This document provides an overview of forex risk management in India and mechanisms to manage project risks at different stages. It discusses ways to manage forex risk such as currency swaps and forward contracts. It also summarizes risks that can be transferred, shared, or absorbed at different project stages. Key terms discussed include pre-operative expenses, power purchase agreements, and off-taking contracts for transport projects.
2. Ways and means of forex risk
management in India
• Currency swap with permitted currencies
• Forward contracts only with authorized
dealers
• Currency futures through authorized
exchanges
• Options in permitted currencies
3. Mechanism of forex risk management
• Process beyond the scope of such PPT slides
• Reading the textbook will help
• Once students get the basics right about forex
markets and processes this will be easier
• Separate material would be provided
4. Recall of what we have seen in PPT 2
• Risks are of three kinds:
– Risks that are transferred
– Risks that are shared &
– Risks that are absorbed - retained
• We have seen some examples of the above
risks
5. Recap of PPT 2
• Further we have also seen stages of risks in a
project
• Construction or pre-implementation &
• Operations
• Certain risks are exclusive to these stages
• Some others like interest rate risk and forex
risk are common
6. Understanding the examples
through textbook
• Transferring risks not only to insurance
companies
• Also through proper allocation of risks to
counterparties involved in a project
• Counterparties would accept such risks as
they are able to control & manage having
regard to their specialized skills
7. The core of project risks
• Transfer of risks through their proper
allocation looking at the expertise of the
counterparties
8. Pre-completion stage
• Any delay in implementation of the project
results in ‘overrun’
• Overrun = overshooting the estimated sum or
target date for completion
• Overshooting the estimated sum = cost
overrun
• Overshooting target date = time overrun
9. Overrun as a concept
• Students will appreciate that time overrun
would involve cost overrun always
• Cost overrun on the other hand need not
involve time overrun
• Example, forex rate going up on imported
machinery/equipment
• Involves only cost overrun and not time
overrun
10. Time overrun
• On the contrary, time overrun would always
involve cost overrun
• Increase in costs of project etc. would occur
due to time overrun
• Effect of time overrun spills over the
implementation period
• Into the operations stage
11. How?
• Delay in supply from commercial production
• In terms of sale agreements with prospective
buyers/customers
• Project company has to compensate for any
loss suffered by the buyer
• Hence it is absolutely essential to control time
overrun
12. Concept of pre-operative expenses
• During project implementation period
expenses on:
• Labour
• Interest on loans before repayment starts
• Material for trial runs
• Insurance on assets including building
material
13. Pre-operative expenses
• Power
• Cost of other utilities
• In short, all expenses other than direct capital
expenditure like land, building, plant and
machinery, equipments etc.
• Should be noted that trial runs are in the pre-
implementation stage
14. Accounting treatment of pre-
operative expenses in India
• As per ICAI’s accounting standards
• Step 1 – List all capital assets made with actual
costs
• Excepting on land pre-operative expenses pro-
rata added to all other fixed assets
• Best learnt through a numerical example in
the class
• In short, all pre-operative expenses written off
through depreciation
15. Pre-operative stage (POS)- Technical
risks
• Suitability of land
• Suitability of soil for construction
• Suitability of water
• Suitability of construction for the proposed
product etc.
• Technical risk also includes technological risk
16. POS – Foreign exchange risk
• On imported items of plant, machinery etc.
• On foreign exchange loan interest
• On materials, components etc. for trial runs
17. POS – Interest rate risk
• On domestic project loan rate of interest going
up
• On personal borrowings by promoters - rate of
interest going up
18. POS – Financial risk
• Project sponsors not being able to raise equity
and other resources in time
• Delay in project loan disbursement by project
lenders
• Cost overrun due to inflation or international
market situation
19. POS – Other risk areas
• Quality of material for trial runs
• Plant not reaching the assured and prescribed
minimum production levels/standards
• Effluent treatment plant not functioning as
per expected standards even during trial runs
• Regulatory risks
• Country/political risks
20. Operations stage risks
• Material supply risk
• Other utilities supply risk
• Technological risks
– Not suitable for scale of operations
– Outmoded technology
– Nascent technology (first time being tried)
21. Operations stage ….
• Plant performance being less than the ‘MPS’
(minimum prescribed standards)
• Quality risks with material etc.
• Inadequate supply of materials, components,
accessories etc.
• Forex risk on materials/components being
imported etc.
• Interest rate risk on loans
22. Operations stage
• Forex risk on exports (in case home currency is
stronger)
• Liquidity risk – not being able to pay creditors
in time
• Delay in customers paying as per credit period
agreed upon
• Off take by customers less than contracted
23. Operations stage
• Exaggerated demand estimation while
designing the project
• Sudden contract in demand due to changes in
government policy
• Credit risk – default by customers on payment
(distinct from delay in payment)
24. Operations stage ….
• Regulatory risks – due to government
policies/rules and regulations changing
• Environmental risks – Project output polluting
environment
• Political and country risks – fall under the
category of ‘Force Majeure’ risks
• Legal risks
25. Operations stage ….
• Inflation risk
• Something not available in India
– Consumer Price Index swap - page 42 (64)
– To protect the SPVs and other counterparties from
inflation effect
26. Certain terms to remember
• EPC = Engineering, procurement and
construction
• Contractor guarantees the SPV the following:
– The completion date
– The cost of the works
– Plant performance
• Due diligence at every stage
27. Certain terms ….
• Post-completion or operations stage:
– Minimum performance standards (MPS)
– Commercial operating date (COD)
• Upon plant meeting the MPS:
– Provisional acceptance certificate or PAC
– Final plant testing &
– Final acceptance certificate or FAC
28. Certain terms ….
• Allocation of supply risk – Put or pay
agreements
– Diagrammatic sketch on page 48 (70)
• Allocation of operational and maintenance
risks – O & M contracts
– Fixed price contract or
– Pass through contract
– Diagrammatic sketch on page 49 (71)
29. Power Purchase Agreement
• Has two components
– Fuel supply agreement (FSA)
– Power purchase agreement (PPA)
– Off taker takes a minimum purchase or power
with a minimum fee
– Minimum fee has a fixed and variable component
30. PPA ….
• Fixed component = Capacity charge
• Capacity charge = FOC + ROI + debt service
• PPA rate = Capacity charge + Energy fee
• Energy fee = Fuel charge + O & M costs
31. PPA ….
• Two kinds – The American model & the British
model
• An alternative to PPA – tolling structure
• First invented in petrochemical industry in
crude oil refining sector
32. Unique features of a tolling ….
• All market risks relating to supply and sale are
to the toller’s account
• The toller takes care of all FSA and sale
agreement for sale of power
• Only operating risk is with the SPV
• Project company or SPV’s cash flows would be
reliable without any risk of fluctuation either
in supply price or price of power for sale
33. Current market practice
• Internationally but not yet in India
• Merchant structure instead of tolling structure
• In which the SPV is exposed to market risks,
both on the supply side and the sale side
• This is due to aggressive posture of the market
34. Off taking contracts in
transport sector
• Known as the shadow toll system
• Practiced in BOT or its variant, DBFO – Design,
build, finance and operate
• The Government pays to the contractor and
not the user
• Hence it is known as shadow system
• It involves both senior and junior debt