ECONOMIC EVALUATION OF IRRIGATION PROJECTS

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ECONOMIC EVALUATION OF IRRIGATION PROJECTS
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Pre-Independence- Development of financial
policy

• Considered as commercial ventures like any other
  infrastructure projects
• The feasibility of irrigation projects
  essentially evolved from the concept of financial
  soundness of public investment
• Close of last century with the acceptance of the
  proposal for construction of irrigation works
  through loan funds

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Pre-Independence- Development of financial
policy

• The Select Committee on Indian Public Works
  reporting to the House of Commons in 1879
• Observed
• The financial results of works of irrigation
  are in the opinion of your committee, the best
  test of their utility. A rail road may traverse
  between certain districts which it does not
  materially improve, yet the work may on the
  whole, be beneficial, to the country. However,
  an irrigation work benefits the immediate
  locality in which it is placed, it can be of no
  use to outside districts.

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Pre-Independence- Development of financial
policy

• The committee further observed that
• the construction of new works from borrowed
  money for the future be limited to those schemes
  alone which upon the responsibility of the
  Government are estimated to be productive by
  yielding an annual income equal to the interest
  in the capital expended on their construction
  including in such capital interest during
  construction.
• This recommendation formed the basis for
  selection of irrigation projects.

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Pre-Independence- Development of financial
policy

• First Indian Irrigation Commission (1901-1903)
• An irrigation work is classed as productive
  and sanctioned against loan funds when it has
  shown to the satisfaction of the Secretary of
  state that it is likely to fulfill the
  conditions of productive public work, that is to
  yield a net revenue 10 years after completion,
  sufficient to cover interest charges on the sum
  at charge at that date. By sum at charge is meant
  the total direct and indirect capital cost plus
  the excess, if any, of interest charges to date
  over the net revenue.

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Productivity rate

• The productivity of a scheme was judged with
  reference to the rate of return earned by it on
  full development
• The criterion for the sanction of irrigation
  projects was based on financial results

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Financial results

• 1. The capital cost of any work was taken as the
  sum actually spent on its construction
• 2. The revenue on account of direct receipt and
  indirect receipt was estimated
• 3. The revenue account was debited yearly with
• the simple interest on the capital cost of the
  works at the commencement of the year
• The working expenses of the year
• 4. The revenue account was credited yearly with
  the direct receipts and the indirect receipts
• The difference between 4 and 3 above for any
  year gives the profit or loss for that year

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Productivity rate

• The acceptable value of productivity rate was
  linked to prevailing Rate of interest
• The productivity rate varied between 4 to 6
  percent during 1919 to 1937
• After April, 1937, Government of India prescribed
  Rate of Return as 6 percent
• However, recognising the importance of irrigation
  to meet the food and fiber requirement of the
  public at large, most of the Provinces reduced
  the productivity rate to 4 percent

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Productivity rate

• The financial viability test was rigidly applied
  to all irrigation projects
• Earlier large irrigation schemes were mostly
  diversion works and were relatively inexpensive.
• During Development of New projects it was felt
  that the development of irrigation was being held
  up by the rigid application of the financial
  criterion
• Apart from direct irrigation revenues, other
  benefits accrued to the Government in the shape
  of increased revenue from excise duties, income
  tax, sales tax, transport etc.

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Resolution of The Central Board of Irrigation
(1936)

• as the expansion of irrigation is seriously
  handicapped by the restricted view taken of the
  value of irrigation, an economic survey should be
  carried out with a view to estimate the direct
  and indirect financial benefits accruing to the
  Central and Local Governments from Irrigation
  Projects.

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Protective Work

• A view was taken that if a project did not
  fulfill the financial criterion, but was still
  considered necessary in the public interest, it
  could be sanctioned as a protective work.
• Number of irrigation projects which failed to
  satisfy the financial criterion were accordingly
  taken up as protective works.

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Plan era

• A change in the approach to the irrigation
  projects
• These projects were viewed as investment in the
  development and social benefit where profit was
  not the sole motive
• Rate of return on the capital outlay for
  classifying a capital work as productive was
  reduced to 3.75 percent which continued upto the
  year 1954
• The rate was raised to 4.5 per cent and this rate
  continued up to March, 1960.

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Benefit Cost Ratio

• It was felt that irrigation project in an area
  should not only be viewed as source of income to
  the Govt. but as a means for increased
  agricultural produce and economic development of
  that area and in the process, of the country as a
  whole.
• The Planning Commission in 1958 initiated studies
  of some of the major projects to assess the
  overall benefits of the irrigation projects and
  to find a more appropriate criterion for
  deciding whether various irrigation projects
  should be undertaken.

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Committee headed by Prof. D.R.Gadgil

• Large benefits accrued from irrigation in terms
  of double cropping, diversification and better
  quality crops, higher yields, larger income and
  greater opportunities of employment.
• Indirect benefits that accrued were the
  establishment of processing industries, expansion
  of consumer industries, retail trade, transport
  and communications.
• Total benefits from irrigation were far larger
  that the direct financial returns accruing to
  Government from water rates and betterment levy.

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Gadgil Committee

• The Committee recommended that in future the
  concept of benefit cost ratio should be used for
  assessing the feasibility of new projects instead
  of the traditional criterion of the direct
  financial return to the Government.
• For simplicity it was considered that the
  indirect or secondary benefits and cost need not
  be taken into account.

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Gadgil Committee Recommendations

• The net annual benefit was to be worked out as
  the difference between the monetary value of the
  net agricultural production (total value of
  produce- cost of cultivation ) before and
  after the introduction of irrigation.
• The annual cost should be taken to comprise the
  annual interest on capital, depreciation and
  expenditure on maintenance and operation.

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Recommendations- Contd..

• Gadgil Committee report submitted in 1964
  recommend the adoption of economic benefit
  criterion instead of the financial criterion.
• The Government accepted this recommendations and
  benefit cost ratio criterion has been adopted.
• Benefit-Cost Ratio criterion for judging the
  economic soundness of irrigation projects is in
  practice till date.

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B.C. Ratio

• B.C. ratio is obtained by dividing the annual
  benefits by the annual cost.
• Net annual benefit is estimated as the difference
  in the net value of agricultural produce before
  and after irrigation
• The annual cost in the denominator comprise
• interest on capital cost of the project at the
  rate of ten percent per annum
• depreciation charges at the rate of 1 percent in
  case of projects having 100 years life say
  storage scheme and 2 in case life of the project
  is considered as 50 years
• operation and maintenance expenses.

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B.C. Ratio

• Criteria
• Irrigation projects with B.C. ratio greater than
  1.5 are considered acceptable from economic point
  of view.
• BC ratio of 1.5 instead of 1.0 was suggested as
  a prudent precaution against likely increase in
  cost of the project.
• Subsequently, acceptable value of B.C. ratio was
  reduced to 1.0 for irrigation projects in drought
  prone areas.

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Internal Rate of Return

• Reflect the further cost involved in long
  gestation that takes place during the
  construction
• Obligatory For World Bank aided project
• Internal Rate of Return is calculated on the
  basis of market prices without any adjustment for
  economic prices because of non availability of
  national parameters for economic prices

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Views of Irrigation Commission (1972)

• The economic benefit criterion is more suitable
  than the financial return criterion.
• The rate of return methods is more suited as a
  basis for making a choice between two investments
  where financial return is the dominant
  consideration and no constraints are imposed by
  national goals
• Recommended the continued use of the benefit cost
  ratio for irrigation projects not only because it
  is simpler but also because it is used in most
  countries.

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Views of Irrigation Commission (1972)

• The application of the benefit-cost-ratio
  criterion minimises the importance of securing
  adequate return from investments on irrigation
  projects
• Recommended that at the time of considering
  project for acceptance that the financial return
  of the project should also be carefully examined.
  
• If the return does not cover working expenses
  and interest charges on capital, the impact of
  the project on the irrigation revenues of the
  State should be examined to see if an upward
  revision of the water rates in the States, would
  be necessary.

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Review of Criteria

• The Fifth Conference of Irrigation State
  Ministers (1980)
• Recommended that whole criteria of B.C. ratio
  should be reviewed on the basis of actual
  performance of irrigation system and norms for
  evaluation of benefits.
• Accordingly a Committee under the Chairmanship
  of Shri Nitin Desai was constituted by Government
  of India in December, 1981

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Nitin Desai- Report

• The Committee noted the following methodological
  deficiencies in the approach
• The method of calculation of benefits and the
  criterion for selection relies on the increment
  in the net value of agricultural production. This
  does not reflect the range of objectives which
  irrigation investments have to subserve.
• Irrigation projects take time to implement and,
  what is important, the time required varies from
  project to project. The comparison of annualised
  benefits and annualised costs does not reflect
  the value of time adequately

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Desai Committee Findings

• Generally all costs and benefits are evaluated at
  market prices. Because of the presence of many
  distorting influences, these market prices may
  not reflect the true value of these costs and
  benefits to the economy
• Many of the cost parameters are evaluated on the
  basis of ad hoc norms. For instance, fodder
  expenses and dung receipts.

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Desai Committee- recommendations

• Recommendations of Nitin Desai Committee
• The committee reviewed the existing norms of
  evaluating project benefits, cropping patterns,
  yields, valuation of outputs, cost of
  cultivation, international prices, concept of
  opportunity cost adjustment for social cost etc
• The present procedure does not take into account
  the time taken to reach the full benefit
• Discounted cash flow (DCF) method must be
  followed in the benefit-cost analysis of
  irrigation projects

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Review of Existing Criteria

• There is no analysis of risk and uncertainty and
  the extent to which the project will help to
  reduce the variability of agricultural
  production, a deficiency which is particularly
  serious since stabilisation of production is one
  of the major objectives of irrigation development
• There is no systematic attempt at sensitivity
  analysis to take into account likely variations
  in yields, costs etc.
• The benefit cost analysis is generally added on
  to a project after technical parameter are firmed
  up. A techno-economic analysis of all available
  options is seldom attempted

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Review of Existing Criteria

• Working Group(1999) for updating Existing
  Guidelines on Guidelines for preparation of
  Detailed Project Reports of Irrigation and
  Multipurpose Project(1980)
• W.G. recommended for continuation of existing
  practice with the following modifications
• Cost of on-farm Development works be worked out
  separately and two sets of the benefit cost ratio
  of the project be worked out with and without
  considering the cost of these works.

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WG (1999) recommendations

• Benefits due to fisheries, horticulture,
  catchment area treatment, aforestation, animal
  husbandry etc. in addition to agricultural
  production may also be assessed and accounted in
  benefits
• the quantity of water reserved for domestic and
  industrial water supply may be assigned certain
  cost in consultation with concerned authority

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Recommendations Contd..

• For modernisation project, the two sets of
  benefit cost ratio be computed one considering
  net benefit and net costs and other considering
  total benefits and total cost. The higher of the
  two be considered for deciding economic viability
  of the project.
• B.C. ratio limits of 1.5/1.0 (for drought prone
  areas) and above need to be reviewed in view of
  landing of the project with so many additional
  costs and a lower B.C. ratio of 1.0 may be
  acceptable for determining economic viability of
  the project.

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Where do we Stand Today?

• The recommendations of the Nitin Desai Committee
  not implemented
• The Format for estimating Benefit Cost Ration
  remains the same
• The ratio is the sole criteria for acceptance of
  the project may not give a true pictue of the
  economics of the project

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Issues Unanswered

• Sensitivity analysis are rarely performed
• Benefits and costs are estimated at the end of
  the preparation of the project
• Such exercise needs to be carried out at planning
  stage to evaluate various Project alternatives as
  decision making aid

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Concerns

• Irrigation systems are largely designed based on
  inadequate or unreliable data on water resources,
  irrigation efficiencies, distribution of cropping
  pattern in the command etc.
• The lack of detailed survey Investigation data

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Issues of concerns

• In many cases the project is in advanced stage of
  construction even before it is appraised it is
  already a fait accomplice
• Most econometric models of investments are based
  on implicit assumption that investment
  expenditure are reversible.
• However, most large irrigation projects are
  irreversible, once started. They can of course be
  restructured, but not completely shifted

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Concerns

• The Planning Commissions capital cost estimation
  procedure suffers from many
• serious limitations. It neglects gestation lag
  that exists between the time investment is
  undertaken and the time irrigation potential is
  created and it fails to recognise that society
  values investments differently as time passes,
  among others.

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Concerns

• Analysis of 346 M M irrigation projects show
  that a fixed period of 12
• years between the time investment is made and
  potential created is representative of most
  irrigation works.

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Other Considerations

• The present format deals with static aspects.
• The dynamic aspects such as shift in demand and
  supply post project also needs to be looked into
• The costs of inputs such as fertilizers etc have
  a component of subsidy where as benefits are at
  market price there is need to look into this
  aspect as well

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Other aspects

• Rent of the land ( of Gross Produce) do not
  reflect the opportunity cost of the land
• Labour cost is only towards hired labours and do
  not account for the family labours

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Benefits /Costs not Accounted

• Flood Control
• Recreation
• Inland fishing
• Improvement in life of the people
• The flow of funds over long period remains locked
  and the benefits are delivered ( Partial or full)
  much later

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Recent Developments

• Planning Commission constituted a committee to
  revisit the methodology of computation of BC
  ratio
• Ministry of Water Resources constituted a
  committee to study the issues related to
  estimation of BC Ratio (Chawla Committee)

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Findings Planning Commission

• Concept of with and without project introduced
  Opportunity cost of the project
• Intangible benefits recognised but in the absence
  of procedure to assign monetary value not
  proposed to be included in the benefits
• Irrigation projects compared with other
  infrastructure projects such as metro, roads,
  communication etc.

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Planning Commission- report

• Need for accounting the factor for deferred
  irrigation
• The valuation of cost Benefits should reflect
  preferences for the choices made
• Benefits are measured by the market choice
• Some measurements of benefits requires valuation
  of Human Life

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Findings of Planning Commission

• Projects having BC ratio more than 1 be compared
  for the NPV
• The discount rate be varied for sensitivity
  analysis of NPV
• The present estimation of BC ratio is not on
  realistic data and do not clearly reflect the
  contribution of the project to the economic growth

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Planning Commission

• The data on costs are not based on detailed
  survey and investigations
• There is a need for post facto evaluation of
  project as a feed back to the appraisal
• Discounted cash flow method be used for
  estimation of BC ratio
• Positive and negative social impacts balance each
  other

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Chawla Committee- Findings

• Need to do away with BC ratio criteria for water
  supply projects
• Cost towards rent, depreciation on implements,
  land revenue on age basis needs modification or
  to do away with
• Benefits towards the flood protection needs to be
  evaluated and added to the benefits

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Findings of Chawla Committee

• Benefit from afforestation, CAT, also needs to
  be added
• Tertiary benefits to be added

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Issues for Discussions

• The BC ratio criteria is used to make investment
  decisions in irrigation sector. Can we afford not
  to achieve the available command area potential?
• Arent irrigation projects essential for
  maintaining food self sufficiency
• Why the irrigation projects cannot be treated
  similar to defense preparedness, climate change,
  sewage treatment plants, pollution control etc. ?

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Issues

• Do we really need to have BC ratio as the
  criteria for economic evaluation of irrigation
  projects?
• Should not BC ratio be used for benchmarking /
  inter-se priority of the project or ranking of
  the projects for development
• Impact of LARR 2014 policy on irrigation
  projects, it will severely impact the BC ratio,
  should the land cost be excluded from BC ratio
  estimation

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Issues for considerations

• The concept of with without project is not
  applicable because of water availability
  constraints and spread of irrigable area
• Usefulness of BC ratio evaluation for ongoing
  projects / RCE as irrigation investments are
  irreversible
• Rationality of BC ratio criteria for drinking
  water projects

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Issues

• There is always a criticism of irrigation
  projects for time and cost overrun
• The scheduled completion time of the project be
  realistic and not linked with the Plan period
• The fund flow to the irrigation projects should
  be timely and smooth so that realistic time
  schedule can be maintained

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Issues for considerations

• The performance evaluation has to be must for the
  projects which are declared completed
• Cost towards OM be made part of the Plan funds
  of the state- ERM projects are largely because
  of OM issues
• The reasonableness of applicability of concept of
  opportunity cost and concept of with and without
  project to irrigation project

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Other Issues

• Detailed Survey Investigation must for
  accepting the DPR for appraisal
• ERM project proposals should contain detailed
  survey investigations and performance analysis
  of the current stage of the project
• Need for sensitivity analysis considering the
  ground condition for completion of the project

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Other Issues

• How the period when no benefits have been derived
  can be reflected in financial terms for
  evaluation of BC ratio?
• The benefits for drinking water are not
  commensurate with the costs as beyond head works
  huge cost is incurred for making the drinking
  water available
• Benefits from forests, CAT etc not accounted for
  need for accounting

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Issues

• Benefits accrued at RCE stage needs to be
  accounted towards the cost and the BC ratio be
  estimated on net costs rather than total costs
• Sometime even the full costs have been recovered
  but not compensated

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Some Thoughts

• Do the BC ratio for irrigation projects has
  relevance in light of new Land acquisition act
  2014 ?

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Discussions

• Inputs/ Suggestions Invited Please!

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Thank You