SUMMARY

Guidelines for the Economic Analysis of Projects

Economic viability depends on the sustainability of project effects over the project’s life. Photo credit: ADB.
Economic viability depends on the sustainability of project effects over the project’s life. Photo credit: ADB.

The Asian Development Bank has revised its guidelines for project economic analysis, which help ensure investment decisions are based on economic and efficiency considerations.

Overview

The economic analysis of development projects helps to ensure that scarce resources are allocated efficiently, and investment brings benefits to a country and raises the welfare of its citizens. It is a tool used by the Asian Development Bank (ADB) to ensure that its operations comply with the ADB Charter and contribute to the broad objectives of poverty reduction, inclusive economic growth, environmental sustainability, and regional integration.

The guidelines in this publication are a revised version of the 1997 edition. The revision responds to the changing development context and ADB operational priorities, and aims to address the recommendations of the ADB Quality-at-Entry Assessments for more methodological work on project economic analysis.

The revised guidelines provide general principles for the conduct of project economic analysis. The appendices provide illustrations of their application.

Changes in the guidelines from the 1997 edition include

  • revised minimum required economic internal rate of return for investment decisions;
  • several issues that have emerged or become more important since the adoption of the 1997 edition, including economic analysis under various financing modalities, the treatment of the social cost of carbon, and economic analysis of regional economic cooperation projects; and
  • a new chapter on benefit valuation by sector, which details the method for valuing project, benefits in major sectors of ADB operations.

These guidelines should be read together with handbooks, technical reports, and other reference materials published by ADB, which discuss sector-specific project economic analysis in detail.

Contents

The Agreement Establishing the Asian Development Bank (ADB Charter) requires staff to “take the necessary measures to ensure that the proceeds of any loan made, guaranteed or participated in by the Bank are used only for the purposes for which the loan was granted and with due attention to considerations of economy and efficiency” (Article 14.11). It also states that “only economic considerations shall be relevant to their decisions” (Article 36.2).1 Project economic analysis is a key tool to ensure that ADB operations comply with the mandate of the ADB Charter and contribute to the broad objectives of poverty reduction, inclusive economic growth, environmental sustainability, and regional integration. Read more.

A well-conducted economic analysis should show that

  1. a project is in line with the development context of a borrowing country and ADB’s country partnership strategy;
  2. there is strong rationale for the public sector and ADB to finance the project; and
  3. the selected project represents the most efficient or least-cost option among all the feasible alternatives for achieving the intended project benefits and, when benefit can be valued, it will generate a positive economic net present value (ENPV) using the minimum required economic internal rate of return (EIRR) as the discount rate, i.e., the project has an EIRR higher than the discount rate.

Read more.

With and Without Project Scenarios, Constant Prices, and Project Life

There are four broad steps in project economic analysis:

  1. Identify gross project benefits and costs;
  2. Quantify and value the benefits and costs, initially in market or financial prices;
  3. Adjust the costs and benefits to reflect their economic values; and
  4. Compare gross economic benefits with economic costs..

Read more.

Economic valuation of project benefits and costs involves converting their financial values into economic values, also known as “shadow pricing.” This conversion requires economic prices of project outputs and inputs to be estimated. Economic prices reflect values of goods, services, and other project effects on the national economy. The basis for estimating economic prices differs between internationally traded and nontraded goods and services, between project outputs and inputs, and between incremental and non-incremental outputs and inputs. Read more.

Unless otherwise indicated, benefit valuation as discussed below refers to gross benefit of a project, rather than its net benefit that is the difference between gross benefit and cost. While the general principles of benefit valuation—distinguishing between non-incremental benefits that are measured at cost savings and incremental benefits that are measured at market prices (where there is no consumer surplus) or willingness to pay—apply to all sectors, detailed applications differ among sectors. Read more.

Discounting and Indicators of Economic Viability

After identifying and valuing project benefit and cost flows accrued in different years of a project’s life that normally spans over 20–30 years, the future flows should be converted to their present value (or the value of a base year) by discounting at a required economic discount rate. The discounting allows calculating aggregated indicators of economic viability of a project for making investment decisions. The most commonly used indicators to determine economic viability are economic net present value (ENPV) and economic internal rate of return (EIRR). Other commonly used indicators are the benefit–cost ratio (BCR) and cost-effectiveness ratio (CER). Read more.

Project economic analysis uses the most likely forecast values of economic benefits and costs. However, streams of benefits and costs are influenced by a wide range of factors and they may deviate from the forecasts. Sensitivity analysis aims to assess the effect of adverse changes in key variables upon the project ENPV and EIRR and the implications of these changes for the project investment decision. Risk analysis incorporates the probabilities that the key variables will deviate from their forecast values and the associated risk to the project arising when these key variables vary simultaneously. These techniques can be used to assess the implications of uncertainty for investment decisions, and should be used to inform the design of mitigating actions. Appendix 19 provides more details and examples of sensitivity and risk analyses. Read more.

Economic viability depends on the sustainability of project effects over the project’s life. Hence, project economic analysis should ensure that an adequate analysis of the financial and institutional sustainability of the sponsoring agency and of the environmental sustainability of the project itself has been carried out. Read more.

Distribution analysis is an important component of project economic analysis. First, a project must be financially sustainable and, hence, financial incentives must be adequate for each of the main project stakeholders. Second, where the government is involved it will be important to know how far the project will add to or reduce future government financial commitments. Third, where parties from different countries are involved, it will be important to establish the distribution of net gains and costs between these countries. Finally, where projects are intended to contribute to the goal of inclusive growth, it will be important to establish how target groups are affected. Read more.

Appendices

Appendix 1: Reference Materials on Project Economic Analysis in ADB

Appendix 2: Use of Constant Prices in the Economic Analysis of Projects

Appendix 3: Method for Constructing a Project Statement

Appendix 4: Consumer Surplus and Gross Project Economic Benefits

Appendix 5: Methods for Valuing Nonmarket Impacts

Appendix 6: Treatment of Working Capital

Appendix 7: Examples of Deriving Economic Prices

Appendix 8: Illustrations of Estimating the Shadow Wage Rate

Appendix 9: Economic Price of Land and Treatment of Resettlement

Appendix 10: Depletion Premium

Appendix 11: Use of Domestic Price Numeraire

Appendix 12: Illustration of Estimating the Shadow Exchange Rate

Appendix 13: Using Conversion Factors: A Water Project Example

Appendix 14: Examples of Benefit Transfer Method

Appendix 15: Distribution Analysis of Regional Cooperation Projects

Appendix 16: Estimating the Economic Rate of Return: Irrigation Rehabilitation Project

Appendix 17: Illustration of Least-Cost and Cost-Effectiveness Analysis

Appendix 18: Estimating the National Economic Discount Rate

Appendix 19: Treatment of Uncertainty: Sensitivity and Risk Analysis

Appendix 20: Distribution of Project Effects

Resources

Asian Development Bank (ADB). 2017. Guidelines for the Economic Analysis of Projects. Manila.

ADB. Economic Analysis of Projects.

ADB. 2001. Handbook for Integrating Poverty Impact Assessment in the Economic Analysis of Projects. Manila.

Ask the Experts

  • Edimon Ginting
    Deputy Director General, Economic Research and Regional Cooperation Department, Asian Development Bank

    Edimon Ginting served as director of the economic analysis and operational support division of the Economic Research and Regional Cooperation Department before being appointed its deputy director general. He joined ADB in 2007, where he has led strategic operations to support economic reforms, including loans to support developing countries' response to the global financial crisis. Before joining ADB, he was an economist at the International Monetary Fund; advisor to the Indonesian Parliament; research economist at the Productivity Commission, Australia; researcher and lecturer at the University of Indonesia; postdoctoral fellow at Monash University; and research economist at Gadjah Mada University. He received his PhD in economics from Monash University. 

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  • Juzhong Zhuang
    Senior Economic Advisor, Economic Research and Regional Cooperation Department, Asian Development Bank

    Juzhong Zhuang joined Asian Development Bank in 1997, and is currently Senior Economic Advisor working in the Economic Research and Regional Cooperation Department. From 1992 to 1997, he was a research officer of the Development Economics Research Program at the London School of Economics. He holds a Ph.D. in Economics from the University of Manchester.

  • Kee-Yung Nam
    Principal Energy Economist, Sustainable Development and Climate Change Department, Asian Development Bank

    As principal energy economist, Kee-Yung Nam develops strategies and policies, analyzes and assesses key issues (particularly on clean energy technologies), and provides advice for projects in the energy sector. He is also responsible for the Energy Sector Trust Funds. Before joining ADB, he was energy economist/energy planner at the International Atomic Energy Agency in Vienna, Austria. He received his Ph.D. in Economics from the University of Vienna.

  • Maria Rowena M. Cham
    Senior Economics Officer, Asian Development Bank

    Maria Rowena M. Cham is a senior economics officer in the Economic Research and Regional Cooperation Department (ERCD).  She has worked at the National Economic and Development Authority and Power Sector Assets and Liabilities Management Corporation in the Philippines.  She has co-authored chapters in the country diagnostic studies published by ERCD and published journal articles on the Philippine economy.  She has a master’s in economics from the University of the Philippines.

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   Last updated: January 2019



Disclaimer

The views expressed on this website are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area.




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  • Edimon Ginting
    Deputy Director General, Economic Research and Regional Cooperation Department, Asian Development Bank

  • Juzhong Zhuang
    Senior Economic Advisor, Economic Research and Regional Cooperation Department, Asian Development Bank

  • Kee-Yung Nam
    Principal Energy Economist, Sustainable Development and Climate Change Department, Asian Development Bank

  • Maria Rowena M. Cham
    Senior Economics Officer, Asian Development Bank