22 August 2019

Project Preparation in the Republic of Korea: rigorous evaluation for fiscal soundness

Written by Seungbeum Rho, Specialist, Korea Development Institute
22 August 2019

Country context

Korea’s infrastructure quality has ranked highly (6 out of 140 in 2018, 8 out of 137 in 2017) in the World Economic Forum’s Global Competitiveness Report[1]. Korea’s central government debt ratio as a percentage of GDP is 39.89 (International Monetary Fund, 2017), which is lower than the average of OECD countries[2].

The Global Infrastructure Hub (GI Hub) has collaborated on this blog with Seungbeum Rho, a Specialist at the Korea Development Institute (KDI). This blog outlines some of the lessons learned in Korea on the topic of project preparation, which can be found in more detail in the GI Hub’s Reference Tool on Governmental Processes Facilitating Infrastructure Project Preparation.

Pioneers in fiscal sector reform

Korea is considered a pioneer in implementing institutional and process reforms to improve the quality of project preparation.

The strong commitment of the Korean Government to efficient investment and fiscal soundness dates back to the fiscal sector reforms in 1999. In the mid-1990s, public investment management (PIM) in Korea was not well established. At that time, line ministries and local governments were in charge of project preparation, including feasibility studies. They were, in general, incentivised to implement as many projects as possible, so it was very tough for them to maintain objective viewpoints when assessing projects. In addition, they were vulnerable to political pressure. ?From 1994 to 1998, thirty-two out of thirty-three projects were evaluated as feasible in feasibility studies conducted by line ministries. Cost overrun cases were also prevalent, which implied that costs had been underestimated very often in the project preparation phase.

In 1997-1998, the Asian financial crisis hit Korea and had a devastating impact on the economy. For example, per capita income sharply dropped from USD 13.137 (1996) to USD 8,085 (1998)[3]. In the wake of the financial crisis, the Korean Government recognised the significance of fiscal soundness and decided to reform PIM in order to increase efficiency and transparency. ??

In 1999, the preliminary feasibility study (PFS) was introduced as part of PIM reform. The PFS was an ex-ante assessment of project feasibility, required for large projects with total costs amounting to KRW 50 billion (USD 44 million). The key feature of PFS was its governance. It was governed by budget authority (currently, the Ministry of Economy and Finance), not by line ministries. Also, it was conducted by an independent evaluation unit, Public Investment Management Center (PIMA, currently PIMAC) in the Korea Development Institute (KDI).

The PFS has acted as a gatekeeper in the Korean project preparation process and contributed to enhancing the objectivity and transparency of project evaluation. From 1999 to 2017, the total number of PFS cases was 767, and the average ratio of feasible projects was 63.3%. PIMAC has estimated that the PFS has saved the government 141 trillion (USD 101 billion) cumulatively during that period.

Seeking a sustainable PPP system

?Since the mid-1980s, demand for infrastructure investment in Korea has increased significantly. For example, in the early-1990s, the number of registered vehicles increased by more than eight times.

The Korean Government enacted the PPP law in 1994 and focused on introducing policies to promote private investment. For example, in 1998, the government adopted the Marginal Revenue Guarantee (MRG) system to reduce concessionaires’ demand risk. As a result, investors surged to the PPP market, and a lot of large-scale projects were implemented through the PPP model. 15.8% of all infrastructure investment was through PPPs in 2005.

However, in the mid-2000s, the government became aware of the need to revamp the PPP system. Back then, for PPP projects, PFS was not required, and only a brief review of the project plan had to be completed by a PPP facilitating agency, Private Infrastructure Investment Center of Korea (PICKO). In some projects, feasibility studies and reviews were later proven to have been conducted poorly, and demand was overestimated significantly. Demand overestimation, together with MRG, caused considerable government financial burden.

In 2005, the government revised the PPP law to require a rigorous feasibility study for PPP projects. The study was to be monitored by the Ministry of Economy and Finance and conducted by an independent agency. PIMA and PICKO merged to become PIMAC, and it undertook the ex-ante evaluation of both government-financed projects and PPP projects. Furthermore, the government abolished the MRG system in 2009. These measures tightened the PPP project preparation process, curbing the implementation of projects that lack economic feasibility or profitability.

Challenges

In Korea, welfare expenditures are expected to increase steadily due to demographic changes, such as the aging population. Therefore, project evaluation will be more important for the efficiency of infrastructure investment and fiscal soundness. However, the demand for improvement of PFS is growing continuously. The claim for incorporating diverse social values is arising. Some argue that there is an adverse effect of PFS on balanced regional development particularly for more remote areas.

Government measures related to PPP have been effective in preventing the implementation of projects without economic feasibility or profitability and reducing the potential government financial burden. From 1999 to 2017, a total of 712 PPP projects have been initiated with a total investment amount of KRW 108 trillion (USD 66 billion).? However, some argue that the preparation process has become too strict and time-consuming. Recently, the government announced measures to accelerate the PPP project preparation process. For example, it designated several agencies to evaluate PPP project plans, in addition to PIMAC.

The evolution of Korea’s PPP framework demonstrates the importance of maintaining a balance between investor demand and fiscal discipline and evolving the framework as demand and context changes.

Further reading

More detail on the project preparation landscape in Korea can be found in the GI Hub Reference Tool.

You can read our previous blogs in the project preparation series at the following links:

Introduction: Laying the foundations and charting a way forward

Enabling environment: what are the prerequisites required to facilitate the preparation of quality infrastructure projects?

Financing project preparation: how can governments effectively utilise project preparation financing sources?

What are the benefits of well-planned and prioritised infrastructure investment?

How do you translate a concept into a bankable project?

How should governments communicate projects?

Project Preparation in Indonesia – how has the government attracted private participation?

Project Preparation in India – how specialised institutional structures help in planning complex projects

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[1]http://reports.weforum.org/global-competitiveness-report-2018/country-economy-profiles/#economy=KOR

[2] IMF, 2017 https://www.imf.org/external/datamapper/CG_DEBT_GDP@GDD/KOR

[3] The World Bank?https://data.worldbank.org/indicator/NY.GDP.PCAP.CD?end=2016&locations=KR&start=1996

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