Introduction:
At the end of last week’s column I had indicated that, beginning this week, I would merge my on-going consideration of the decision-making process in regard to Guyana’s public investment projects into a wider discussion of the National Budget 2013. This is not an easy task to accomplish and I will probably have to pursue this over several future columns.
Also, in last week’s column I had wrapped-up my presentation of the notions: time value of money and uncertainty and risk, which I had represented as central to the systematic appraisal of government projects.
Two observations are warranted at this point. First, in the previous discussion of the time value of money I sought principally to highlight the crucial importance of choosing an appropriate discount rate when converting into their present values, future benefits flowing to projects and future operational costs incurred after project construction.
Relatedly, readers should note that the interest rate is not the only factor to be considered in arriving at the appropriate discount rate.
Other considerations are important; for example, the expected increase in future prices (inflation) as this reduces the present value of future flows of money. Another example is economic uncertainty, which invariably reduces confidence in the value of future flows of benefits and hence their conversion to present values.
Sensitivity and
Contingency Analysis
There are a number of techniques used in social cost benefit analysis to reduce the adverse impact of uncertainty and risk on projects. Sensitivity analysis is one such technique. Basically this requires the key quantitative assumptions, which underline projects, to be changed in a systematic manner, in order to assess their impacts on the outcomes of the projects.
Put another way this technique seeks to predict alternative outcomes for the project, if important quantitative computations or assumptions are changed.
Good examples of such changes would include: 1) deliberate variations in the size of the discount rate applied in the project analysis (given the major bearing I indicated this has on project outcomes) 2) variations in the expected life of the project (for example, changes in the period required for construction, and the estimated earning life of the project) and 3) variations in the operating costs and revenue earned from the project when it fully comes on stream.
Another complementary technique that is used is termed contingency analysis. Here the technique is directed at variations in the qualitative assumptions underlying the project. These assumptions usually deal with project uncertainty since this cannot be statistically estimated because there are no historical data from which to undertake this exercise. In this case the practice has been to introduce different scenarios for the project and the question is then posed: what-if any of the scenarios descend on the project? Contingency analysis is sometimes termed what-if analysis.
Examples of contingency analysis in the case of existing public projects would be seeking responses to the following types of questions. I) what-if there is an unprecedented flood or drought at the Amaila Hydro Power site? What would be the impact on the project? 2) What-if an earthquake takes place off-shore Guyana (Caribbean- Venezuela area) and one or more tidal waves affect the Demerara coastline?
Apart from the “immediate disaster”, what would be the long term economic impact on the Marriott Hotel site? Techniques that have been used to address such types of questions include consultations with relevant experts, individuals, and organizations and holding brain-storming sessions with key project personnel and selected participants.
As we can see from the above, sensitivity and contingency analyses seek to contain project risk and reduce project uncertainty. The overarching goal is to arrive at an estimate of the tolerances of the project for changes/variations outside the boundaries set by the feasibility study for the project.
As a rule of thumb, I prefer to see projects analysed for three distinct levels or ranges, namely, 1) the expected outcome, guided by the feasibility study 2) the pessimistic outcome, where the “least likely” is consistently evaluated and 3) the optimistic outcome, where the “best-likely” is consistently evaluated.
Aid to, and not
Substitute for
It is important for readers not to draw the conclusion from the discussion thus far that all which is required for the economic efficiency of public projects in Guyana, is to conduct feasibility/social cost benefit analyses before undertaking these.
This would be highly incorrect, and far from what is intended. Social cost-benefit analyses/feasibility studies aid, but do not substitute for the application of systematic thinking, which should start with the configuration of a public investment strategy for Guyana, then the selection of projects, their design, implementation, monitoring and ex-post auditing. When used as recommended here, these analytics are considered good practice, but alone they do not constitute best-practice in this area.
Good economic governance in democratic practice requires that the National Budget constitutes the definitive financial expression of a government’s intentions as regards to its spending priorities for current and on-going items (goods and services) as well as capital spending (on its listed projects). The National Budget is also the definitive record of revenues previously raised and to be raised as well as government’s past and intended borrowings However, in the case of Guyana due to gross financial irregularities such as 1) the existence of lavish unofficial unrecorded “slush” funds (NICIL, National Lotto, etc) 2) irregularities in the process of legal and financial authorisation 3) weak accounting for government’s contingent debt obligations and 4) statistical under-handedness and manipulation by the Authorities, this universal democratic practice is regularly breached.
As I shall indicate in forthcoming columns, the path to Guyana’s several troubled projects is strewn with the financial irregularities listed above. Equally important is the absence also of a systematically thought-out and purposefully executed public investment strategy.
