From RIL to L&T and Adani, corporate giants build on EPC rule change

A shift from the high-debt hybrid annuity scheme for infra projects to a low-debt, performance-linked model is encouraging government and private majors to pivot to this business in a bigger way

The year-end announcement by Reliance Industries Ltd (RIL) to the stock exchanges stating that it would merge its engineering, procurement and construction (EPC) subsidiary Reliance Projects and Property Management Services with itself offers a strong signal of a significant shift in the nature of government infrastructure contracts that is shrinking the space for smaller infra companies in favour of larger ones.
 

Apart from Larsen & Toubro, which has been in the EPC business for years, the coming year is likely to see big groups such as Adani, Tata Projects and RIL as well as government-owned Rail Vikas Nigam Ltd pivot towards government EPC contracts in a major way. NBCC, which has a large project management consultancy division, also expects to expand its EPC business.
 

This shift is primarily on account of several initiatives by government agencies in 2022, most prominently the National Highways Authority of India (NHAI) and the Railways. As a result, new entrants will operate on a low-debt model to build greenfield assets, with the government responsible for selling the completed (brownfield) projects.
 

The trigger for the shift was a series of decisions taken in the summer of 2022. Government agencies are now handing out infrastructure contracts stating that bidders have to separate the project financing plans from the post-construction phase. This change was mainly the result of NHAI’s Rs 3.3-trillion debt burden.

The finance ministry discovered that most of the debt was run up to pay for the extravagant hybrid annuity model-based projects for roads. Under this model, the bidders were offered a sweetener to build the roads or bridges on a tight budget and timeline and were allowed to compensate themselves from the returns when the projects become operational by, for instance, charging tolls.

But because many contractors were leery about collecting tolls or levying user charges, NHAI offered assured returns of up to 40 per cent of the total project expenditure, payable over, usually, 10 years. The contractor had to arrange the rest. Unsurprisingly, contractors inflated projections, effectively pocketing more money. Projects often came up late even as the government’s bill mounted.
 

The railways, urban development and a clutch of other ministries were also in favour of adopting the model as part of their infrastructure build-up plans but the finance ministry has put its foot down. A chastened NHAI not only now asks the contractors to show how much the project construction will cost, but it has also begun to use drones and satellite triangulation to monitor the pace of the progress.
 

More salient is another step the finance ministry has insisted on. In June 2022, it said the past experience of the contractors has to be checked before issuing tenders. In fact, this order was first issued in 2017, but has been revised and made mandatory for implementation by Finance Secretary T V Somanathan last year.
 

The new paradigm for infrastructure projects suits companies like L&T, RVNL, Adani or RIL. An EPC project begins life with a 20 per cent upfront payment contract offered by the bidding agency. Subsequent payments are linked to achieving project milestones that can be monitored by technology.
 

Most importantly, bidders need to hardly raise any debt. Why? Take a look at RVNL’s balance sheet, for example. It has a reserve of Rs 3,546.39 crore (as of March 2022). According to a BSE filing on January 5, 2023, the company won a project worth Rs 166 crore from Gujarat Metro Rail Corporation (GMRC) for a segment of the Surat Metro Rail. The company was helped by the size of its reserves to offer a comfort to GMRC that it has enough cash to run the project. But since the payments will be linked to achieving the milestones RVNL hardly needs to break into a sweat. A week earlier, it was appointed the project implementation agency for development of the UTF Harbour Project in the Maldives for Rs 1,544.60 crore. RVNL’s short-term borrowing is just Rs 279.95 crore. Both NBCC (Rs 1,594.75 crore cash reserves) and RVNL expect to remain near zero-debt companies, a fact that has not escaped their private sector competitors.
 

“The EPC market continues to be strong as more manufacturing continues to shift to the private sector in India due to global supply chain issues,” said Vinayak Pai, managing director, Tata Projects. The company is building three refineries in Rajasthan for a state-owned refiner and is involved in the construction of the new Parliament building and the Central Vista project.
 

These are some of the reasons RIL has decided after several decades to enter the construction business on its own balance sheet. The turnover of its subsidiary Reliance Projects and Property Management for the financial year ended March 31, 2022, was Rs 43,071 crore, the company noted in its statement. But on the mother company’s humongous cash reserves of Rs 4.67 trillion (as of March 2022), much larger projects can be targeted now.
 

The change has been aided by the rapidly expanding scope of the Infrastructure Investment Trusts (InVIT) market. In this market, earnings from built assets such as roads or railway stations can be monetised by government departments. The returns from tolls or other user charges such as airline parking slots can be used to pay for the InVITs. The National Monetisation Pipeline puts the responsibility on government departments to find buyers, making infrastructure building a safe option for India’s corporate giants to dabble in.

MODEL CHANGE

• Under the old hybrid annuity model EPC contractors were offered assured 40% returns by the bidding agency (such as NHAI) payable over 10 years
• In turn contractors inflated project cost and delays became endemic, adding to the government agency’s debt (NHAI, for instance, has racked up debt of Rs 3.3 trillion)
• Under the new model the bidding agency will pay the EPC contractor 20% upfront
• Subsequent payments will be linked to achieving milestones that can be monitored by drones, etc.
• This is a low-debt model that suits companies with strong balance sheets such as L&T, RIL, Tata group, Adani, RVNL and NBCC
• Projects will be awarded only to those with a proven track record, a stipulation introduced in 2017 but enforced in 2022