debt service which becomes due on a fixed date irrespective of whether the project is
completed or not.
Lenders, which contribute to the majority of the financing, always insist on
protection against this risk, which is normally achieved by some form of loan facility
on the part of the host government, available on a stand-by basis over a certain period
of time to cater for debt service, if and when the project company’s cash flow is
inadequate for this purpose.
18.9.7 Inflation Risks
It is inevitable that costs will increase over the project’s development construction,
and operation, phases. Lenders and equity investors always request protection from
this. This is normally covered by provision of Variation of Price (VOP) clauses in the
Implementation Agreement, or by the provision of increases in tariffs at the consumers’ end. Usually price adjustments, which are effected periodically, may only be
partial, always lagging behind actual inflation. However, advance VOP adjustments
may also be negotiated.
18.9.8 Foreign Exchange Risks
This component of project financing is probably the most important one. A BOT
project may generate income directly in foreign exchange (e.g. in the case of an
off-shore oil development contract) which is required for debt service.
However, in most cases, a BOT infrastructure project normally generates revenue
in local currency (e.g. in the case of a power plant, a toll road or a water treatment
plant). Lenders, and equity investors normally insist that the interests and principal
payments (in case of lenders) and dividends (in case of investors) are payable in the
original currency, convertible at a realistic exchange rate. This means that the host
government should:
(i) guarantee that the local currency earnings can be readily converted into foreign
currency,
(ii) guarantee the availability of such currencies at the time of the conversion and
transfer,
(iii) guarantee that the conversion rate will not be unduly unfavourable.
The above provisions are referred to as “availability, convertibility and transferability” of foreign exchange. The mechanism involved in dealing with these provisions entails different economic options best suited to economists.
Broad options are as follows:
(i) Exchange risk insurance schemes
(ii) Government support backed by multilaterals commitments.
18.9 Analysis of BOT Project Risks
521
completed or not.
Lenders, which contribute to the majority of the financing, always insist on
protection against this risk, which is normally achieved by some form of loan facility
on the part of the host government, available on a stand-by basis over a certain period
of time to cater for debt service, if and when the project company’s cash flow is
inadequate for this purpose.
18.9.7 Inflation Risks
It is inevitable that costs will increase over the project’s development construction,
and operation, phases. Lenders and equity investors always request protection from
this. This is normally covered by provision of Variation of Price (VOP) clauses in the
Implementation Agreement, or by the provision of increases in tariffs at the consumers’ end. Usually price adjustments, which are effected periodically, may only be
partial, always lagging behind actual inflation. However, advance VOP adjustments
may also be negotiated.
18.9.8 Foreign Exchange Risks
This component of project financing is probably the most important one. A BOT
project may generate income directly in foreign exchange (e.g. in the case of an
off-shore oil development contract) which is required for debt service.
However, in most cases, a BOT infrastructure project normally generates revenue
in local currency (e.g. in the case of a power plant, a toll road or a water treatment
plant). Lenders, and equity investors normally insist that the interests and principal
payments (in case of lenders) and dividends (in case of investors) are payable in the
original currency, convertible at a realistic exchange rate. This means that the host
government should:
(i) guarantee that the local currency earnings can be readily converted into foreign
currency,
(ii) guarantee the availability of such currencies at the time of the conversion and
transfer,
(iii) guarantee that the conversion rate will not be unduly unfavourable.
The above provisions are referred to as “availability, convertibility and transferability” of foreign exchange. The mechanism involved in dealing with these provisions entails different economic options best suited to economists.
Broad options are as follows:
(i) Exchange risk insurance schemes
(ii) Government support backed by multilaterals commitments.
18.9 Analysis of BOT Project Risks
521