Macroeconomic Risks

Publisher Summary This chapter discusses the macroeconomic risks, namely inflation, interest rate, and currency exchange rate movements. Inflation may be either a risk or a benefit to a project company. The construction costs should not be vulnerable to inflation-based increases; the engineering, procurement and construction (EPC) contract price, financing costs, and most advisers' costs should all be fixed. In preparing the construction cost budget, however, an allowance has to be made for inflation over the construction period in costs that are not fixed, such as the project company's general personnel costs, and purchase of any items not included in the scope of the EPC contract. In many markets, bank lenders do not provide long-term loans at fixed rates because their deposit base is short-term, and fixed-rate long-term funding is either unavailable or uneconomic. The base interest rate on project finance loans is thus often adjusted at intervals to the then current wholesale market rate at which the lenders raise their funding, and is therefore on a floating (variable) rate rather than fixed-rate basis. Currency exchange rate risks may exist during both the construction and operating phases of the financing. During the construction phase, if costs are in one currency and funding in another, the Project Company is exposed to the risk that the currency in which the costs are being incurred may appreciate.