Click here for search results
Search in Manual

OP 10.04 - Economic Evaluation of Investment Operations


These policies were prepared for use by World Bank staff and are not necessarily a complete treatment of the subject.
OP 10.04
September, 1994
 
 

Note:  OP 10.04 replaces the version dated April 1994.  Please retain the April 1994 BP 10.04.  OP and BP 10.04 are complemented by OP/BP10.00, Investment Lending: Identification to Board Presentation. OP and BP 10.04 replace the Operational Memorandum Treatment of Environmental Externalities in the Evaluation of Investment Projects, 10/4/93, and draw on the following documents: OMS 2.20, Project Appraisal; OMS 2.21, Economic Analysis of Projects; OPN 2.01, Investment Criteria in Economic Analysis of Projects; OPN 2.02, Risk and Sensitivity Analysis in the Economic Analysis of Projects; OPN 2.04, Economic Analysis of Projects with Foreign Participation; OPN 2.05, Foreign Exchange Effects and Project Justification; OPN 2.06, Use of the Investment Premium and Distribution Weights in Project Analysis; OPN 2.07, Reporting and Monitoring Poverty Alleviation Work in the Bank; and OPN 2.09, Presentation of Project Justification and Economic Analysis in Staff Appraisal Reports.  Additional guidance on project economic evaluation is provided in Handbook on Economic Analysis of Investment Operations. Questions may be addressed to opmanual@worldbank.org.



1.  The Bank
1 evaluates investment projects to ensure that they promote the development goals of the borrower country.  For every investment project, Bank staff conduct economic analysis to determine whether the project creates more net benefits to the economy than other mutually exclusive options for the use of the resources in question.2
 
Criterion for Acceptability

2.  The basic criterion for a project's acceptability involves the discounted expected present value of its benefits, net of costs.  Both benefits and costs are defined as incremental compared to the situation without the project.  To be acceptable on economic grounds, a project must meet two conditions: (a) the expected present value of the project's net benefits must not be negative; and (b) the expected present value of the project's net benefits must be higher than or equal to the expected net present value of mutually exclusive project alternatives.3
 
Alternatives

3.  Consideration of alternatives is one of the most important features of proper project analysis throughout the project cycle.  To ensure that the project maximizes expected net present value, subject to financial, institutional, and other constraints, the Bank and the borrower explore alternative, mutually exclusive, designs.  The project design is compared with other designs involving differences in such important aspects as choice of beneficiaries, types of outputs and services, production technology, location, starting date, and sequencing of components.  The project is also compared with the alternative of not doing it at all.
 
Nonmonetary Benefits

4.  If the project is expected to generate benefits that cannot be measured in monetary terms, the analysis (a) clearly defines and justifies the project objectives, reviewing broader sectoral or economywide programs to ensure that the objectives have been appropriately chosen, and (b) shows that the project represents the least-cost way of attaining the stated objectives.
 
Sustainability

5.  To obtain a reasonable assurance that the project's benefits will materialize as expected and will be sustained throughout the life of the project, the Bank assesses the robustness of the project with respect to economic, financial, institutional, and environmental risks.  Bank staff check, among other things, (a) whether the legal and institutional framework either is in place or will be developed during implementation to ensure that the project functions as designed, and (b) whether critical private and institutional stakeholders have or will have the incentives to implement the project successfully.  Assessing sustainability includes evaluating the project's financial impact on the implementing/sponsoring institution and estimating the direct effect on public finances of the project's capital outlays and recurrent costs.
 
Risk

6.  The economic analysis of projects is necessarily based on uncertain future events and inexact data and, therefore, inevitably involves probability judgments.  Accordingly, the Bank's economic evaluation considers the sources, magnitude, and effects of the risks associated with the project by taking into account the possible range in the values of the basic variables and assessing the robustness of the project's outcome with respect to changes in these values.  The analysis estimates the switching values of key variables (i.e., the value that each variable must assume to reduce the net present value of the project to zero) and the sensitivity of the project's net present value to changes in those variables (e.g., delays in implementation, cost overruns, and other variables that can be controlled to some extent).  The main purpose of this analysis is to identify the scope for improving project design, increase the project's expected value, and reduce the risk of failure.
 
Poverty

7.  The economic analysis examines the project's consistency with the Bank's poverty reduction strategy.4  If the project is to be included in the Program of Targeted Interventions, the analysis considers mechanisms for targeting the poor.
 
Externalities

8.  A project may have domestic, cross-border, or global externalities.5  A large proportion of such externalities are environmental.  The economic evaluation of Bank-financed projects takes into account any domestic and cross-border externalities.  A project's global externalities--normally identified in the Bank's sector work or in the environmental assessment process--are considered in the economic analysis when (a) payments related to the project are made under an international agreement, or (b) projects or project components are financed by the Global Environment Facility.6  Otherwise, global externalities are fully assessed (to the extent tools are available) as part of the environment assessment process7 and taken into account in project design and selection.8

  ____________

  1. "Bank" includes IBRD and IDA, and "loans" includes IDA credits and IDA grants.
  2. All flows are measured in terms of opportunity costs and benefits, using "shadow prices," and after adjustments for inflation.
  3. Although it has long been the Bank's policy to calculate the expected net present value, standard practice has been to calculate the expected internal rate of economic return, that is, the rate of discount that results in a zero expected net present value for the project.  The expected rate of return is not fully satisfactory (e.g., when comparing mutually exclusive project alternatives); however, it is widely understood and may continue to be used for the purpose of presenting the results of analysis.
  4. See  OP 1.00, Poverty Reduction.
  5. "Cross-border externalities" are effects on neighboring countries (e.g., effects produced by the construction of a dam on a river).  "Global externalities" affect the entire world (i.e., emissions of greenhouse gases or ozone-depleting substances, pollution of international waters, or impacts on biodiversity).
  6. See OP/BP 10.20, Global Environment Facility Operations.
  7. See  OP/BP 4.01, Environmental Assessment.
  8. The Bank's Environment Department provides guidance on analyzing, ranking, and physically quantifying environmental externalities--whether domestic, cross-border, or global--and on taking them into account in project design and selection.