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

Luciano de Castro; Claudio Frischtak; Arthur Rodrigues

doi:10.1111/jpet.70003

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

Journal article

Open access

Peer reviewed

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

Luciano de Castro, Claudio Frischtak and Arthur Rodrigues

Journal of public economic theory, Vol.27(1), e70003

02/01/2025

DOI: 10.1111/jpet.70003

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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. In this article, we propose 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. We illustrate the general mechanism with three alternative specifications and use data from a 25-year highway franchise to simulate how they would play out in eight different emerging economies that exhibit diverse exchange rate trajectories. Results show relatively small length adjustments, and suggest the mechanism offers a powerful policy tool to cost-effectively attract vital foreign infrastructure investment for developing countries.

bidding for public projects

concession periods

exchange rate risk

government protection

infrastructure projects

insurance for exchange rate risk

investors risk aversion

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Details

Title: Subtitle: How to Deal with Exchange Rate Risk in Infrastructure and Other Long-Lived Projects
Creators: Luciano de Castro - University of Iowa
Claudio Frischtak - London School of Economics and Political Science
Arthur Rodrigues - Pontifical Catholic University of Rio de Janeiro
Resource Type: Journal article
Publication Details: Journal of public economic theory, Vol.27(1), e70003
Publisher: Wiley
DOI: 10.1111/jpet.70003
ISSN: 1097-3923
eISSN: 1467-9779
Number of pages: 25
Grant note: National Development Bank of Brazil (BNDES)
Language: English
Date published: 02/01/2025
Academic Unit: Economics
Record Identifier: 9984774238202771

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