Project Finance Risk In Emerging Markets

Project finance risk in emerging markets is something we look at closely. For more than five years, really since the global financial crisis, a great many project finance handicappers and journalists have continued to project persistent stagnation in emerging market economies. Because our clients, and by extension us, have significant project financing investments in the pipeline, we were compelled to do more than look closely at project finance risk in emerging markets.

In performing our assessment of project finance risk in emerging markets, we discovered a recent article in the Financial Times that pushes back against the consensus negativity about emerging markets. The Financial Times article which was very constructive directly contradicts the consensus naysayers.

The article states “despite their vulnerability to a long-run stagnation in global trade growth, we think such risks are overemphasized and that emerging market assets –characterized by much improved external balances, high yields, and unchallenging valuations – are well-positioned to benefit when more favorable trade winds return.”

Our assessment of project finance risk in emerging markets correlates very closely with the Financial Times analysis. After analyzing project finance risk in emerging markets, we believe there is a real possibility that emerging markets are well on the road to recovery and are now beginning to attract fresh investment capital for project financings.

The real question is, do emerging markets offer opportunities that will deliver a return on investment that sufficiently compensates for the additional project finance risk in emerging markets? That, of course, depends on the individual markets, but it seems clear that emerging markets worldwide are experiencing significant recovery.

Although there is no official definition of what constitutes emerging market economies, most of those have economies with low to middle per capita income. That is just one characteristic which applies to approximately 80% of the global population and approximately 20% of the world’s economies. They are also usually characterized as emerging markets because they have recently implemented reforms that bode well for future growth and improvement.

In other words, they are countries that have made a commitment to economic development and reform programs and have begun to open their markets. They are universally considered fast-growing economies. Most emerging markets are also smaller economies, although that is not a hard and fast rule as large countries are not precluded from the classification. China, for example, is a huge country with a huge economy. It is, nonetheless characterized as an emerging market economy because it has begun economic development and reform programs.

Because they are moving from closed dictatorially controlled economies to open market economies, and are embarking on economic reform programs that promise stronger future economic performance, they are considered transitional. They have all also tacitly if not specifically guaranteed improvements in transparency in capital markets as well as the political arena. Emerging markets make a concerted effort to stabilize and strengthen local currency through exchange rate reforms.

In addition to implementing reforms, emerging market economies likely receive aid and guidance from large donor country organizations like the World Bank and IMF. Another indication that a country has moved into emerging market status is that they experience significant increases in both portfolio and direct project finance foreign investment. The growth of project finance in a country is a key indicator that world financial markets are taking them seriously and that capital flow towards the country will likely continue.

• Low per capita income
• Instituting reforms
• Commitment to development
• Moving from closed economies to open markets
• Improvements in transparency
• Substantial increases in foreign investment
• Stabilizing exchange rates

Before vast amounts of project finance capital can be turned loose in emerging markets, investors and project finance lenders need assurances that they will not have to accept too much political risk. Political risk is real in emerging markets and must be addressed in project finance. Please see our analysis of political risk in project finance.

We will continue to publish content and support material on Political Risk to support our clients that are considering emerging market investments.