Inflation risk

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Description (What is the Risk)

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

Risk Allocation (Who typically bears the risk)

Allocation: Public Private Shared
Rationale

Inflation risks during construction are typically borne by the Private Partner, while inflation risks during the concession term will typically be primarily borne by the Contracting Authority.

On availability-based projects, during the concession term, the availability payment will typically include both a fixed component (where debt has been hedged) and a variable component that will include an escalation factor that accounts for rises in costs as defined by the consumer price index.

Demand risk projects also need the ability to increase the tolls, but this ability may often be restricted (as toll-raising is likely to be a sensitive political issue), and so the Private Partner may need additional Contracting Authority support.

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

During the concession term, the Private Partner will look to be kept neutral in respect of both international and local inflationary costs through respective agreements with its subcontractors.

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

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

Comparison with Emerging Market

In developed markets, inflation is typically minimal and does not experience fluctuations to the extent of emerging markets.

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Description (What is the Risk)

The risk that the 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 project user (on demand-risk projects) or the Contracting Authority (on availability-based projects).

On availability-based projects the availability payment 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 staff and materials).

Demand risk projects also need the ability to increase the tolls, but this ability may often be restricted (as toll-raising is likely to be a sensitive political issue), and so the Private Partner may need additional Contracting Authority support.

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 appropriate inflation uplift or tariff adjustment regime albeit there is always a time lag in how quickly the indexation price increase is available to the Private Partner.

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

The Contracting Authority may need to provide a subsidy to the Private Partner on demand risk projects if users cannot bear the cost increase. It will be more crucial than in developed markets to find appropriate indicators mirroring the project needs rather than a general CPI.

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.

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