Exchange Rate Risk in Cross-Border Engineering Projects

In cross-border engineering projects, companies typically make investments in U.S. dollars or other major international currencies, while revenues or payments in the host country are often settled in the local currency. This currency mismatch is highly susceptible to exchange rate fluctuations. For example, when Chinese companies invest in engineering projects in Indonesia, the investments are usually made in U.S. dollars, but the project revenues and operating costs are primarily settled in Indonesian Rupiah (IDR). Due to the IDR depreciating by nearly 80% against the dollar from 2011 to 2020, companies suffered significant losses when converting the IDR back to U.S. dollars. Similarly, the Sri Lankan Rupee (LKR) depreciated sharply against the dollar in 2022 due to the country’s economic crisis, and the Myanmar Kyat (MMK) lost nearly 50% of its value against the dollar since the political turmoil began in 2021. These cases demonstrate that effective exchange rate risk management is crucial for the financial stability of cross-border projects.

Key Strategies:

1. Forward Exchange Contract
A forward exchange contract is an agreement between a company and a bank to exchange currencies at a predetermined rate on a specific future date. By locking in future exchange rates, companies can mitigate losses caused by unfavorable exchange rate fluctuations. This strategy is particularly useful when project revenues are settled in local currency, while expenditures (e.g., imported raw materials) are paid in U.S. dollars. Using forward exchange contracts allows companies to hedge against potential depreciation of local currency, thus reducing the financial pressure.

2. Currency Swap Agreement
A currency swap agreement is an arrangement between a company and a bank or another financial institution to exchange principal and interest payments in different currencies at agreed-upon conditions for a specified period. Currency swaps enable companies to convert local currency into U.S. dollars or other major currencies, which can be used for importing materials or repaying foreign debts, thereby mitigating the risk of local currency depreciation. For instance, in countries like Sri Lanka or Myanmar, where foreign exchange reserves are low, currency swaps can help companies better manage their U.S. dollar liquidity.

3. Contract Currency and Exchange Rate Provisions
In cross-border project contracts, companies can refer to FIDIC clauses to reasonably set the settlement currency and exchange rate provisions. A multi-currency settlement model can be adopted, where a portion of the contract payments is made in U.S. dollars and another portion in local currency, thereby diversifying the risk brought by exchange rate fluctuations. Additionally, the contract should include provisions on how to handle discrepancies between the exchange rate at the time of invoice issuance and the rate at the time of payment. This helps to avoid disputes over exchange rate differences and the resulting financial liabilities.