The roads & highways sector is on a resurgent path, with fresh government initiatives for revival of projects, and new models such as hybrid annuity are expected to boost investor sentiment.
At a little under 5 million kilometres, India has the second largest road network length in the world, which ranks it next to the US, followed by China that is placed third. However, as the network is a combination of modern highways and dirt roads, India has scope for tremendous improvement. For instance, the country has less than 4 kilometres of road per 1,000 people, compared to the US figure of 21 kilometres per 1,000 people. Similarly, according to Bloomberg data, only 60 per cent of roads in India are paved, compared with 87 per cent in China.
Road construction in India got a boost with the launch of the Golden Quadrilateral in 2001 as the first phase of the National Highways Development Project (NHDP). The project culminated in 2012. Thereafter, road modernisation literally hit a roadblock, slowing down to a paltry 3 kilometres daily at the time of the NDA government assuming office in May 14, 2014.
Construction of roads and highways hit a logjam on account of three main reasons. The first relates to cost over-runs, whether related to delays, change in commodity prices or change in scope. Secondly, incorrect assessment of toll revenues owing to a variety of factors including incorrect assessment of base traffic or traffic network such as alternate roads, over-loading and growth forecasts. And, thirdly, incorrect or aggressive bidding.
On assuming office, the new dispensation had proposed a target of 30 km of roads per day between May 25, 2015 to May 26, 2016. This has now been revised to 41 kilometres for the corresponding period this year. There has also been substantial improvement in national highway project execution and per-day road construction during the year 2015-16, which was about 20 km per day compared to about 16 km per day in the previous year. The government would eventually like to double the length of national highways to 200,000 kilometres. It also proposes to sign road projects totalling nearly 25,000 kilometres by 2017. However, as experts point out, a lot depends on expediting the bidding process and award of projects.
A concerted attempt is also underway to improve connectivity in the North East. In Assam, projects worth Rs 40,000 crore are already underway. Norms have also been made more flexible in order to encourage participation by local contractors in the region as well as other hill areas of the country.
The government also plans to convert roads in certain remote areas for both military and commercial aviation. The move would not only help enhance connectivity, but also bring down the cost of building new runways. Areas bordering China would especially benefit from this exercise. In 2015, the Indian Air Force had test-landed a Mirage 2000 aircraft on an expressway near Delhi in order to evaluate the viability of using national highways as airstrips during emergencies.
The activity in the Indian highways sector started reviving in the 2015-16 period. Abhishek Tyagi, Senior Analyst, Moody´s, told Infrastructure Today from Singapore, ¨The bulk of the new activity over the last two years was driven by engineering, procurement & construction (EPC) projects as compared to build, operate, transfer (BOT) projects. This was reflective of the weakness in the public-private partnership (PPP) framework and poor financial health of the private sector participants in the sector. The government thus came out with initiatives to develop the sector including the Hybrid Annuity Model (HAM), which has seen private sector participation in recent times.¨
Tyagi asserts that the present momentum is likely to sustain with the government identifying a pipeline of projects which needs to be developed under various models such as EPC, BOT or HAM and return of risk appetite of the private sector together with changes to the PPP framework.
The return of traction in the roads and highways sector can be gauged from the rise in consumption of material and sales of road construction equipment.
In a recent media interview, Raghav Chandra, Chairman, National Highways Authority of India, signalled that private sector investment has risen to nearly 40 per cent more than what it was in 2014-15, in the April to July quarter. Government sector spending is also up in the same period. Similarly, sales of road construction equipment have gone up significantly. Compared to last year, cement sales too have increased by 5 per cent this year. Similarly, bitumen production has also improved. The big players in the business are reportedly returning to the bidding process, albeit slowly.
¨We intend bidding out about 30,000 km of road projects over the next two to three years,¨ Chandra said at an industry seminar in New Delhi recently. These include several greenfield projects such as the Delhi-Jaipur, Lucknow-Kanpur, Hyderabad-Bengaluru and Delhi-Jammu links. This year alone, NHAI has bid out 10,000 kilometres of highway projects.
The national highways regulator is also identifying projects to connect export hubs to important ports. ¨We´re looking at creating an economic bridge of projects to identify roads connecting export markets with ports, or with other important economic destinations. For instance, we may look to connect Moradabad with the mainstream or Agra to Mumbai, Mumbai to Kolkata. We will build road connectivity which brings out greater economic competitiveness of our highways,¨ Chandra had remarked at the same event.
The government plans to connect the industrial corridors of Delhi-Mumbai, Amritsar-Kolkata, Chennai-Visakhapatnam and Chennai-Bengaluru with ports, in its bid to virtually create a conveyor belt.
The regulatory changes undertaken by the government have helped in removing the earlier logjam as well as attracting investment into the sector. States Srishti Ahuja, Director, Transaction Services, Ernst & Young, ¨Today, there are multiple secondary transactions happening in the sector as 100 per cent equity divestment was allowed. This in turn is creating liquidity for the developers. These developers can use the capital so released to execute partially completed projects. At the same time, the financial investors who are buying completed projects are able to bring in efficiency in operations and higher standards of maintenance into operational roads.¨ This has also enabled financial investors to also channelise new capital into the roads sector. Adds Ahuja, ¨Another good example is the Hybrid Annuity Model (HAM). As the BOT (toll) tenders were getting tepid response from the private sector, NHAI introduced a new BOT model to bring back interest. Today, HAM tenders are seeing robust bidding with six to eight bids for each project.¨
Says Vikash Kumar Sharda, Director, Capital Projects & Projects, PwC, ¨The sector is certainly on a recovery path with government initiatives with respect to revival of projects already awarded and new models such as hybrid annuity are expected to boost investor sentiment especially among lenders due to obviation of toll revenue risk. This would help developers with available capital and can enhance participation in bidding for new projects.¨
He adds that the efforts towards revival of troubled projects are expected to take time before positive outcomes are visible. ¨The recent tightening of lending norms by RBI is likely to have an immediate negative impact on the sector due to reduction in limits on group exposure,¨ he says.
Are Lenders Wary?
A report published in Financial Express citing unnamed sources claims that with bankers wary of lending to the roads & highways sector, none of the projects awarded by the NHAI under HAM appear to have achieved financial closure so far. Although rules stipulate financial closure to be achieved within 150 days or five months of the date of the concession agreement being inked, given their mixed experience with the BOT model, banks and financial institutions are reportedly treading cautiously on loan applications received from developers.
With 40 per cent of the project cost being contributed by the NHAI, the concessionaire equity contribution in a project is reduced to merely 15 per cent of the remaining 60 per cent or effectively 9 per cent on a proportional basis. The lenders have cited this contribution on part of a promoter as way too insignificant to merit risk-taking on their part.
By introducing the HAM, the government has sought to balance the risk among various stakeholders. However, a few issues still need to be ironed out in order to mitigate risks and support projects. Opines SK Agarwal, Senior Vice-President, SBI Capital Markets, ¨The key issue regarding a no-termination payment during the construction period has been resolved substantially. However, some areas to be addressed include five milestone payments by NHAI during the construction period going up to 90 per cent project completion; no termination payment till 40 per cent construction and only 65 per cent of due debt being covered post-completion; deemed performance guarantee having prior charge over lender dues; and, interest on annuity payment at bank rate, plus 3 per cent when bank rate is not reflective of interest on loan.¨
Says Agarwal, ¨There are, as such, no constraints in financing of infrastructure projects in the roads & highways sector, provided the same is backed by a good promoter, is well-prepared in terms of land availability, clearances, etc., and suitably structured without aggressive leveraging.¨ He is quick to add that there is a need to improve the overall financing climate.
Public sector bankers that Infrastructure Today spoke to off the record pointed out that they, in general, are not very keen to support long-tenor infrastructure projects given the past experience where a large number of loans have become stressed or restructured or turned into NPAs owing to various implementation risks. Early resolution and learning from past experiences would go a long way in this regard. While there have been intensive efforts made by the government, more is required to be done.
Another big constraint is the financial health of EPC companies. Immediate measures need to be taken to address their issues to ensure that creditable EPC contractors whom banks can support are ready to participate in bidding for projects in the roads & highway sector.
So what could be some of the innovative financing tools for the sector? ¨Innovation in financing for infrastructure in general, including roads, has already been brought with the concept of loan life being linked to 80 per cent of the economic life of the project, with financing under the 5/25 approach. The same allows a proper tenor with regular refinancing options, including accessing the bond market as and when the rating reaches appropriate levels. Generally, there is a need for proper structuring of repayments, suitably aligned with cash flows and with an adequate safety margin,¨ points out SBI´s Agarwal.
The government has already initiated measures for a Credit Enhancement Institution. The same will help in improving rating of greenfield projects, allowing them to access the lower cost bond market. In addition, banks are now also being allowed partial credit enhancement.
The Reserve Bank of India has come out with guidelines limiting the group exposure norms which are also likely to affect roads and highways. PwC´s Sharda suggests, ¨The banking regulator can think of removing certain operational special purpose vehicles with zero revenue risk from the purview of group exposure limitations, so as to enhance lending bandwidth to developers.¨
Nitin Gadkari, Minister for Road Transport & Highways, has admitted in several forums that the decision making process vis-a-vis infrastructure development needs to be expedited, as presently several processes were taking anywhere from three to four months to achieve clearing.
More than the policies, there is a lot of scope for improving the execution and project management from the government perspective. There is a need for better preparation of projects. Experts welcome the fact that the bidding process for a PPP road project cannot commence without 80 per cent of right of way (ROW) under possession. Similarly, the government speeding up clearances is also likely to increase the speed of infrastructure delivery. Says Sharda, ¨The government can also think of creating a single-window system for road sector-related approvals. There is also a need to improve the current arbitration process, because even after an award in favour of a developer by the panel unanimously, claim amount has not been paid and the award has been challenged in court. The entire process of arbitration and litigation should be resolved in a time-bound manner through a separate policy mechanism.¨
Adds Ernst & Young´s Ahuja, ¨The biggest relief for the sector will be a more efficient dispute-resolution mechanism. Any delay in projects quickly adds to project cost, and therefore dips into the project returns; hence, an effective framework to ensure that project execution timelines are not stretched for want of decision making is the key.¨ She adds that other areas meriting attention include need for transparency in land acquisition status, timely release of funds in case of change of scope and, similarly, timely disbursement of grants and annuities.
Ahuja also points out, ¨One aspect affecting viability that has caught everybody by surprise is inflation. In India, the toll rates continue to be pegged to the Wholesale Price Index (WPI), though it is no longer reflective of the actual inflation. It may hold the sector in good stead to gradually migrate to the Consumer Price Index (CPI) as the inflation indicator.¨
In terms of award of project, we may soon see that the private players with the necessary financial resources today may pick a few projects and then have limited appetite for new projects. Experts, therefore, feel that it is imperative to get international developers to again start investing in the Indian roads & highways sector, in a market that is presently dominated by domestic players. This makes it necessary for the government to take tough decisions on troubled projects under construction, as there is a need to facilitate entry of new investors using concession provisions. The NHAI too needs to bite the bullet in certain cases with termination if a contract fails and quickly rebid the project by changing the terms if necessary.\ As the nodal agency of the Ministry of Road Transport and Highways, it also needs to work with the lenders and undertake substitution or change of developer or contractor, where projects are found to be languishing.
- Manish Pant