Rising commodity prices risk raising costs for India's infra plans

Commodity super-cycle may upset plans for national infrastructure pipeline, raise expenses for Railways

Inflation will likely hurt as commodity prices rise. The wholesale price index for basic metals and manufacturing has been mimicking metal prices. Rising commodity prices will hurt India's national infrastructure pipeline project, where the government plans to invest Rs 114 trillion (Rs 114 lakh crore) by 2024-25.

“Structurally, copper and aluminium are bubbling with the possibility of a super-cycle given high potential demand arising from greenification policies amidst lethargic supply, but in steel, the recent rally holds less steam beyond 1-2 quarters. Steel demand growth shall moderate on a high base of last year in China as iron ore prices also correct,” Isha Chaudhary, Director, Crisil, told 'Business Standard'.

A commodity super cycle is a sustained period of strong demand growth that producers struggle to match, sparking an increase in prices that can last years.

Determining the impact of a super-cycle is difficult. Commodity usage differs across sectors. Indian Railways requires more steel for construction than the roads and highways sector. The impact of a super-cycle could be higher for Railways projects than roads.

Project reports give little insight into the composition of commodities required for construction, allowing a way to adjudge this is to examine cost overruns.

Every quarter, the government releases a report on the performance of infrastructure projects over Rs 1.5 billion (Rs 150 crore).

“A sharp rise in commodity prices runs the risk of inflating the cost of ongoing projects and rendering them unviable. Large infrastructure projects (>Rs 1.5 billion) of Central Government over the last two years have consistently recorded cost overruns of nearly 20 per cent (versus the last sanctioned limits); dominated by projects in sectors of steel, telecom, power & water resources," said Yuvika Singhal, economist at QuantEco Research.

Government reports highlight that the cost overruns over the last two years have averaged 20 per cent. Moreover, an analysis of historical patterns shows that cost overruns tend to inch higher when commodity prices are rising.

Delays in land acquisition, time overruns and rising commodities prices are common causes of projects turning out more expensive. While India has been able to reduce the overrun component, it still tends to be too high.

Until March 1999, nearly all projects faced cost overruns. The state of planning was such that projects would extend well beyond their time and, on average, would be completed at 41 per cent higher cost than the original estimate.

But, by 2006, the use of technology and better monitoring techniques brought down the total cost overruns to 17 per cent. As prices of commodities dipped starting 2007—owing to the downcycle in the US—anticipated costs were reduced to 12 per cent.

A rise in commodity prices pushed this back up again. And, by 2011, at the height of the last commodity supercycle, cost over-runs had again increased to 18.69 per cent.

And, over the last three years, as countries have been making more infrastructure commitments cost overruns have been rising again.

A 'Business Standard' analysis finds that every time commodity prices edge up, there is a 36 per cent increase in the cost overruns experienced by the economy.

Assuming that the 2020-21 commodity super-cycle continues, then cost could rise to 27 per cent from 20 per cent until March 2021.

A 27 per cent increase across all infrastructure projects would end up incurring an additional cost of Rs 8 trillion (Rs 8 lakh crore) for the entire Rs 114 trillion (Rs 114 lakh crore) National Infrastructure Pipeline.

This projection is estimated on the fact that prices will increase at a similar pace to the last cycle and will stabilise at these levels.

The analysis assumes that the cost over-run across sectors would be similar, but this usually doesn’t happen.

An analysis of cost overruns across sectors shows the Railways projects tend to attract higher cost over-runs than other infrastructure projects. Until March 2021, for instance, while the average cost over-runs were 19.8 per cent for all infrastructure projects commissioned by the government, for Railway projects, the overrun was 51 per cent.

Historically, analysis indicates a lower 30 per cent increase in Railways' cost overruns (for the entire infrastructure sector, the corresponding increase was 36 per cent) associated with a rise in commodity prices. However, a 30 per cent increase on a high base of 51 per cent translates into a cost overrun of 66.3 per cent.

Railways accounts for Rs 14 trillion (Rs 14 lakh crore) of investment in the National Infrastructure Pipeline. If the cost overruns for Railways remain at similar levels, then a 15.3% additional expense would add Rs 2.14 trillion (Rs 2.14 lakh crore) to the original capex. Coupled with the 7% additional cost for other infrastructure projects (27% cost overrun against 20% base) under NIP worth Rs 100 trillion (Rs 100 lakh crore), this would translate into a total additional capex of Rs 9.1 trillion (Rs 9.1 lakh crore).

If the government doesn’t find ways to minimise costs in land acquisition or curb time delays, the commodity super-cycle may cost a lot.