Inflation risk

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Description (What is the Risk)

The risk that the inflation costs of the project increase more than expected.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Inflation risks during construction will be borne by the Private Partner

Under a regulated model the tariff set for each regulatory period may include some level of inflation linkage although it is common for it to be structured on a CPI-X model to incentivise year on year cost reductions and efficiency.

Mitigation Measures (What can be done to minimize the risk)

In some markets the project may be financed with RPI-linked debt.

Government Support Arrangements (What other government measures may be needed to be taken)

The tariff may account for inflation costs by incorporating the consumer price index.

Comparison with Emerging Market

In many developed markets over recent years, inflation does not experience fluctuations to the extent of emerging markets. However, investors will expect tariffs to include a degree of protection against inflation.

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Description (What is the Risk)

The risk that the inflation costs of the project increase more than expected.

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Inflation risk is typically borne by the Contracting Authority.

The tariff will typically include both a fixed component (where debt has been hedged) and a variable component (to reflect variable financing costs and variable inputs such as operating costs and insurance).

Mitigation Measures (What can be done to minimize the risk)

The Private Partner will look to be kept neutral in respect of both international and local inflationary costs through an appropriate inflation uplift or tariff adjustment regime.

The Contracting Authority may encourage the Private Partner to hedge against inflation through locking in long term supply contracts.

Government Support Arrangements (What other government measures may be needed to be taken)

The payment mechanism incorporates indexation for inflation costs by incorporating the consumer price index into the monthly payments.

Comparison with Developed Market

The fluctuation of inflationary costs is a greater risk in emerging markets than it is in developed markets and the Private Partner's expectation will be that this risk is borne and managed by the Contracting Authority during the concession term.

Indexation for inflation is typically linked to local (sometimes in conjunction with an international) consumer index.

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