US Federal Reserve rate rise to push construction costs

The increase in interest rates by the US federal reserve last week is likely to make borrowing costs for projects and contractors more expensive but is unlikely to derail funding plans for major projects by governments and other clients in the region.

“In terms of raising bonds and the general, day-to-day project finance that contractors have to deal with, I don’t think that an increase of that range makes a huge impact,” said Zander Muego, a partner at the cost consultancy Thomas and Adamson.

“Obviously, if the cost of money gets more expensive then it does impact contractors, and ultimately it impacts the industry.

“There’s obviously a number of factors impacting the industry just now. Certainly, material prices have been moving around, the market is fairly tight as well, so there aren’t huge margins for contractors in the first place.

“But the bigger challenges for contractors is one of cash flow and having sufficient cash to raise bonds rather than small adjustments in the rates,” Mr Muego said.

He said in terms of project finance, the rise in interest rates is only likely to be of note if it becomes part of a wider trend.

“If a project is feasible, then I would suggest that that small adjustment in the rate would not suddenly make that project not feasible. But if that continues, it would have an impact.”

Faithful + Gould’s regional development director, David Clifton, said: “There’s probably going to be another rate rise this year as well, and it’s not the individual ones that are a concern, it’s the compounded effect of them that might cause concern in due course.”

However, he said that liquidity, rather than the cost of finance, was of greater concern for project funding.

“There is liquidity; it just takes time for that to reach the market.”

He also said that as governments move towards alternative financing methods to fund projects, it will be long-term borrowing rates that will be more keenly watched.

“Short-term interest rates probably aren’t going to cause a lot of pain right now,” said Mr Clifton.

Maarten Wolfs, a partner and Middle East infrastructure finance leader at PwC, said any increase in base rates will increase borrowing costs for the industry but, in terms of infrastructure financing, interest rates are only one part of a much more complex set of sums.

“The cost of long-term interest rate hedging and the lenders’ risk premium must also be taken into account. We have seen a number of incremental rate hikes over the last few years. However, it is fair to say we are still in a macro-economic cycle of historically low interest rates.”

He said, in general, higher interest rates “have rarely prevented important infrastructure projects from advancing”.

“And in the case of many projects which are structured as PPPs, interest rate risk is a pass-through to the government or end-user under the offtake contract.”

mfahy@thenational.ae

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