Economic Analysis of Projects:

Principles and Concepts

29 May 2006

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 What Economic Analysis of
Project Really is:

• More than rate of return calculations

• Framework/tool to select and design good
projects
relevant and responsive (Economic
Rationale)
feasible, result-delivering -
contributing to welfare of country and its
people (Project Economic Analysis)

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Differences between Economic &
Financial Analyses:
Financial Economic

Perspective Project entity or Economy-wide,

participants all members of
society
Benefits and Financial flows Non-market
Costs values,
Opportunity costs

For a project to be economically viable, it

must be financially sustainable

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 Selected Steps in Project
Economic Analysis
1. Macro Context
2. Sector Analysis
3. Rationale for Public Validating the Economic Rationale
Sector Involvement
4. Choice of Modality
5. Demand Analysis
6. Alternative Analysis and Least Cost
7. Valuation of Benefits & Costs
PROJECT Economic
8. Financial & Institutional Sustainability Analysis
9. Distribution Analysis
10. Sensitivity Analysis
11. Monitoring & Evaluation

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 Macroeconomic Context
A project cannot be designed in isolation from the rest of the
economy.

• project must be relevant vis-à-vis country and ADB objectives

 link to country broader development objectives
 link to CSP
• country’s resource position must be carefully assessed
• macroeconomic factors may affect project performance
 identify factors most likely to influence target sector
 economic outlook

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 Sector Analysis
What are key problems and issues that need to be addressed?

 policy and regulatory environment

 who supplies & what constraint do they face
 financing: who pays for the good or service
 role of public versus private sector

identify possible areas for investment and policy

reform

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 Public Sector Rationale and Choice of
Modality

Why should there be public sector intervention?

• Market or institutional failures
• Public good
• Equity issue
• What is counterfactual if government is not
involved?
What Modality is the most appropriate?

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 Demand Analysis
How much of the output is wanted? How much are
users willing to pay for it?

• Project design should be demand-driven

• Assess demand for product or service
• Identify demand shifting factors
• Project growth rate of demand, influence of demand shifters
(size of project)
basis for identification of project size, timing and
overall benefits

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Alternative and Least Cost Analysis

What is the most efficient way of addressing the

problem at hand?
• Evaluate alternative project design in terms of
lending modalities, financial arrangements,
scale and timing, location, etc.
• Explain why proposed alternative chosen
(least cost alternative)

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 Valuation of Benefits & Costs

• Assess what will happen w/o project (counterfactual)

• Identify project benefits & costs
• Value project benefits & costs
• Economic viability: Benefits > Costs
• Cost effectiveness analysis if benefits cannot be
valued

10
 Financial and Institutional
Sustainability

Are there enough resources to ensure flow of

benefits?
• Assess financial performance of project entity for
revenue generating projects
• Assess self-financing capacity of project entity
• Fiscal impact (implicit or explicit subsidy)
• Sources of funds to meet net financial requirements
• Institutional capacity assessment

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 Distribution Analysis

Who benefits and by how much?

• Identify groups that gain or lose
• Assess size of gains and losses
• Target groups (poor, women, etc.)

shed light on likely impact of project,

sustainability

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 Sensitivity and Risk Analysis
What are the chances that benefits & costs will be
realized as anticipated?
• Identify variables to which project is sensitive
• Assess change in parameters required to change
project decision
• Assess likelihood of these changes occurring
• Consider mitigating actions against main sources of
uncertainty

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 Monitoring & Evaluation

Do initial assumptions maintain validity

throughout project life?
• Identify key variables necessary to measure
project outcome/impact
• Establish system to collect data on all key
variables

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 Overall Assessment

• Is project relevant in country/sector context?

• Has rationale for public sector intervention been
clearly established?
• Does project incorporate best alternative design?
• Is project economically sound?
• Is project feasible/sustainable?

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 Key Areas of Analysis in ADB’s
Project Processing Cycle
A . C o u n tr y B . T A F a c t - F in d in g C . T A Im p le m e n t a t io n D . L o a n F a c t- E. M RM , SRC
S tra te g y a n d F in d i n g
Step

P ro g r a m m in g

1 . M a c r o e c o n o m ic 1, 2, 3. 2 , 3 . S e c to r a n d p r o je c t 1 - 5 .O v e r a ll 1 -1 0 .
c o n te x t U p d a t e o f m a c r o e c o n o m ic , d e m a n d a n a l y s is A ssessm ent of F u ll c o n f ir m a t io n
assessm ent s e c to r c o n t e x t, d e m a n d d e v e lo p in g p r o je c t o f th e p r o je c t’s
2 . S e c to r c o n te x t a n a ly s e s in v e s tm e n t e c o n o m ic v ia b ilit y
assessm ent a n d r e s o lu t io n o f
3. D em and o u ts t a n d in g
A n a ly s is e c o n o m ic is s u e s
4 . I d e n t if ic a tio n o f 4 . C o n f ir m a t io n o f
e c o n o m ic r a tio n a le e c o n o m ic r a tio n a le
a n d o p e r a t io n
p r o s p e c t iv e 5 . I d e n t if ic a tio n o f p r o je c t 5 . C o n f ir m a tio n o f th e
a lte r n a tiv e s o p tim a l p r o je c t
a lte r n a t iv e
Activity

6 . P r e lim in a r y id e n t if ic a tio n 6 . F u ll id e n tif ic a t io n o f 6 . V a lid a t io n o f

o f b e n e f its a n d c o s t s , a n d c o s ts a n d b e n e f it s , c o s t- b e n e f it
d is tr ib u t io n a l is s u e s in c lu d in g a n a ly s is
m e th o d s o f m e a s u r in g
7 . I d e n t if y f is c a l a n d b e n e f its a n d c o s t s 7 . F in a n c ia l a n d
f in a n c ia l s u s ta in a b ilit y in s tit u t io n a l
is s u e s s u s ta in a b ilit y
a n a ly s is

1 - 7 . E x p e c t a t io n s / 8 . D is tr ib u t io n
o v e r a ll a s s e s s m e n t o f a n a ly s is
th e p r o p o s e d p r o je c t
in v e s t m e n t 9 . S e n s it iv it y a n d
r is k a n a ly s is

10. PPM S
Output

C S P /P r o je c t TA Paper In t e r im /D r a f t F in a l D r a f t R R P w it h RRP
C oncept Paper R e p o rts S u p p le m e n t a r y
A p p e n d ix e s

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