One of the biggest reasons for the slowdown in India has been the lack of spending, both in the government and private sector. While the private sector has not invested on account of declining demand and higher cost of doing business, the lack of government spending has been blamed on policy paralysis. This is apparent in the infrastructure sector, which has been stretched to its limits. However, within this space, there are certain areas which have seen a good amount of work. Awarding of road contracts was one such area.
Road contractors have received 16,375 km of orders from National Highway Authority of India (NHAI) over the last three years at an average of over 5,000 km per year. But this fast pace has now hit a brick wall.
A Business Line report says that the finance ministry has asked public sector banks to disburse loans only after National Highway Authority of India or state governments have acquired 100 per cent right-of-way for road projects. Currently, NHAI awards the project even if it had acquired 85 per cent of the right-of-way.
The Business Line article defined “right-of-way” as an area of land over which people and goods have the right to pass or travel. It describes the right to pass through land owned by someone else for a specific purpose.
While the finance ministry’s concern is on the deteriorating health of public sector bank financed road projects, the overall pace of road construction can be impacted.
There are signs that the boom in road construction was not what it was made out to be. Encouraged by the response over the last three years, NHAI had fixed an ambitious target of 9,500 km for FY13. But till date it has only been able to award only 560 km of order.
Citi in its report on India Infrastructure titled “Scouting for Opportunities in Road, Airports and Port Sector”, says that this is on account of a general lack of interest among bidders. In other words what the report is saying is that there are no takers for road projects.
Citi says that this could be because most of the contractors have bagged a number of projects which are under different phases of implementation and thus are not keen on adding some more. While capacity constraint has never really stopped a construction company earlier from bidding for orders, the real reason seems to be lack of funds and the return generated on it.
Citi’s report adds that banks are near their sector limits as far as funding road projects go. Finance is scarce as well as costly. Equity is the only other option of funding, but the current market scenario does not augur well for these companies to raise funds.
More importantly in the mad rush to bag orders, contractors aggressively bid for the orders pushing down IRRs (internal rate of return) for their projects. Also, their assumptions of traffic growth were very optimistic. Of the ten Fitch rated road projects, eight were witnessing, on an average, around 20 per cent lower than anticipated traffic with the maximum being 45 per cent lower. Out of the remaining two, only one had around 35 per cent higher traffic while the other one matched expectation.
Along with these, delay in commissioning, higher interest rates and other increases in project costs have resulted in an erosion of IRRs of these projects.
So is the road construction story over? If there is no money to be made who will construct roads? The stretched balance sheets of small to mid-size companies do make it difficult for them to bid for the projects. Unless the funding mechanism or the method of awarding such projects is changed, it does look like the end of the road for these construction companies.
There is a little light at the end of the tunnel though. NHAI seems to have taken the scarcity of funds into account and is planning to award 3,000 km of road orders on an EPC (engineering, procurement and construction) basis. These projects will be funded by NHAI, but the profitability in these projects will be low. The success of this 3,000-km order will decide the outcome of road projects as well as the future of small to mid-size companies going forward.
