Infrastructure could witness a rebound in prices

The sector is so beaten-down that select stocks can be multi-baggers

The construction industry has been in trouble for three years. Construction employs over 40 million people, many of them semi-skilled or unskilled and often in temporary jobs. An agricultural labourer looking for a change is very likely to be absorbed into construction. The industry also contributes a large share of GDP - estimates vary from 6-12 per cent of GDP. It is the biggest consumer of industrial materials such as cement, steel, bitumen, etc.

The industry is in trouble because its two big customers are both in trouble. One is the real estate sector, which has been struggling to cope with low demand and high interest rates. The other major customer - the larger one - is the infrastructure sector. Every project involves some construction and in most cases, construction is the largest cost-item in an infra project. In fact, many construction firms have transformed themselves into infrastructure developers.

The infrastructure sector has stalled for multiple reasons. One is a lack of financing, or very high-cost, high-risk financing. Projects are capital intensive and long gestation. Rupee interest rates are very high. Overseas borrowings are low-interest but fraught with risks due to the currency volatility.

Another cause for the slow pace of activity is the complex processes of "statutory clearances". Land acquisition is tough in itself; getting permission to start a project involves getting clearances from all sorts of agencies and ministries. This can take years - or it may never happen. And then, there's also policy. Flip-flops and ambiguities have scarred developers. Almost every sector has been hit by unpredictable changes in policy and there have also been multiple disputes as a result.

Over Rs 3,00,000 crore (Rs 3 lakh crore) worth of investment is stuck in projects, which are awaiting some clearance or another. Many would-be promoters have entered the infrastructure business and realised that they don't want to negotiate this logjam after bitter experiences.

Alternatively, developers have built the political connections required to influence policy and accelerate processes. That has led to corruption and opaque deals. The result has been infrastructure built at non-viable costs with under-the-table expenses invoiced into tariffs. Or it has led to the massive capture of natural resources. Neither outcome is desirable. The backlash has been loud and justified accusations of scams and further turmoil with the resulting criminal charges and litigation. Given the logjam in the Indian justice system that has meant stasis.

Construction and associated industries like steel and cement are not the only sufferers due to the slowdown in infrastructure. Banking and the financial sector has been hit very hard - the bulk of the sticky loans in the banking sector are in some infra sector or another. In fact, the entire economy has been hit. Vast amounts of capital are locked up; the capacity that locked-up capital was supposed to create has not been created; growth has slowed as a result.

The impact on the stock market has been severe.

The CNX Infra index is a collection of 23 large listed companies, all of which are also traded in the derivatives segment.

This includes five construction-developer majors, 11 energy businesses across oil, gas and power, four telecom companies, one private port and three capital goods manufacturers. The index shows how hard infrastructure has been hit.

The CNX Infra is down 12 per cent in the past year, down 33 per cent in the past three years, and down 12 per cent over the past five years.

How long can this situation go on? If infrastructure is crippled, the overall economy performs like a car being driven with the handbrake on. The impending elections have led to some high-level clearances being obtained for some stalled projects.

But the market has lost faith in government. Very little money will come in and many projects will remain on hold until there is a change in the central government. Even then, there will need to be some credible assurances of speed and consistency in policy-making at the central and state levels before enough confidence returns.

Is it worth betting on the resolution of such a messy situation? I think so, purely on the basis of sunk cost. Investors who are already stuck in stalled projects will be prepared to spend some more money to rescue their investments. If there is money available, politicians and bureaucrats may find ways to get things moving again. It may take time and turnarounds will be uneven. But the sector is so beaten-down that prices could rebound with multi-bagger effects.