Authors:
Dobrica Vesić, research fellow at the Institute of International politics and Economics in Belgrade;
Srbijanka Stojić, JP „Srbijavode“, Belgrade;
Lidija Beko, Faculty of Philosophy, Belgrade.

Part 2 of last weeks article

Project Financing Risk Analysis

The biggest risks that project sponsors confront with in modern conditions of global financial and general economic crisis are: political, legal, financial, constructive, operational and commercial risks.

Political risk comes out of potential possibilities of political phenomenon, like war, revolution, expropriation of active, the change of tax policy, currency devaluation, and problems of controlling foreign exchanges, exporting limits, and all other Government activities, that can influence on the project profitability. ((Lang L.H.P., 1998, “Project finance in Asia” Northland , Amsterdam)) However, political risks can be extremely high, especially in developing countries, which have unstable Government so that all Government changes can influence on the project policy as well as on project sponsorship. ((Tam, C.M., 1999, “Financial commitments of BOT projects”, International Journal of Project Management, 17 (6) ))

Financial risk is linked to the rates on which the currency changes, inflation and capital expenses (capital rates). The risk of foreign exchange is often very high in developing countries, especially in those ones where high rate of inflation is characteristic. The capital expense does not have to be linked directly to the country in which it is supposed to be realised, but can directly be linked to countries where it is being collected.

Construction risk is firstly related to the delay of construction phase and the time of expense remittance. The delay of constructive phase can be conditioned by technical difficulties, by bad management, or by both factors equally. At project financing investors rely on income derived from realised projects, in sense of expense remittance of the investment, it is certain that each delay of ending the project itself will at the same time delay their possibility of payment based on the achieved income. Expense remittance will influence on profitability of projects by increasing constructive and financial expenses.

Operational risk relate to business expense of complete basic means. In general, business and maintenance expenses may overcome the planned expenses. Non-involved, actually neglected, business expenses will also take negative effect of project profitability.

Commercial risk the most often results from the risk of demand and price. Risk of demand is certainly based on demand for the product itself or the service, which is possible to offer by realisation of specific project. Price risk is a risk directly related later on the product or service price, which is ensured by realisation of infrastructural project. Of course the price is always liable to certain corrections by the government who then takes adequate sub financing obligations, which can be seen very often at pay tolls, or at sub financing similar types. Understanding the project risk is very significant while defining suitable and concrete financial strategies. Loaners, as well as investors, certainly avoid participation in projects that are highly risky, except in the situations when they can not resist because of the extremely high rate of reimbursement on involved funds.

Guarantees for Investment Projects

At the legal and economic aspect, guarantees are basic instrument of reducing expected or foreseen project risk. ((Guarantee is a contract by which third party, guarantor, stands surety that certain obligation, ex. building and financing of some facility, will be carried out by the guarantor in case that the instructing party, orderer, failed to do that)) In modern terms of hardening collection of financial means, guarantees are issued most often by the banks or insurance companies.

Bank guarantees are used in obtaining investment business where contractor submit to the buyer several kinds of guarantees. Their use is possible in other domestic or international business transactions, and even when additional insurance is wanted to be obtained for refund of specific amount or accomplishing obligations. Basic bank sorts of guarantees are:

• offered guarantees – where contractor assures entering the contract with the buyer if his offer would be chosen as the most suitable one
• guarantee for refund of advance payment – with which complete execution of tender previously defined criteria. ((It is ensured with adequate securities and/or with an obligation for compensation for damages to the investor))

Institutions offering guarantees in international transactions, with banks and insurance companies, are divided in two basic groups:

• export credit agencies – with credits, export credit agencies offer guarantees and insurances to their clients; in some cases their guarantees are conditioned by counter guarantees of the country where the project is being realised, and
• multilateral developing banks – a bank like World bank and European banks for restoration and development (EBRD) that, with credits approve guarantees and insurances (from political risks or commercial risks).

In the range of World Bank the guarantees are issued by International bank for restoration and development and by Multilateral Insurance Guarantee Agency (MIGA). IBRD approves to private loaners guarantees with partial credit remittance, with which some debt payments are ensured from all sorts of risks. MIGA provides insurances to creditors from political risks according to the contract providing guarantees for the foreign capital and debtors investments, not asking for the guarantees of the country in which it is invested.

Conclusion

Project financing is applied today both in undeveloped and in highly developed countries to finance the biggest investments, but also in developing countries, it shows on its superiority in comparison with direct investment and other forms of investing abroad, which makes it attractive and modern in our conditions as well. By increasing the number of investors in Serbia, and by developing the need for improvement and construction of infrastructure, there came a need for project financing which is not only based upon the business report of the enterprise in previous period but is based on report of justifying financial analysis of the project itself. At the same time legal sites are made for realisation of this kind of financing. In that sense, this way of financing would be especially contributed to improvement of the process of financing the construction of domiciles and business residences, industrial and touristy capacities ((hotels, industrial halls, stockrooms, logistic centres)), commercial objects ((hypermarkets, shopping centres, etc.)), but firstly infrastructural objects ((like investments in business residences and supports to doing business in energetic, transportation, irrigation, melioration, telecommunications, oil, gas, education and health protection)) in Serbia. The width of public-private partnership appliance will depend upon the development of competences of the bodies of governmental management and local and regional autonomy, as well as from the development of the private sector. Effectiveness of the usage of this model requires economic and ecological project maintenance, as well as their positive influence on the quality life of the population and total social-economic development.

Literature

1. Davis, H., 2003, “Project Finance: Practical Case Studies”, Euro money books, London.
2. Jazić, B., 2008, „Rizici u bankarskom poslovanju”, Stubovi kulture, Beograd.
3. Lukić, B., 2009, „Novi pristup u upravljanju i merenju kreditnog rizika u finansijskoj industriji, Ekonomski fakultet, Beograd.
4. Lang, L.H.P., 1998, “Project finance in Asia”, Nort-Holand, Amsterdam.
5. Siver, L.M., 1989, “System analysis and design”, Addison – Wesley Publishing Company, New York, pp. 74–75.
6. Tam, C.M., 1999, “Financial commitments of BOT projects”, International Journal of Project Management, 17 (6).
7.  Tiong, R.L.K., 1997, “CSF-s in competitive for BOT project”, International Journal of Project Management, 16 (2).