Africa and Asia. In addition, increased funds were allotted to such sectors as agriculture and education. McNamara was innovative with his emphasis on population growth, which he viewed as the greatest single obstacle to development (Finance and Development, 1979). To show his commitment to family planning and population growth, the Bank established a Population Projects Department in 1971, and lending for family planning increased (The World Bank, 1981) . Projects in energy and transportation increased in absolute amounts due to the doubling of the Bank's lending, but they declined as a percentage of total disbursements. McNamara, like his predecessors, reiterated that the Bank's role in the development field was primarily that of external financing, which had to come from commercial banks, bilateral aid and private sector direct investors. McNamara was also innovative in initiating a structural adjustment lending scheme (SAL) intended specifically for those developing countries with no access to a commercial sources of finance. This step was taken in response to the 26 increasing severity of the balance-of-payments deficits in oil-importing developing countries. To qualify for such loans, the borrower had to agree to implement changes in its policies and programs that would enable its economy to adapt over a reasonable period to changes in the international economic environment, without sacrificing its long-term growth objectives (Wright, 1984). Funds would be disbursed quickly, over a one to three-year period, and aimed to support specific policy changes and institutional reforms designed to alleviate balance of payments problems. In addition SALs were designed to assist a country in meeting the transitional costs of structural changes in industry and agriculture by increasing the supply of foreign exchange available (Williamson, 1983). According to Robert Ayres, the McNamara years at the Bank will be remembered largely as an effort to rectify some of the omissions of the Bretton Woods Agreements. According to Naylor: The World Bank ceased to be a junior partner to the IMF. It became a crucial source of development financing, and a source of foreign exchange alternative to both the IMF and the transnational banks. It became a source of such exchange without the short term repayment typical of IMF loans; and it reached out to the poorer of the developing countries who could not meet the commercial criteria imposed by the transnational banks for project loans (Naylor, 1982). According to the World Bank Operations and Evaluations Study, though poverty did not dominate the Bank's rhetoric in 27 1980's, it remained a central concern in the design, appraisal, and execution of projects (The World Bank, 198.9) . In short, under McNamara the bank changed its strategies for lending to address the quality of human resources and moved from the project approach, as the only vehicle to development, to include loans that would support institutional reforms and structural changes in industry, agriculture and other sectors. 2.3.5 Growth and Responsiveness to Free Market Principles as a Path to Development: Tom Clausen Period (1981-1985): Clausen had a view for approaching development which differed from his predecessor McNamara. He believed that development could be better achieved by growth and responsiveness to free market principles. He put more emphasis on the private sector and less on human resources. He claimed that the private sector should play a key role in development efforts. In his view, those developing countries which had successfully weathered the economic storms of the 1970's were those that had stressed the promotion of private sector efforts (Leslie, 1987). In his address to the Board of Governors, Clausen said: International private capital is essential to the development process, in the form of both direct investment and commercial lending... IFC has a special responsibility within the Bank family to . 28 serve as a catalyst in private sector development by bringing together capital, technology and managerial know-how (Clausen, 1983). Thus, for Clausen, one of the Bank's responsibilities for the 1980's was to act as a conduit for private investment to the Third World via increased co-financing with private banks. During the Clausen tenure, Bank loans became subject to floating interest rates. Beginning in 1982, adjustments in rates occurred every six months to reflect the cost of Bank borrowing in international financial markets. Throughout his term, Clausen reiterated that Third World development efforts should be based on economic efficiency. Only then could questions of equity be addressed. In his address to the Board of Governors in September 29, 1981, Clausen said: Our borrowing countries...must shape their internal policies in such a way that their domestic resources can be utilized with greater efficiency. This means re-designing policies: to stimulate agriculture production through a more effective structure of incentives; to reduce the disincentives to private efforts; to encourage exports; and to reduce the drain on government budgets from unwarranted subsidies and ineffective enterprises (The World Bank, 1981). In short, Clausen made his impact on the World Bank by replacing McNamara's focus on poverty and human resources development by economic growth and responsiveness to free market principles. 29 2.3.6 Macroeconomic Stabilization and Structural Reform as a Path to Development: Conable Period (1985-present): During the tenure of Barabe B. Conable Jr., policy-based lending and collaboration with the IMF became the new theme of the World Bank. Conable, a Republican Congressman for twenty years, has a clear private sector bias. Conable maintains that only economic growth will generate the income to ensure debt repayment and ultimately reduce poverty. For Conable, the path to development is growth and the approach to growth has three facets: private sector development; new capital flows to developing countries; and liberalization of world trade. The debt crisis brought Conable to the World Bank by Reagan's Administration in order to implement the Baker Plan. The plan was established by Secretary of the Treasury James Baker, and was designed to address the problems of debt crisis and severe economic imbalances in most borrower countries. The plan favors a monetarist approach characterized by tight money, minimum state intervention, and emphasis on the private sector. The Baker plan assigned a key role to the World Bank and the IMF in the current debt crisis. Much emphasis is placed on the potential of favorable price and interest-rate policies and liberal trade regimes. On the other hand, less emphasis is given to human resources development and investments in physical infrastructure. 30 Currently, the Bank and the IMF have new tasks that are to implement the adjustments needed for both macroeconomic stabilization and the structural reforms required to reestablish the conditions for growth over the long-run. These tasks are central to the Bank and the IMF missions, and have called for close collaboration between the two institutions for their advice to the borrower countries and the timing of their financial assistance. For the World Bank, the lending programs include: structural adjustment loans; sector adjustment loans; and specific investment projects loans. Although structure adjustment lending was initiated by McNamara in the late 1970's, it had not received enough emphasis until the mid 1980's. For the Bank, lending in support of structural adjustment has three purposes (World Bank Operations Evaluation Study, 1989) : First, it would be a fundamental instrument for dialogue between the Bank and the borrower country. Second, it would provide finance over a number of years in direct support of policy reforms. Third, it would provide foreign exchange not linked in advance to any specific investment programs. Such loans would therefore disburse quickly. Although the Baker plan seeks to address and solve some important problems that are currently facing developing 31 countries, it lays the ground for the Bank and the IMF to become political institutions and instruments of U.S. foreign policy. 2.4 The Operational Procedure of the World Bank Aid Program in Egypt: The World Bank aid program in Egypt is influenced by many factors. These include: the IMF economic reform package, the five Year plan for Egypt, U.S. foreign policy in the Middle East, and economic and social problems currently facing Egypt As figure (1.2) indicates, all these factors interact and eventually contribute to the World Bank aid programs in Egypt. Obviously, loans for specific investment projects are an element of the aid program. In other words, identification of projects financed by the World Bank is affected by the all above mentioned factors. To better understand how projects are generated and identified, it is useful to begin by analyzing the environment and the decision making process in which the World Bank operates. 2.4.1 The IMF Economic Reform Program: The IMF is mainly concerned with short-term stabilization adjustments that affects demand management and balance of payments. On the other hand, the World Bank is also concerned 32 with supply-side macro-policies. Shortly, we will see that these distinctions have become blurred in the case of Egypt. The IMF economic reform program, as figure (1.2) indicates, is a product of collaboration between the Government of Egypt and the IMF staff. This program, when approved by the IMF, is considered as a green light, not only for the World Bank but also for the other international lending organizations, e.g. USAID, African Development Bank (ADB) and the Paris Club. Their decision to lend or not to lend to any developing country depends on its agreement with the Fund for economic reform. So, the IMF is recognized by donors, and Egypt alike as the "policeman" in international financial affairs. Thus bilateral donors and private banks see an agreement with IMF as an indication of a commitment to economic reform on the part of Egypt. The Government of Egypt has no options available other than to reach an agreement with the Fund for an economic reform program to be implemented in the next few years. The government can neither support the level of foreign indebtedness it has accumulated over the past decade, nor can it continue to afford the extensive domestic deficit finance which has cost the Egyptian economy an ever accelerating inflation. Negotiation with the Fund is influenced by many factors that affect any decision made by any one of the two parties, i. e. the government of Egypt and the Fund. 33 On Egypt's part, the factors that influence the government decision include: a high foreign debt that exceeds 40 billion dollars; a slowing rate of growth that went from 8 percent in early 1980 to 2 percent at the end of the decade; high inflation that exceeds 20 percent annually; a high growth rate of population. In addition, political opposition comes from groups affected by the implementation of the economic reform program. Needless to say, the society's ability to sustain the IMF reform program, that may have significant short-term social costs, is an important factor that influences the Government of Egypt in negotiating with the Fund. As matter of fact, this factor has affected the pace of economic reform in Egypt in the last two decades. On the IMF's part, similar to The World Bank, the factors that influence its decision include the availability of fund for loans. Second, the Fund and the Bank are subjected to influence by major donors, mainly through the system of weighted voting in the executive committee. In fact, the Fund and the World Bank are not completely free agents in relating to Western governments, in particular, the United States. They are by nature political institutions, as they are made up of member governments, each with special interests. Their ability to use their resources to promote development according to their own agendas is limited by their financial dependence on the governments and capital markets of the developed countries. The President and key persons of both institutions are appointed by the United States. For instance, the current president of the World Bank, Barabe B.Conable Jr., was appointed by the Reagan administration in 1985. Although, in principle, the Bank's and the Fund's technical advice and assistance do not appear to be influenced by political considerations, the number and size of their operations for any developing country have strong political implications. For instance, the decision made during Black's tenure in 1956 not to finance the High Dam project in Egypt was based on political considerations. Moreover, the decision that was made after the Gulf war in 1990 to increase foreign aid to Egypt, was based on political factors. One may raise the question, why, e.g. after the Gulf war, Egypt needs foreign aid more than Sudan, Chad or other Subsaharan countries? In this respect, the two international institutions are instruments in the hands of the United States to implement its foreign policy. 2.4.1.1 Elements of the IMF Program Design: Egypt, like many developing countries, has a large external deficit and a large fiscal deficit. The external deficits arise from a large debt, an overvalued currency, excessive fiscal deficits and deteriorating terms of trade (Adjustment Lending, the World Bank, 1988) . The fiscal deficits come from heavy government investment, public enterprise deficits, subsidies, pricing policies, declining tax revenues as inflation has increased, and large external and internal interest payments. High inflation stems in part from a fiscal deficit financed initially by borrowing abroad and then by printing money. Under these circumstances, an economic reform program would combine stabilization with structure adjustment. The stabilization policies limit money and credit growth, reduce the fiscal deficit, and implement a real devaluation. The structure adjustment policies increase the efficiency of the public sector through cost recovery and improved institutional management. Reducing export taxes and removing import quotas, along with the real depreciation of the exchange rate, improves the competitiveness of the domestic economy, increases export, and redirects production and consumption into tradable goods industries that now meet the market test. The needed external finance would be available to make adjustment possible at a lower cost in terms of consumption and investment foregone. Based on the IMF assumptions, after the period of adjustment, the econoiry would make the transition to higher growth with stability and increased microeconomic efficiency. For the IMF, the measures that require support differ from country to country, but have certain common elements: a program of stabilization and reform to achieve agreed objectives over a certain period, usually five years; the macro measures needed to attain those objectives; a timetable 36 , for carrying them out; and a feasible system for monitoring those measures closely. For Egypt, the above mentioned elements are included in the reform agenda presented to the IMF in May 1986. 2.4.1.2 Egypt-IMF Standby Agreement: The reform program focuses on five major items of reform covering fiscal policy, exchange rates, interest rates and pricing policies, as well as the reorganization and autonomy of the public sector: 2.4.1.2.1 Fiscal Policies: Demand management is the primary objective of fiscal policies which are aimed at reducing aggregate expenditures and controlling inflation. The IMF asked the Government of Egypt to reduce government expenditure by cutting down on explicit consumer subsidies from 13 percent to 6 percent, by curbing the nominal rate of growth of the government wage bill and by reducing public investment expenditure in real terms. The budget deficit in Egypt has been reduced from 24 percent of GDP in 1982 to 20 percent in 1987 and to 16 percent in 1988 . 2.4.1.2.2 The Exchange Rate: There is more than one purpose to reforming the exchange rate in Egypt. First, the balance of payments deficit must be reduced and exports must be promoted through the use of a sufficiently flexible and competitive exchange rate. Second, for efficient resource allocation, the exchange rate should be unified so as to reflect its real scarcity value in transactions across all sectors of the economy. Negotiation with the IMF on exchange rate centers on both the issues of flexibility and unification. The IMF asked the Government of Egypt to move the exchange rate rapidly toward the free market rate so as to avoid present price distortions that are carried through the domestic system via the government's transactions. Partial reforms have been implemented as part of the proposed reform program. In May 1987, the commercial bank exchange rate was devalued from one dollar equals 1.3 6 L.E.to one dollar equals 2.17 L.E. By December 1989, it had been raised to one dollar equals 2.55 L.E. and the official Central Bank rate devalued from one dollar equals .7 L.E. to one dollar equals 1.16 L.E. The overall implications of adopting a single and more flexible exchange rate policy is likely to be highly positive (Handoussa, 1990) . Indicators of competitiveness of manufactured exports point to great sensitivity of both traditional and non-traditional manufactures to the exchange rate. This change in the exchange rate affects the economic analysis of project appraisal of World Bank financed operations in Egypt, as will be discussed later in chapter 4. In fact, a substantial amount of capital and operating cost of electricity projects is in foreign exchange. 2.4.1.2.3 The Interest Rate: The role of the interest rate in the context of structural adjustment is to complement other macro-economic instruments in managing aggregate demand and restoring equilibrium in the domestic and external accounts. The IMF reform program stipulates an increase in domestic interest rates so as to achieve a positive real rate of interest that will encourage savings, rationalize the allocation of investment, and attract a large inflow of workers remittances from abroad. In fact, the issue of the interest rate is closely related to that of inflation, the exchange rate and employment. In Egypt, interest rates were raised by 2 percentage points in 1987 and 3 percentage points in 1989. At present, commercial banks charge investors an interest rate of 22 per cent. This has both negative and positive effects on the Egyptian economy. For the positive impact, high interest rates curb inflation, and encourage savings. On the other hand, high interest rates discourage expansion in investments and this has its negative impact on employment. In fact, changes in interest rate affect the calculation of the economic internal rate of return (ERR), 39 which is a key parameter in economic analysis for project appraisal as will be discussed later in chapter 4. 2.4.1.2.4 Public Sector Autonomy: The IMF asked the government of Egypt to implement measures to liberalize the policy environment within which public enterprises operate. For instance, Egypt was asked to discontinue the policy of guaranteed employment for the public sector, allow public enterprises to design individual incentive payment schemes, liquidate inefficient production units, and set their own selling prices. Egypt's State-owned enterprises play a dominant role in the economy. The level of efficiency of the public sector is therefore reflected in all macroeconomic indicators of performance. These include labor productivity, wages, the rate of return on capital employed, capacity utilization, the competitiveness of exports, and the rate of savings. The increased autonomy for public enterprises has significantly improved their financial and economic performance. Results of the operation of the largest group, the 116 public enterprises affiliated to the Ministry of Industry shows that between 1985 and 1989, these enterprises were able to reduce their surplus labor force, and to raise labor productivity by 10 percent in real terms (Handoussa, 1990). For electricity projects in Egypt, price reforms for 40 input and output should have a positive impact on both economic and financial performance. 2.4.1.2.5 Price Policies: In Egypt, the structure of domestic prices is highly distorted on account of the government's attempt to provide an acceptable standard of living for the poor and to curb inflation. This goal has been pursued by enforcing fixed selling prices on the vast majority of publicly produced goods and services at levels well below the opportunity cost of these products. This has been achieved at an enormous cost to the Egyptian economy in terms of misallocation and waste in the system of production and imposition of a huge financial burden on the budget. The objective of price reform is to promote a structure of domestic relative prices that reflects opportunity costs. Implementing such a policy is expected to have three positive outcomes. The first is a better allocation of scarce resources, the second is elimination of the black market, and the third is rationalization of consumption. Applying these principles to electricity projects in Egypt, we would expect a reduction in the rate of growth of electricity consumption. This should have the effect on investments in the electricity sector of redirecting demand for electricity to more productive activities other than the subsidized domestic sector. 41 The IMF program consists of a gradual elimination of price controls and subsidies for producers operating under competitive conditions and the adjustment of regulated prices in monopoly sectors, e.g. the electricity sector, so as to approach shadow or international prices. 2.5. The Effect of the IMF Economic Reform Program (Standby Agreement) on Appraisal of Electricity Projects in Egypt: Based on the above IMF standby agreement, it is expected that the exchange rate will increase. Consequently, this will be reflected in the cost of imported items of electricity projects which constitute almost 80 per cent of the total costs of the projects. In addition, an increase in domestic interest rates will affect the discount rate used to estimate the profitability (rate of return) of electricity projects, as will be discussed in detail in chapter 4 in this study. Moreover, it is expected that electricity prices will increase. This will affect the total revenues of projects. On the other hand, an increase in fuel prices will affect operating costs which will reduce the rate of return from proj ects. 42 2.6 Assessment of World Bank Operations in Egypt: 2.6.1 Methodology: For better assessment of the nature and extent of the World Bank operations in Egypt, a comprehensive approaches is needed. As figures (2.1-) and (2.2) indicate, this approach will encompass Egypt's national objectives and macroeconomic aspects of the Egyptian economy as well as the potential areas of investment and development in Egypt. First, the study will identify and shed some light on Egypt's national objectives and its prevailing problems. Egypt's national objectives and its prevailing problems not only should be the final targets for policy makers in Egypt but also the starting point in designing the World Bank's and other international development organizations aid programs, e.g. USAID. Moreover, the impact on these prevailing problems should serve as the leading criteria in assessing the success or failure of any program. Next, the study will identify and examine potential areas of economic and social development. Then, the study will concentrate on two areas of investment, electricity and rural development (agriculture and land reclamation) and assess the World Bank's and the government of Egypt's efforts in these two vital areas. The assessment will focus on the impact on development in each area on Egypt's national objectives as well as on economic and social problems facing Egypt. Project Identification Macroeconomic Policies Interactions National Ob j ectives Areas of Potential Development Impact of Develop.on National Objectives Project Identification Figure (2.1) National O bjectives & Problems Population Growth & Emploment Poverty Allevit. Growth Internal Stability Security Urbanization Pressure Macroeconomic Policies Development Areas Balance Of Paym. * Exchange R . * Foreign Invest. Budget Deficit Expenditures Revenues * Defence * T axes * Subsidies * Pub. Enterp. * Pub, Inves. Pricing X. Industry & Technology I Dev. Banks & Privatization I Agriculture Money Growth Interest Rate Credit Allocation Electricity i i Health & Education Figure (2.2) 45 The concentration on agriculture and electricity sectors will not, however, obscure the importance and complexity of policy interactions in this comprehensive approach,some of which are shown in figure (2.3) . 2.6.2 Egypt's National Objectives and Prevailing Problems: Egypt has a population estimated at about 54 million in 1991, increasing at an annual rate of about 2.5 per cent. Arid desert land accounts for about 95 per cent of one million square kilometers of surface area, leaving only 35,500 square kilometers of urban and agriculturally productive land with a population density of about 1,400 per square kilometer. Consequently, the rapid population growth combined with a relatively small cultivated and inhabitable area has resulted in one of the world's smallest arable land to man ratios (the World Bank report no. 86047-EGT, 1990) . Rapid population growth with such limited land has brought about intense social pressures of urbanization and high population density in the Nile Valley. Located in the turbulent Middle East region, Egypt has witnessed and suffered from six major wars in the last five decades. Therefore, security is one of the main national objectives of Egypt. National O bjectives & Problems Growth Population L - Foreign Urbanization Security & Poverty Allevit. Growth & Emploment ^ Debt j t Pressure Macroeconomic Policies External Policies Balance Of Payr Exchange Foreign Invest. Development Areas Industry & Technology Fiscal Policies K ExpendWes Revenues DefencXj * Taxes i * Subsidie?* * Pub. Entwp. * Pub. Inves._ Pricing Dev. Banks & Privatization Agriculture" Land Reclamation Monetary Policies Interest Rate Credit Allocation Electricity Health & Education Polcies Ineractions Figure (2.3) Unemployment figures in Egypt are staggering. Results of the Population Census (PC) that were published by CAPMAS in December 1989 show that unemployment in Egypt was 12 per cent of the labor force. In addition, other sources of data on employment including the Labor Force Sample Survey (LFSS) show a gradual increase in unemployment from 2.5 per cent in 1975 to 12 per cent in 1989. Table (2.1) and figure (2.4) indicate the increase in the unemployment rate in Egypt from 1975 to 1989 . Table (2.1) Increase in Unemployment Rate in Egypt (from 1975 to 1989) (per cent of the total labor force) Year 1975 1982 1987 1989 1991 Unemployment <%) 2.5 5.7 10.5 12 18 * * Rough Estimate Sources: - Central Agency For Public Mobilization And Statistics (CAPMAS), 1989 - Labor Force Sample Survey (LFSS), 1986 After the Gulf War, the unemployment figure escalated to 18 per cent of the total labor force. Egypt has a huge foreign debt that exceeds 40 billion dollars. This represents a heavy burden to the Egyptian economy and is a great obstacle to its development process. Finally, increase in the growth rate and alleviation of poverty are among Egypt's main national objectives. Figure (2.4) Development of Unemploment Rate In Egypt (per cent of total labor force) (1975-1991) <u O a < D o M < D U 0 «•§ < P V tS rH C (0 § * * O O t * 0 ) a p 1 8 1 6 14 12 10 8 6 4 2 0 1975 1982 1987 Year 1989 1991 0 0 ; 49 2.6.3 Potential Areas of Development in Egypt: i These include rural development, education, health, energy, infrastructure, small scale industries, technology transfer and industry, research and development and development banks. 2.6.4 Agriculture and Rural Development in Egypt: 2.6.4.1 Agriculture Development and Balance of Payments and Foreign Debt: Agriculture and rural development are critical for development in Egypt. As noted, Egypt is characterized by rapid population growth combined with a relatively small cultivated area, This has transformed Egypt into a net import country of agriculture products. At present, Egypt imports 40 per cent of its food. As table (2.2) indicates, the agriculture trade balance of Egypt has changed from 255 millon in 1975 (a net-export country) to -2,500 million in 1981 (a net-import country). Therefore, development in agriculture and land reclamation could contribute to improvement in the balance of payments and alleviate some burden of Egypt's foreign debt. Table (2.2) shows how some key economic indicators of the agriculture sector in Egypt have been deteriorating. 50 Table (2.2) Agriculture Sector Development Some Key Indicators (1960-1990) Key Indicators 1960 1974 1981 1990 -Share of Agriculture In Value Added (%) 28 25 20 -Agriculture Exports As % Of Total Exports 33 25 9 -Agriculture Trade Balance <$ Million, Current Prices) 255 300 -2500 -Self Sufficiency (%) In Major Products * Wheat 70 73 25 * Rice 144 111 102 86 * Sugar 114 96 53 * Lentils 92 81 6 * Cotton 400 232 150 134 * Meat 95 99 73 56 * Milk 94 93 62 44 - Population Index 100 138 170 Sources: - FAO/World Bank Cooperation Program Report, 1986. - Projections From World Bank Report No.4136. EGT, Jan., 1983 . - IMF, Government Statistical Year Book, 1990. To expand the agriculture sector, Egypt must to a large extent rely upon expanding its land base. Fortunately, Egypt has a potential for expanding its land base. According to the Ministry of Agriculture Master Plan of Land (MPL), Egypt has 2.88 million acres which are potentially reclaimable and irrigable from the Nile water source. In addition, 750,000 acres are identified as reclaimable and irrigable from ground water (the World Bank Report no.8047 EGT, Feb.,1990). 51 2.6.4 . 2 Agriculture Development and Employment: The agriculture sector in Egypt is usually more labor- intensive and less import-intensive than the rest of the economy. This has significant potential positive repercussion for unemployment and balance of payments. 2.6.4. 3 Agriculture Development and Social Welfare: Moreover, investing in agriculture and land reclamation not only has a positive impact on employment and balance of payments, but also should improve the social welfare of the country. Indeed, adding to the land base can be seen from a social perspective as a way to alleviate some of the social pressure of urbanization and high population density in the Nile Valley. In Egypt, there is a need to constrain and rationalize urban growth in the Nile Valley, and encourage rural development in the desert. In fact, urban encroachment on agriculture land in the Nile Valley and delta has resulted in substantial agriculture land losses. 2 . 6 .4 .4 Rural Development and Security: Rural development and increasing the number of settlements in Sinai peninsula could contribute to Egypt's national security. Recent wars in the Middle East and Africa have proven that accumulation of weapons and building of arsenals do not guarantee national security of a country any more than 52 building settlements and rural development in areas along its threatened boundary. As matter of fact, in the Middle East, Africa and Eastern Europe, there are significant disputes concerning areas along boundaries. 2.6.4.5 Economic Rate of Return of Rural Development Projects: Based on World Bank reports, land reclamation projects in Egypt have an economic rate of return that ranges from 14 to 19 per cent, and agriculture projects yield up to 3 0 per cent, e.g. fruit projects (World Bank report no.8047-EGT, 19 90 and report no. EGT, 1986). However, electricity projects in Egypt yield an economic rate of return that ranges from 6.1 to 12.65 percent. In fact, the actual difference is greater than that of the World Bank and FOA reports figures for two reasons. First, as will be discussed in chapter 4, electricity projects in Egypt yield an economic rate of return of less than 12 percent. Second, electricity projects are characterized by foreign currency-intensive investments that exceed 80 per cent of the total costs of the projects, as illustrated in chapter 4 in this study. On the other hand, the foreign currency component of land reclamation projects in Egypt do not exceed 40 per cent of the total costs of projects. Also, agriculture projects depends to a lesser extent on foreign currency investments. Given the fact that the Egyptian pound is overvalued, land reclamation projects yield an economic rate 53 of return that exceeds the rate of return from electricity proj ects. 2.6.4.6 Major Constraints on Rural Development in Egypt: Based on the Food and Agriculture Organization (FAO) of the United Nations report, 1986., aside from the limited availability of arable land, the major constraints that have prevented agriculture from performing its potentially key role in the Egyptian Economy include: limited investments in the agriculture sector and failure to develop and use technology needed for expanding agriculture production. Investments and technology could be provided by the World Bank through an optimally designed aid program that addressed Egypt's needs and prevailing problems. Having reviewed the potentials and constraints of agriculture and rural development in Egypt, this study presents how the government of Egypt and the World Bank address and allocate their resources in the areas of agriculture and rural development compared to development in electricity sector. Based on the Ministry Of Planning reports, the Government of Egypt allocates more investments to the electricity sector than it does in the land reclamation sector by 30 per cent. Table (2.3) (below) shows the allocated investments in electricity and land reclamation sectors in three consecutive 54 five-year plans: 1977- 1987 plan, 1982-1987 plan, and 1988- 1992 plan. Table (2.3-) Total Investments in Agriculture and Land Reclamation Versus Investments in Electricity sector (1977-1992) (in millions of L.E.) Sector Investmen 1977/82 Plan Investmen. 1982/87 Plan Invest. 1987/92 Plan Total Invest. Agricult.& Land Reel. 1658.5 1678.4 3502 .3 6839 .2 Electricity 1292.5 2903.9 4761.3 8957.7 Sources: - Ministry of Planning Report, Five-year Plan (1977-1982) - Ministry of Planning Report, Five-year Plan (1982-1887) - Ministry of Planning Report, Five-year Plan (1887-1992) The World Bank also allocates more resources to the electricity sector than to both agriculture and land reclamation. As table (2.4) indicates, the for electricity sector in Egypt, the World Bank has allocated a total amount of 869.3 millions dollar and has successfully managed to mobilize a total amount of 4099.8 million dollars from other international organizations and donors to finance electricity projects in Egypt. Table (2.4) The World Bank Investments in The Electricity Sector in Egypt (1977-1992) (in millions of dollars) Proj ect World Bank Investments (in millions of dollars) Total Proj ect Investments (in millions of dollars) Regional Electrification 48 240 Power II Project 174 870 Power III Project 127 677 .8 Power Supplement Project 59 59 Power IV Project 19 .3 19 .3 Vocational Train. Proj ect 165 848.5 Total Investments 869.3 4099.8 Sources: - The World Bank Report Staff Appraisal Report, 1980 - The World Bank Report Staff Appraisal Report, 1989 - The World Bank Report Staff Appraisal Report, 1991 For land reclamation development, as table (2.5) j i indicates,the World Bank has allocated less investments | i compared to that in the electricity sector. ; Table (2.5) World Bank Investments in the Land Reclamation Sector in Egypt (1970-1991) (in millions of dollars) Proj ect The World Bank Investments (in millions of dollars) The Nile Delta I Project 26 The Upper Egypt I Proj ect 36 The Upper Egypt II Project 50 The Nile Delta II Project 66 Drainage V Project 98 Total World Bank Investments 276 Sources: - The World Bank Report no.8047-EGT, 1990 - The World Bank Report no.6044-EGT, 1986 Table (2.6) and figure (2.5) show the development in land ' ! reclamation in Egypt in the period from 1952 to 1988. The | figure shows that during the period from 1969 to 1981, j development in the area of land reclamation in Egypt was minimal. Surprisingly, this occurred during the period of ; McNamara's tenure where the main emphasis of the World Bank ! was on rural development. Table (2.6) Land Reclamation in Egypt (1960-1988) (in millions of acres) Year 60 61 62 63 64 65 66 67 68 69 Land Reel 0.1 .12 .2 .32 . 5 . 6 .8 .85 .89 .92 Year 70 71 72 73 74 75 76 77 78 Land Reel .94 .98 . 98 .98 .98 .98 .98 .98 .98 Year 79 80 81 82 83 84 85 86 87 Land Reel 1 1.02 1.04 1.15 1.18 1.2 1.3 1.38 1.4 Sources: - The World Bank Report no. 8047-EGT,1990 Table (2.7) shows World Bank cumulative lending operations ' in agriculture and land reclamation, and electricity to all countries versus cumulative lending operations to Egypt in the i same areas of development in millions of dollars. ; Millions Of Acres Figure (2.5) Land Reclamation In Egypt (1960-1987) (in millions of acres) 1.4 1.2 1 0.8 McNamara Period 0.6 0.4 0.2 0 rO in tl fl N C O fflO <O<O<0C0(OCD<O<0h~ T - e a e o M - i o t o N c o m o T - c M c o ^ i - i n t o r ' - . S S K S S N S K S e o m c o f f l f f l c o r a c o o to Year U1 00 59 I Table (2.7) World Bank Cumulative Lending Operations to Countries Versus Cumulative Lending Operations to Egypt (1946-1991) (in millions of dollars) Sector All Countries in million per cent of T. Invest. Egypt in million per cent of T. Invest. Agriculture & Land R. 60,983 .7 22 % 366 9 % Electricity 39,825 14 % 869 21.3 % T.Investments 267,569 100 % 4070 100 % Sources: - The World Bank Annual Report, 1991 Table (2.8) summarizes some of the effects of development in the electricity sector versus the effects of development in agriculture and rural sectors in Egypt. The study presents the impact of development in both areas on some of the prevailing social and economic problems that currently face Egypt. 60 Table (2.8) The Impact of Development in the Electricity Sector Versus The Impact of Development in Agriculture and the Rural Sector __________ in Egypt Criteria Electricity Agricul. & Rural Employment Capital Intensive Labor Intensive Impact on Balance of Payments and Foreign Debt Foreign Currency Intensive 80% Less than 40% of total costs in foreign currency Per Capita Consumption in Egypt 1000 KWH 40 % above average compared to countries with the same per c.income 0.14 acre per cap . The World's smallest arable land to man ratio Economic Rate of Return (W.B. reports) 6.1 - 12.65 Agriculture 15.6 - 30 Land Reclamation 14 - 19 Total Gov. of Egypt investments in 3 five-year plans ( in millions of L.E.) 8957 .7 6839.2 Total W.B. Investments (in million of $) 869 .3 276 + (176) Annual rate of growth (%) 11.6 3.4 Share in GDP ** 0.9 13 .5 Consistency with W.B. trends & Policies Inconsistent expenditures above W.B. trends Inconsistent expenditures below W.B.trends National Security Could contribute to the national security of Egypt Could contribute to the national security of Egypt Density populat. and social pressure from urbanization Neutral Can contribute to alleviation of social pressure from urbanization ** Electricity sector has an indirect impact on GDP 61 2 . 7 C o n c l u s i o n : The analysis in this chapter supports the conclusion that development in the agriculture and rural sector (s) is not less important to Egypt than the development and investments in electricity sector. However, as Tables (2.3), (2.4) and (2.5) show, the government of Egypt and the World Bank have allocated more resources in electricity sector. In addition, World Bank lending operations in Egypt are not consistent with its policies and trends in lending for development. As table (2.7) indicates, while the World Bank' i has allocated 22 per cent of its lending in agriculture in all ! i countries, the agriculture and land reclamation sector in Egypt received only 9 per cent of its lending operations in Egypt. On the other hand, the electricity sector has received 20 per cent of the World Bank operations in Egypt while its trends show that other countries have received only 14 per cent of its cumulative lending operations . ! Moreover, World Bank lending program in Egypt is not I consistent with the adopted policies and views of its leadership. For instance, while McNamara's era is j characterized by putting more emphasis on agriculture and rural development, as figure (2.5) and table (2.6) indicate, development in this area in Egypt is almost negligible. In addition, project appraisal for the World Bank (in general) is based on economic rate of return and sector needs. This chapter illustrates that there is a need to take a more I ; comprehensive view in identifying projects in developing 'countries. This would include other criteria for project r selection, e.g. national security, employment, and the impact P ion balance of payments and foreign debt. In fact, World Bank ,projects in general have put more emphasis on economic rate of return, this has turned out to be inaccurate, and has ! neglected sector needs for service of goods, institutional |aspects, and linking of project outcomes to national 'objectives and prevailing problems outside the sector under 1 investigation. i Finally, for development planning in Egypt there is a 'need for guidelines or criteria of selection of projects on I the national level (as contrasted to the sector level) that would help policy makers in planning and allocating the Egypt's resources. Chapter Three Electricity Sector in Egypt i i \ i 3.1 Purpose: i i The purpose of this chapter is to survey the economics of the electricity sector and its impact on development in Egypt. The chapter also discusses the political factors that | influence and shape the decision making process of i allocating resources among different sectors of the economy. ; I i ; j I 3.2 Introduction: I | Egypt's main indigenous energy resources are oil, natural • gas, coal, hydropower, and solar energy. Proved oil reserves ) I are 480 million tons. Proved natural gas reserves are 250 « t I I million tons oil equivalent (MTOE) . Reserves of coal are l I limited; the only mining project now being considered at the , Mahgara Mine in Sinai would produce 600,000 tons per year t j (0.4 MOTE) by 1995. Most of the hydro power potential of the Nile River is already being exploited and in normal 1 hydrological years produces about 10,500 GWH (equivalent to j 2.6 MTOE of primary energy if fuel had to be used to produce > ; the same electricity) (World Bank Staff Appraisal Report, 1989) . ; : Egypt has also a vast potential of solar energy averaging i | about 5.73 KWH per day per square meter, which is about 41 64 per cent more direct insolation than the sunniest region in the United States (World Bank Staff Appraisal Report, 1980) . Unfortunately, this vast energy resource has not been not utilized and is neglected in both the government of Egypt and World Bank development plans. 3.3 Institutional Framework: Egypt's energy sector is managed by the Ministry of Electricity and Energy (MEE) and the Ministry of Petroleum (MOP) . MEE is a highly centralized organization with a bureaucratic administrative system and little delegation of authority. In fact, bureaucracy in the government of Egypt has deep roots that extend back five thousands years to the Ancient Egyptians. One of the major problems for the electricity sector is the lack of an adequate and coherent accounting and management information system for the subsector as a whole. For instance, the accounting system of EEA and ADCs suffer from a number of weaknesses among which the most important are poor property accounting; improper accrual of revenues and expenses; unsatisfactory cost and budgetary control; and deficient management information system (World Bank Staff Appraisal Report, 1989). MEE is headed by the minister of electricity, a political figure who has a good reputation as an achiever. Many officials in the government claim that he is a man who gets what he wants, whether from the Ministry of Planning (MOP), the World Bank, or any other international organization. The minister speaks fluently three foreign languages and, during his tenure, his communication skills brought huge investments to the electricity sector compared to other sectors in the economy. In fact, he is persuasive when he speaks on TV, addresses the People's Assembly (the Congress of Egypt), or negotiates with the Ministry of Planning. Sometimes he threatens that Egypt would be dark and production in factories would be stopped unless all the needs and investments of the electricity sector are satisfied. Some officials claim that he usually inaugurates the same power plant several times. Whenever there is an expansion, or addition of new equipment in any station, e.g. an electrical transformer, it is an opportunity to reinaugrate the old power station and to invite the mass media, which include the press and TV, to show MEE's achievements to the people. Top officials in different ministries and public offices claim that the allocation of Egypt's limited resources among different sectors of the economy by the Ministry of Planning is subjected to negotiations and subjective considerations. For instance, in Summer 1991, while unemployment prevailed in Egypt and many graduates were in the streets looking for jobs, hundreds of millions of Egyptian pounds were spent to finance the African Sporting Games held in Cairo. Clearly, in any mixed or centrally planned economy of a developing country, top officials have much authority, but little resources to allocate among needy sectors, and limited knowledge and information about sectors and activities of the econorry. In addition, the mass media are owned and controlled by the government. This is a situation which lays the ground for political factors to play an important role in the allocation or misallocation of resources of the economy. 3.4 Organization: MEE controls the electricity sector through the following four major entities: i I I 3.4.1 Egyptian Electricity Authority (EEA): \ I EEA is a government-owned enterprise regulated by the J Ministry of Electricity and Energy. EEA was established in ; early 197 6 under Law No. 12 of 197 6 as part of the j reorganization of the power sector by the Ministry of j Electricity and Energy. Under this law, EEA was made j ' I responsible for implementation, management, operation and t maintenance of all public service electric power facilities j i in Egypt. It became financially autonomous from the [ S government to the extent that it was able to prepare its own j annual budget and five-year plan subject to government j 67 approval, retain any revenues for its development, and contract loans from both foreign and local sources. 3.4.2 The Electricity Distribution Authority (EDA): The EDA was established in 1983 under Law No. 97 to act as a holding company with overall management and control functions over the seven local Electricity Distribution Companies (EDCs). Share holdings in the EDCs are held by the EEA and the government. The EDCs are responsible for preparing their annual budgets and five-year plans and submitting them to the EDA, which consolidates them for all the companies before submitting them to the Ministries of Planning and Finance for approval. The formation of EDA provides a formal channel through which EEA can assemble subsector data necessary for management and planning decisions. Distribution companies have 53,000 employees and provide their services to 9.3 million customers (The Electricity Distribution Authority Annual Report, 1990). 3.4.3 The Rural Electrification Authority (REA): The principal function of REA is to extend electricity services to the rural population and rehabilitate the networks around urban areas where the urban poor tend to concentrate. By the year 1990, electricity was available to about 28 million persons. REA has contributed to the improvement of the welfare and living conditions for many- poor and urban people in Egypt. On the other hand, the National Rural Electrification Plan (NEP) has contributed to the high growth rate of electricity consumption in Egypt in the last decade (1980s). 3.4.4 The General Authority for Construction and Electrical Equipment Industries (ACEEI): AMCE was established in 1983 under Law No. 422. Its function is to supervise electricity projects and manufacture electrical equipment. It acts as a holding company with over-all management control functions over four companies producing electrical equipment, such as transformers. 3.5 Production of Energy: Egypt at present is a net energy surplus country and has been a net exporter of petroleum since the mid-1970s. The petroleum sector has developed into the second largest sector in the economy (after agriculture) , accounting for about two thirds of the value of merchandise exports in dollars terms and 12 per cent of central government revenues in 1988. Therefore, oil prices have a great impact on Egypt's economy. 69 In Egypt, almost all oil exploration, development and production activities are carried out by foreign companies. Falling export prices over the past several years, together with rising development and operating costs, have resulted in a larger amount of production accruing to the foreign partner companies for cost recovery. Consequently, Egypt's share in total output, which was more than 82 per cent in 1981, fell to 60 per cent in 1990. In 1988, total commercial energy production was about 53 MTOE. Oil accounted for 83 per cent, natural gas and condensates 12 per cent and hydro electricity 5 per cent. About 2 0 per cent of Egypt's electricity generation was meant to be provided by Aswan High Dam. However, this was not the case because the water in Lake Nasser progressively fell from its peak of 177 meters in 1977 to 157 meters in early 1988, thereby reducing electricity generation from that source by about one third. This has required increasing generation by fuel and gas firing stations with a concomitant diversion of potential exports to electricity generation for domestic consumption. Table (3.1) and figure (3.1) indicate that the generating power in Egypt has grown from 180 MW in 1952 to 14,000 MW in 1991, i.e. by 77 times. 70 Table (3.1) Development of Generating Power in Egypt (1952-1992) (in MW) Year 1952 1981 1990 1992* Generating Power 180 4700 11500 14000 * Forecasted Sources: - Ministry of Electricity Achievement Report, 1991. 3.6 Consumption of Electricity and Its Pattern: Per capita energy consumption in Egypt in 1988 was approximately 0.538 MTOE, as compared with 0.237 MTOE per capita for 16 other developing countries at a similar income level ( The World Development Report, 1989). Over the last decade Egypt has experienced high growth in energy consumption. Commercial energy consumption increased at an annual rate of about 11 per cent from 197 5 to 1985 (World Bank Staff Appraisal Report, 1989) . This high growth rate of commercial energy consumption increase is mainly in response to rapid economic growth (8.4 per cent per year), falling real prices for petroleum products (a decline of 21 per cent between 1974 and 1985) and electricity tariffs. However, the growth rate for consumption slowed down after 1985 due to the lower growth in the economy. Generating Power in Figure (3.1) Development of Generating Power in Egypt in MW 14000 T 12000 -- 10000 8000 -- 6000 -- 4000 -- 2000 -- 1952 1960 1965 1970 1975 1980 1985 1991 Year 72 ' In line with overall consumption, electricity use has grown rapidly in the last three decades. Per capita consumption of electricity has grown from 50 KWH in 1952 to 1000 KWH in 1991 (Ministry of Electricity and Energy ' Achievement Report, 1991), The rapid growth in electricity consumption reflected to the following factors: - The growth of the economy - Decreases in real electricity prices - The Ministry of Electricity and Energy and World Bank programs to expand the availability of electricity, e.g. rural electrification program. - Expansion in energy intensive industry. In Egypt, the largest energy consuming firms operate chemical and fertilizer firms. 3.6.1 Geographical Pattern of Energy Consumption: As table (3.2) and figure (3.2) indicate, the pattern of electricity consumption in Egypt is not homogenous. While the population of greater Cairo (including the city of Giza) is 2 0 per cent of the total population of Egypt, its consumption exceeds 37 per cent of the total electricity consumption in Egypt. On the other hand, while the population of Upper Egypt is 27.8 per cent of the total population, its consumption is only 14.42 per cent of the total electricity consumption in Egypt. 73 Table (3.2) Consumption of Electricity in Egypt by Zones (as per cent of the total consumption in Egypt) Geographical Area Electricity Consumption (as per cent) Population (as per cent) Cairo 37.62 % 20 % Alexandria 15.64 % 6.4 % Suez Canal Zone 9.45 % 2.6 % Delta 22 % 42.2 % Upper Egypt 14.42 % 27.8 % Sinai 0.5 % .6 % Red Sea 0.2 % .3 % Total 100 % 100 % Sources: - Central Agency for Public Mobilization and Statistics Year Book, 1990. - Ministry of Electricity and Energy, Ten Years of Achievement Report, 1991. Consumption of Electricity (as %) and Population (as %) — * • rv s ro o j to 0 1 o 0 1 o u i Cairo Alexandria m CD O 2. «<r o o 3 OT C 3 -a o' 3 □ TJ O T3 E. a > o ' 3 Suez Canal o ^ , 0 Delta ( D m Upper Egypt Sinia Red Sea Consumption of Electricity and Population i n Egypt by Zone 75 Table (3.3) and figure (3.3) indicate the pattern of electricity consumption in Cairo and Upper Egypt by sector. The table shows that the residential sector in Upper Egypt consumes 57.1 per cent while the industrial sector only consumes 13.2 per cent of the total electricity consumption in the area. This means that even the relatively small amount of electricity consumed in Upper Egypt compared to Cairo is directed towards non productive activities. For Cairo zone, the industrial sector consumes 35.6 per cent, close to the consumption of the residential sector, which is 37.1 per cent of the total electricity consumption of the zone. Table (3.3) Pattern of Electricity Consumption in Cairo and Upper Egypt by Sector (as per cent of the total consumption) Sector Cairo Upper Egypt Residential % 37.1 % 54.1 % Industrial % 35.2 % 13 .1 % Public Utilities % 6.2 % 13 . 9 % Agriculture % 0.3 % 6.1 % Government % 4.1 % 4.14 % Others % 16.2 % 9 % Total 100 % 100 % Sources: - The Distribution Electricity Authority, Annual Report, 1990. Electricity Consumption (as % of total Figure (3.3) i Pattern of Electricity Consumption in Cairo and Ufcper Egyj by Sector (as % of total consumption) 60 - - 50 - - a 40 - Residential Industrial Public Utilies Agriculture Government Sector I Cairo G Upper Egypt i 'j C T \ Tables (3.4) and (3.5), and figure (3.4) show the actual and the projected electricity consumption of the residential and the industrial sectors in Egypt in the periods from 1977 to 1988 and from 1990 to 2006 respectively. The tables and figures show that consumption of the industrial sector has changed from 56 per cent of the total electricity consumption in Egypt in 1980 to 43.2 per cent in 1987. Based on the forecast model developed by EEA, by year 2 006, the projected electricity consumption of the industrial sector is expected to decrease to 23.6 per cent of the total electricity consumption in Egypt (Stone and Webster Kurimate Feasibility Study, 1989). On the other hand, table (3.4) indicates that the consumption of electricity of the residential sector has increased from 20.37 per cent in 1980 to 34.4 per cent in 1987 of the total electricity consumption in Egypt. Also, based on the forecast model developed by EEA, the projected consumption of the residential sector is expected to increase to 48.4 per cent of the total electricity consumption by year 2006. If the EEA forecast of electricity consumption actually occurs, and as figure (3.4) indicates, the trend in Egypt is to allocate more energy and resources in non-productive sectors and activities, e.g. the residential sector, compared to the productive ones, e.g. the industrial sector. In other words, Egypt is not on the right path for development. 78 Table (3.4) Actual Electricity Consumption of Residential and Industrial Sectors (in GWH) and (as per cent of the total consumption) Sector 1980 1982 1984 1987 Residential Sec Consumption (GWH) (%) 2681.8 20.3 % 4419 25.6 % 6792 30.4 % 9802 34.4 % Industrial Sec. Consumption (GWH) (%) 6518 56 % 8928 51.8 % 9535 47.2 % 12551 43 .2 % Total Cons. (GWH) 13,156 17,239 22,307 28,474 Losses as % of Total Generation 19.6 % 21.3 % 19.6 % 19.1 % Table (3.5) Projected Electricity Consumption of Residential and Industrial Sectors (in GWH) and (as per cent of the total consumption) Sector 1992 1997 2001 2006 Residential Sec Consumption (GWH) (%) 20726 39 % 30340 44 % 37754 47 % 46141 48.4 % Industrial Sec. Consumption (GWH) (%) 15928 30 % 18197 26.5 % 2082 25 % 22483 24 % Total Cons. (GWH) 44,174 58,013 68,983 82,013 Sources: - Stone and Webster Engineering Consultants, Feasibility Study for El-Kureimat, 1989. Electricity Figure (3.4) Actual and Projected Electricity Consumption of Residential and idustrial Sectors (as %) 60 C O d ( T j O —' -H £ 50 d g O d •rl CO ft O 40 S o rH d d O 4 J 30 a o 0 20 4J d a ) o .. u < u ft 1980 1982 1984 1987 1992 1997 2001 Year Residential Sector-------------- Industrial Sector 2006 80 3.7 Electricity Pricing in Egypt: The current retail price of electricity in Egypt of 46.3 milliemes (about 1.39 cents) per KWH is one-fifth of the World Bank estimate made in 1989 of the economic cost of electricity in Egypt, estimated at 6.6 cents per KWH. This rate is also very low compared to other countries where electricity prices are charged on economic bases, e.g. in L.A., California, the adjusted domestic retail price is 9.37 cents per KWH. Subsidization has the effect of increasing domestic consumption beyond what it would otherwise have been. The management of electricity tariffs in the 1980s reflected the government's policy to reduce inflationary pressures for low income people. As table (3.6) indicates, real rate increases did not begin until the mid-1980s with an increase in the average tariff of 35 per cent, followed by increases of 29 per cent in 1987 and 30 per cent in 1989. The EEA wholesale price for electricity increased about half as rapidly as the wholesale price index in Egypt from 1984 to 1988 . 81 Table (3.6) Changes in Average Electricity Prices (1974-1990) (in milliemes per KWH) Year Sales in Millions of KWH Value in Millions of L.E. Average Tariff in m per KWH Wholesale price index (1974=100) Price index elect. (1974= 100) 1974 6895 50 .2 7 .27 100 100 1979 14546 107 .3 7.38 154 101.5 1980 16114 120 .4 7 .47 177 102 .8 1982 21546 179 8.34 249 114.7 1984 26175 288 1.1 318 151.6 1986 28664 513 .5 1.645 421 2263 1987 33420 735 .3 2.2 488 302 .6 1890 37428 1131. 3 .02 679 415 .4 Sources: - The Egyptian Electricity Authority, Annual Report, 1990 . - IMF, International Financial Statistics, 1990. 3.8 The Electricity Tariff Structure in Egypt; The electricity tariff structure in Egypt is relatively simple. Very high voltage customers pay only a KWH rate. Public sector customers who use electricity at medium or low voltage pay both a KWH rate and demand charge per KW. Residential and commercial customers pay a KWH rate which increases for successively higher blocks of consumption per month. The rate structure is not economically efficient because it does not vary with regard to peak versus non-peak demand. In addition, the rate structure discriminates between users in public and private sector firms. Currently, large public sector industrial consumers, such as the aluminum 82 smelter at Nag Hamadi and the Kima Fertilizer plant are charged as little as 12.2 milliemes (about .35 cents) and 19.9 milliemes (about .6 cents) per KWH respectively. At the other end of the spectrum, private sector firms with foreign partners organized under Law 43 are charged as much as 2 00 milliemes per KWH. About 24.4 per cent of EEA electricity sales in 1989 were made directly (i.e. not through distribution companies) to firms under special tariffs for very high, high, and medium voltages. Six firms in the very high voltage group accounted for 17.6 per cent of EEA total sales in 1989 (EEA, Annual Report, 19 90) . This includes 8.7 per cent to the Nag Hammadi aluminum plant and 4.6 per cent to the Kima fertilizer plant. During 1989 the average rate charged to this group was 15.6 milliemes per KWH. EEA direct sales to firms at high and medium voltages in 1989 were at an average charge of 28.5 milliemes per KWH, and sales to this group amounted to 6.8 per cent of EEA total sales. From the economic point of view, all consumer groups are subsidized. As compared with an average charge, the rate structure gives a high subsidy to large state enterprises and middle income households. Also, there is a price discrimination between public and private sector firms, even those producing similar goods, because of differences in the scale of operation or by virtue of the law under which the private sector firms were organized. Public sector firms are 83 in the very high and high voltages categories or contracting more than 500 KW. Private sector firms are predominately in the medium to low voltage category which contract for less than 500 KW or are organized under Law 43 which pay a rate adjustment premium (O'Farrell, 1988). If the private sector firms were incorporated under Law 43, its average rate would be 96.3 milliemes per KWH. The 40 milliemes per KWH premium is to eliminate the fuel subsidy provided to EEA because the international status of Law 43 eliminates eligibility for subsidy (Adler, 1990) . The combination of the commercial rate schedule and Law 43 status gives rise to rates in excess of 200 milliemes per KWH for commercial firms consuming over 2,000 KWH per month (Adler, 1990). Reportedly, private sector firms currently pay an average of 148 milliemes per KWH. 3.9 Volume of Subsidy and Its Economic Impact: Electricity prices are heavily subsidized in Egypt. The subsidies, explicit and implicit, involved with keeping domestic energy prices below their economic levels is roughly 7 billion Egyptian pounds (about 2 billions dollars) per year (World Bank Staff Appraisal Report, 1989). The explicit and implicit subsidies that led to the fact that users are charged only 3 0 per cent of economic cost is explained by the fact that the government of Egypt maintains a low transfer price for fuel supplied to EEA and that there is less than a full recovery of capital and interest charges for the electric plants. These subsidies are equivalent to about 10 per cent of GDP, and approximately 40 per cent of the budget deficit (IMF, Egypt: Recent Economic Developments, 1989). Low energy prices have financial, economic, and social costs. They have encouraged rapid growth in demand and wasteful use of energy; promoted questionable energy-intensive industrial investments; placed a severe strain on Government finances, and diverted potential petroleum exports to the domestic market with adverse impacts on the balance of payments and the economy. In fact, artificially low prices lead users to act as if energy prices were not scarce, leading to over consumption of energy and to a lower efficiency of investments. With low energy prices the process of investment as related to energy use becomes less efficient as more energy-intensive technology is installed. The use of energy intensive- technology throughout the economy is likely to causes greater waste. This occurs because energy prices become embodied in physical plants, that are less energy efficient than those that would have been selected by correct energy prices. Therefore, a substantial portion of investment through a broad spectrum of the Egyptian economy has to be viewed as wasted because it embodies technology that is too energy intensive and cannot be sustained in the face of a likely increase in energy prices. 3.10 Import Substitution and Sustained Development: 3.10.1 World Bank and EEA investments in Imported Goods: ! During the last two decades, the World Bank and the i Government of Egypt have allocated huge investments to the electricity sector in Egypt. As table (2.3) indicates, the Government of Egypt has allocated an amount of 8957.7 | Egyptian pounds (about 2.7 billion dollars) to the i I electricity sector. Similarly, as table (2.4) indicates, the World Bank has allocated an amount of 869.3 million dollars I { and managed to mobilize from international organizations an i : amount of 4099.9 million dollars for the Egyptian electricity I sector. Based on World Bank Staff Reports, 1980, 1989, and 1 i 1991, 80 per cent of investments in electricity projects are | in foreign currency. Therefore, there is a demand for ! imported electrical equipment in Egypt. 3.10.2 The Potential of Producing Electrical i Equipment in Egypt: Egypt's human resource pool and industrial base j represent a good potential for manufacturing locally a i 1 substantial amount and percentage of its needs for power i station equipments. Dr. Ali El Sa'eidy, Director of the Nuclear Power Plants Authority (NPPA) and one of the top i , officials in MEE, claims that Egypt has the potential for 86 producing more than 5 0 per cent of its needs from power station equipment (Electricity and Energy Magazine, 1991) . In addition, research papers presented to a seminar held in Cairo in September 1991, "Production of Capital Goods in Egypt", argue that Egypt has the potential of producing 60 per cent of power station equipment and installations. These include electrical boards, boilers, condensers, pipe lines, and mechanical constructions. 3.10.3 World Bank and Electricity Sector Investments in Electrical Equipment Industry: Based on World Bank documents, the Bank's operations in Egypt do not include any investments in the electrical industry. Based on MEE Achievement Report, as table (3.7) indicates, the Ministry of Electricity and Energy has invested only a total amount of 38.6 million Egyptian pounds (about 11.69 million dollars) in more than three decades in electrical industry. 87 Table (3.7) Electricity Sector Investments in Electrical Industry in Egypt (in millions of Egyptian pounds) Enterprise Name Capital Invest. (in mill. L.E. ) Annual Product. (in mill. L.E.) Establish. date El Nasr Company for Electrical Industry (ALAMACO) 8 45 1962 German Venture Comp. (EG-MAC) 30 40 1977 French Venture Comp. (REF-CO) 0.6 N. A. 1983 Total 38.6 ** ** equals to 11.7 million dollars Sources: - The Ministry of Electricity and Energy Achievement Report, 1991. The above analysis shows that both the Government of Egypt and the World Bank have not allocated enough investments to local manufacturing of electrical equipment in Egypt. Needless to say, for sustained development, and to alleviate the problem of unemployment, Egypt needs to allocate some of its resources, including foreign aid, to industrialization and transfer of technology rather than allocating vast amount of its resources to imported goods. 3.10 Conclusions: Political factors play an important role in the allocation or misallocation of Egypt's limited resources. This is mainly because of the mixed-semi-centrally planned economy adopted in Egypt, control of mass media by the government, and the absence of a well defined strategy for sustained development. Needless to say, Egypt needs a strategy that will direct some of its resources, local and foreign aid, to local manufacturing of electrical equipment instead of importing 100 per cent of what is needed from the USA as imposed by USAID conditionality. Moreover, Egypt needs a strategy that would promote land reclamation and urban development instead of spending tens of billions of dollars in importing grain from the US agriculture market, also_ imposed by USAID conditionality. Per capita consumption of grain in Egypt is considered the highest rate in the world. For sustained development, Egypt needs to invest some of its resources in industrialization and land reclamation to create jobs, be self sufficient, and be independent. The pattern of electricity consumption in Egypt indicates the following important facts: - The trends in electricity consumption in Egypt is not towards productive sectors which give an indication that Egypt is not on the right path for development. - Development in Egypt is not geographically balanced. More resources are allocated to Cairo and the big over 89 populated cities in northern Egypt as compared to in Upper Egypt and rural areas. This has brought about a serious problem of urbanization pressure which has had a negative impact on the welfare of Egypt in the long run. - The boundaries of Egypt are less 'developed and less inhabited, which adversely affects Egypt's security. The electricity tariff rate structure in Egypt is inefficient, and distorted. It still reflects the historical circumstances of surplus cheap hydroelectric power from the Aswan dam in the 1960s. It is inefficient because rates do not vary with regard to time of day, e.g. peak load versus non-peak demand, while the cost of meeting peak demand without outages is obviously higher than the average cost per KWH. The rate structure is distorted because it favors state- owned enterprise and energy-intensive industry, both of which usually operate inefficiently . In addition, the rate structure favors the residential sector, which has resulted in an over-consumption of electricity in non-productive activities. 90 Chapter Four The Appraisal of Electricity Projects in Egypt 4.1 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 demand and technical appraisal of the project must be provided to evaluate its feasibility; the institutional and administrative aspects must be fairly assessed; the 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 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 specialists, financial analysts, and economists. For the World Bank, project appraisal is solely its 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 on feasibility studies that are conducted by well known consultant firms, e.g. "Overseas Bechtel", "Stone & Webster Engineering Corporation", and "Sanderson & Porter, Inc". These studies are very expensive and their cost may exceed five or ten millions Dollars. They are usually financed by an international development organization, e.g. USAID, UNIDO, or UNDP. Because of the Bank's close involvement in identification and preparation, project appraisal rarely results in rejection; but it may be extensively modified or redesigned during this process to correct flaws that otherwise might have led to its rejection. For the Government of Egypt, project appraisal is 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 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 State) and is empowered to carry out field investigation, planning, design, conduct and supervision of projects. For the Ministry of Agriculture, the Agriculture Research Center (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 evaluation. 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 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 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 impact of electricity pricing policy on the welfare of a particular group of people, the information on who the customers are and their relative consumption pattern of electricity will eventually be essential in determining the 93 capacity and specifications of a generator in a power station. An evaluation of a public sector project that examines technical and financial variables alone is not very meaningful, no matter how accurately it has been carried 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 (4.1) 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 rejection. This process is expected to cover the following areas: 4.1.1 Demand Forecast: Here, the demand for electricity, services, and prices or the relative needs of social services are estimated, quantified, and justified. In Egypt, production and distribution of electricity is a public sector monopoly, 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 Financial Technical Demand Forecast Institutional Economic Social Figure (4.1) 95 4.1.2 Technical and Engineering Aspects: Technical appraisal is concerned with questions of physical scale, layout, and locations of facilities and the technology to be used. This includes types of equipment or processes and their appropriateness to local conditions. So the input parameters of the projects are specified in detail and cost estimates are developed. The technical appraisal also reviews proposed procurement arrangements to make sure that the World Bank's requirements are met. The potential impact of the project on the human and physical environment is examined to make sure that any adverse effects will be controlled or minimized. The World Bank has to ensure that projects are soundly designed, appropriately engineered, and follow accepted electrical standards. The appraisal team studies technical alternatives considered, solutions proposed, and expected results. 4.1.3 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 electricity sector in Egypt and the government policies that condition its working environment. 96 4.1.4 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 projects. Will it be able to meet all its financial obligations, including debt service to the Bank? Will it be able to generate enough funds from internal sources to earn a reasonable rate of return on its assets and make a satisfactory contribution to its capital requirements? The finances of the balance sheet, income statement, and cash flow must also be considered. 4.1.5 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. 97 4.1.6 Social Aspects: Extra-economic impacts of the projects must be identified and quantified. These include the impact of a project on the well-being of particular groups in society. Political factors should be identified as well as the long run impacts of the project on the community. 4.2 Electricity Demand Forecast: The electricity demand forecasts are used to draw up plans and to make investments in expanding generation, transmission and distribution capacities. It is therefore important to know the magnitude of the future power load before investing in the power sector. 4.2.1 Factors That affect the Growth of Electricity Consumption: The growth in electricity consumption in any country is influenced by the following factors (The Economist Intelligence Unit, 1989) : - Growth Rate of Gross Domestic Product (GDP). - Change in electricity prices. - Rate of population growth. - The rate of electricity penetration. - The increase in access to electricity. - The extent which electricity consumption approaches saturation point. 4.2.2 Load Forecast for Electricity Projects in Egypt: For appraisal of electricity projects in Egypt, a demand 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) , 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 and Establishment Census." The load forecast is the aggregate of the following sectors: 4.2.2.1 The Residential-Commercial Sector: Energy sales are projected using demographic and appliance saturation end-use models. The demographic models 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 historical and projected appliance production in the residential average consumption model to project future use 99 per residential-commercial customer. The following model was developed (feasibility study for Kuriemat plant, final report, 1989). Ln RES-KWH = 14.425 - 277.876/POP + 0.4045*DUMRES1 Where: Ln = natural logarithm RES-KWH = Residential/small commercial sales in KWH POP = Population DUMRES1 = 1 for 1979 to 1984 and 0 otherwise 4.2.2. 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: Ln = natural logarithm PUB-KWH = electricity sales to public utilities in KWH POP = Population in millions 4 .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 Kuriemat Plant, final report, 1989). 100 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 4.2.2.4 The Very High Voltage(VHV)-Industrial Sector: 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. 4.3 Analysis of Electricity Demand Forecast: For better analysis of demand forecast of an electricity project, we have to examine how different factors which affect electricity consumption fit into the econometric models developed by EEA and are applied in demand forecasts. 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 following are the results of the analysis: 4.3.1 Growth Rate of Gross Domestic Product (GDP): Growth of national income is probably one of the most 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 (4.1) and figure (4.2) indicate estimates of the real GDP growth rates. Table (4.1) Real GDP Growth Rates (in per cent ) Year 1979 1980 1981 1982 1883 1984 GDP Growth Rat e(%) 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: - Ministry of Planning, 1991. 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. Figure (4.2) Real GDP Growth Rates 1987 (in % ) (1979-1990 CO o> O CO CO <T> o cn a> T— V" r- O to 103 4.3.2. 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 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 Economist Intelligence Unit, 1989) . Therefore, the impact of pricing policy on the level and shape of electricity demand has been significant and should be taken into consideration in projecting electricity demand. It is expected that electricity prices in Egypt will be increased radically for more than one reason as follows: First, Egyptians are used to consuming more energy than the average for countries at a similar income level. As The World Bank staff appraisal report (1989) indicates, per capita 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 (4.2) indicates per capita electricity consumption in Egypt compared to some other developing countries. 104 Table (4.2) 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 Egypt during the last three decades is very high. As table (4.3) and figure (4.3) indicate, the per capita electricity consumption in Egypt has grown from 50 KWH in the year 1952 to 1000 KWH in the year 1992. 105 Table (4.3) 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 must be reduced in order that the budget deficit may be lowered. In Egypt, the budget deficit represents 8 per cent 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 year 1995. The World Bank mission's estimates of electricity price increases needed to meet loan conditions are shown in table (4.4) below: Figure (4.3) Per Capita Consumption of Egypt (in KWH) 000 T 900 -- 800 - 700 - 600 -- 500 -- 400 -- v' 300 -- 200 -- / 0 H---------1 -------- 1 -------- 1 ---------1 — 1952 1960 1965 1975 1980 Year Electricity (PCCE) in (1952-1992) \ i 1985 1989 1990 1992 107 Table (4.4) 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 39.5 41.7 44 46.3 Ave.Price (M/KWH) 30 .5 43 .3 60.7 83 106 Year 1995 199 6 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 (4.4), 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 (4.5). 108 Table (4.5) 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. (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 Souxces: - 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 (4.4) shown below. As shown in figure (4.4), 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) M ^ O I O O O N ^ O t O O O O O O O O O O O O 1 9 7 8 1 9 7 9 - 1 9 8 0 - 1 9 8 1 1 9 8 2 1 9 8 3 - 1 9 8 4 - 1 9 8 5 - 1 9 8 6 1 9 8 7 - Kj 1 9 8 8 - K 1 9 8 9 1 9 9 0 - 1 9 9 1 1 9 9 2 - 1 9 9 3 - 1 9 9 4 - 1 9 9 5 - 1 9 9 6 - 1 9 9 7 - 1 9 9 8 - 1 9 9 9 1 H O i_i. ( D O ft < D Cb M H ( D O ft H H* O H-* » * < a CO p. P> £ » p. ( 0 © 3 M. w s ( P 3 * § I s p> *d H H- o ( 0 t n H P o H © © t o <p 31 cq' c CD 601 110 4.3.3 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 7 9.007 by 2006 as indicated in table (4.6) and figure (4.5) shown below: Table (4.6) 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. 4.3.4 The Rate of Electricity Penetration: This is the rate at which electricity displaces other 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 the CAPMAS Statistical Year Book are used, along with the newly developed customer account information, to project the average future consumption per customer. Population Growth (in millions) Population Growth In Egypt (in millions) (1960-2006) 80 7 0 6 0 5 0 4 0 3 0 20 1 9 6 0 1 9 6 6 1 9 7 6 1 9 8 6 19 9 1 1 9 9 6 2001 2 0 0 6 Year Figure (4.5) ill 112 4.3.5 The Increase in Access to Electricity: For Egypt, a rural electrification policy was adopted in 1976, 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. 4.3.6 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 electricity use. Electricity consumption is expected to continue to experience growth rates that are not affected by saturation. 4.4 Comments on Demand Forecast: Some of the factors that affect growth in electricity consumption are included in the econometeric models used to 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, historical data that include an increase in electricity consumption due to past expansion in rural areas will not reflect future demand adequately. Consequently, the forecasted demand has been over 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. 114 4.5 Economic Analysis: 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) = £c=n (Bt - Ct )/(l +IRR)t = 0 t=° where: Bt = 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. 115 4.5.1 Methodology: The methodology used for conducting economic analysis for electricity projects in Egypt is based on the following procedures (Stone and Webster, 1989): 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 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 be discounted to make it the equivalent in value of present consumption (Little and Mirlees, 1974). For Jenkins, this is defined as the discount rate used to reflect the value of consumption and investment that is 116 postponed due to the expansion of the public sector project (Jenkins, 1990) . 6- Sensitivity analyses are conducted to analyze the impact on the basic result of major uncertainties inherent in project appraisal, for example, the impact of the change in exchange rate on the IRR. All the above costs and benefits are adjusted for economic concepts, by using shadow prices which differ from prices observed in the market because of non-competitive behavior, 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 a result of withdrawing one unit of a good from its existing employment. 4.5.2 Economic Internal Rate of Return (EIRR): 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 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. 117 The economic internal rate of return (EIRR) is a product of cost-benefit analysis, designed to measure the contribution of the investment to the national economy as a whole. Although it is an important indicator of the performance of a project, there are some aspects which it 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 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 discount rate, shadow prices, and the exchange rate. For better evaluation of any project, we need to be sure that all calculations are based on appropriate estimations of these key parameters. 4.5.3 The Discount Rate as a Key Parameter in Economic Analysis: The discount rate is a key parameter in the economic analysis of development projects. It is a yardstick by which 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 funds. It is an important indicator which has an influence 118 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 decision whether to have nuclear or conventional energy to generate electricity is sensitive to the discount rate. The former decision uses more capital initially, but saves costs later. Therefore, it requires a relatively low discount rate to look better than the latter. 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 discount rate reflecting the economic opportunity cost of public funds are as follows: 4.5.3.1 Hirshleifer's Approach: Proponents of this approach argue that public sector 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; 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 sector projects have a higher expected economic return, then the government should see to it that funds are invested in the private rather than public projects. 119 This approach assumes that if additional funds are invested in the public sector, then no change or movement of resources will take place between private investment and consumption. This approach has a weakness in that it does not allow for adjustment in the allocation of funds that will take place in a reasonably well functioning capital market. For instance, Jenkins argues that if people from their perspective have already allocated their funds between investment and consumption optimally, then if the government 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 productivity of private investment, but is some mix of the gross return from private investment and private consumption. 4. 5.3.2 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 in Egypt (Stone and Webster, 1989) . Little and Mirrlees have 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 Mirrlees, 1974). 120 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 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 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 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: 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 of 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 rate of interest should be adjusted upwards. Also, if too few projects look promising, the adjustment should go the other way (Little and Mirrlees, 1974). Although the methodology employed in the economic analysis of electricity projects (cost-benefit analysis using shadow prices that was developed by Little and Mirrlees), is an appropriate technique for project evaluation, the approach used in estimating the economic opportunity cost of public funds and shadow prices has some shortcomings. For instance, in estimating the opportunity cost of public funds, the approach only considers the marginal return from public sector projects and neglects the possibility that if public sector 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 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 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 than what Egypt would gain by simply paying some of its debt. Harberger's approach in estimating the discount rate is more 122 'comprehensive compared to Little's approach, as will be discussed below. I I I 4.5.3.3 Harberger's Approach: 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, plus the cost of additional foreign borrowing which arises because of the expansion of the public sector (Harberger and Jenkins, 1991). The above approach is characterized by a broader view of the effect of an expansion of the public sector on the rest of the economy. For example, it does not neglect the impact of 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 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 ditures (Jenkins, 1991) . As in the estimation of the supply price of any other good or service, the marginal economic opportunity cost must be based on the highest cost source of supply which can be expanded to meet an incremental demand. Currently, the 123 government of Egypt obtains some of its funds to finance its budget deficit from the capital market by issuing bonds at a rate of 19 per cent. In supply of funds to the public sector projects, e.g. electricity projects, the capital market represents the most common source of incremental funds. To estimate the economic opportunity cost of public funds, we begin, as shown in the figure (4.6) below, with a situation where the market rate of interest is iD , and the quantity of funds demanded and supplied in the capital market for equilibrium is Q°. If the government now borrows 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 it , thus inducing 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 Q° Q1. The economic cost of postponing consumption is equal to the area Q°ABQS, which is the return savers receive from their increased savings. This is the area under the S-S 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 Ql. 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*ei *R)/(es - e^ *R) where: es is the elasticity of supply of private sector saving with respect to changes in the rate of interest rate. et 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 R ate (in % ) Quantity of Investm ents and Saving Q1 Q° Qs Opportunity Cost of Public Funds H to Ui 4.5.3.4 Changes in Interest Rate in Egypt: Table (4.7) and figure (4.7) indicate the changes in interest rate in Egypt from 1960 to 1992. Table (4.7) 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 0 0 C O 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 i o 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 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 %) 20 -- 18 - 1 6 -- 2 ” o - T“ CM to CO o C v l to to o CM M- to CO to to to to to K N. h- N. CO CO 00 00 CO o> CD CD CD CD CD O) CD CD 05 CD OJ CD CD 05 T" T— T“ T — T“ T* T" i — T* T— T — T- T — T- T“ Year Discount Rate (%) Deposit Rate (%) Lending Rate (%) Figure (4.7) H to *0 1 9 9 0 128 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 following: I = 22 per cent, interest charged by commercial 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), e£ = -1, R = .9, ratio of private-sector investment to total saving. Therefore, the economic opportunity cost of public funds (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 the economic viability of electricity projects that will be implemented in the 1990's. This rate differs from the 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 129 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 197 9 (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). Third, for any consultant firm, there is a need to justify 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 130 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 motive for a consultant firm to justify the implementation of any project in which it conducted a feasibility study. 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 1,3 00 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. 4.5.4 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 131 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 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. 4.5.4.1 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 economy. The following shows how Egypt has had a multiple exchange rate: 132 The Central Bank Pool: 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. 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 the commercial bank pool ( worker remittance and tourism) and satisfies demand by the private sector for exchange for visible and invisible transactions. Table (4.8) and figure (4.8) indicate the development in the multiple exchange rate in Egypt during the period from 1982 to 1992. Transactions in the Central Bank pool were mainly at the official rate of L.E. 0.7 per dollar. 133 Table (4.8) 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 .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, 1991. A new bank foreign exchange market, in which all autho rized commercial banks were permitted to operate, began operations on May 11, 1987. This new market was established in order to prevent multiple applications for foreign 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 Development of Exchange Rate in Egypt (in L.E./$) 3.5 j S 3- w J 2.5 -- 2 - ■ 1.5 -- 0.5 0 - I 1- - - - - - - - - - - - - - - 1- - - - - - - - - - - - - - 1 - . . . . . . . — I- - - - - - - - - - - - - 1- - - - - - - - - - - - - - I - - - - - - - - - - - - - - 1- - - - - - - - - - - - - - 1- - - - - - - - - - - - - - 1- - - - - - - - - - - - - - 1 1 9 8 2 1 9 8 3 1 9 8 4 1 9 8 5 1 9 8 6 1 9 8 7 1 9 8 8 1 9 8 9 1 9 9 0 1 9 9 1 1 9 9 2 Year Central B. Pool Commercial B. Free Market New Bank Rate Pool Rate 134 135 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 bank pool was closed in March 1988. 4.5.4.2 Exchange Rate and the World Bank-financed Projects: As table (4.9) indicates, a substantial amount of the total cost of the World Bank-financed projects was incurred in foreign currency. Table (4.9) 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 Proj ect % 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 % Sources: - El Kuriemat Staff Appraisal Report, Aide-Memoir, 1991. - Fourth Project Staff Appraisal Report, 1989. - Third Project Staff Appraisal Report, 1980. j 136 i , Therefore, an accurate estimation of economic exchange i 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, i although spent in Egypt, would draw down the country's foreign reserve. For instance, the use of construction fuel is a local expense but reduces the amount of petroleum available for export. 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 the price of the exchange rate and taking into consideration the likely future change in its value. Indeed, it would be 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 (4.10) indicates, the estimation of the exchange rate by World Bank staff appraisal reports does not reflect the real cost of the scarce resource drawn down from 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 137 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 (4.8) . 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 199 0 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. per US dollar was estimated in 1991 by the World Bank staff. Both estimates reflect input costs to a project that will be implemented in the period from 1992 to 1996. In all cases, for both the World Bank and the consultant firm, there is a need to justify the project economically in order that the project may be implemented. 138 Table (4.10) 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 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: t=n Net Present Value (NPV) = j (Bt - Ct ) / (1 +EIRR)t = 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 (4.9) 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. 140 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 O & M costs (Stone and Webster, 1989) . The EIRR is extremely sensitive to change in the costs of tradable inputs, i.e. fuel, spare parts for operations and maintenance, and capital costs. Table (4.11) and figure (4.9) 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 one dollar = 3.33 L.E., the Kuriemat project yields an EIRR of 4 per cent, which is, according to ray estimates far below the opportuni ty cost of public funds. Table (4.11) The Effect of Changes in the Exchange Rate (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./$) 14 Estimated Yield 12 10 8 6 Actual Yield 4 - ^ ________ ! ~ 2 Estimated Rate Current Rate o 2 2.3 2.75 3 3.3 3.5 Excchange Rate (L.E./$) 141 142 4.5.5 Shadow Prices as a Key Parameter in Economic Analysis: In Egypt, as a development country, government policy introduces externalities, non-competitive behavior, and 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, 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 proj ect. 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 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 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 for project appraisal which may implemented in 19 90's. However, the basic principles involved should play an integral role in sound project appraisal. 143 4.5.5.1 Methodology Used by Page to Estimate Shadow Prices in Egypt: Page expresses the shadow prices of any commodity or factor of production used as an input to a project in terms of a 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 international prices of delivering them to a representa tive project. For tradable goods, this consists of the world price of 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 into tradable inputs, non-tradable inputs and primary inputs, for example, labor and foreign exchange. Further, he 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. This is simply an application of input-out analysis. The shadow price of the commodity is then given by the sum of the shadow value of traded inputs plus the shadow value of the primary inputs. 144 4.5.6 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 project evaluation of any development project in Egypt, we need to institute a wide-ranging system of economic prices that reflect the real cost and benefits to society or the 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 of project evaluators would be the body which would consult closely with the government of Egypt not only in setting economic prices, but also in the choice and selection of the large development projects, specially those which are financed by an international organization, e.g., The World 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 145 should invest in development. Needless to say, it would be time consuming and inefficient if the appraisal team for 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 traded goods and services which are used in almost all proj ects. 4.6 Institutional Analysis: 4.6.1 Introduction: Of all the aspects of a project, institution building 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). 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 within the power plant a viable and sustainable institution 146 that is equipped with well developed staff who understand how to interact with their cultural environment. For Baum: Institutional building means that the transfer of financial resources and the construction of physical facilities, however valuable in their own right, are less important in the long run than the creation of a sound and viable local "institution", interpreted in its broadest sense to cover not only the borrowing entity itself, its organization, management, staffing, policies, and procedures, but also the whole array of government policies that conditions the environment in which the institution 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 "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. 4.6*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 147 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 Bretton Woods agreement, is "to make investment of lasting productive value" 3- To support the development of electricity sector institutions and the linkages among them. Clearly, the first objective has a short-term focus and, usually, it is covered in the World Bank electricity projects in Egypt. This includes consultancy services and the other technical assistance activities that facilitate project implementation. The second and the third objectives 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 given to these objectives in a development project sponsored by the World Bank. Needless to say, the scope of institu tional development will be wider when all the three objec 148 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 core of the design of the institution development component. For the World Bank projects this mix of elements in an institutional development component is not balanced. This mix is designed to further the first objective at the expense of the others. The mix used is dominated by elements that strengthen project implementation and neglect the long term capacity of sector level incentives framework, e.g. compensation, personnel development, and system development. 4.6.3 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 197 9, 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. 149 5- in fiscal year 1986, Vocational Training Project, Loan no.25 94-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 (4.12) 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 (4.12) 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 150 respectively, while the rest, which is 84 per cent, goes to physical facilities and equipments. Table {4.12) 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. 151 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 (4.13) and (4.14) indicate, unlike to 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 (4.13) 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 2 152 Table (4.14) 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. 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 analysis are being left to the World Bank staff appraisal mission. But as Tables (4.13) and (4.14) indicate, the skills and specialization of the World Bank staff mission are often inadequate to deal with these broader institu tional development issues because they are usually econo mists, financial analysts or engineers. Therefore, for The World Bank mission, there is a need for staff members who can address the institutional develop ment aspects of the project to join other specialists. 153 4.6.4 The World Bank Strategy: The Bank's strategy in the power subsector has been 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. 4.6.5 Problems of Institutional Development in 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. Ironically, these problems were first pointed out in the UNDP power sector survey report in 197 6, 15 years ago, by a firm of foreign consultants. In general, the power sector in Egypt is dominated by a single public utility, the Egyptian Electricity Authority (EEA) . The EEA is a highly centralized organization with cumbersome authority and little coordination between 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). 154 More specifically, the accounting systems of EEA and electricity Distribution Companies suffer from poor property 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 Electricity Distribution Company, e.g. Shoubra, Dokki, or Maadie, will show how badly the electricity sector needs institutional development. 4.6.6 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 155 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 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. 4- 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 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 competi tive, 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 157 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. 7- For sustainability of electricity projects, it is essen tial 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 expens es, unsatisfactory cost and 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. 158 Chapter Five Conclusions This study focused on project identification and project appraisal of investments in Egypt, notably in electricity. Concerning project identification, the electricity sector was compared with the agriculture and land reclamation sectors as a means of employing project identification for priority ordering of investment for development in Egypt. The key criteria for evaluation are the effects of developments in each sector upon Egypt's national objectives and needs. These include employment opportunities, growth, alleviation of poverty, cross comparison of per capita consumption in each sector, economic rate of return, national security, balance of payments and foreign debt. The study shows that the allocation of scarce investments would have been more efficient in agriculture than in electricity in terms of meeting Egypt's national objectives and needs. The study shows that the World Bank has over- invested in the electricity sector and under-invested in both agriculture and land reclamation (chapter 2). Consequently, resources were not efficiently employed and allocated among the productive sectors of the economy. 159 Therefore, World Bank development projects in Egypt were not optimally identified, and its aid programs may not be the optimal path to development. The study shows, as figure (1.2) indicates, that World Bank development projects in Egypt are subjected to more than one conditionality. These include conditionalities imposed by IMF, the World Bank, USAID, and other international development organizations. In general, conditionalities have some positive and negative side effects. For instance, the USAID conditionality imposes an expensive technical assistance component and promotes US exports at the expense of Egypt's long-term development in some areas of potential development like land reclamation and locally manufactured electrical equipment. The Egyptian economy would have been better off had USAID and the World Bank invested in land reclamation and industrialization rather than importing grains and all items to equip power stations from the US. Moreover, USAID conditionality contradicts not only the free market and free competition principles, but also free trade and other IMF principles. In fact, USAID conditionality imposes US products that may be less competitive, in quality or price, compared with German and Japanese products. The study also shows that World Bank lending operations in Egypt are not consistent with its policies and trends in lending for development. While the World Bank has allocated 160 22 per cent of its cumulative lending to rural development in other countries, the agriculture and land reclamation sectors in Egypt, despite their importance, have received only 9 per cent of its lending operations in Egypt. On the other hand, the electricity sector has received 20 per cent of the World Bank operations in Egypt, while its declining investment trends in the electricity sector in the whole world are shown to have received only 14 per cent of its cumulative lending operations for this sector. Moreover, the World Bank lending program in Egypt is not consistent with the adopted policies and views of its leadership. While the McNamara era was characterized by its emphasis on agriculture and rural development, data for this period indicate that development in this area in Egypt was almost negligible. To strengthen and enhance the process of project identification, there are some actions that should be taken by both the Government of Egypt and the World Bank. For the Government of Egypt, there is a need for the development of a strong methodology, guidelines and a checklist for the design of investment programs for public sector projects. The main objective of this methodology should be to establish institutional and procedural reforms in the process by which public sector projects are identified and prepared. The starting point in designing the methodology should be Egypt's national objectives and 161 prevailing problems. The methodology should include a set of criteria for establishing priorities and ranking projects. This would include employment opportunities, national security, balance of payments deficit, and foreign debt. For the World Bank, there is a need for a more comprehensive approach for identifying projects in developing countries. This would include criteria other than EIRR by linking project outcomes to national objectives and needs outside the sector under investigation. In chapter 3, the study shows that political factors play an important role in the allocation or misallocation of Egypt's limited resources. This is mainly because of the mixed- semi-centrally planned economy adopted in Egypt, the control of mass media by the government, and the absence of a well-defined strategy for sustained development. The study reveals the need for Egypt to adopt an import- substitution policy for some goods, mainly, electrical equipment, for which demand is assured. This should create jobs, reduce balance of payments deficits, and contribute to Egypt's self sufficiency and independence. The pattern of electricity consumption in Egypt indicates that consumption of the industrial sector has declined from 56 per cent in 1980 to 43.2 per cent in 1987, and is expected to decline to 23.6 per cent of total electricity consumption in Egypt by the year 2006. On the other hand, the consumption of electricity in the 162 residential sector has increased from 2 0.37 per cent in 1980 to 34.4 per cent in 1987, and is expected to increase to 48.4 per cent of the total electricity consumption in Egypt by the year 2 006. Therefore, the trend in electricity consumption in Egypt is not towards the most productive sectors, which gives an additional indication that Egypt is not on the right path to development. In chapter 3, the study also shows that the geographical pattern of electricity consumption in Egypt is not balanced. While the population of Cairo is 2 0 per cent of the total population of Egypt, its consumption exceeds 37 per cent of the total electricity consumption in Egypt. On the other hand, while the population of Delta and Upper Egypt are 27.8 and 42.2 per cent respectively of the total population in Egypt, their consumption percentages of electricity are only 14.42 and 22 per cent respectively. Therefore, development in Egypt is not geographically balanced. More resources are allocated to Cairo and big cities in northern Egypt compared to Upper Egypt and its urban areas. This has brought about intense social pressures of urbanization and high population in the Nile Valley. The study depicts historical price trends and the structure of tariffs and sales of electricity in Egypt which indicate that from the viewpoint of the economic cost of electricity, nearly all consumer groups are subsidized. 163 Moreover, the data indicate that the rate structure gives a strong subsidy to large state enterprises. The study indicates that such a pricing policy has led to an inefficient process of investment in other productive sectors in the Egyptian econony. In fact, the electricity pricing policy has led the Ministry of Industry to act as if energy resources were not scarce, leading to lower efficiency of investment in energy-intensive technology plants. Chapter 3 also shows that there is a need for the formulation of a pricing strategy that is based on the marginal cost structure with a proposed adjustment of tariffs to incorporate social and financial considerations. Chapter 4 identified key parameters in evaluating the economic viability and efficiency of development projects: (1) the discount rate (the 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 basic alternative approaches employed to determine the discount rates reflecting the economic cost of public funds. These include Hirshleifer's approach, Little and Mirrlee's approach, and Harberger's approach. 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 164 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 in Egypt in the mid 1990's. The study thus 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. The divergence between 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. The study shows that for better economic analysis of development projects in Egypt, there are some actions should be taken by both the Government of Egypt and the World Bank. 165 For the Government of Egypt, there is the need to institute a wide-ranging system of economic prices that 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 will necessitate establishment of an organization or team of project evaluators whose main function is to consult closely with the Government of Egypt not only in setting economic prices, but also in selecting 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 economic 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. Finally, Chapter 4 analyzes institutional aspects of the World Bank projects. It presents the problems and the factors that adversely affect the institutional development performance of electricity projects in Egypt. 166 Glossary Stabilization: Policies to achieve sustainable reductions in the current account of the balance of payments and the fiscal deficit. Stabilization also aims to reduce the rate of inflation to a sustainable level. Adjustment: Policies to achieve changes in internal and external balances, in the structure of incentives and institutions, or both. Where the focus is on the former, it will be identified as stabilization, and where on the latter, as structural adjustment. Structural Adjustment: Reforms of policies and institutions: microeconomic (such as taxes), macroeconomic (such as fiscal imbalance), and institutional (public sector inefficiencies). These changes improve resource allocation, increase economic efficiency, expand growth potential, and increase resilience to future shocks. The economic distortions that require adjustment interact. For example, an overhauled exchange rate is evidence of macroeconomic distortions because 167 traded-goods producers face a relative price which often leads to microeconomic distortions when prices do not reflect costs, institutional distortions in that managers have inadequate incentives to be efficient, and macroeconomic distortions as deficits become large. Structure Adjustment Loans (SAL): The World Bank lending that supports structural adjustment. The macroeconomic framework in which these loans have been made has often included IMF stabilization targets, to which structural elements were added. SALs were initiated to address balance of payments needs, provide stabilization and structural adjustment policies would be undertaken. All such loans have provided general import financing. 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Asset Metadata

Creator El Sabaa, Salah M. (author)

Core Title Key factors in appraising development project in Egypt

Degree Doctor of Philosophy

Degree Program Political Economy and Public Policy

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

Tag economics, general,OAI-PMH Harvest

Language English

Contributor Digitized by ProQuest (provenance)

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

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c20-281890

Unique identifier UC11259813

Identifier DP23386.pdf (filename),usctheses-c20-281890 (legacy record id)

Legacy Identifier DP23386.pdf

Dmrecord 281890

Document Type Dissertation

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