International Construction Project and Finance - Coursework Example

International construction Project and finance Name Course Course Code Instructor’s Name 2nd March, 2012. 1. Outline how fluctuating currency exchange rates can affect an international construction project. A fluctuating exchange rate is also called a floating exchange rate wherein a currency’s value is allowed to fluctuate according to the foreign exchange market. A currency that uses a floating or a fluctuating exchange rate is called a floating currency. A floating exchange rate is more preferable than a fixed exchange rate since free forces of demand and supply are allowed to determine the exchange rate. Due to these automatic adjustments, a country is able to reduce impact of shocks and foreign business cycles and also preempt any possibility of having a balance of payment deficit. In cases of extreme appreciation or depreciation of a currency, central banks normally intervene to stabilize the currency. Hence, the exchange rate regimes of floating currencies may be technically known as a managed float (MacDonald 2010, pp 189) A floating exchange rate can affect an international construction project both positively and negatively. To a smaller extent, a flexible exchange rate boosts international trade since there are no restrictions under the regime. An international construction company therefore benefits since there is free movement of capital, be it physical or monetary. Given the fact that a fixed exchange rate can be altered, this alteration can be done in favor of the international construction project (Marsh 2010, PP 98). To a greater extent, a floating exchange rate has a number of draw backs hence International investments are not promoted by fluctuating exchange rates. Therefore an international construction project will not work well in such a currency regime because lenders cannot expect the exchange rate to remain stable over a long period of time. If for instance the construction company imports construction materials, it could be forced to wait until stability is reached, or otherwise incur losses. As a result of unstable conditions of uncertainty and instability of the exchange rate, the volume of international trade and foreign investment is reduced (Marsh 2010, PP 123). Flexible exchange rate system involves greater responsibility of inflationary effect of exchange depreciation on domestic price levels of a country. This implies that if the international construction project is run by use of domestic currency, more in terms of local currency is spent because of inflationary tendencies caused by flexible exchange rates. Flexible exchange rate may discourage a construction project because it results to speculative capital movement which eventually leads to the problem of extremely high liquidity preference (Marsh 2010, PP 65). In a situation of high liquidity preference, there is a tendency of hoarding a currency, interest rates increments, and fall in investments and there is large-scale unemployment in an economy. Under flexible exchange rate system, there is immobility of factors of production. This therefore deprives flexible exchange rate system its advantages arising from adoption of monetary and other policies for maintaining internal stability. Such policies produce desirable effects on production and employment only when supply of factors of production is elastic. In such a case, the international construction project may not work well because of immobility of essential factors of production. In conclusion, flexible exchange rate has many negative effects in an economy as the case was during first and second world wars. Flexible exchange rate should therefore be by all means eliminated in an economy to ensure economic stability. 2. Discuss why shadow prices might be more representative than market a project in a developing prices when appraising country. Projects impose varying costs to the beneficiary countries/communities and these costs that projects impose vary in terms of social costs, environmental costs as well as economic costs. In most cases, some projects are rejected while others are accepted when they are viewed in terms of attaining policy goals of the country/community. Shadow prices refer to the maximum amount of price that a company will pay per extra unit of a resource and hence in economics, shadow price refer to the change in the value (objective value) of a best solution (Elio 2003, pp 55). In a layman’s language, shadow prices can be said to be the costs of doing an activity or a project where the actual value of undertaking the activity is unknown or if known does little to reflect the actual costs which would have been incurred. Shadow price therefore becomes the opportunity costs of undertaking a project or an activity. For instance, an organization’s constraint can be the number of hours that employees are supposed to be working. Shadow price in such a case becomes the price that the organization is willing and able to pay for any additional hours that the employees cover while undertaking a certain activity or project. With the above facts presented, why then are shadow prices more representative than market prices when appraising projects in a developing country? Shadow pricing is more representative than market prices when appraising a project in developing countries and more especially when it comes to shadow price for foreign exchange. Foreign exchange has turned out to be a scarce resource for developing nations, since these nations face numerous problems of balance of payment. As a result, the demand price is greater than the official price of foreign exchange. At this point, a cost benefit analysis needs to determine whether the price of imports and exports is to be estimated at the nominal price or the adjusted price. Most economists consider that pricing should be adjusted upwards for both exports and imports, so that the adjusted price complies with the scarcity value, which is reflected by the demand price of foreign exchange (Elio, 2003, pp 112). Shadow prices are a means of converting projected program impacts into social benefits, which can be measured in terms of society’s willingness to pay for them and at the same time a means of converting program resources into social costs which are measured in opportunity costs. Many plausible, but imperfect, shadow prices are available in early childhood context, mostly based on data from long term experiments. More wholesale experiments are necessary to provide the bases for useful shadow prices, which are important when it comes to the question of benefit-cost analysis. In conclusion, market prices are associated with market failures which are responsible for social loss and constitute part of the barrier to economic development. To rectify these failures of market prices, shadow prices can be used especially when it comes to evaluation of new projects. Although market failures associated with market prices are responsible for social loss and constitute part of barrier to economic development, it is very possible to seek substitute prices to improve on actual imperfect market failures (Manuel 1996, pp 123). For this reason, shadow prices still turn out to be one of the best prices to use when appraising a project in developing countries. 3. The role of international economic institutions in Development The World Bank and the International Monetary Fund are two names one cannot avoid to mention whenever discussing funding of international projects and economy. The World Bank and the International monetary fund are known collectively as the Bretton Woods institution after the small town in the United States of America where they were founded. The two institutions are the pillars of the world economic and financial order. The two institutions differ in that the IMF is concerned with an efficient payments and receipts system between nations. The World Bank along with other institutions based at the continental level, like the African Development Bank (AFDB) funds economic Development (Devesh et al 1997, pp. 126). International economic institutions have the following roles in development: Providing Debt Relief Many Developing countries have accumulated billions of dollars of debts some carried forward from the colonial days (Boas & Desmond 2003, pp. 236). The World Bank and the IMF has introduced the heavily indebted Poor Countries (HIPC) Initiative and Multilateral Debt Relief Initiative (MDRI). Debt relief provides poor countries an opportunity to focus their resources on development projects rather than on debt repayment. Poverty Reduction The Bretton wood institutions in 1999 came up with the Poverty and Growth facility, which lends to developing countries if they satisfy certain conditions. The conditions are aimed at creating sustainable political stability, which in turn leads to healthy investment climate essential for growth of enterprise and poverty reduction (Ha-Joon 2002, pp.78). The World Bank funds projects are aimed at making recipient citizens self-sufficient. The World Bank is involved in projects that directly impact on the lives of World’s poorest people. The World Bank lends through other local development partners for agricultural research, rural development projects and small scale investments. Crisis Response The IMF and World Bank since 2008 have been helping countries hit by the global financial crisis. By the end of August 2010, the IMF had committed $200billion in emergency intervention for countries affected by this crisis. These interventions have enabled ongoing development project to continue in the affected countries. The IMF has helped countries recover from natural disasters that would have otherwise have negative effects on development (Graham 2003, pp. 45). Provision of Technical and Financial Assistance The World Bank provides lending facilities for its member countries, but unless the funds borrowed are effectively used for the intended project, lending does not achieve its goal. The World Bank provides technical assistance alongside its loan projects; it sends experts with wide experience in previous projects to consult with locals in implementing the project on the ground. Assistance in realization of the millennium Development Goals The World Bank in collaboration with the United Nations is assisting developing countries to achieve the Millennium Development Goals (MDGs). The World Bank helps the poor increase productivity and easily access safe drinking water, good sanitation facilities, good health services, family-planning assistance, nutrition, education, and housing. To touch the lives of the poor, the World Bank has switched focus to rural electrification, access roads to transport produce from farms. The bank also supports environmental stability through use of renewable sources of energy. 4. Financing of Konza Technological City, Kenya. Kenya is a country in East Africa; it is the largest economy in the region in terms of GDP. Its Capital Nairobi is a regional hub for business; travelers come from all the neighboring countries to transact their business in the country. Kenya has come up with an economic blueprint called “Vision 2030” that seeks to achieve middle income status for its citizens. As part of this economic plan Kenya plans a number of infrastructure projects including roads, business parks, technological cities, railway lines and new ports. The Konza technological City is one of Vision 2030 flagship projects. Konza city will be 60 km from Nairobi and is to be built from scratch along the Mombasa- Nairobi highway, which links the capital city and the Mombasa port (Vision 2030 2011). The Development is on a 2000 acre vacant piece of land. The project will employ world class architectural design aimed at producing Africa’s first world class city in terms of architecture. The project will cost the Kenyan Government $10 billion and the government plans to raise the following ways. Charge, Fees and Earnings Charges and fees are funds obtained by levying public provided goods and services that are underprovided or would cost great social resource for the private sector to provide. These goods should only directly benefit the consumer and should not have a positive spillover (Atkinson& Stiglitz 1980, pp.67). An example of finances obtained this way is provision of adjudication cases by courts of law in torts (disputes between citizens). The government also charges a fee to citizens for use of assets it holds as custodian of National assets. These assets include wildlife parks, beaches, museums, monuments, mines, forests and national parks. In charging fees for these assets, the government sets them high enough to avoid their overexploitation (Gupta n.d., pp.1). Earnings for the Government consist of manufactured outputs of public sector undertakings, while the government is not supposed to make any profits through sale of public sector outputs; most governments still maintain undertakings that are still a significant source of finance. Seignorage and Debt Seignorage is the profit gained as a result of producing currency; it is the interest payment to central bank on the total amount of currency issued (Buchanan & Musgrave 1989, pp.145) . The debt of a government is the accumulated borrowing made by a government and government can borrow internally (through government’s treasury bills and treasury bonds) and externally (from external sources for instance the World Bank). General Taxation Taxation accounts for more than half of the Government spending every year. The Kenya revenue Authority is mandated to collect tax from the population. The Government of Kenya has a number of tax categories including Value added tax and pay as you earn tax. Governments should only use general taxation as source of finance only when other sources are inadequate. General taxes are inevitably distortionary and have negative effects on income distribution. The levying of General tax on a country’s citizen has been a thorny issue, especially in third world countries where people are poor and taxation further pushes them into poverty. Bibliographies Atkinson, A. B. & Stiglitz, J. G. 1980, Lectures in Public Economics. New York: McGraw-Hill Economics Handbook. Buchanan, J.M & Musgrave, R. A. 1989, Public Finance and Public Choice: Two Contrasting Visions of the State. Cambridge: MIT Press. MacDonald, R. 2010, Currency Union and Exchange Rate Issues: Lessons for the Gulf States (New Horizons in Money and Finance). UK: Edward Elgar Publishers. Marsh, D. 2010, the Politics of the New Global Currency. USA: Yale University Press. Elio, H L 2003, Shadow prices for project appraisal.USA: Edward Elgar Publishing limited. Manuel, H J. 1996, monetary policy, A Market Approach. USA: Praeger Publishers. Gupta, A. n.d., “Sources of Government Finance”. Available from: www1.worldbank.org/publicsector/.../Das-GuptaI [Accessed: March 1, 2012]. Vision 2030. 2011, “The Master plan”. Available from: http://www.konzacity.co.ke/?page_id=2193 [Accessed: March 1, 2012]. Devesh, K. et al.1997, The World Bank: Its First Half Century .Washington: The Brookings Institution. Graham, B. 2003, “Restructuring IMFs Lending Facilities” World Economy Volume 26, No. 3 Boas, M. & Desmond, M. 2003, Multilateral Institutions: A Critical Introduction. London: Pluto Press. Ha-Joon, C. 2002, Kicking Away the Ladder: Development Policy in Historical Perspective. London: Anthem Press Read More