Only a quarter of private infrastructure deals in developing markets are conducted in local currency

Source: Global Infrastructure Hub based on Realfin data. Note that figures may not add to 100% due to rounding.

Foreign investors are often reluctant to invest in infrastructure projects in developing markets due to concerns about currency volatility and foreign exchange (FX) risk. As projects typically generate revenue in local currency, there is a mismatch between revenues and debt service for projects borrowing funds in a foreign currency, exposing the project to the risk of local currency devaluation over time. While transactions denominated in local currency would avoid this risk, such an option may not be possible in financial markets that lack appropriate long-term financing instruments, as is often the case in developing countries. Furthermore, long-term market-based hedging mechanisms to mitigate FX risk (such as derivative contracts) are often limited in availability or too costly to implement in these markets.

From 2018 to 2022, almost three-quarters (74%) of private investment in infrastructure in low- and middle-income countries (LMICs) was denominated in foreign currencies, most notably in US dollars, which accounted for 65% of total LMIC investment alone. In other words, only 26% of private infrastructure investment in LMICs during this period was conducted in local currencies. Almost half of this local currency investment occurred in Brazil (45%), with India accounting for a further 20%. However, hard currencies are still favoured in India overall, with only 31% of investment occurring in Indian rupees from 2018-2022.

Brazil, on the other hand, is one of the few LMIC countries where the local currency is the preferred currency of transaction for private investment in infrastructure (alongside South Africa and Thailand). From 2018 to 2022, 63% of private investment in Brazilian infrastructure projects were denominated in Brazilian Real, a share that has skyrocketed from just 10% in 2016. Indeed, Brazil has been the driving force behind a trend increase in the share of local currency-denominated transactions in private infrastructure investment across LMICs, with the share rising from 15% in 2016 to 37% in 2022. Aside from a relatively deep and well-developed local financial market, this increase in Brazil likely reflects a number of policy and regulatory changes, such as the expansion of tax incentives for debentures (primarily issued in local currency), the reduction of the Federal funds rate (SELIC) throughout 2017 which boosted the relative attractiveness of other investment opportunities in local currency (including in infrastructure), and the acceleration of project preparation through the creation of the Investment Partnership Program (PPI) in 2016. Despite these changes, FX risk is still seen as one of the largest barriers to foreign private investment in infrastructure in Brazil, evident through continued government support for initiatives to mitigate FX risk, such as the recently launched Eco Invest Brasil, an FX hedge program for sustainable investment.

Exchange rate volatility can be a significant barrier to catalysing greater private capital for infrastructure investment, particularly for developing markets, where around three-quarters of private infrastructure investment is conducted in foreign currencies. Addressing FX risk through the greater use of innovative mitigation mechanisms, such as indexing project revenues to the US dollar or building in contractual risk allocation mechanisms into concession agreements, is therefore critical to unlocking greater pools of foreign private capital in markets where it is needed most.

Only a quarter of private infrastructure deals in developing markets are conducted in local currency.