The Hindu Business Line : Project impact assessment — Importance of social-cost benefit analysis

While projects promoted by multinational corporations are a good augury for a State's economy, they have their flip side. The Government has an obligation to ensure that such projects do not adversely impact the people. To gauge the likely impact of a project on a State's economy, a social-cost benefit analysis is needed, says R. VENKATESAN.

MR SOUNG-SIK CHO, CMD, Posco... Big projects must benefit all stakeholders. — Ashoke Chakrabarty

With the economy opened up, States are in a rush to get projects, especially those promoted by multinational corporations. In the MNCs' hunt for raw materials, naturally States well-endowed with natural resources become all the more attractive. The Eastern States are a case in point. Orissa has signed a slew of MoUs for steel plants, the jewel in the crown being the Posco project that involves an investment of Rs 52,813 crore to build a 12-million tonne per annum steel plant over three phases between 2007 and 2016.

While such projects are a good augury for the State's economy, they may not be without their flip side.'

For the Government, profit alone cannot be the motive as it has an obligation to ensure that such projects do not adversely impact the people. To gauge the likely impact of a project on a State's economy, a Social-Cost Benefit Analysis (SCB Analysis) is often commissioned, as Orissa did for the POSCO project.

Financial viability

Such an approach allows the assessment of the impact of a project on the national economy, unlike financial analysis which has a narrowperspective — of profit accruing to the project, and to the stake-holders. Of course, the starting point of such an exercise is the financial viability, else, how will it accumulate social profits?

Computation of social profits at the economic hurdle rate is a key step in assessing whether the project is in the national interest and for computing the kind of concessions that can be provided by the Central/State governments, such as tax concessions or waivers, or giving it SEZ (special Economic Zone) status..

The Posco project was especially interesting because of the controversy it had generated over maintaining status quo on iron ore exports (that allowing them) vis-à-vis banning/capping export of medium and high grade haematite iron ore for future utilisation in the domestic economy.

NCAER study

The NCAER study broadly used the ADB/World Bank methodology on the social cost-benefit with minor adjustments for the local parameters. Econometric models were used to project border prices for the useful life of the project. The project's impact from the State economy perspective — in terms of the impact on the State GDP (output multiplier effects) and employment opportunities created within the State (employment multiplier effects) was also assessed.

The output multiplier for iron ore was found to be 1.4 compared to 2.36 for steel. In other words, every Rs 1 lakh worth of output in the iron ore sector would result in Rs 1.4 lakh of output (including the Rs 1 lakh output of iron ore) compared to Rs 2.36 lakh for every Rs 1 lakh output of steel. The employment multipliers for iron ore and steel work out to 0.35 and 0.69 man-years respectively. Therefore, in terms of both output and employment, steel has a larger impact.

These multipliers imply that the Posco project would create an additional employment of 50,000 person years annually for the next 30 years vis-à-vis 870,000 person years in the steel project alternative. In terms of value addition, the iron ore and steel project alternatives would contribute 1.3 per cent and 11.5 per cent to Orissa's State Gross Domestic Product (or SGDP) by 2016-17 respectively.

An important part of the study was the Least Cost Analysis of technology options in the steel-making, the Finex process that Posco purports to bring and the traditional blast-furnace technology. The Average Incremental Economic Cost was used as the yardstick; this was followed by computing the economic IRR (internal rate of return) to examine whether the project was economically worthwhile from the national economy point of view.

The EIRR for the Orissa project works out to 16.6 per cent for base case and even in the worst case scenario, the EIRR at 13.9 per cent would remain above the hurdle rate of 12 per cent. The economic impact of the project was estimated at $2.5 billion at the test discount rate of 12 per cent.

The significant feature of the study was the estimation of depletion premium or the opportunity cost for depleteable and non-renewable resource iron ore for reasons cited below:

India's high-grade ore (+ 65 per cent Fe content — Haematite) reserves, proven and probable, amount to only 0.58 billion tonnes. And even if we were to factor in indicative and inferred reserves (probable/feasible), the total reserves (proven and possibly future potential) would be only 0.92 billion tonnes.

India's medium-grade ore (+62 per cent Fe to 65 per cent Fe — Haematite) reserves, proven and probable, is only 1.3 billion tonnes. Here too, if we factor in indicative and inferred (probable/feasible and pre-feasibility estimated) reserves, the total reserves (proven and possibly future potential) will be only 2.8 billion tonnes.

Policy Implications

Orissa stands to gain significantly if instead of exporting iron ore it processes it to steel within the State, in terms of both employment generation (17 times), and GDP impact (9 times).

India's high and medium grade iron ore reserves may not last more than 19 years even if exports of these grades are frozen at the current level or if the targets set out in the draft steel policy are to be met. The economic analysis considered the depletion premium for high and medium grade iron ore. This is the opportunity cost to the national economy of using the depletable resource, which is the average incremental cost of depletion premiums computed year-wise.

Any exporter of iron ore of medium and high grades from the State needs to pay a depletion premium of $27 per tonne. Even this would be a sub-optimal policy from the State's viewpoint if it can process the medium and high grade ore to steel. No such depletion premium has been applied for coking coal as its price did not exhibit any trend before the recent steep price hike.

For the eastern States seeking to raise the mineral sector's share in their GDP, it may be a good idea to set up processing facilities. It would not be advisable to allocate iron ore mines through open bids or accept increased royalty payments, even accounting for the depletion premium, compared to the option of processing iron ore to steel. Future cost-competitiveness and logistical advantage imply that iron ore-rich States can compete with existing over-capacities in the US, Europe and Japan even after factoring in the capital charges for new investments.

Export of iron ore needs to be restricted to grades other than medium and high-grade ore categories; for instance, export of beneficiated ore from Goa using inland waterways logistics advantages could be encouraged. Allowing exports of high grade ore would facilitate export of steel from existing over-capacities in the US, Europe and Japan to East Asia at the expense of future steel exports from new Indian steel capacities which are likely to enjoy cost-competitiveness over existing over-capacities elsewhere.

(The author is with NCAER. The views are personal.)

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