ECONOMIC ANALYSIS. A. General

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1 East West Highway (Khevi Ubisa Section) Improvement Project (RRP GEO 49257) ECONOMIC ANALYSIS A. General 1. The proposed project is part of a major project to upgrade the East West Highway (EWH). The EWH serves one of the two principal transit corridors in Georgia, formed of the E60 (Poti Senaki Tbilisi Red Bridge) and the E70 (Senaki Poti Batumi Sarpi). The project road is a kilometer (km) section whose eastern end is approximately 10 km west of the Rikoti tunnel and 152 km west of Tbilisi. It connects the settlements of Khevi and Ubisa. The project will expand Georgia s transit capacity and provide enhanced safety features. It will reduce transport costs and provide much-needed additional capacity. The Government of Georgia plans to capture transport cost savings and use them to generate wider economic benefits, for example by establishing logistics centers along the EWH. 2. Transit trade is significant: in 2015 transit trade (11.0 million tonnes) was similar to the total of exports (2.0 million tonnes) and imports (8.9 million tonnes). Approximately 4 million tonnes of transit freight is containerized and 75 percent of this is carried by road. There are two predominant road transit routes: between Sarpi and Red Bridge (on the Turkish and Azerbaijan borders respectively) and between Sadakhlo and Kazbegi (Armenian and Russian borders respectively). Approximately 1 million tonnes of containerized freight is carried from Sarpi to Red Bridge via the EWH. In addition to its role as a transit route, the EWH provides road access to the resorts of Batumi and Kobuleti along the Ajara coastline, and to the poor settlements that lie along the EWH. The existing road is a two-lane asphaltic concrete (AC) road. It is now operating close to its capacity. Travel is hazardous: between 2012 and 2017, 29 deaths and 182 injuries were recorded in Roads Department s (RD) statistics. 3. In 2015 the World Bank used a computable general equilibrium (CGE) model to quantify the indirect benefits of investment in the EWH. 1 The results showed that the reduction in travel costs had a positive effect on growth and welfare. Compared with outcomes in the absence of an upgrade, Georgia s long term real gross domestic product (GDP) would be 4.2 percent higher. 4. The feasibility study (FS) considered three alternative alignments for non-tolled facilities and both AC and concrete pavements and favored an alignment that followed the existing alignment as much as possible with a minimum horizontal radius of 250 m and maximum vertical grade of 7% (blue alignment). At the FS stage blue alternative had an economic internal rate of return (EIRR) of 13.1% in case of AC pavement or 14.7% in case of concrete pavement. Green alternative was mainly on a new alignment with a minimum horizontal radius of 250 m and maximum vertical grade of 6%. This alternative was, however, dropped at the early stage of the FS and the EIRR for the green alternative is not available. Subsequent to the FS, traffic management, resettlement and slope stability considerations, plus RD s wish for a higher standard of service, led to adoption of higher standard alignment (similar to the FS consultants yellow alignment) with a concrete pavement. The minimum horizontal radius of this alternative is 500 m (450 m in the FS) and maximum vertical grade is 3.8% (5% in the FS). At the FS stage this alternative had an EIRR of 7.9% with a unit economic construction cost of $18.9 million per km (7.2% with the AC pavement). The proposed road will be a high standard four lane road with a concrete pavement on the road and tunnel sections (3.2 km and 4.8 km respectively) and an AC wearing course on the concrete decks of the bridge sections (4.1 km). For analysis purposes the entire road is treated as having a concrete pavement. 1 The results of both the CGE and a gravity modeling exercise are reported in World Bank, 2017: Project Paper for the East West Highway Corridor Improvement Project, Washington DC.

2 2 5. In the absence of the project (the without-project scenario) the EWH is expected to require significant periodic maintenance. Under the with-project scenario a new four lane road will be provided, safety features will be improved, and the tunnels and bridges will be constructed to modern standards. Properly constructed, the road will need very little on-carriageway maintenance. The improved pavement will have an initial international roughness index (IRI) of 1.6. Average travel speed on the road is expected to increase to 73 km/h, up from the current 55 km/h. Improvements to the horizontal alignment will reduce the section length from 14.5 km to km. There will be no major diversions during construction. The road will not be tolled. B. Demand Estimate 6. Estimates of traffic demand used in the economic analysis are based on regular traffic counts undertaken by the roads department on the S1 road between Tbilisi and Senaki (the S1 being the domestic designation of this section of the EWH), and on manual classified counts (MCCs) undertaken by the FS consultants in 2014 and by the design consultants in Base year (2017) traffic is shown below. Detailed traffic studies are described in a separate appendix. Table 1: Base year (2017) traffic Cars, SUVs Vans & Medium 2-axle 3-axle 4-axle trucktrailers AADT etc Mini-buses pickups buses trucks trucks veh/day 9,159 1,183 1,420 1, ,132 14,462 Source: Asian Development Bank estimates. 7. Average annual historic traffic growth on the project road from 2007 to 2016 was 9%, approximately double GDP growth over the same period. Traffic dropped in 2009 and 2014 in response to regional crises. Much of the traffic is long haul and goods traffic is closely related to the flow of truck-trailer traffic across the Turkish border at Sarpi. In the short to medium term strong growth of heavy goods traffic is expected to continue. In the longer term, merchandize trade and its use of road transport may be displaced by trade in services. The growth of heavy goods traffic is forecast to fall from 7.9% to 4.3% over the course of the evaluation period. Georgia Railways has invested in new trains and rolling stock on its principal tourist route from Tbilisi to Batumi and bus traffic on the project road is likely to suffer some diversion as a result. 8. Acknowledging the various influences on traffic growth, from 2018 to 2020 the weighted average growth rate is assumed to be 5.8%, implying an income elasticity of 1.2 with respect to forecast GDP growth over the same period. In subsequent periods both elasticity and growth are reduced to 1.0 and 4.0% ( ) and 0.9 and 3.2% (2030 onwards). A new deep-water port at Anaklia is in the first phase of development. The FS considered that this would increase project road heavy goods traffic by an initial 330 vehicles per day (vpd) in 2019, rising to 1,880 vpd in For this evaluation a more modest level of additional traffic is taken: from 150 vpd in 2022, thereafter increasing at the same rate as normal truck-trailer traffic. C. Economic Costs 9. The economic costs of the project comprise (i) capital investment, which includes civil works, land acquisition and resettlement, as well as consulting services for construction supervision and social safeguard management, and (ii) road maintenance. Construction was assumed to take place over a three year period from 2019.

3 3 10. Financial costs were converted to economic costs in line with ADB guidelines. 2 All predicted project costs and benefits are measured in 2018 economic prices expressed in $. Traded goods are measured at world prices and non-traded inputs at domestic prices less indirect taxes multiplied by a standard conversion factor (SCF). Georgia imposes very low taxes on international trade and in consequence the SCF was estimated at A shadow wage rate factor (SWRF) of was taken from the original World Bank FS and applied to unskilled labor used in road construction. A SWRF of 1.0 was applied to skilled and professional labor. Detail of land and resettlement costs were not available at the time of reporting, financial costs were adjusted by an assumed conversion factor of A residual value equivalent to 30% of the investment cost estimated by applying the straight-line depreciation method to individual project items based on assumed lifespans was included in the economic analysis. 12. Project base financial cost at 2018 prices, including works, land acquisition and resettlement, and project management and supervision was estimated at $390m, a sum that includes VAT and physical contingencies of 7.5% applied to works costs. This was converted to an economic price of $322 m by (a) deducting value added tax (VAT), (b) converting to $ at an official exchange rate (OER) of GEL2.5 = $1, (c) applying conversion factors as above, and (d) applying the SWRF to the estimated 5% of construction costs that represent unskilled labor. The weighted average economic cost per km was $26.7 m, i.e. 40% higher than at the feasibility stage. 13. The assumed without project maintenance regime is shown below. For the new concrete pavement maintenance was confined to the annual routine maintenance interventions shown in the table, plus an estimated $10,000/km/year to cover incremental operating expenses of lighting and fan ventilation. 5 Table 2: Without project maintenance interventions Intervention Economic unit cost Intervention criteria AC pavement reconstruction $1 m/km IRI>10, first intervention after mm overlay $29 /m 2 plus preparatory works 10 year intervals, post-works IRI = 3 Pothole patching $12 /m 2 Potholes > 5 / km, 85% patched Crack sealing $5 /m 2 Every 2 years, 85% sealed Drain clearing etc. $1,000 /km Annually Winter maintenance $1,000 /km Annually AC = asphaltic concrete, IRI = international roughness index, km = kilometer, m = meter, m 2 = square meter. Source: Asian Development Bank assumptions. D. Economic Benefits 14. The main quantifiable economic benefits are vehicle operating cost (VOC) savings, savings in travel time, crash cost and emission reductions. The scope for generated traffic was considered insignificant and thus benefits were confined to normal traffic. 2 ADB Guidelines for the Economic Analysis of Projects. Manila. 3 Using the ADB simplified method based on merchandize imports of $7.293bn, exports of $2.384bn and taxes on trade of $51m (averages in current $ for from World Bank data). 4 World Bank, Project Appraisal Document for the 3 rd East West Highway Improvement Project. Washington, DC. 5 Eight tunnels over 500m long are proposed, each of which will require fan ventilation.

4 4 15. The shadow price of gasoline and diesel was estimated at $0.70 per liter. This reflects the expected average price of crude oil to 2030 (from the April 2018 World Bank Quarterly Commodity Outlook), fuel excise duties and VAT, and the margin between fuel costs 6 and retail prices. Labor and working time costs are anchored by an estimated 2018 GDP per head of $2.2 per hour and an average wage in Q of $2.7 per hour. 16. An economic evaluation was undertaken using the Highway Development and Management (HDM-4) model. Travel time savings have been identified based upon the vehicle speed relationships included in HDM-4. These benefits have been monetised by applying values of time estimated for different categories of road users. Forecast with- and without-project operating speeds were km/h and km/h respectively, 7 leading to a journey time saving of approximately 6 minutes (of which approximately 70 percent are attributable to speed and the remainder to distance). Based on recent Georgian wages, working time is given a shadow price of between $2.7 per hour (bus passengers) and $4 per hour (car passengers). GDP per capita in 2018 is estimated at $2.2 per hour. Non-working time is valued at 30% of working time. The value of time savings was increased in line with GDP per capita, conservatively assumed to be 3% per year. 8 Time savings account for 49% of project benefits. 17. Over the period an annual average of five deaths and 30 injuries are recorded along the project road. 9 Using the irap methodology, 10 the present value (PV) of crash costs over the entire evaluation period is $73 million 11 in the without project scenario. As no formal assessment of the expected change in deaths and injuries has yet been made as part of the road safety audit, a nominal 25% crash cost savings are included in the evaluation. 18. Changes in pavement quality affect engine performance which in turn affects tailpipe greenhouse gas (GHG) emissions. HDM-4 calculates emissions from fuel consumption. The HDM-4 approach has been criticized, 12 but is straightforward to use and was used here to estimate project savings of carbon dioxide. Using the recommended ADB unit value of $36.30 per ton in 2016, and real terms increases of 2% per annum, the stream of emission reduction benefits had a PV of $6.6 million. E. Results of Economic Analysis 19. An economic assessment of the project was carried out using the standard appraisal methodology. This methodology compares the incremental benefits of reductions in VOCs, travel times, emissions and crash costs arising from resulting from construction of the project road with the initial investment costs and changes in operation and maintenance costs over a 24 year appraisal period (four years implementation, including three years construction, and 20 years operation). The results of the economic analysis are shown in Table 6 expressed in terms of the key economic indicators, namely benefit-cost ratio (BCR), economic internal rate of return (EIRR) and net present value (NPV) at a 9% discount rate. The results are presented using the world price numeraire. 6 Georgia imports refined product from Azerbaijan, Romania and Russia, amongst others. 7 Much lower than the 25km/h increase (from 55 to 80km/h) claimed in the FS. 8 GDP per head grew at an annual average of 5.6% from 2007 to Roads Department data. 10 irap The True Cost of Road Crashes. London. 11 Assumes that value increases in proportion to real GDP growth and to traffic growth. 12 See for example ETSU: Emissions Modeling Framework for HDM4, working paper, 1997.

5 5 20. The results indicate that the project is just economically viable, with a BCR of 1.02, an EIRR of 9.2% and an NPV of $6m. Table 3 shows the stream of costs and benefits over time. Incremental costs are negative in years when capital works are needed in the without project case. Main project benefits start in Table 3: Costs and benefits streams (2018 world prices, $ million) Incremental costs Incremental benefits Total Net Year Investment Maintenance VOC Time Emissions Safety benefits benefits (32.2) (160.8) (128.6) 2022 (14.5) (2.9) (0.1) (96.5) PV at 9% NPV 5.1 EIRR 9.2% BCR 1.02 () = negative, BCR = benefit-cost ratio, EIRR = economic internal rate of return, NPV = net present value, PV = present value, VOC = vehicle operating cost. 21. Sensitivity tests were carried out to determine the effect of variations in key input parameters. Table 4 shows switching values of 103% with respect to construction costs and 98% with respect to benefits, meaning that the project would still be economically viable if construction costs were to rise by 3% or the benefits to fall to 98% of base case values, the project would still be economically efficient. Project EIRR falls to just below 9% if crash cost savings are excluded. Table 4: Sensitivity analysis Case EIRR NPV, $m Switching value Base case 9.2% +5.1 Cost +20% 7.6% (42.9) 103% Benefits -20% 7.3% (44.6) 98% Cost+20% & benefits -20% 5.9% (92.0) No crash cost benefits 8.6% (9.8) () = negative, EIRR = economic internal rate of return, NPV = net present value. Source: Asian Development Bank estimates.