Estimation of foreign exchange exposure for public-private partnership infrastructure projects

Abstract

Economic foreign exchange (FX) exposure is an important risk factor which affects Public-private partnership (PPP) projects in developing countries. The risk exists because PPP projects typically sell their outputs domestically and generate revenues in local currency, while their financing costs and operating and maintenance costs are often denominated in hard currencies. Traditionally, FX risk is tested through the use of risk factors on revenue and costs or by adopting conservative assumptions in the cash flow. While this method provides a range of the risk value based on scenarios it does not give the potential FX risk exposure. What constitutes minimum and maximum risk values is often defined on the basis of subjective judgments. This research contributes to the solution of this problem with a methodology to quantify annual economic FX exposure in project companies financed under project finance modality. The application of the developed FX index to describe the project feasibility on economic FX exposure is superior as it is an extra tool which is linked to the financial models without the ambiguities to incorporate risk factors in the cash flow. It is a unique mathematical process for dimensioning currency risk on a various set of cash flow positions.