Project Finance in an Unstable Political Environment - Essay Example

Project Finance in an Unstable Political Environment

Introduction

Project finance is used by the private and public sectors as a perfect mechanism to finance projects that are estimated to have economic benefits. According to Esty (2014), many infrastructure projects in most countries especially India and the UK get financed through project finance. As a matter of fact, the unit or infrastructure financed through project finance is mainly a capital investment that has economic and legal independent assets. Such projects include pipelines, telecommunication infrastructure, highways, and power plants. As such, the projects rely on the assets to generate revenue and service debts. Because every project is legally independent in project finance, creditors have recourse to the assets and cash flow of the project only. However, as Gardner and Wright (2014) stated, in an environment that is politically and institutionally unstable, several risks might be present about project finance. Therefore, measures must be put in place to manage the risks that may arise from the unstable environments. Since non-recourse or limited recourse finance usually favors the borrower and only protects the lender to a particular degree, the creditor must take measures to protect their money. Additionally, the project managers must also take measures to ensure that the project is protected financially to avoid a collapse in an unstable environment.

Economic Analysts

Political unrest in India and other countries could cause major changes in the business sector and cause lenders to lose money where the collateral is not enough to pay the debt. When legislators change laws about foreign investments, they force foreign investors to either withdraw their investments or lose their money without any set means for compensation (Bekaert 2014). Thus, when a foreign company invests in India or another country, it should hire both political and economic analysts to assess the political and economic situation in the country. Because politics in any part of the world change regularly, a company should hire political analysts who are not biased and have no interest in any side of the political divide to assess any risks that may arise. In doing so, the company can make informed decisions with clear objectives of what to include in its contracts to protect the money from lenders. Also, it is imperative to hire economic analysts who would shade light on the credit situation of the country, future expectations of profit margins and inflation. Such information enables investors to decide whether financing a project will ensure the lenders will get their money back and in the case of closure is the available assets will be enough to cover all the debt. Lending institutions are entitled to have their economic analyst so that they carry a research as they wait for that done by the investor’s analyst for comparison before making a decisive judgment.

Political Data

When Enron decided to invest in a power plant in India aiming to create the biggest power plant in the world, it took advantage of the political instability in the country at the time and the fact that the institutions responsible for negotiations and supply were weak and unstable as well. Nevertheless, in the end, the Dabhol Project was halted, and lawsuits followed where many lenders lost their money (Pretorius 2008). Thus, there was a need for the concerned institutions and parties to take measures to protect their interests as it was evident that the political environment in India was unstable and had a lot of influence in the activities of the project. Although some economic benefits come out of political instability, investing in a foreign country without fully understanding the dangers, opportunities, and risks can be futile. Taking such risks may lead to wastage of resources that would have been directed to other fields or another secure country. Hence, hiring political and economic analysts, studying economic data, and developing a framework for renegotiations are some of the measures Enron and Maharashtra State Electricity Board (MSEB) could have taken.

Although it is practically impossible to measure the political stability of a country and put it as data for comparison, several grounds can be used to assess the stability of a country and that of surrounding countries. Consequently, a company should not evaluate the direct links to the government; instead, it should collect data about factors that influence the government institutions (Vasileiou 2014). Since the reliability of the institutions associated with investments and government activities and decisions are influenced by the human behavior of the people, measuring the behavioral changes gives a company an idea of how stable a country is and what to do. For instance, instead of measuring how independent the judiciary of a country is, political analysts focus on what makes the judges reliable. So, a company should hire political analysts so they can assess how judges are paid, the benefits they get, assassination attempts targeted on them, and programs funded to inform them about new laws. Additionally, the criminal opportunities available should be assessed against the salaries police and other law enforcers earn. Moreover, it is vital for the political analysts to study and determine the percentage of children who attend school and the rate of unemployment. After all the data is collected, a company can determine the strengths and weaknesses of a country. Despite determining the strengths and weaknesses, the company can clinch on the opportunities and threats it is likely to encounter. The company can conduct prompt checks to ensure the country makes changes to the situations it faces if it has interests in it. Consequently, it will be possible for investors to decide how to invest in a country with political instability associated with non-recourse finance (Grant, 2015).

Local Partnerships

Another approach that an investor such as Enron could have used since India had political and institutional instabilities is the inclusion of local investors. Instead of using foreign investors to do project finance concerning non-recourse or limited recourse finance, it is essential to include local investors. Even in a politically unstable environment, it is in the interest of every government to protect the investments of their citizens. Notably, if Enron had included one local investor to contribute in the capital for the construction of Dabhol power plant, even with the changing political interests every few years, the government would have made decisions that protect the money of the local lender. However, since the decisions cannot affect one investor, it would have ensured that other foreign investors are also protected, and their money's safety assured after the fall out with MSEB. Subsequently, partnering with local investors in any foreign company is one step to guarantee that the government and institutions of that country safeguard the interests of the investors no matter how unstable the political and institutional environment is at the time. Partnering makes the local employees feel secure because they have some of their local citizens to requests for their needs if there are ignored. The progress the investors acquire from the local ones acts as a guide and to the expectations they should come across upon establishing the business there.

Conclusion

In summary, knowing the odds of a country depends mostly on the industry an investor wants to finance projects. Furthermore, understanding how unstable the political or institutional environment of a country is a big issue for investors because it informs their investment decisions. Even if sourcing from foreign investors to finance a project in a country with unstable political and institutional environment might seem appealing due to the benefits associated with it, considering several approaches would help manage the risks related to non-recourse and limited recourse finance (Sadgrove 2015). Thus, involving political analysts to assess how the economic and political situation of a country change and how it is estimated to change in the long run is necessary. Besides, it is also significant for political analysts hired by investors to assess the factors that influence the political climate of a country. The level of employment, criminal activities and law enforcement agencies, the number of children acquiring education, and accessibility to medical care are some of the situations that must be assessed. The assessment may be a good guide for investors because some business opportunities do not thrive well in some countries. In addition to evaluation and collection of data about the institutional and political environment, foreign investors should also include local lenders when sourcing for funds to finance a project. Lending locally ensures a better relationship between the investors and the local institutions because they rely on them for safety in the custody of their money. All the measures ensure that the interests of the creditors are protected when collateral does not fully insure their money.

Even though foreign investment must pose some risks, formulating approaches to minimize the risks where there is non-recourse or limited recourse finance reduces the losses (Srivastava 2014). Despite there being so many risks that are prone to occur in businesses, some of these countries attract some investors by ensuring they give them security which is only provided for short periods. Some countries have un-utilized resources, such as in the case whereby Enron and Maharashtra aim at utilizing them. They target to create business opportunities in the foreign country.