How to Deal with Exchange Rate Risk in Infrastructure and Other Long-Lived Projects

Luciano de Castro, Claudio R. Frischtak and Arthur Rodrigues

No 10568, Policy Research Working Paper Series from The World Bank

Abstract: Most developing economies rely on foreign capital to finance their infrastructure needs. These projects are usually structured as long-term (25–35 years) franchises that pay in local currency. If investors evaluate their returns in terms of foreign currency, exchange rate volatility introduces risk that may reduce the level of investment below what would be socially optimal. This paper proposes a mechanism with very general features that hedges exchange rate fluctuation by adjusting the concession period. Such mechanism does not imply additional costs to the government and could be offered as a zero-cost option to lenders and investors exposed to currency fluctuations. This general mechanism is illustrated with three alternative specifications and data from a 25-year highway franchise is used to simulate how they would play out in eight different countries that exhibit diverse exchange rate trajectories.

Date: 2023-09-19
New Economics Papers: this item is included in nep-mac, nep-mon and nep-ppm
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