Managing Currency Risk to Catalyze Climate Finance - August 2024

As shown in Figure 1, the exchange rate of the Egyptian pound against the US dollar depreciated significantly in 2016 and 2023 due to domestic monetary policy reforms.8 Sound macroeconomic management and the development of local financial markets in EMDEs are the most sustainable remedies to long-term depreciation and short-term currency volatility. [...] Such long-term financing exposes the project to long-term currency fluctuation risks and increases the cost and complexity of hedging over the life of the loans. [...] 7 Managing Currency Risk to Catalyze Climate Finance exceed actual (ex-post) rates of currency depreciation.25 Full analysis of currency risk hedge pricing is beyond the scope of this paper, but it is clear that this pricing reflects both the risks that providers assume in offering the hedge and a return on capital to the providers. [...] For example, a 2015 analysis of clean energy projects in India indicated that hedges for hard currency loans typically cost 600 to 700 basis points, making the hedged cost of the foreign currency loan roughly equivalent to the nominal cost of a local currency loan.26 Borrowing foreign currency to finance projects in EMDEs can, therefore, be viewed as a way to disaggregate the project’s risks. [...] Long-term: Over the long-term, the platform’s sponsors would need to identify appropriate plans and policies to support financial development in the markets where it operates, including the amount of local-currency liquidity the platform could absorb without causing stress in the local market.