S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo

8/13/2019 S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo

1/19

Capital Budgeting

Kuben Naidoo

South Africa


2/19

What well cover

Why is capital different?

Should we budget for capital differently?

Modalities of budgeting for capital

Getting value for money from capitalspending

Policy issues to consider


3/19

What is investment? Spending that improves public services in the

long-term: expects a long term return, creates

public assets In laymans terms, spending on durable goods

that will contribute to the provision of publicservices over a number of years

E.g. Building Hospitals, buying IT systems

Not e.g. training teachers, redundancy costs

Why not?


4/19

Where capital fits in?

Capital

baseline

Public

asset

base

PUBLIC

SERVICES

Current

spending

(wages)depreciation

New investment

capital

budget

Conventionally, we think that recurrent spending plus capital

spending delivers a service

This is wrong

Public asset base plus recurrent spending delivers service


5/19

Theoretical issues to consider Think of a continuum of spending to impact

If I hire a teacher, I get an output immediately

If I budget to build a school I get a school in say two years time

If I budget to build a power plant, I get power in seven years time

If I under-maintain an asset, I see a deterioration in public services

in ten to fifteen years time

This introduces an inherent bias against

capital spending Benefits not visible immediately

or costs of not investing only visible in the long term

Tougher to cut recurrent spending

Easier to cut maintenance spending than fire teachers


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Should you budget separately for

capital? Case for

It counters the bias against capital spending It allows government to direct the increase in the

capital base towards priorities

It allows for more robust cost-benefit analysis

Case against Returns to capital not always the same

Links between capital and the related recurrent costsare harder to secure

What about different policy options: More police or close circuit TV cameras

More police or more vehicles

Surely these decisions cannot be taken centrally


7/19

Modalities of capital budgeting Centralised

Treasury appraises all capital projects and decides

which ones to spend on Advantage: high benefit projects are favoured

Disadvantage: not easy to measure benefits and wellorganised departments capture too much resources

Decentralised Allocate money to for capital to police

They decide which police station to build

Advantage: closer alignment between allocations andpriorities and between need and spend

Disadvantage: departments may do high profile lowbenefit projects


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Measures of performance People generally look at spending numbers

Must shift focus to look at outputs Houses built, new electricity connections, kms of roadsbuilt or resurfaced

Also look at outcomes

Capacity constraints, congestion

Most importantly, but not easy to do objectively

Focus on the state of the stock Tension between need to maintain infrastructure

(which is often in richer areas) and build new

capacity in poorer areas


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Its the state of the stock that mattersState of bus stock

7

8

9

10

11

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Years

70

72

74

76

78

80

82

Vehicles

'000

Average age of bus fleet

Size of vehicle stock


10/19

Its the state of the stock that matters(road defects index)


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Capital budgeting in South Africa We generally have a decentralised system

Police, education, health, roads agency receive abudget

They decide which project to implement

Treasury tries to raise the bar on cost benefit analysis

For large projects over R1.2 billion, treasury

does evaluation and allocates money directly

95% of capital spending is done through

conventional budgeting

5% through PPPs


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How does PPP or PFI work? Government specifies exactly what we want

Private sector raises capital, builds and thenmaintains

Government pays a unitary charge consisting ofcapital portion and maintenance portion

Key thing is to pass some risk onto the privatesector

Do they work?

If the specs are good and the department has thecapacity to manage the contract, then we get value formoney

If not, its often more costly


13/19

Optimism bias Departments under-budget for costs because they think

that if they are honest with the costs, money will not be

allocated Project overruns are a nightmare for spending control, yet

they are endemic in the public sector

Outturn Cost % of Expected Cost100%

No of

Projects

Expected Cost


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Examples of optimism bias

Green point

stadium budget:

R1.7 bil lion

Revised

estimate:

R3 billion

Freedom park

budget:

R400 million

Revised estimate:

R1 billion

Automated

fingerprint IDsystem

Budget:

R700 mill ion

Outturn:

R2 billion


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Under-spending on capital

0

5

10

15

20

25

30

98-99

99-00

00-01

'01-02

'02-03

'03-04

'04-05

'05-06

'06-07

'07-08

Outturn (at Budget)

Plans

Why? Failure to cascade 3 year budgeting

Longer lead times for complex procurements

No capacity and expertise to deliver


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What might be happening?

Why the underspending?

Some ideas:

Failure to cascade 3 year budgeting

Longer lead times for complexprocurements

No capacity and expertise to deliver


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Infrastructure bunching Typical scenario

Commodity prices rise, exchange rate appreciates,

interest rates fall Domestic demand increases

Higher domestic investment in non-tradables E.g. telecomms, retail space, housing, banking

Construction boom Prices rise due to capacity constraints

Imports rise, current account deficit widens

Interest rates rise Boom turns to bust

It is critical for the public sector to avoid bunching

Rather save and smooth infrastructure spending growth


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Gross fixed capital formation

10

12

14

16

18

20

22

24

26

28

30

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

per

centofGDP

Strong investment will increase domestic capacity and raise potentialgrowth in the economy, but pressures on inflation and current accountmust be managed

This is where we

want to be

This is where we are

and we already have a

current account problem


19/19

Any questions?

Documents

S3 PS 1 Capital Budgeting_South Africa_Kuben Naidoo