Learning Curves

OED
May 2007

ProjectCostEstimates
Costunderrunsandoverrunscanbedefinedasthedifferenceintheestimateofprojectcosts uponwhichloanapprovalisbased,andthefinalcostincurredatprojectcompletion. OfallAsianDevelopmentBank(ADB)financedprojectscompletedsince1995,35%hadacost underrunhigherthan20%oftheestimatedprojectcost,and9%acostoverrunhigherthan20%. Puttogether,almosthalfoftheprojectswerecharacterizedbyinaccuratecostestimates. Costunderrunsleadtoloancancellationsandtheseimpactbothborrowingcountriesand ADBsoperations.Intheformer,loansavingscouldhavefinancedadditionalprojectsand,if ADBfinancingisfromordinarycapitalresources,undulylargeloansincurunnecessary commitmentfees.ForADB,costunderrunsindicateinefficientallocationofscarceresources.
Background ThehighnumberofADBprojectsaffectedbylarge costunderrunsoroverrunshasbeenanissueforyears. In2004,theOperationsEvaluationDepartment undertookaSpecialEvaluationStudyonProjectCost Estimatesto(i)determinethemajorcausesofcost underrunsandoverruns;(ii)assessthecontributionof eachtocostvariations;and(iii)recommendwaysto improvethereliabilityofcostestimates,andsharethe riskofunpredictablechanges. 1 Theanalysiscovered 220projectswithcompletionreportsissuedfrom1998 tomid2003,withafocusontypicalinvestmentprojects inagricultureandnaturalresources,energy,transport andcommunications,andsocialinfrastructure.Case studieswereconductedinIndia,Indonesia,and Pakistan.ADBstaffandconsultantsweresurveyed. SummaryofFindings Untilthe1980s,threefourthsofprojectshad overrunsaveraging63%oftheoriginalcostestimate. Sincethen,underrunshavepredominated:twothirds ofprojectshadcostunderrunsaveraging26%.(Projects inagricultureandnaturalresources,energy,andsocial infrastructurehavehadlargerunderrunsthanprojects intransportandcommunications.Inthelattersector, thereweremoreoverruns.)Thefactorsthatexplainthe changehaveincluded(i)inflationandexchangerate developments;(ii)thesmallershareofcivilworksin laterprojects;(iii)ashiftinthesectorcompositionof ADBsportfolio;and,perhaps,(iv)ADBstaffs experienceinpreparingsupplementaryloans.Overthe
Operations Evaluation Department Asian Development Bank

years,projectshavealsohadlargercomponentsfor training,institutionaldevelopment,andoperationsand maintenancethat,inpractice,havetendedtobe overdesigned.Overestimationofthecostofequipment andmaterialshasalsobeenafeature,althoughanother reasonwasaslumpinpricesinthe1990s. Overall,costestimationisnowbetterthaninADBs first1015yearsbutthetendencytooverdesignsmaller orsoftercomponentsremains,aswellastheinclination tooverestimateequipmentandmaterials,andphysical andfinancialcontingencies.Thismorethan counterbalancesthegeneralunderestimationofthecost ofcivilworks. Projectdesignsandcostestimatescanbeimproved, butthisdependsinpartonmakingresourcesavailable forthat.Somedegreeofcostvariationislikelyto remain,insideandoutsideADB. Recommendations Toimproveestimationofprocessesforprojectcosts, itisessentialthatadequateresources,inbothtime andmoney,beallocatedtoconductrequired analyses.Betterprojectdesignsandcostestimates canbeexpectedtoleadtosmootherimplementation, fewerloancancellations,andmorepositiveresults. Improvedestimatesofprojectcostsarepossiblewith (i)rigorousconsiderationofinflationand depreciationfactors;(ii)thoroughconsiderationof sectoralandcountryexperienceswithcost variations;(iii)betterestimationandverificationof commitmenttotrainingandinstitutional

6 ADB Avenue, Mandaluyong City, 1550 Metro Manila, Philippines Tel +63 2 632 4847; Fax +63 2 636 2163; evaluation@adb.org; www.adb.org/evaluation/

development;and(iv)realisticestimationofthecost ofcivilworksandtheiroperationandmaintenance. Payingmoreattentiontoprojectadministrationwill reducecostunderrunsandoverruns.Projectsmired inimplementationproblemsshouldbereviewed earlywithaviewtotimelycancellationofpartofthe loan.Theinterestthatexecutingagencieshaveto avoidcancellationsshouldbeweighedagainstthe borrowersinterestinreducingthedebtburden. Savingsincontingenciescouldbereducedbygiving togovernmentstheoptionnottoborrowfor contingencies.Thisoptionshouldbemadeavailable iftheborrowerhasthecapacityandcommitmentto financecontingencieswhentheyarise. Periodicupdatingofcostestimateswillhelpin timelyassessmentofloansavings.Consistentwith ADBsnewthrusttowardresultsbased management,standardoperatingloan administrationproceduresshouldrequireexecuting agenciestoannuallyupdateprojectcostestimates forreviewinADB. Feedback

shouldbegiventotheneedtoreviewADBscurrent policiesorpracticesondeterminingthesizeofloans, localcostfinancing,procedurescoveringphysicaland pricecontingenciesandtheiramounts,financingof interestandotherchargesduringconstruction, commitmentchargeaccrual,supplementaryfinancing, anduseofsurplusloanproceeds.Committeemembers remarkedthat: Improvementofcostestimationisdirectlyrelatedto capacitybuildinginexecutingagencies. InreviewingADBssupplementaryloanpolicy, thereisroomfortheBoardofDirectorstoconsider furtherdelegationofrelateddecisionmakingto ADBsManagement.Inthiscontext,theconceptofa twopartloansystemthefirstpartforbasecost, thesecondforcontingenciesandafixedpercentage forcostoverruns,withapprovalforuseofthe secondpartpossiblydelegatedtoADBs Managementcouldbefurtheranalyzedand subjectedtocarefulconsultationwithborrowing members.However,increasedflexibilityshouldnot beattheexpenseoftheBoardsresponsibilityfor duediligence.

ADBManagementsResponsesignifiedthatADBs Innovativesolutions,suchastheoptionfora Managementandstaffwillcontinuetomakeeffortsto governmentnottoborrowforcontingencies,should enhanceprojectdesignandimplementationby beconsidered. improvingthequalityofcostestimatesas TheissueofinconsistentapplicationofADBs recommended.TheChairsSummaryofthe guidelinesforestimationofpricecontingenciesmust DevelopmentEffectivenessCommitteeDiscussions befurtherexamined.Accountabilityforensuring consideredthestudytobeamajorandimportantinput consistentapplicationoftheguidelinesmustbe toanactionplanfornextsteps.Atthesametime,the clarifiedandestablished. Committeeemphasizedthatmoreaccuratecost estimationwasnotanendbutameanstoimprove Sincecorruptionandpoorgovernancewere efficiencyandeffectivenessinallocationofADBs perceivedbyADBstaffandconsultantsasmajor resourcesandreducenegativeimpactsonborrowing factorsforprojectcostvariances,thesedeserve countries.Withthetotalamountofloancancellations furtherspecificexamination. havingdoubledfrom1998tomid2003,theneedfor Theeffectofincreasedloanconditionalitiesoncost immediateactionwasrealandpressing.Asolutionto overrunsshouldbeassessed. theissueofpersistentcostunderrunswouldnotbe Theimplicitfinancialeffectsofpoorprojectcost achievedovernight,butmonitorablechangehadtostart. estimatesonborrowingcountriesshouldbefurther Suchchangemightrequirefundamentallynew definedsothatthesecanbeaddressedinthefuture. businessprocessesandsystems,notmereadjustments. TheCommitteeremainedconcernedthatborrowing countriesmightbeincurringexcesscommitment 1 ADB.2004.SpecialEvaluationStudyonProjectCost chargesonloansfromordinarycapitalresourcesfor Estimates.Manila.Available: projectsaffectedbymajorcostunderruns.Atthesame http://www.adb.org/Documents/Reports/Evaluation/sst reg200406/sespce.pdf time,ADBanditsdevelopingmembercountriesshare responsibilityforgoodprojectdesign.Consideration
Learning Curves available @ www.adb.org/evaluation/ Team Leader: Walter Kolkma; Tel +63 2 632 4189; wkolkma@adb.org