INVESTMENT/PROJECT APPRAISAL IN THE PUBLIC SECTOR -EXPERIENCE OF UGANDAN LOCAL GOVERNMENTS

1.INTRODUCTION.

Recent developments, such as privatization and the private finance initiative, have raised the issue of which assets should be owned by the public sector and whether assets have different values in the public and private sectors. In order to answer these questions, it should be noted first that the allocative considerations that usually motivate government intervention need not require the direct provision of services by the government using government-owned assets. it should then be argued that the government should own the assets used to provide the services where the private sector fears expropriation by the government, or where ownership confers on the private sector such power as to preclude efficient allocations. Finally, it should be argued that the discount rate for governments' projects equals the expected return on comparable investments in the capital markets. The government should, however, discount pre tax cash flows at the pre-tax discount rate, for it receives all tax.
Economies have become knowledge-based, critically depending on good infrastructure to sustain the effectiveness of urban and rural areas as places both to do business and to live successful and rewarding lives. In this context projects that may appear to be ‘too expensive’ are in fact essential to continuing success of the people living in them.

Some of the Public investments such as those of health services, roads, education, care for the environment, security have wider public externalities or benefits beyond the immediately existence of a finished structure such that .failure to meet fully the costs say for immunisation against a contagious disease will, for example, have far reaching consequences for the immediate and distant community.

On the question of maintenance, operation and general sustainability of the undertaken investment projects, the overall improvement and sustainability of services from these projects, the communities who are beneficiaries of these projects cannot afford to meet all cost needs on their own (consider the case of operating and maintaining a health centre on a sustainable basis). Currently The National taxpayers and foreign donors through the GoU are already meeting a substantial cost of sustaining finished projects in LGs service through conditional transfers from the centre to these Local Governments. This implies that residents from other LGs within Uganda contribute to costs of running LGs where taxpaying individuals may not necessarily be residents. If all Nationals fail to exercise the correct attitude in paying then there will be a complete breakdown in the LG system. The LG and National taxpayer must therefore be able to meet the cost of services from locally generated funds given that the GoU already is financially constrained and that some part of the National Budget is funded by Donors. Alternatively it implies that local government should undertake proper feasibility study for all investments undertaken to ensure cost effectiveness and sustainability of these projects.
According to Igor Ansoff, capital investment appraisal is concerned with the last two steps of a more complex process of strategic decision making. (The process has four steps as below:
§ Perception of the need for investment or awareness of a potential opportunity
§ Formulation of an alternative course of action
§ Evaluation of alternatives and
§ The choice of one of these alternatives for implementation.
The Process of Project/ investment appraisal in Local governments in Uganda is guided by the Decentralisation policy which is the Constitutional administrative structure of Governance in the country. The Decentralisation Policy as indicated under Schedule 6 of the 1995 Constitution, transfers political, administrative, financial and planning authority from the Centre to Local Governments. And in relation to service delivery is intended to improve local council capacities to plan, finance and manage service delivery to their constituents and also empower Local councils to promote the welfare of citizens through planning, allocation and use of resources for service delivery.
Also Local Governments are required to allocate funds towards local investment and delivery of services out of their locally raised revenues. Article 189 of the Constitution indicates services that are devolved to LGs.
The local governments receive funding from central governments as part of budgetary support to carry out capital development are required to allocate at most of the conditional grants (at least 85% for LGDF and PMA) and at least not less than 15% of the local revenue on capital development projects and most of these on the mandatory government priority areas. (conditional grants is a category of transfers constituting funds which are expenditure specific and given to the Local Governments to finance programmes that are considered National Priorities in line PEAP goals, or programmes that are agreed upon by the CG and LGs. Distribution is based on formula as contained in the constitution. Since 1999 they have registered a growth of over 300% and now comprise over 85% of total transfers. Grants are meant for numerous specific priority programmes in health, education, environment, roads and capacity building; and each grant type has different operating conditions). According to the Local government finance commission, the process and allocation of has not had a lot of emphasis on poverty sensitive issues. There are numerous conditionalities attached, the other challenge has been late release and over vigorous emphasis on documentary accountability without adequate regard for lengthy procurement processes and value for money. This category of transfer has had a significant impact in the Health, Agriculture and education sectors. Also over 80% of this transfer is donor supported.

In the Districts of Uganda, the process of identifying investment projects is guided by the need to have strategic interventions to address the development challenges as identified in the District planning process. The planning guidelines and investment priorities are based on the national PEAP and the targets of Millennium Development Goals (MDGs).An example of an MDG is Halving poverty 1990-2015; even with the more cautious macroeconomic projections in the revised PEAP, poverty should fall to 28% by 2013/4 and 26% by 2015 and further if inequality is reduced or fertility falls (both of which are objectives of the PEAP).

The planning process up to the formulation of development priorities ( investment priorities) from Village to the district is guided by the overall development goal and objectives in a development planning process popularly known as participatory bottom up planning. It’s a means through which local governments are guided through the development process, streamlining service delivery and allocating resources geared towards poverty reduction and improving the quality of life of the people (poor). This is reinforced by the 1995 constitution of the Republic of Uganda Article 176 and the local government Act chapter 243 section 35(3) which provides for local governments to produce comprehensive integrated three year rolling development plans through a bottom- up participatory planning process.
The above planning process is guided by the following principles:-
· Involvement of a wide range of stakeholders (men, women, PWDs, Youth, elderly, CSOs, political leaders, religious leaders, livelihood groups)
· Integration of results of participatory pre-planning process in parish planning and subsequently in sub county planning.
· Integration of cross cutting issues (HIV/AIDS, Poverty issues, Gender, Environmental issues)
· Building on vision, strength, opportunities to address obstacles and challenges
· Reviewing functionality of technical planning committee
· Carrying out a situational analysis, livelihood analysis and
· Carrying out SWOT analysis
· Dissemination of IPFs to parishes, villages
· Data collection.
The activities done throughout this process include the following:
· Planning meetings (pre-planning and parish planning) meeting are held to identify issues (projects) i.e. village priorities and parish priorities. Village priorities are forwarded to parishes for prioritisation and parish priorities to the sub county for prioritisation.
· The sub county technical committee reviews proposals for parishes and prioritised them to come up with sub county priorities and projects referred to the district for consideration.
· The technical staff are involved in pre-planning and parish planning process up to sub county prioritisation and formulation of a development plan,
· This is after the sub county SWOT has been developed. Projects were developed there after.
· Behind the Principles and Activities during Priority Setting is a SWOT analysis. SWOT analysis, visioning and goal setting. During SWOT analysis, a linkage is made between the internal strength and weaknesses and ways are designed to build on internal strength to overcome weaknesses and opportunities are exploited to minimize threats.

The steps above clearly show that every body is a player when it comes planning affairs and the identification of investment priorities in the District. The participatory nature of planning is enshrined in the steps and level of service delivery in the District

As part of their development planning, Local governments are required to carry out strategic analysis involving internal appraisal and SWOT analysis to aid in the identification of investment opportunities. The investment opportunities available are very many and each of them might appear attractive unless thorough investment appraisal is undertaken. The government’s project appraisal process also serve to create a bias against long-term investment in the larger, more complex infrastructure projects.

It is a requirement that LGs need to maintain operating assets in good useable state through operations and maintenance programmes so as to retain the concept of Value for Money in service delivery and efficient resource utilisation. This implies that the projects adopted during the strategic planning process must also be in such a way that the projects made by the local government themselves are sustainable in addition to a sustainable and increase levels of service delivery.
In some recurrent expenditure projects, it may be harder to define unit costs for activities in some sectors than in other parts of the local Government, but it is still important to find less expensive ways to achieve the efficient functioning of Government and this can only be through an effective investment appraisal.

Local Governments have to meet the costs of social and infrastructure services, which benefit all their constituents. Most of these services have a wider public impact and yet demands and costs have been rising because of exogenous factors such as inflation and demand arising from increasing populations especially in urban areas.

In order to ascertain the quality of service Delivery in the Public sector, The Local Government Auditing manual (2007) requires that there should be value for money Audit. Value-for-Money (VFM) auditing represents an extension of the traditional audit concerns with financial systems. Broadly, VFM auditing is concerned with the good allocation, and efficient use, of resources, and determining to what extent a Local Government is achieving its objectives, delivering its programmes and activities, and providing an acceptable standard of service delivery, given its budgetary constraints.

The main approach to VFM is the Local Government’s control over the use of resources rather than over financial transactions, in order to achieve its objectives.VFM auditing is concerned with "three E's": economy, efficiency and effectiveness.

Economy is concerned with minimizing the cost of resources acquired or used, having regard to quality (i.e. spending less for an equivalent product or service);

Efficiency is concerned with the relationship between the outputs of goods, services or other results and the resources used to produce them. How far is maximum output achieved for a given input, or minimum input used for a given output? (I.e. spending well and not wasting money on reaching a particular level of service);

Effectiveness is concerned with the relationship between the intended results and the actual results of projects, programmes or other activities. How successfully do outputs of goods, services or other results achieve policy objectives, operational goals and other intended effects? (i.e. spending wisely to achieve policy. It is possible to be economic and efficient but not achieve the aim of a policy - this in not effective).
In practice the boundaries between economy, efficiency and effectiveness are seldom clear-cut. VFM audits may, therefore, pursue these different aspects as a joint exercise, particularly when considering the closely linked aspects of economy and

There is therefore a challenge to carry out a cost benefit analysis to ensure that the government obtains value for money from the development and recurrent spending and to ensure that the projects undertaken address the poverty eradication requirements as contained in the government PEAP.

CHALLENGES IN THE PUBLIC PROJECTS APPRAISAL
The main problem in the most public projects appraisal is their uneconomic nature and impossibility to measure such data, like as turnover and current costs, necessary for NPV or IRR calculation.
An appraisal of economic effi-ciency, as a measure of the net contribution of a project to overall social welfare, should be conducted to each single case. Standard appraisal methods based on projected profits and investment expenditures are not applicable because of intangible nature of pure public projects.

In such cases Cost – Benefit Analysis (CBA) has been applied. The purpose of CBA is to ensure that the public sector allocates scarce re-sources efficiently to competing public sector projects. A basic assumptions of CBA is an identification the crucial benefits effected from a project and their valuation to con-duct project appraisal in terms of its effectiveness. A mixture of benefits and costs will be differentiated, because of pro-ject purpose and designing. The cost of a project should be somehow related to the benefit expected from it.

The rule that has evolved over many years is that benefits must ex-ceed the costs from a project. CBA estimates and totals up the equivalent money value of the benefits and costs to the community of projects to establish whether they are worth-while. This means that all benefits and costs of a project should be measured in terms of their equivalent money value and in particular time. The most useful financial results in a CBA appear in a time-based cash flow summary. The basic rule of CBA is that project should be performed only then, when dis-counted benefits would be higher than discounted invest-ment expenditures. As the investment expenditures are treated exact cost of investment and operation costs after project putting into life. After some years of CBA exercising such analysis has still prompted some doubts connected mainly to choice of appropriate discount rate, externalities, risk and irre-versibility. Their override is a subject of research of many economists.

Despite of critical remarks and some simplifications CBA has still been treated as a simple tool with numerous applications in various spheres, especially in environmental and other pure public projects, used commonly by banks and investors, more rarely by state agendas and local governments – especially in less

Establishing Public Sector Investment Discount Rate

According to the Center for Economic Analyses (CEA) (Prepared by Vlatko Andonov and Vesna Garvanlieva, MBA (February 2009 ), Establishing Public Sector Investment Discount Rate For each capital investment the cost benefit analysis is an essential tool for evaluating the return of the investment, the related risks, and other variables that affect the costs of the investment on one hand and the benefits of the investment on the other hand. The investments can be either in the private sector or they can be investments of the public sector. There are different models and approaches developed by many researches who are discussing the topic of how to evaluate certain investment and how to assess the return of the investment. However, it is commonly understood that there are certain differences when it comes to investments in the public sector. The difference is mainly seen in the beneficiaries of the investment and the nature of the investors’ capital. When it comes to assessing the return of an investment in the private sector in Macedonia there are sufficient information and data that an investor can process in order to calculate the expected return of a given investment. On the other hand, this cannot be confirmed when we discuss the return on investments in the public sector. Having this in mind, this analysis will try to give an explanation of one possible method used to estimate the discount rate necessary for public sector investments since the discount rate is an essential part of each investment appraisal approach. The approach used in this paper is the tax-adjusted Capital Asset Pricing Model (CAPM).
To determine the present value of the forecasted cash flows, these are discounted with a discount rate to reflect the principle of time value of money. The present value of the future forecasted cash flows allows all cash flows to be restated in monetary terms in the current year when the investment is undertaken in order to have a meaningful comparison of the cash flows over time. Thus, the discount rate represents the adjustment factor used to restate the cash flows. One of the most common methods used to determine the opportunity cost of capital is the weighted average cost of capital (WACC) method. The discount rate which is used to evaluate the capital expenditures represents the cost of capital for the investor, or the interest rate that the investor must pay to secure the money. If the evaluated project has a return larger than the discount rate, then the project is acceptable and can provide adequate returns for the investor in the future period.

Tax-Adjusted CAPM1 – Discount Rate for Public Sector Investment in Macedonia The tax-adjusted CAPM uses the following formula to calculate the cost of capital in the public sector: WACC nominal = [RFR x (1 -Tc) + (Ep x βa) ] / (1 - Te) Where: RFR – risk free rate; Ep – equity premium Tc – corporate tax rate Te – effective tax rate βa – Asset beta The real Weighted Cost of Capital (WACCreal) on the other hand is computed using the following formula: WACC real = [(1 + WACCnominal) / (1 + i)] -1 Where: WACCreal – Tax-adjusted Weighted Average Cost of Capital; WACCnominal – Nominal Weighted Average Cost of Capital; i - Inflation Rate. Having these formulas the discount rate for the Macedonian public sector can be computed by using calculations based on information available on the Macedonian Stock Exchange (MSE) and from the audited annual financial reports of the listed companies. The basic formula that this analysis will use is the WACCreal to determine the inflation adjusted cost of capital. However, in order to determine this inflation adjusted discount rate, first of all we need to calculate the WACCnominal which incorporates several variables including the determination of the risk free rate for the Macedonian economy, the expected equity premium, the asset beta and the corporate tax rate.

Coments to be continued
MBAMANYIRE MEDARD.
JULY 2009