The discount rate in calculating the budgetary efficiency of investment projects: approaches and methods

Goleva Ol'ga Ivanovna ORCID: 0000-0002-0846-4913 PhD in Economics Associate professor of Finance, Credit and Exchange Department, Perm State University; Senior researcher, Federal Scientific Center for Medical and Preventative Health Risk Management Technologies 614990, Russia, Perm Krai, Perm, Bukireva str., 15 OlgaGoleva@psu.ru Other publications by this author     Martyanov Nikolai Sergeevich PhD in Economics Associate professor of Finance, Credit and Exchange Department, Perm State University 614990, Russia, Perm Krai, Perm, Bukireva str., 15 mart@psu.ru

Melnikov Aleksei Evgenevich PhD in Economics Associate professor of Finance, Credit and Exchange Department, Perm State University 614990, Russia, Perm Krai, Perm, Bukireva str., 15 melnikov-ae@yandex.ru

Introduction

In economic practice, the analysis of the effectiveness of investment projects uses general approaches reflected in the methodological recommendations for evaluating the effectiveness of investment projects No. VK 477 dated 06/21/1999 approved by the Ministry of Economy of the Russian Federation, the Ministry of Finance of the Russian Federation, the State Committee of the Russian Federation for Construction, Architectural and Housing Policy ^I. These Recommendations are intended for enterprises and organizations of all forms of ownership involved in the development, examination and implementation of investment projects.

Within the framework of this document, it is proposed to evaluate several types of effectiveness:

- the overall effectiveness of the project (public and commercial);

- the effectiveness of participation in the project (the effectiveness of the investment project for participating enterprises; efficiency for shareholders of joint-stock enterprises participating; the effectiveness of participation in the project of higher-level structures in relation to enterprises participating in the investment project - regional and national economic efficiency, sectoral efficiency, budgetary efficiency).

The subordination of these types of efficiency of investment projects is shown in Figure 1.

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Figure 1 – Types of effectiveness of investment projects (in accordance with the methodological recommendations for evaluating the effectiveness of investment projects No. VK 477 dated 06/21/1999)

A lot has been said about how to conduct an economic assessment of the effectiveness of investment projects: approaches, methods, key indicators, etc. The term efficiency itself is interpreted in different ways. In GOST R ISO 9000 – 2008 "Quality management systems. The main provisions and vocabulary" are highlighted as the category of efficiency ("The relationship between the achieved result and the resources used") and effectiveness ^II ("The degree of implementation of planned activities and achievement of planned results") ^III.

As a rule, efficiency is understood as the relative effect of a process, operation, project, defined as the ratio of the effect, result to the costs, expenses that caused and ensured its receipt.

In this regard, the comparison of effects and costs (investments) should be carried out taking into account that both effects and costs are distributed over time, and take into account the concept of the time value of money, which provides for discounting cash flows to correctly compare effects and costs (investments).

Then, the general scheme for evaluating the effectiveness of an investment project can be presented in Figure 2.

Figure 2 – A general scheme for evaluating the effectiveness of an investment project, taking into account the time value of money

It is worth noting that the figure shows the basic model, whereas there are approaches that provide for more complex options: different discount rates for effects and costs, as well as different rates for the forecast and post-forecast periods in the evaluation of the project.

This scheme is applicable for evaluating both commercial and budgetary efficiency (for calculating the indicators of which the corresponding cash flows and discount rates must be estimated and justified). 

But, if a large number of works are devoted to the calculation of commercial efficiency (including fundamental ones on classical finance theory, investment valuation theory, financial management, etc.), which include a detailed description of the construction of cash flows and investments, the choice and justification of the planning horizon and discount rates; then budget efficiency is often only mentioned, and the calculation of the main parameters is left to the expert/ analyst.

At the same time, the issue of discounting in relation to the effects on the budget of a country or region arises not only in connection with "classic" investment projects implemented by businesses in a certain territory, but also in connection with any management decisions requiring budget expenditures and/or implying an analysis of alternative solutions.

Analysis of regulatory documents and author's methods for determining the discount rate when evaluating deferred effects in calculating budget efficiency

Among the areas where the issue of assessing budget efficiency (and assessing deferred effects on the budget) has been worked out to a greater or lesser extent, the following can be noted:

- assessment of the effectiveness of investment projects with the participation of the state (budget financing),

- evaluation of the effectiveness of public-private partnership and municipal-private partnership projects (including special economic zones),

- assessment of the effectiveness of tax benefits/tax expenses (and other changes in tax legislation),

- assessment of the effectiveness of various non-tax measures and measures to support and stimulate the development of certain industries and categories of economic entities,

- evaluation of the effectiveness of projects in the public sector of the economy (provision of public goods, including meritorious ones),

- assessment of the regulatory impact and assessment of the actual impact of regulations (when adopting and subsequent analysis of government regulation measures),

- assessment of measures, measures and technologies for managing risks to the life and health of the population (primarily within the framework of pharmacoeconomics).

That is, the need to assess budget efficiency may be due to both the content of projects/activities and the mechanism of their implementation. In some cases, an appropriate assessment is mandatory.

The need to assess delayed effects arises with a significant duration of the events themselves and the remoteness of the expected effects. That is, in order to determine the need to calculate the discount rate and apply the discounting procedure in general, it is important to understand the planning horizon for the project and its features (social, environmental significance, etc.).

Thus, in foreign practice, within the framework of BIA (Budget Impact Analysis), one of the approaches to analyzing the impact of the use of medical technologies and drugs on the budget (typical for pharmacoeconomics), in the last decade there has been a change in views on discounting and its necessity (in relation to cash flows for the budget of a country or region) from denial of necessity ^[1] to discussion and analysis of the nuances of the application of models and methods of discounting ^[2]. Thus, it can be seen that even to solve similar issues and justify the effectiveness of similar projects (measures, measures), discounting may not be applied at all or applied at different discount rates (built within the framework of different approaches), which, of course, affects the evaluation result ^[3].

An overview of the available approaches and methods for justifying and constructing discount rates for the purpose of evaluating budget efficiency is presented in table 1. In the table, both normative documents at the level of the Russian Federation and individual subjects of the Russian Federation, as well as author's methods, are proposed for consideration and comparison.

Table 1 – Overview of approaches and methods for determining the discount rate for the purpose of evaluating budget efficiency

 Note that for the construction and justification of the discount rate (for any purpose), two components are characteristic, on the basis of which the calculation (construction) is performed Bids:

- the required rate of return for the investor (project participant), which is the minimum rate to which the investor agrees, taking into account the existing risks and features of the project,

- the alternative cost of capital for the investor (project participant), taking into account the capabilities of this investor in terms of investment options and sources of capital attraction (cost of capital).

Thus, the general logic of the discount rate is based either on a risk analysis or an analysis of alternatives.

From table 1, it can be seen that different discount rates can be used for the same purposes in the same economic conditions.

Various fields of application have developed their own approaches to substantiating discount rates, in some cases these approaches are fixed in methodological recommendations adopted at the federal, regional and local levels.

Among the most popular options for setting discount rates for the purpose of evaluating budget efficiency are the following:

- fixed rate (numeric value),

- fixed rate (with reference to the values of macroeconomic indicators: key rate, inflation rate, yield on government loans, etc.),

- cumulative construction method (risk-free rate and risk premiums),

- methods of constructing a social discount rate (in some cases).

The choice of methods for calculating the discount rate for evaluating budget efficiency

The considered approaches and methods of constructing and justifying the discount rate for the purpose of evaluating budget efficiency are numerous and diverse. That is, the possible range of possible discount rate values is wide, which can significantly affect the results of evaluating the budgetary effectiveness of the project/event, etc.

The sequence of actions in determining the discount rate when evaluating deferred effects in calculating the budgetary effectiveness of priority investment projects is shown in Figure 3.

Figure 3 – Algorithm for determining the discount rate when evaluating deferred effects in calculating budget efficiency

The selection and justification of the bid involves several steps.

1. Description of the project, definition of its main characteristics (which largely determine the further choice). The main characteristics include the following: purpose, volume and structure of financing, scale, territory of implementation, main investors and stakeholders, deadlines and stages of implementation, project effects and externalities, types of efficiency that require assessment (commercial, socio-economic, budgetary, etc.).
2. Determination of the availability of regulatory documents regulating the evaluation procedure (availability of relevant requirements of investors and/or stakeholders).
3. In the event that there is a valid regulatory document with methodological recommendations for evaluating budget efficiency, then you should adhere to the approaches and values recommended by it [steps 5 and 6] or abandon the use of the discounting procedure, if this follows from the methodology [step 4].
4. Refusal to use discounting in calculations (if there are methodological recommendations). The refusal to take into account the time value of money may be justified when evaluating the effectiveness of short-term projects or the high complexity of calculations, but it should be understood that the evaluation result does not take into account the time factor, which will be important not only when determining efficiency in accordance with the stated criteria, but also when comparing projects with different planning horizons.
5. Determination of the method for calculating the discount rate. Methodological recommendations may provide several options for estimating and justifying the discount rate. The choice should be based on the principles of objectivity and sufficiency of data.
6. Implementation of the calculation according to the presented method. The data for the calculation should be taken from official sources of information, supported by links to sources.
7. In the absence of regulatory documents regulating the evaluation procedure, the planning horizon should be analyzed. Short–term projects, as a rule, do not require taking into account the time value of money (it is advisable to abandon discounting - step 8). In the analysis of medium- and long-term projects, the planning horizon (the presence of one or more intervals) and the need for evaluation in the post-forecast period should be determined. The assessment in different planning intervals and the post-forecast period may be accompanied by the use of different rates.
8. Refusal to use discounting in calculations (in the absence of methodological recommendations). The risks are the same as when implementing step 4.
9. Defining the scope of the project. Currently, the following areas of project implementation have been formed, which may have features in assessing budget efficiency and methods of calculating the discount rate: evaluating the effectiveness of investment projects (including those involving public financing or support), evaluating the effectiveness of public-private partnership and municipal-private partnership projects (including special economic zones), assessment of the effectiveness of tax benefits/tax expenditures (and other changes in tax legislation), assessment of the effectiveness of various non-tax measures and measures to support and stimulate the development of certain industries and categories of economic entities, assessment of the effectiveness of projects in the public sector of the economy (provision of public goods, including meritorious ones), assessment of the regulatory impact and assessment of the actual impact of regulations (in the adoption and subsequent analysis of government regulation measures), assessment of measures, measures and technologies for managing risks to life and health of the population.
10. Determination of recommended methods for calculating the discount rate. The scope of the project dictates the main approaches that have developed in assessing budget efficiency and, accordingly, building a discount rate. In some cases, projects can be assigned to several fields of application.
11. Data sufficiency analysis for the selected methods. The data for the calculation should be taken from official sources of information, supported by links to sources. If there are contradictions according to data from different sources of information of the same level (in terms of significance), priority is given to the option based on the principle of economic expediency and reasonableness.
12. The choice of available methods for calculating the discount rate according to the criteria of objectivity and sufficiency of data.
13. The implementation of the calculation. The calculation is carried out for all intervals of the forecast period and the post-forecast period, if it is provided.

Conclusion

The variety of approaches and methods for calculating discount rates in general, and for evaluating budget efficiency in particular, dictate the need for systematization for the purposes of their application in practice. The variability in the choice of the method of constructing the rate, on the one hand, and the importance of this parameter in calculations, on the other, make the question of constructing and justifying the discount rate for the purpose of evaluating budget efficiency relevant and in demand.

The analysis of normative, methodological and normative literature has shown that today all the main approaches to the construction and justification of the discount rate in assessing deferred effects in calculating budget efficiency can be grouped by application areas and the following can be distinguished:

- assessment of the effectiveness of investment projects with the participation of the state (budget financing),

- evaluation of the effectiveness of public-private partnership and municipal-private partnership projects (including special economic zones),

- assessment of the effectiveness of tax benefits/tax expenses (and other changes in tax legislation),

- assessment of the effectiveness of various non-tax measures and measures to support and stimulate the development of certain industries and categories of economic entities,

- evaluation of the effectiveness of projects in the public sector of the economy (provision of public goods, including meritorious ones),

- assessment of the regulatory impact and assessment of the actual impact of regulations (in the adoption and subsequent analysis of government regulation measures),

- assessment of measures, measures and technologies for managing risks to the life and health of the population (primarily within the framework of pharmacoeconomics).

Taking into account the specifics of each of the fields of application of projects/activities in science and practice, approaches and methods for constructing discount rates (sometimes contradictory) are proposed.

The range of proposed values ranges from risk-free levels (inflation rate, government securities rate) to rates taking into account premiums for various types of risk.

Based on the results of the analysis of existing approaches and methods for constructing and justifying the discount rate when evaluating deferred effects in calculating budget efficiency, an algorithm for making a decision regarding the justification of the discount rate for the projects being evaluated is proposed. The algorithm provides for situations where there is no regulatory regulation of this issue and/or there is no regulation of this issue in the available regulatory documents.

The proposed algorithm for selecting and justifying the discount rate for calculating the budgetary efficiency of investment projects will allow taking into account the specifics and industry specifics of projects. The results of the study can be used to evaluate the effectiveness of investment projects (including priority investment projects) for different industries and scenarios.

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^I "Methodological recommendations for evaluating the effectiveness of investment projects" (approved by the Ministry of Economy of the Russian Federation, the Ministry of Finance of the Russian Federation, Gosstroy of the Russian Federation dated 06/21/1999 N VK 477) 

^II It is worth noting that in some cases there is a confusion between the concepts of efficiency and effectiveness, when "efficiency" does not provide for a comparison of effects (including deferred ones) with spent resources. Nevertheless, for the purposes of this study, it is important to consider the procedure itself for evaluating deferred effects, even in cases where they are not compared with investments.

^III "GOST R ISO 9000-2008. Quality management systems. Basic provisions and dictionary" (approved by the Order of Rostec Regulation dated 12/18/2008 N 470-st)

^IV Methodological recommendations for evaluating the effectiveness of investment projects (Third edition, revised and supplemented). [electronic resource]. URL: http://www.isa.ru/images/Documents/metod.zip (accessed 08/15/2023).

^V Order of the Ministry of Regional Development of the Russian Federation dated 10/30/2009 No. 493 "On approval of the Methodology for calculating indicators and applying criteria for the effectiveness of regional investment projects applying for state support from budgetary allocations of the Investment Fund of the Russian Federation"

^VI Order of the Ministry of Economic Development of the Russian Federation dated 12/14/2013 No. 741 (as amended on 12/24/2021) "On approval of methodological guidelines for the preparation of strategic and comprehensive Justifications for an investment project, as well as for the evaluation of investment projects Applying for financing from the National Welfare Fund and (or) pension Savings held in trust by a State management Company, on a returnable basis based on"

^VII Order of the Ministry of Industry and Trade of the Russian Federation dated 05/15/2018 No. 1870 "On approval of methodological guidelines for the development of the concept of an investment project in the field of forest development, applying for inclusion in the list of priority investment projects in the field of forest development"

^VIII In some cases (currently) is the basis for regional and municipal legislation in matters of competitive selection of investment projects in the territory. For example, the Ivanovo region (https://invest-ivanovo.ru/investment-climate /) , Sayansk (https://www.admsayansk.ru/pub/files/QA/7050/17.11.21.doc ) and others.

^IX Decree of the Government of the Russian Federation dated 11/22/1997 No. 1470 (as amended on 09/03/1998) "On approval of the Procedure for Providing State Guarantees on a Competitive basis at the expense of the Development Budget of the Russian Federation and Regulations on evaluating the effectiveness of investment projects when Placing centralized investment Resources of the Development Budget of the Russian Federation on a competitive basis"

^X Appendix to the Procedure for Interaction between JSC "Rosselkhoznadzor" and accredited persons.    [Electronic resource]. URL: https://www.rshb.ru/download-file/214

^XI Order of the Ministry of Economic Development of the Russian Federation dated 11/30/2015 No. 894 "On approval of the Methodology for evaluating the effectiveness of a public-private partnership project, a municipal-private partnership project and determining their comparative advantage"

^XII Order of Rosavtodor dated 08.09.2014 N 1714-r "On approval of the Methodology for structuring an investment project for the possibility of using various investment mechanisms, including public-private partnership mechanisms, Methods for evaluating the effectiveness of investment mechanisms, including public-private partnership mechanisms, Methods for choosing optimal investment mechanisms, including mechanisms public-private partnership, implementation of investment projects"

^XIII Methodological recommendations for assessing the effectiveness of tax benefits (tax expenditures) of the subjects of the Russian Federation and municipalities.  URL: https://minfin.gov.ru/common/upload/library/2018/04/main/Pismo_ot_28.04.2018_23-05-07_29126_v_subekty_RF.pdf (accessed 08/22/2022).

^XIV Actual values are given for 2018.

^XV Resolution of the Government of the Russian Federation dated 04/12/2019 No. 439 (as amended on 04/08/2023) "On approval of the Rules for the formation of a list of tax expenditures of the Russian Federation and assessment of tax expenditures of the Russian Federation"

^XVI The actual values are given for 2019.

^XVII Decree of the Government of Moscow dated 04/29/2004 No. 838-RP "On approval of the methodology for calculating the budgetary effectiveness of economic incentives for organizations attracting investments using Stock Market Instruments at the expense of the budget of the city of Moscow"

^XVIII OECD (2018), Cost-Benefit Analysis and the Environment: Further Developments and Policy Use, OECD Publishing, Paris, https://doi.org/10.1787/9789264085169-en.