Roads on a Hot Streak

Sustained government thrust through policy changes, investments and proactive addressing of nagging issues, has placed the roads sector in what could be its best growth trajectory yet. If the progress on key parameters is any indication, growth would remain elevated and sustain well into fiscal 2022.<br />
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The revival began with the National Highways Authority of India (NHAI) awarding 3,091 km of highway projects in fiscal 2015, which is almost double that of the 1,522 km awarded the preceding year.&nbsp; <br />
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The momentum held through fiscal 2016 with the kilometre length awarded by NHAI rising by 40 per cent. During this period, non-NHAI projects awarded by various other departments of the Ministry of Road Transport and Highways also rose substantially.<br />
In fiscal 2017, projects awarded by the NHAI flatlined at 4,337 km, which is a touch short of the previous fiscal. This was due to delays in the financial closure of projects awarded on hybrid annuity mode (HAM).<br />
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However, the government has actively been addressing issues such as delays in land acquisition and environmental clearances, tendering of projects with low traffic density and weak financials of private players that had throttled growth between fiscals 2012 and 2014. Hence, both project awarding and execution are expected to improve from here.<br />
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<span style="font-weight: bold;">Policy reforms and budgetary support to boost execution</span><br />
CRISIL Research expects investments by NHAI between fiscals 2018 and 2022 to be two to three times of that in the past five years. The government will continue to account for more than half of these investments. However, the ability of private sectors to fund the remaining proportion by raising debt externally will remain monitorable.<br />
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In the past two years, the government and the NHAI have implemented policies such as fast-tracking environmental clearance, delinking forest and environment clearances, increasing the limit on sand mining and enabling online filing to obtain clearances to construct rail overbridges and underbridges. On its part, the NHAI has, over the last two years, tried to ensure that at least 80 per cent of the land is in possession when projects are awarded. <br />
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<span style="font-weight: bold;">Hybrid annuity model to dominate</span><br />
The hybrid annuity model (HAM) which comprised over half of NHAI’s awards in 2016v17 is expected to remain steady in fiscal 2018.<br />
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As of June 2017, 44 projects aggregating 2,780 km had been awarded, of which 26 had achieved financial closure. At least 10 projects had crossed the limit of 150 days within which financial closure is required, and three projects have been terminated due to failure to secure funds. <br />
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Bankers are hesitant to provide funds to lesser-known developers, as promoter equity in the project is only 12 to 15 per cent and can be even lower in the case of projects that were bid out considerably above NHAI’s estimated cost. We, however, believe that projects awarded to developers with a good track record should not face issues in securing funding.<br />
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<span style="font-weight: bold;">Cost overrun </span><br />
Unlike in a build-operate-transfer (BOT) toll model where the developer can anticipate higher toll revenues in future, revenue in a HAM project is pre-determined as a proportion of the bid project cost. Hence, any cost overrun during construction can severely impact the developer’s returns. <br />
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This, coupled with the fact that the developer’s contribution in a HAM project is quite low, can significantly increase probability of concessionaire default in the event of cost overruns.<br />
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<span style="font-weight: bold;">Competition in HAM to remain low</span><br />
Competition in HAM, which had increased significantly in the first half of fiscal 2017 (from two or three bidders in January 2016 to 10 bidders in August 2016), has reduced to four or five bidders in March 2017. This is because the cautious approach of the bankers has made it difficult for smaller players to secure funds.<br />
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<span style="font-weight: bold;">HAM to be offered in state projects too</span><br />
Private participation in state road projects is expected to remain steady. Currently, 12 to 15 per cent of the total investment in state road projects happens through the publicvprivate partnership (PPP) route. <br />
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Gujarat, Madhya Pradesh, Maharashtra and Rajasthan are expected to lead the way in implementing state highway projects through the PPP route.<br />
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Maharashtra and Karnataka have already released tenders for development work on the HAM model, whereas Madhya Pradesh has floated tenders for preparing feasibility study reports for projects to be awarded on HAM basis.<br />
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<span style="font-weight: bold;">New funding mechanisms to support project execution</span><br />
With public investment constituting a considerable 57 per cent of the total investment in national highways, the funding needs of the NHAI, the key implementing agency, is set to rise. While cess used to be its biggest source of funding, the model is undergoing a change with NHAI supporting project execution through higher external borrowings.<br />
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LIC agreed in-principle to subscribe to NHAI’s taxable bonds to the tune of Rs 250 billion over the next three to four years. In fiscal 2018, NHAI has raised Rs 30 billion on the London Stock Exchange as well in the form of masala bonds. <br />
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<span style="font-weight: bold;">NHAI actively pursuing TOT model</span><br />
NHAI has introduced a new model v toll-operate-transfer or TOT v to raise funds. CRISIL Research estimates that the TOT model can result in an inflow of about Rs 400 billion over the next three years. NHAI floated the first bundle of nine projects in Andhra Pradesh and Gujarat in October 2017 and expects to float at least one more bundle before March 2018.<br />
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<span style="font-weight: bold;">- Binaifer F Jehani, Director, CRISIL Research</span><br />