TABLE OF CONTENTS External macroeconomic risks (also known as financial risks), namely inflation ( 9.1), and interest rate ( 9.2) and currency exchange rate movements ( 9.3), do not relate to the project in particular, but to the economic environment in which it operates. These risks need to be analyzed and mitigated in the same way as the more direct commercial risks discussed in the previous chapter.
Depending on its timing, inflation may be either a risk or a benefit to the Project Company.
During the construction period, if inflation leads to higher project costs than projected, a cost overrun results, with the consequences set out in 8.5.4. Most of the construction costs should not be vulnerable to inflation-based increases; the 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 (such as spare parts) not included in the scope of the EPC Contract.
During the operating period, if inflation leads to higher operating costs than projected, the level of lenders' cover ratios, and the return for investors, may be reduced. If the Project Company has a long-term Project Agreement under which revenues are received on the basis of an agreed Tariff, some elements of the Tariff may be indexed against inflation (cf. 6.1.6), thus substantially reducing any inflation risk mismatch between costs and revenues. (Equally, sales prices in a competitive market should also reflect inflation.) In fact,...
