ECONOMIC AND FINANCIAL ANALYSIS

Transcription

1 Greater Mekong Subregion East West Economic Corridor Agriculture Infrastructure Sector Project (RRP LAO 44138) A. Introduction ECONOMIC AND FINANCIAL ANALYSIS 1. The Greater Mekong Subregion East West Economic Corridor (EWEC) Agriculture Infrastructure Sector Project will have three outputs: (i) improved agriculture infrastructure, (ii) increased capacity of farmers to manage and use agriculture infrastructure efficiently, and (iii) efficient project management. Approximately 25 subprojects will be implemented in Savannakhet and Saravane provinces in southern Lao PDR. B. Overall Benefits from the Project 2. The project will support the Lao PDR s competitive position within the Association of Southeast Asian Nations Economic Community, set to commence in Investments in EWEC s physical infrastructure will create opportunities for economic development and trade. The project is designed to increase agriculture productivity and market efficiency through improved access to markets. The Lao PDR suffers from low productivity resulting from limited access to improved inputs, weak extension services, and limited or no access to the market intelligence and information (such as prevailing commodity prices) that is required to make timely decisions on the crops to be grown. Investments made through this project will yield medium- and long-term benefits to the communities through improved livelihoods, contributing to the overall welfare of the communities. 3. A key benefit of the project is an expected increase of 38,000 tons (t) in rice output, of which about 85% will be marketable surplus. This increase represents about 1% of current Lao PDR rice production but it will have a significant economic impact by reducing some of the nation s current import needs. About 85% of the incremental output will be glutinous rice (Oryza glutinosa), referred to as sticky rice herein, which will have limited export potential. The main market for the sticky rice output will be the domestic market. The project is also expected to have a significant positive impact on the production of tomatoes, chilies, and other cash crops. 4. Quality infrastructure is often a necessary precursor to growth and development. As a consequence, lack of infrastructure can seriously hamper economic outcomes. The project s investments in agricultural infrastructure will help reduce these impediments by increasing access to the outside world with improved connectivity and networks. For example, the project will modernize irrigation systems, which will increase the efficiency of water use and its sustainability over time. Availability of efficient irrigation will help rural communities to grow more than one crop a year and realize additional income. 5. Well-organized operation and maintenance (O&M) of irrigation infrastructure is critical for long-term sustainability. The overall benefits from the project will be locked in and solidified through the support to water user groups (WUG) or Water User Associations (WUA). These groups will be provided with training and capacity building to improve management systems, accounting procedures, reporting, and communication among members. 6. The project will help strengthen extension services, which is one of the main weaknesses in the agriculture sector. Improved extension services are a prerequisite to improve agriculture production and productivity. C. Economic and Financial Analysis of Representative Subprojects 7. Bung Xe, Phanomxay, and Vapy Neua are the representative subprojects selected for detailed feasibility studies. The objectives, nature, and scope of the subprojects are similar, with

2 2 the development objective to improve farm household livelihoods in the subproject areas principally through increasing agricultural production (predominantly rice). Each subproject will (i) rehabilitate existing irrigation infrastructure to improve the supply of irrigation water; (ii) rehabilitate farm roads to improve rice post-harvest processes and market access; (iii) provide agricultural extension and support to ensure the efficiency and effectiveness of both wet and dry season crop production with reliable irrigation water; and (iv) establish and strengthen the capacity of the WUGs or WUAs to ensure sustained O&M of the rehabilitated irrigation system as well as equitable water allocation to farmers in the command area. D. Project Costs 8. Investment costs consist of major items such as (i) civil works, including (a) rehabilitation of irrigation schemes, and farm access roads; and (b) construction of offices for a project management unit, and offices for WUGs at each site; (ii) WUG capacity building; (iii) farmer extension support; (iv) village-based farm extension services; (v) training for provincial and district agriculture support staff; and (vi) establishment of a project administration structure. Contingencies used in the analysis are as follows: (i) general price contingencies of about 5.5% per year for the 8-year implementation period, based on the manufacture unit value (MUV) index; (ii) consulting services price contingencies are zero; and (iii) physical contingencies are zero for all inputs. Table 1 summarizes the total investment costs of the representative subprojects. Table 1: Summary of Investment Costs by Site ($) Cost Elements Bung Xe Phanomxay Vapy Neua A. Civil Works 1,853,600 1,465,600 1,133, Survey, design, supervision 77,250 82,400 77, Irrigation 1,429, , , Farm roads a 333, , , Rural market facility , Office 13,000 12,000 12,047 B. Vehicles and Equipment 21,131 16,333 16,554 C. Training and Capacity Building 57,810 44,935 46,358 D. Consulting Services 185, , ,159 Total Investment Costs b 2,118,100 1,657,173 1,335,199 Civil works per ha 4,413 5,862 4,197 Total investment costs per ha 5,043 6,629 4,945 a Costs generated from COSTAB, allocated to subprojects on a pro-rata basis according to area as a % of total hectares, and include cost contingencies but exclude project implementation administration and management costs. Road costs include land acquisition and resettlement costs. b Numbers may not sum precisely because of rounding. 9. O&M costs mainly consist of (i) routine or recurrent O&M expenses for civil works, and (ii) routine O&M costs for vehicles and equipment. The recurrent O&M cost represents the costs of labor cost, minor repairs and routine maintenance as well in some instances the cost of electricity required for pumping water into the distribution system. Information gathered at the three subprojects indicates that currently available O&M is 10% 30% of that needed for sustainability over a 20-year life. The O&M costs are shown in three parts: (i) the government funding a declining share of $80 per hectare (ha) over 5 years; (ii) WUGs or WUAs increasing their share of $80/ha as government contributions decline; and (iii) farm road maintenance costs of $1,200/kilometer/year. The irrigation maintenance costs are progressively transferred from the government to the WUGs or WUAs over five years, with the WUGs or WUAs paying 20% in year 2, 40% in year 3, 60% in year 4, 80% in year 5 after rehabilitation, and 100% thereafter. Table 2 summarizes the total recurrent costs of the representative subprojects.

3 3 Table 2: Summary of Infrastructure Operation and Maintenance Costs by Site ($) Cost Elements Bung Xe Phanomxay Vapy Neua A. Government Assistance with O&M Fee 123,540 86,400 55,590 (over 4 years) B. Irrigation Operating Costs in Year 8 a 99,560 64,900 54, Maintenance 51,160 36,100 23, Electricity 48,400 28,800 31,110 C. Road O&M Costs in Year 8 a 28,660 18,130 16,030 Total O&M Costs (B+C) 128,220 83,030 70,360 O&M costs per hectare O&M = operation and maintenance. Note: Supplemental O&M is funded by the Asian Development Bank (ADB) loan on a declining basis. Costs are generated from COSTAB, allocated on pro-rata basis, and include cost contingencies. a These O&M costs are paid by the beneficiaries. E. Production and Costs 10. Detailed analysis of the farming systems at each of the three subprojects was undertaken. Wet season sticky rice production is the dominant agricultural output. Other supplementary aspects of the farming system include a cash crop at Bun Xe site and vegetables at the other two sites. For the purposes of this analysis, it is assumed that rice production will continue to be the dominant land use after infrastructure rehabilitation, but that a small increment in the areas of supplementary crops will occur. However, a swing from sticky rice to the more profitable white rice production in the wet season command area is already happening and will continue. It is assumed 50% of the wet season rice crop will be white rice by project year Table 3 presents a summary of the scope of the representative subprojects. The command areas of the subprojects are typical of the area 420 ha for Bung Xe, 250 ha for Phanomxay, and 270 ha for Vapy Neua. When compared to yields achieved by farmers in neighboring Thailand and Viet Nam, rice yields are currently low at about 2.5 t per ha for the wet season and 3.5 t per ha for the dry season. A number of important reasons explain this suboptimal performance, including insufficient availability of high yielding improved varieties of rice seed, weak agriculture extension support services, mixed messages on rice production technologies (including the use of chemical fertilizers and crop protection methods), rundown irrigation infrastructure, and farmers not receiving an equitable share of the rice value chain. The improvement of farm roads will be critical in assisting farmers to improve both post-harvest care and market access. Table 3: Summary of Project Scope by Site Item Bung Xe Phanomxay Vapy Neua Existing wet season cropping area (ha) Existing dry season cropping area (ha) a Existing cropping intensity (%) Farm road length to be rehabilitated (km) Total cropped area with project (ha) Cropping intensity with project (%) ha = hectare, km = kilometer. Ignores existing minor riverbank recession cropping. 12. The project will endeavor to ensure that gender-sensitive, climate-resilient, pro-poor labor saving devices are introduced wherever appropriate. Labor demand has been analyzed and disaggregated by gender about 20% of wet season rice crop labor and 22% of dry season

4 4 rice crop labor is female. The majority of off-farm employment is during the dry season. Providing profitable on-farm alternatives will reduce the pressure for out-migration to dry season work elsewhere. Social benefits will come from the creation of local dry season employment opportunities. 13. Crop budgets at each subproject have been analyzed with and without the project. Expectations of yield increases are modest while investments in key crop inputs have been increased to underpin yields and ensure sufficient cash flow to fund sustainable O&M of project infrastructure by beneficiary farmers. Annual farm household net incomes are low, but they are calculated to increase by $2,700 in Bung Xe, $2,400 in Phanomxay, and $2,900 in Vapy Neua with improved yields, prices and reduced costs. The impacts of the anticipated changes to cropping patterns, production technologies, and gross margin per hectare are summarized in Table 4. Table 4: Summary of Land Use and Crop Gross Margin Analysis by Site Subproject Site Bung Xe Phanomxay Vapy Neua Without With Without With Without With A. Wet season rice sticky % of Command Area 95% 48% 95% 48% 95% 48% Total Costs Total Income Gross Margin/Ha Incremental Benefit Return to Labor ($/day) B. Wet Season Rice White % of Command Area 47% 47% 47% Total Costs Total Income 1, Gross Margin/Ha Incremental Benefit Return to Labor ($/day) C. Irrigated Dry Season rice Sticky % of Command Area 85% 70% 85% 83% 85% 83% Total Costs Total Income 795 1, Gross Margin/Ha Incremental Benefit Return to Labor ($/day) D. Irrigated Dry Season Tomatoes % of command area 3% 6% 3% 6% Total Costs 961 1, ,410 Total Income 3, , Gross Margin/Ha 2, , Incremental Benefit Return to Labor ($/day) E. Irrigated Dry Season 3% 6% 3% 6% Chilies Total Costs Total Income 1, , Gross Margin/Ha 1, , Incremental Benefit Return to Labor ($/day) ha=hectare, $=United States dollar. Note: The benchmark return to labor is the Bangkok migrant labor rate of about $6.67/day (K53,000)

5 5 14. While expenditure on key inputs is increased (e.g., fertilizer and crop protection expenditure by 70% to 100%) and fully sustainable O&M charges are levied, increases in gross margins of 60% to 100% are still indicated. Thus, the crop analysis demonstrates that irrigation infrastructure should be sustainable for the expected 20-year asset life while farm family livelihoods are still significantly and sustainably enhanced. F. Markets 15. In the Lao PDR, 85% of rice produced and consumed is sticky rice. The Lao PDR is the biggest consumer of sticky rice per capita in the world. Rice production in the Lao PDR fell in 2011 and Output in 2012 is estimated at 2.7 million tons, about 100,000 t short of annual national requirements. In addition, rice quality in the Lao PDR is lower in comparison to its neighbors. The benchmark for internationally traded rice is less than 5% cracked grain, which was trading at $564/t in January Most rice produced in the Lao PDR falls well short of this standard, and is more likely to be graded less than 25% cracked, trading at $540/t in January Although rice production is the single most important economic activity, accounting for 39% of agricultural GDP, very little rice is currently exported While localized natural disasters (droughts and floods) have contributed to falling output, deeper structural issues constrain rice output. Limited access to quality rice seed, weak agricultural extension capability, confused messages to farmers regarding the use of modern crop nutrition and protection methods, and lack of access to dry season irrigation all undermine rice production in the Lao PDR. Compounding this situation is the limited commercial rice milling capability. Most rice is milled by village millers. Some rice is exported to Thailand for milling at quality commercial mills and then imported back to the Lao PDR. 17. The provinces of Savannaket and Saravane are very important rice producers in the Lao PDR. Between them, they account for about 917,000 t of rice output or 33% of total national output. However, dry season rice area constitutes less than 20% of the wet season area, significantly constraining the potential dry season output in both provinces. Further constraining the output of both wet and dry season rice are the national issues of weak extension and limited access to quality improved seed. G. Financial Feasibility 18. Weighted average cost of capital. The financial viability of a development project can be determined by assessment of both the benefit cost ratio and the financial internal rates of return (FIRRs). The benefit cost ratio is the ratio of the net present value of the benefit flow compared with the net present value of the incremental cost flow. The FIRR is compared with the weighted average cost of capital (WACC) of the project and the project is judged to be financially feasible if its FIRR is greater than its WACC. For the proposed project, the cost of borrowing is very small. The interest on the Asian Development Bank (ADB) loan is 1.0% per annum during implementation and 1.5% during amortization. If the rate of inflation in the Lao PDR is 5.5%, and the commercial interest rate is 12%, the WACC for the project net of inflation will be 3.0%. The WACC of 3.0% was used as a benchmark for judging the financial feasibility of the representative subprojects. 19. Financial internal rate of return. The FIRR of the representative subprojects was calculated over a 20-year project life. All representative subprojects are financially feasible as their FIRRs are higher than the WACC at 3.0%. 1 Asian Development Bank, Lao PDR: An Evaluation Synthesis On Rice. Manila

6 6 Table 5: Financial Feasibility Item Bung Xe Phanomxay Vapy Neua FIRR 14.9% 8.2% 14.9% Benefit cost ratio 2.8:1 1.7:1 2.4:1 FIRR = financial internal rate of return. H. Economic Feasibility 20. To calculate the economic returns of the subprojects, the net incremental value of crop production (the main quantifiable benefit of the project) is determined for each year of project life and arranged as a stream of cash flow. The O&M savings of the without-project scenario are arranged as an annual benefit. Without the project, the irrigated area will continue to decline by an estimated 10% per year. Costs are similarly presented, with construction costs occurring in the first project years, followed by annual maintenance costs in each subsequent year. To calculate the cash flow of net project economic benefits, the cost cash flow is subtracted from the benefit cash flow. 21. The following assumptions were used in the calculation of economic prices from the financial prices: (i) The domestic price numeraire is used. (ii) World Bank long-term commodity forecasts and Pink Sheet data (January 2013) are used for the current year for rice, urea, and diammonium phosphate (DAP). (iii) The US dollar is the main unit of account. (iv) The prevailing exchange rate of KN7,900 = $1 is used as the kip is used. (v) For the principal traded inputs and outputs (rice, DAP, and urea), import parity prices were calculated. The economic farm gate price of rice is estimated at $252/ton (KN2.01 million) compared with a financial price of $225/ton (KN1.80 million), thus a conversion factor of (vi) For all other goods and services, conversion factors have been estimated at 0.9. The shadow wage rate for unskilled labor is estimated at 0.9, reflecting the growing dry season out-migration of young male labor to higher paid jobs in Vientiane, Bangkok, and elsewhere. (vii) Transfer payments such as taxes, duties, and subsidies are excluded from calculation of economic values. Following irrigation and farm road rehabilitation, it is assumed that farmers will gain full potential benefits at the rate of 65% (year 1), 80% (year 2), and 100% (year 3). It is also assumed that farm gate prices for outputs will increase by 15% after the rehabilitation of farm roads, reflecting better product quality from improved post-harvest handling (especially drying) and improved market access. 22. All three sites are judged economically viable, with EIRRs from 16% to 24% (applying a discount rate of 12%). Table 6: Economic Feasibility Item Bung Xe Phanomxay Vapy Neua Economic internal rate of return 23.1% 15.9% 24.5% Economic net present value (Kip millions) 9,182 2,238 5,900 Source: ADB estimates 2 Since the border price is generally higher than the farm gate price, Lao PDR farmers are denied an equitable share of the value chain. This issue was verified by subproject farmers who sell informally in Thailand for similar premiums.

7 7 I. Sensitivity Analysis 23. The financial and economic returns of the subprojects are based on the assumption that costs and benefits over the life of the project will be as calculated. As the future may not follow that assumption perfectly, it is useful to examine particular risks and check what difference they may make to the economic returns of the project. 24. Sensitivity test results indicate that all subprojects are strongly robust to moderate increases in investment costs, production costs, and O&M costs; and a moderate reduction in dry season irrigated area. However, sensitivity exists to both reduced rice yields and rice prices. Two sites are significantly sensitive the FIRRs at Phanomxay and Vapy Neua fall below the WACC. Nevertheless, because the project is making a significant investment in agricultural extension support at village level as a strategy to manage this risk, and because the financial impact on individual households in Phanomxay and Vapy Neua is strongly positive, these sites are regarded as feasible. Without effective on-site technical support, these sites will be marginally economically viable. The project will manage this risk by the provision of farm level extension services, value chain and market linkage support. The results of these sensitivity tests are in Table 7. Sensitivity/Risk Table 7: Sensitivity Test Results by Site Variable Change EIRR Switching Value a FIRR Benefit Cost Ratio A. Bung Xe Site Base Case 20.7% 14.7% Investment 2.6 Costs 20% 16.8% 178% 12.2% O&M Costs 20% 19.6% 300% 13.6% 3.1 Production Costs 20% 17.5% 164% 11.7% 3.2 Command Area (20%) 19.9% n.a. 10.9% 2.5 Rice Yields (20%) 6.8% 85% 8.2% 2.5 Rice Price (20%) 11.0% 78% 13.0% 3.0 Tobacco Yields (20%) 17.5% 40% 11.6% 2.9 Tobacco Price (20%) 16.7% 49% 10.7% 2.8 B. Phanomxay Site Base Case 15.7% 7.8% Investment Costs 20% 12.2% 137% 5.2% O&M Costs 20% 14.7% 216% 6.4% 1.7 Production Costs 20% 13.6% 152% 4.7% 1.7 Command Area (20%) 15.3% n.a. 5.7% 1.5 Rice Yields (20%) 6.7% 87% (4.8%) 1.1 Rice Price (20%) 6.7% 87% (5.4%) 1.1 Vegetable Yields (20%) 14.1% 31% Vegetable Prices (20%) 14.1% 31% C. Vapy Neua Site Base Case 24.1% 14.5% Investment Costs 20% 19.5% 196% 11.1% O&M Costs 20% 23.0% 365% 13.2% 2.3 Production Costs 20% 21.3% 191% 10.6% 2.3 Command Area (20%) 23.9% n.a. 7.0% n.a. Rice Yields (20%) 12.3% 76% 0.4% 1.5 Rice Price (20%) 12.3% 76% 0.5% 1.5 Vegetable Yields (20%) 22.0% n.a Vegetable Prices (20%) 22.0% n.a ( ) = negative, EIRR = economic internal rate of return, FIRR = financial internal rate of return, n.a.= not available, O&M = operation and maintenance. a Switching value is the degree of change in a key parameter that is required to reduce the NPV to zero at a given discount rate