Roads: Opportunity for new players?

The need of the hour is positive policy making from government while private sector should contribute by innovation and informed risk taking, writes Sudhir Hoshing.

Indian roads sector is undergoing an evolutionary phase where the government is putting forth several public-private partnership (PPP) models (such as BOT, EPC, OMT, etc) in order to attract the interest of private players for efficient and effective development of the backbone of the nation’s economy. In terms of number of projects, roads and highways are emerging as the favoured destinations for PPP with 53 per cent projects in PPP from road sector.

Sector challenges

The sector, however, witnessed several constraints and financial stress due to inordinate delays in land acquisition, long-winding processes for obtaining statutory clearances, revenue leakage due to toll non-compliance, economic slowdown, etc. These problems led to investors shying away from bidding for any new projects in 2012-13.

The average number of bidders in 2012-13 was five, with 13 projects attracting no bidder at all. This is clearly a drastic drop over the average of 20 bidders during 2011-12. Given drying up of equity markets and lenders apprehensive to lend to the sector, weaker players will find it tough to raise funds. Out of the 32 national highway projects awarded during 2011-12, 18 projects have not succeeded in obtaining the financial closure. The number of projects failing to achieve financial closure further shoots up to over 30 considering projects awarded in 2012-13 as well.

Government response

The government began deliberating on various measures to revive the waning investor interest and put the sector back on the growth path. Alternative sources of project funding are being explored by the government including, but not limited to:

100 per cent government funding through EPC contract, since there are very few takers for BOT projects due to equity crunch.

Encouraging credit enhancement schemes being introduced by companies like IIFCL: Under such schemes, the institution provides partial credit guarantee to enhance the ratings of the project bond thereby enabling channelisation of long term funds from fairly untapped sources such as insurance companies and pension funds etc.

Exploring funding through Infrastructure Debt Funds: The IDF would seek to raise debt capital from domestic as well as foreign resources and invest in projects under the PPP model that have completed a year of operations.

In addition to the above, the government considered a slew of measures to revive the sector, such as:

Grant of partial COD if 75 per cent construction is complete and balance is stuck due to land acquisition issues: Provisional Completion Certificate shall be issued by Independent Engineer/ NHAI for the portion completed and the concessionaire shall be permitted to do partial tolling on the completed portion.

Linkage of NHAI-estimated Total Project Cost to Wholesale Price Index: Usually there is a variation between government’s project cost estimates and developer’s estimates due to cost and time over runs between the initial bid and award stage. This would substantially reduce with the inflation-indexed mechanism being considered by NHAI to appraise Total Project Cost (TPC). NHAI guarantees 90 per cent payment of debt to the lenders in case of termination but it recognises only its own TPC. So, banks have greater risk in lending for a project where the TPC is higher than the NHAI estimate. Termination payment in inflation-indexed mechanism would however be inflation-adjusted, thereby adequately addressing the risk of lenders.

Delinking environment and forest clearances: Proposals of over 20 highway projects, which had already been recommended for environmental clearance last year, are stuck because forest or tree cutting clearances had not come through. Construction work can now begin on these stretches and NHAI can start allowing commercial operations date for four-to-six laning projects, a move that will allow developers to start collecting tolls. Extension of time required to achieve financial closure: The concessionaire is liable to gather its funds for the project within 180 days of the date of awarding the project. If it fails, it can request for a grace period of 120 days more after paying a penalty. However, beyond that, if the firm is unable to submit its sources of funds, the project stands cancelled. It is then either rebid or awarded to the second lowest bidder. NHAI has in some instances allowed the concessionaire more than 300 days for financial closure, where the project was stuck due to reasons beyond the control of the concessionaire. For example, in case of Kota-Jhalawar highway project in Rajasthan which was stuck due to delay in securing statutory clearances, NHAI extended the deadline for financial closure beyond 300 days.

Consideration of loans extended to highways sector as secured loans: The finance ministry has urged the Reserve Bank of India to consider a change in its stance that treats loans to road projects as unsecured, as this makes banks wary of lending.

Early exit options for highway builders after completion of construction: Under the norms in place since November 2009, developers must hold at least 26 per cent of equity up to two years after the COD. The ministry is examining the possibility of easing such restrictions and consequently freeing up equity capital of the developer locked in operational projects. While the move is intended to clear ground for new investors in the funds-starved sector, the departments of economic affairs and expenditure of the finance ministry feel that non-serious investors wanting to make quick capital gains could misuse the proposed facility.

Consolidation phase & opportunities ahead

Of late, the sector seems to be headed towards consolidation with several developers looking to divest their stake in BOT projects. GMR recently sold 74 per cent stake in its subsidiary, GMR Jadcherla Expressways. SBI Macquarie, Uniquest Infra Ventures (Malaysian government sovereign wealth fund Khazanah Nasional Berhad and IDFC JV) are noted to have expressed interest in many road projects. Such secondary market deals would offer a good proposition to buyers having adequate funds to take on the projects. Availability of 50 road projects worth Rs 50,000 crore totalling 5,000 km are on the block in the secondary market with no takers for most of these projects.

Further, as per announcement on Budget 2013, most of the proposed 3,000 km of highways would be awarded on EPC basis. There are many regional players who have expertise in EPC but they shy away from BOT projects as they are not in a position to block their investment for 20 to 30 years and face traffic risk. These regional players will look for EPC opportunity in the areas where they already have their resources mobilised. Thus, they could benefit from EPC projects of size less than Rs 500 crore, where they could earn good returns due to regional presence. The ministry is looking to award projects on Operate, Maintain and Transfer (OMT) basis. A model concession agreement for operation and maintenance of national highways through private players on OMT basis has already been approved. The OMT model is very similar to the Build, Operate and Transfer model except that in case of the former, instead of construction, operation and maintenance, the private entity’s responsibility stands confined to just operation and maintenance of highways.

However, the recent OMT projects that were out for bidding had capex ranging from Rs 50 crore to Rs 100 crore and equity commitment of at least 33 per cent stake during the entire concession period keeps small players, having the requisite expertise, from participating in such projects. This means that pure service providers without balance sheet strength will not be able to participate in such projects, especially given shorter concession period.

Overall, the opportunities are difficult to identify and serious players who can withstand the challenges will be able to survive. The need of the hour is positive policy making from government while private sector should contribute by innovation and informed risk taking.