INVESTMENT COORDINATION COMMITTEE (ICC) RATIONALE, FUNCTIONS AND GUIDELINES

 

 

I.                    Rationale

 

This set of guidelines on project evaluation aims to provide standards of procedures for the ICC in assessing development projects to ensure their technical, financial, economic and social merits.  The procedures are also formulated to achieve uniformity in and set the basis for evaluation.  An appreciation of these procedures is deemed necessary in order for the proponents to understand the various information requirements of the ICC as contained in the ICC-PE forms and is envisioned to facilitate the processing of requests for clearance.

 

These guidelines are organized into eight (8) sections.  The first four (4) sections cover the procedures in undertaking the financial, economic, technical and institutional evaluation of projects.  Section VI provides the steps in undertaking a sensitivity analysis of the selected parameters.  The evaluation of technical assistance components of projects is given in Section VII.  Section VIII, on the other hand, describes the procedures in conducting public consultations on projects.

 

II.                 Financial Evaluation

 

These guidelines shall apply to revenue generating projects of government agencies, government-owned and controlled corporations (GOCCs) and private sector firms/entities whose projects qualify under the conditions set for private sector access to ODA.

 

A special case of financial analysis is carried out for agricultural projects where farm income analysis is undertaken.  Please refer to Technical Annex A for specific guidelines.

 

A.                 Objectives.

 

1.                  To assess the financial viability of a project and its ability to meet its debt-service obligations, and

 

2.                  To determine, thru the GCMCC, the financial capability of government corporations to finance their proposed projects.

 

B.                 Procedures

 

1.                  The project proponents shall submit ICC-PE Forms 1 to 5, hereby attached as Attachment 1.

 

2.                  In addition, the proponent, if a private enterprise, shall submit the following:

 

a.                   projected cash flow of the enterprise covering the entire project life including the year prior to project implementation using the GCMCC format (Attachment 2) with the addition of an account indicating the beginning cash balance; and

 

b.                  the audited financial statements covering a period of at least three (3) years prior to implementation of the project, as applicable.

 

The major assumptions used in the financial statements, (e.g., exchange rates, volume of sales, prices) should be clearly stated.

 

3.                  If necessary and where applicable, the Secretariat may require the proponent to submit a market study of the project.  This shall include a definition of the types and nature of the products/services to be generated by the project, their specific and potential markets, existing and projected demand and the resulting supply gaps.

 

4.                  In the financial analysis (using constant prices), contingency allowances may be provided as follows:

 

a)                  physical contingency, which represents an allowance for increases in the quantity of real goods and services utilized for the project;

 

b)                  price contingencies, for relative price changes, involving changes in the market price structure for project inputs and outputs.

 

Physical contingencies are usually estimated separately for each major cost component, and separately for local and foreign costs.  Normally, this is 10% of direct cost, although higher allowance is possible for complicated/lengthy works which are more vulnerable to design changes and adverse external phenomena.

 

For price contingencies, escalation rate is applied to major cost/benefit items, which is the projected annual price change of the item net of the general inflation rate.

 

5.                  For local cost items, relative price changes can be projected from past trends in the item’s price movement relative to inflation, or from forecast demand/supply trends.  For internationally traded goods, price project can be sourced from international publications (especially World Bank Commodity Price Projections or WBCPP).

 

Projections of relative prices for local items need not extend beyond medium term (5 years).  Local price relationships may be assumed constant beyond the 2-year period.

 

Cash flows given in current prices are converted to constant terms, thru the use of general price deflators.  The GNP Implicit Price Index (IPIN) is the deflator for local costs, while the manufacturing unit value (MUV)  Index (IPIN) is the deflator for local costs, while the manufacturing unit value (MUV) index (from the WBCPP) is appropriate for foreign components.

 

6.                  The ICC-Secretariat shall determine the financial viability of projects from either, or both, of the following viewpoints:  the “all capital” viewpoint and the “equity capital” viewpoint.  The former looks at the discounted returns to all real investment flows for the project as a whole, irrespective of whether these come from equity or from loans.  The latter looks at the proponent’s (investor’s) equity contributions as the investment, such that loans proceeds are treated as inflows, while loan repayments are treated as outflows.

 

7.                  In both cases, the financial internal rate of return (FIRR) and the net present value (NPV) shall be computed based on the validated submissions of the project proponents of the benefit and cost streams.  For the project to be financially viable in the “all capital” invested approach, the resulting FIRR should exceed the weighted average cost of capital (WACC), while the NPV should be greater than zero using the same WACC as the discount rate.  The computation of the WACC shall be described below.

 

Meanwhile, for the “equity capital” approach, the resulting FIRR should exceed the cost of equity contribution of the proponent while the NPV should be greater than zero using cost of equity capital as discount rate.

 

8.                  The WACC is the weighted average of the yields net of tax on different sources of funds of the proponents.  This is determined by calculating the relative weights of the capital resources and multiplying them with the corresponding opportunity cost of capital for each of the capital resource.  The WACC is mathematically represented in equation form by:

 

WACC            =          Pe  X   Re /  P1  X   R1

 

Where   Pe       =          percentage of equity investment to

                                    total capital investment

 

                                                Pc        =          percentage of corporate funds

                                                                        (i.e., internal cash generation

                                                                        for government corporation).

 

                                                P1        =          percentage of loaned funds

 

                                                Re        =          opportunity cost of capital of equity funds

 

                                                Rc        =          opportunity cost of capital of

                                                                        corporate funds

 

                                                R1        =          effective cost of loaned funds,

                                                                        Pe    +    Pc   /  P1   =   1

 

                                    The use of the WACC in financial analysis should be limited to cases where the project’s risk is consistent with the overall  business risk of the company, and that the project will be financed from a pool of funds with proportions indicated in the WACC.

 

                                    Otherwise, the equity capital approach is more appropriate, particularly

 

a.                   when capital markets are imperfect, where cost and availability of long term capital is unpredictable, and prevailing financing sources are relied upon at any given time; and

 

b.                  when the nature and scale of the project influences the sources and cost of financing, such as in a case when foreign financing is tied to the project.

 

Conditions relevant to GOCCs appear to warrant the application of the “equity capital” approach if the sources of financing being considered come from abroad and may be viewed as tied to the particular project at hand.  Since the “stockholder” of the GOCC is the economy-at-large, the cost of equity capital is the opportunity cost of capital to the economy.

 

If the project involves foreign sources of funds, the decision makers have to decide whether foreign funds may be treated as tied to the project, in which case, the “equity capital” viewpoint should be adopted.

 

Specific examples of the appropriate approach to pursue are provided in Technical Annex B.

9.                  The proponent shall be guided by the projected foreign exchange rates as indicated by the Secretariat, in converting foreign funds into their local currency equivalent.

 

10.              Under the “all capital” analysis, the foreign exchange risk can be captured by adjusting the WACC.  Projected annual movements in the peso rate against relevant currencies will be converted by the Secretariat into corresponding percentage points adjustments in the WACC.

 

Under an “equity” capital approach, repayments for foreign loans as outflows should be converted to peso equivalent using projected exchange rates.

 

11.              For public sector proponents, the GCMCC shall evaluate the ability of the corporation to finance the investment cost (local component) and meet the debt-service requirements of the project.  GCMCC shall then submit a formal evaluation to the  ICC, indicating therein its recommendations, findings and the bases for favorable endorsement of the GOCC’s project to the Technical Board.

 

For private sector proponents, the ICC Secretariat shall appraise the private firm’s capability to shoulder the investment cost and assess its repayment capacity.  This will be undertaken through the following:

 

a.                   Ability of the corporation to finance the local investment cost of the project.

 

This shall be determined by subtracting the capital requirements of ongoing projects and the corporate debt-service from the internal cash generation (ICG) and comparing the net with the local cost component of the proposed project.  A net ICG greater than the local cost component indicates that the corporation may be able to finance the project; otherwise, it can be expected that it will resort to borrowings.

 

b.                  Ability of the corporation to service its principal amortization and interest payment.

 

This requires a projection of the financial position of the company when the project is already operational and when it is already amortizing its loan.

 

To determine the effect of the project on the corporation’s financial position, the ICG of the corporation should be positive after deducting the project’s interest and principal repayments, together with other obligations falling due.  Otherwise, the corporation, based on its own operations may not be able to service fully or in part the project’s debt service requirements and may have to resort to external funding.

 

12.              For both public and private proponents, cash flows should also capture tax payments (i.e., corporate taxes) inasmuch as the cost of capital measure is on an after-tax basis.

 

13.              For private firms, the financial evaluation shall be complemented by the estimation of relevant financial ratios, with and without the project, based on submitted balance sheets and income statements.  The ratios are contained in Technical Annex C.

 

III.               Economic Evaluation

 

A.                 Objective

 

To ascertain the project’s desirability in terms of its net contribution to the economic and social welfare of the country as a whole.

 

B.                 Procedures

 

1.                  Documents submitted by proponent agencies for financial analysis shall be the take-off point for economic analysis.

 

2.                  The steps involved in economic evaluation are as follows:

 

a.         Identification of project costs and benefits.  Since projects are usually evaluated in terms of their effect on national income, costs and benefits identified must necessarily reflect the additions to and reductions from national income as a result of project implementation.

 

i.         Economic Costs[1].  The basic guidelines in identifying the costs of a project stems from the definition of cost itself, or activities that involve use of real resources.  Cost items are usually classified into two (2) types:  capital costs and operating and maintenance costs which may include the following:

 

Capital Costs – land, detailed engineering and design; preparatory installation work; cost of equipment; raw materials and supplies for construction; cost of buildings and auxiliary installations; engineering and administrative cost during construction, organization cost;;

 

Operating and Maintenance Costs – raw materials and other supplies; energy and fuels; labor; rent and insurance; depletion of natural resources.

 

ii.                   Benefits.  A benefit constitutes an increase in output or savings in resource use.  In the case of transport projects for instance, the set of benefits may include:  reduced vehicle operating costs; lower maintenance costs; fewer accidents, savings in time for passenger and freight; and in the case of developmental transport infrastructure, production increases.  Of these cases, only the first two benefits and the last are easily quantifiable.  However, to the extent possible, the effects of other benefits on national income should be quantified (e.g., value of each human life saved in terms of the capacity to earn during productive life).

 

 

iii.                  Externalities and Secondary Benefits.  In several cases, project effects – positive or negative – go beyond the limits of the project, but are not reflected in the financial accounts of the project.  If these effects, known as “externalities,” involve a significant economic cost or confer a significant economic benefit, these should be taken into account in estimating the overall economic impact of the project.

 

The external economic impact on the cost side may include increased pollution resulting from cement or a chemical plant, or the adverse effects of an irrigation scheme on health and fisheries.  External economic benefits may include improved recreational or tourist facilities provided by a water storage dam.  While it may not be possible to measure all such effects, an attempt should be made to identify them, and if they appear to be significant, to evaluate them.

 

Secondary benefits, on the other hand, refer to the beneficial effects on activities which are technologically linked to the project’s direct users, either forward as consumers, or backward prove to be significant, they should, whenever possible, be incorporated into the  analysis.

 

                                    b.         Valuation of costs and benefits in terms of economic prices.  This procedure involves adjustment of the financial prices of goods and services of both costs and benefits to reflect economic values.  Market prices may not be an acceptable measure of the true costs and benefits due to distortions (i.e., taxes, subsidies, quotas, regulatory measures, or monopolistic practices).  To deal with this problem, shadow prices are employed to measure the value of a commodity from the economy’s viewpoint.  Technical Annex D provides techniques for adjusting inputs from financial statements to conform with concepts in economic evaluation.

 

The valuation of  project costs and benefits should be in constant prices at the current year’s level.  In the case of projects where price levels are not in current year’s levels, appropriate price indices shall be applied to inflate or deflate prices accordingly.

 

i.                     Valuation of Costs.  Estimation of project costs involves an analysis of the supply-demand situation of the project inputs and, in the case of major projects, the corresponding price changes resulting from the project’s implementation.  General procedures are as follows:

 

-                     The entire set of project inputs must be differentiated between those inputs that reduce the supply to other users, and those inputs that would be supplied from increased production.

 

-                     For inputs resulting in reduced supply to other users, the shadow price is the market selling price appropriately adjusted for the value of rationed components, the effect of monopoly power in buying or selling and the actual price impact of the supply reduction.

 

-                     If the supply of inputs is obtained  from expanded production, the relevant cost estimate is the actual cost of production.

 

-                     If some of the inputs are imported or are substitutes for exports, the foreign exchange cost involved, corrected by the shadow price of foreign exchange, should be estimated and any transport costs and trade service margin should be added.

 

ii.                   Valuation of Benefits.  Estimation of direct benefits involves the following steps:

 

-                     For outputs leading to additional supply or reducing the output of other local producers, the shadow price is the market price, corrected for the following:  effects of any rationing, monopoly power of some buyers, and actual price impact based on the size of the additional supply.

 

-                     For goods that substitute for imports or add to exports, foreign exchange earnings or savings involved are estimated and corrected by shadow price of foreign exchange.

 

-                     For goods/services that are supplied freely, the value placed by users on the facilities should be estimated, i.e., what they would pay if they were to purchase the facilities.  This would likely involve some value judgment.[2]

 

c.                   Measurement of economic desirability, sensitivity analysis and selection of projects based on economic feasibility indicators.

 

The indicator to be used for estimating the economic desirability of projects shall be the economic internal rate of return (EIRR), defined as the discount rate which equates the net present social value (NPSV) of the benefits and costs of the project such that the NPSV is zero and the benefit cost ratio (BCR) is one.  The NPSV is the discounted net economic benefit accruing to the project.  The decision rule is to accept projects where the NPV is greater than zero.

 

3.                  The ICC Secretariat shall provide the following parameters for estimating the economic stream of costs and benefits:

 

a.                   Shadow Exchange Rate

 

                        The shadow exchange rate (SER) is applied to correct the distortion in the prevailing exchange rate due to balance of payments disequilibrium and the projection structure.  The SER currently adopted is 1.20 of the prevailing exchange rate, and shall be applied to all direct and indirect foreign exchange costs of a project and those benefits which may expressed in foreign exchange, particularly in the case of exports and/or import substitutes or savings.

 

b.                  Shadow Wage Rate

 

                                    The shadow wage rate (SWR) is used to reflect the true economic value of labor employed in a project.  The SWR is applicable only to the unskilled labor component of wages paid and is currently estimated at 60 percent of legislated wage rates.

 

c.                   Shadow Discount Rate

 

                                    The social discount rate (SDR) shall be used to discount the stream of economic costs and benefits to their present values.  It is the rate at which the social value of project costs and benefits decline over time.  The SDR shall likewise be used as the hurdle rate for a project’s EIRR.  SDR currently used is 15 percent.

 

4.                  In addition to the EIRR, the ICC Secretariat shall compute for the domestic resource cost (DRC) of tradeable goods as the output of the project, where relevant.  This will indicate the amount of domestic resources used for every foreign exchange earned or saved from production.  The DRC shall apply in projects that involve production of tradeable goods (e.g., coal, steel, sugar, etc.)

 

IV.              Technical Evaluation

 

A.                 Objectives

 

1.                  To determine if the project is technically feasible, workable and that its operations and maintenance can be locally sustained;

 

2.                  To ascertain if the proposed technology is cost effective; and

 

3.                  To ensure that the project does not adversely affect the environment and/or that appropriate measures are taken to protect the environment.

 

B.                 Procedures

 

1.                  The ICC Secretariat shall evaluate the technical aspects of the project, and may consult with DOST in cases when the proposed technologies are untried, new, or old/obsolete.  Inputs or comments from other experts, consultants from industry or academe may also be solicited as necessary.   The technical evaluation shall cover, among others, the following:

 

a.                   Issues of technical design such as size, location, timing and technology package proposed for the project (Refer to Technical Annex E for details);

b.                  Advantages and limitations of the technology used by the project;

c.                   If a new technology is applied; success rate in other countries;

d.                  Applicability of the new technology to Philippine conditions particularly to the proposed project area;

e.                   Environmental impact that would arise out of using the proposed design of the project; and

 

V.                 Social Analysis

 

A.                 Objective

 

To determine if the proposed project is responsive to national objectives of poverty alleviation, employment generation and income redistribution.

 

B.                 Procedures

 

The ICC Secretariat shall, whenever possible, take into consideration project benefits beyond those that are simply financial and economic.  If the project is of interest mainly because of its social benefit, this section takes on added importance.  The Secretariat should devote considerable attention to the analysis of socially desirable but financially unviable projects.  This will be especially true for private non-profit firms whose projects may be eligible for access to ODA.

 

The following aspects may be considered in the qualitative assessment of the social benefits of the project:

 

1.                  Income Distribution.  The extent to which the income of the poorest sector o the rural population is improved as a result of the project may be quantified.  Reference must be made to the relative improvement in comparison with other groups in the country.

2.                  Employment.  The extent to which the project reduces underemployment may be assessed.  This may be quantified in terms of work years created by the project, with distinction made between permanent employment and employment during the investment or construction phase.  The number of jobs created may be compared with the expected increase in the labor force of the project area.

3.                  Access to Land.  If the project includes a land settlement or land reform element, the distribution of land rights with and without the project should be demonstrated.

4.                  Internal Migration.  It may be useful to note the possible effect of the project on rural-urban migration.

5.                  Nutrition and Health.  If the project is located in an area where serious nutrition or health problems exist, or if the project is directed toward groups with nutrition and health deficiencies, the expected effects of the project on these problems might be mentioned.  In some cases, the effect on nutrition may be quantified in the daily intake of calories in protein that is expected as a result of the project.

6.                  Other Indicators of the Quality of Life.  Some projects may have a significant effect on the quality of rural life through improvements in access to domestic water supplies, electricity, schools, and other facilities.  These may be mentioned and the quantities of the new amenities noted.

 

                        Technical Annex F presents some pointers for social analysis for reference.

 

VI.              Institutional Evaluation

 

A.                 Objectives

 

1.                  To review and recommend improvement/revisions on the institutional arrangements and linkages in order to ensure a more efficient implementation of the project.

2.                  To ascertain the ability of the project proponent(s) to implement the project as proposed and scheduled.

 


 

B.                 Procedures

 

1.                  The ICC Secretariat shall assess the capability of the project proponent(s) to implement the project, per the proposed activities and as scheduled, considering the following:

 

a.                   The internal arrangements within the project organization/implementing agency and the external arrangements among the project proponent(s) or concerned agencies;

b.                  The feasibility of proceeding as scheduled based on the preparedness of all concerned agencies; and

c.                   When relevant, the arrangements made to address the concern of those who may oppose the project (e.g., environmental conservation groups and those who may be relocated).

The above shall be complemented with a review of the past performance of the proponent(s) on related/similar projects.

2.                  The ICC shall recommend possible measures to improve the program of implementation.

 

VII.            Sensitivity Analysis in Project Evaluation

 

A.                 Objective

 

                        To determine whether the project will remain feasible if changes in the assumptions used in the calculation/projections were to take place according to the degree in which they are likely to vary from the estimated or projected values.

 

B.                 Procedures

 

1.                  Financial Evaluation

 

Case I  :           Increase in projected costs by 10% and 20%

Case II :           Decrease in revenues by 10% and 20%

Case III            :           Combination of Cases I and II

 

2.                  Economic Evaluation

 

The sensitivity parameters above shall likewise be applied in the economic evaluation of projects.  The basis will be the cost-benefit flows (adjusted to economic terms).

 

Probability weights for the above sensitivity analysis may later be assigned as validated by the Secretariat.

 

3.                  Sensitivity analysis, when constant prices are used, involves testing of relative price changes.  Price contingencies should not be applied to items for which sensitivity analysis will be performed.

 

VIII.         Evaluation of Technical Assistance Components

 

A.                 Objective

 

To determine/evaluate project components that may be eligible for separate technical assistance (TA) funding.

 

B.                 Procedures

 

1.                  The ICC Secretariat shall determine which components of the project may be considered for separate technical assistance financing.

2.                  In general, financing for technical assistance involving pre-feasibility or feasibility studies, project identification, sector survey, institution building activities including training, shall be sourced from grants.  On the other hand, consultancy/advisory services related to construction activities, including detailed engineering, shall be considered as part of the project capital cost and may be financed by the project loan.

3.                  Section 10 of E.O. 182 (Rationalizing Public Works Measures, Appropriating Funds for Public Works, and for Other Purposes; dated 3 June 1987) which sets the guidelines on the Use of Consultancy Services, shall be considered in the review of the estimated amounts for hiring of consultants for the conduct of feasibility studies, detailed engineering, and construction supervision.

 

a)                  Farm Enterprise Profit.  The objective of farm enterprise analysis is to determine the profitability of the individual production activities or enterprises.  As such, it provides useful information for decision-making on which activities to pursue, which to emphasize, and which to discard altogether.  It also helps determine whether and how a particular enterprise may be made more viable.

 

In terms of definition, enterprise profit is simply the difference between gross value of production and total cost of production.

 

b)                  Farm Enterprise Gross Value of Production.  Gross Value of Production.  Gross value of production is a measure of the value of output produced by the enterprise, whether the output is sold, consumed on the farm, or stored for consumption or sale in future accounting periods.  All outputs are valued at th