Inflation Risk and Project Finance

Abstract

Project finance investments are highly exposed to inflation risk, especially if they are financed by foreign debt and located in developing countries with volatile currencies. In Public Private Partnerships, inflation risk may be mostly born by the private counterpart and its backing lenders, and it represents a zero sum game with compensating winners and losers, up to a force majeure earth-quaking threshold. In its uneven impact, inflation may consequentially remix corporate governance equilibriums among different stakeholders, so requiring adequate adjustments, even beyond ex ante contracting, in order to rebalance shifting risk sharing. Prompt monitoring and resilient contractual design ease inflation risk detection, management and mitigation, together with proper and flexible financial modelling. Appropriate sharing and handling of inflation risk may greatly help dealing with its potentially disrupting impact, especially if unpredictable or chronically enduring. An innovative accounting, economic and financial reference to an asset-liability framework, integrated with the profit & loss account and the cash flow statement, such as that proposed in this paper, may help detecting the relevant impact of inflation on Project Finance investments, fostering much desired economic and financial sustainability.