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Engineering, Procurement and Construction (EPC) projects do have certain advantages which amount to lesser amount of risk for the private company. While a successful EPC road project, the partnership between the contractor and the government, practitioners say repair work is badly needed now, or project failures will cost us dearly.
Abhijit Avarsekar, VCMD & CEO, Unity Infraprojects, a leading civil contractor in India who has successfully completed some of the most challenging infrastructure projects in the country.
Santosh Rai, Head - Transport Sales, HCC, which has successfully completed the Pir Panjal tunnel project recently.
Satish Parakh, Managing Director, Ashoka Buildcon, which has been selected recently for development of road projects in Tamil Nadu.
Goutham Reddy, Executive Director, Ramky Infra, a leading infrastructure developer in multiple domains.
SM Ramchandani, Joint MD, MSRDC, the road development agency of Maharashtra.
Will private players choose EPC over BOT in road projects?
In the current scenario where equities have dried up, companies prefer enginee¡ring, procurement and construction (EPC) over build, own and transfer (BOT) but this will be short-lived until the equity markets pick up. Private players stopped themselves from BOT projects, especially in road sector because risk mitigation time horizon in EPC model is much shorter than BOT. On the other hand, BOT projects need deep understanding of risk management in terms of planning, execution, mobilisation, resources and profitability because of their larger period of operations. BOT model projects have their own sets of difficulties like high interest rates, land acquisition and permissions, lower than estimated traffic level, challenges of achieving financial closure, lenders demanding more equity stake, financial crunch, etc.
We believe that both EPC and BOT are separate business models and the private player will distinguish the two. General contractors will always like to be in the EPC space whereas developers would always like to seek a role in BOT opportunities.
The debate on EPC vs BOT cannot be very conclusive. As a matter of fact, both sectors differ in so many respects that weigh¡ing them on apple-to-apple basis is not justifiable. While EPC refers to construction of a project in defined parameters, BOT projects is related to a joint partnership between the government and the private player in an attempt to initiate infrastructure development.
We have all seen the impact the BOT-based projects have brought on the status of highways and roads in our country. Not just that, when the condition of our roads improved, all sectors that were directly or indirectly dependent on surface transportation witnessed a boost.
The reasons why private players have not been very enthusiastic about BOT projects are many. Yet, this should not be generalised as a complete failure for BOT concept. The basic reason is that the projects which have come up in recent times are not very viable and the risk involved is too high. Therefore, construction com¡panies prefer to opt for EPC-based projects. Whenever a viable project would be on the cards, there will be a good level of participation by private players.
Other reasons that have led to the present situation include growth uncertainty leading to traffic uncertainty, political interference, acquisition issues and delay in clearances.
Lack of coordination between central, state and local government has also played a role in deterring the private players from entering into BOT projects. Therefore, there is definitely a need to address these issues. Until such developments are seen, we can expect that private players may look at EPC projects to build their order books.
In current scenario, do you think there will be few takers on EPC model too?
I would not say that there will be fewer takers for EPC. I strongly believe that there will be adequate demand for EPC as BOT certainly has a very constrained time. Given that scenario almost all road developers are struggling and cash flow committing equity is a bigger challenge for them. Thus I think EPC will take the position on road sector and players will participate.
EPC model is not being able to attract investors mainly because of the clearance issues. Clearances from various ministries take time which in turn delays the completion date of the project.
Hence, the toll collection date also gets postponed and the whole economics of the investment comes at stake. That is the reason why there is much lesser interest and responses on EPC model too.
How far will RBI's initiative be able to assure financial security of private players?
There are no tangible security loans given to roads, bridges and other public property, as these cannot be taken up by banks and sold off. But, all these projects have toll collections that can serve collaterally. There is a view that these advances should be considered secured assets. Once revenues began to come in as toll fee for use of roads and bridges, loans to them could be used as collateral, making it secured exposure. The RBI saw the logic of the Planning Commission's suggestion that loans to the sector be treated as secured.
This initiative can reduce the cost of funds for the projects and encourage investors to take larger exposures in road projects.
The various possibilities created by the government for an early exit of the developer of the road project may have more interest into the sector but cannot be the key driver for the business.
What are the pros and cons of EPC road projects?
EPC business has risk boxed in for shorter period. Risks related planning, execution, mobilisation, resour¡ces and profitability can be projected reasonably with accuracy which contributes in commissioning a project within definitive cost lines. But lack of planning, land acquisition issues, tardy execution, inadequate resource mobilisation, government clearances and design changes in midway of the project execution can delay the project resulting in cost overruns.
In EPC projects the design, engineering and construc¡tion lie with the EPC contractor, while the role for acquisition of land remains with the government. Therefore, it is a beneficial model as both the entities can perform through core role and drive efficiencies while executing such projects.
It gives the contactor enormous opportun¡ities to bring in new engineering solutions, durable designs, etc, for the client. However, for a successful EPC road project, the partnership between the contrac¡tor and the government is very important. If that is lacking, it can lead to delays in terms of delay in approval of engineering proposals, etc.
EPC projects do have certain advantages which amount to lesser amount of risk for the private company. This of course translates into the fact that the profitability is also limited to an extent. In an EPC project, the responsibility on the construction company is limited. For example, the defect liability period in an EPC highway project is of two years while it is limited to five years in case of structures. In EPC projects, the cost for maintenance in the first year is paid by the government to the tune of 1.5 per cent and to the tune of two per cent in the second year. When it comes to BOT, the private player has to maintain the project, till the end of the concession period. An EPC project is awarded to the construction company after 90 per cent of the land is acquired and all the environmental clearances are received. This saves a lot of hassles for the EPC contrac¡tor. The EPC contractor receives payment at various phases of construction, therefore the investment risk is lesser compared to BOT project. Most impor¡tantly, escalations in costs are compensated by the government.
On the other hand, EPC project has its own problems. The number of projects that can be completed on EPC basis is governed by the availability of funds with the government. Therefore, where the BOT concept brings in private funds for national development, the EPC projects will look upon the tax payers' money and government treasury for their existence.
How can more private players be attracted in roads sector again?
Road sector has been waiting anxiously for regulatory changes as it would help infuse liquidity for developers. To attract private players to road sector, the finance ministry has directed banks to lower the land acquisition requirement for disbursing loans to road projects, seeking to ease the flow of funds to the crucial infrastructure sector. The ministry asked the lenders to switch back to an earlier norm that mandated disbursal of loans to projects that had completed 80 per cent of their land acquisition instead of the current requirement of 100 per cent.
The government has also taken a step to ease lending to the infrastructure sector. In March, the Reserve Bank of India asked banks to consider a PPP infrastructure project as "secured" as long as the user or toll charges are kept in an escrow account where senior lenders have a priority over withdrawals by the concessionaire and lenders have a right to trigger termination in case of default in debt service. The move was aimed at increasing the availability of credit to the infrastructure sector at a cheaper rate of interest.
The government moves ahead with its plans to attract more foreign direct investment (FDI) across various sectors, it is also eyeing FDI in roads from China. The roads ministry has been preparing internal notes for FDI inflow to the tune of $2-3 billion. India has set a target of about $10 billion in road sector by 2015. Japan and UK are also potentially looking to invest in road sector.
We believe it is the aspect of partnership which is to be truly honoured by both the developer and the govern¡ment to make private participation in road sector success¡ful. More reasoned and logical acquisition of projects, proper and up to date market based estimation of projects, setting norms for top order PQ and the ability of government to handle the risk of land acquisition, governmental permissions and reinstate the faith of private players.
The BOT sector does have its share of problems. It is very difficult for a private player to overcome all these difficulties such as financial risks, high rate of interest, delay in land acquisition, clearances, state and local government issues frequent policy changes etc.
To bring back the private players there is a need to take concrete steps that would reduce the usual hurdles faced by the BOT operator during the construction process. The government has been working on it and we are certain that soon it will come up with solutions that will motivate more construction companies to invest in Public Private Partnership projects.
Solutions like fast track committees to sort inci¡dental issues on projects, clarity of policies, adherence to state support agreement can be good points to start from. To reduce the financial risk for the developer, BOT projects should have a provision for compensa¡ting extraordinary escalations of costs during the construc¡tion period. We believe that the BOT (Annuity) model will be the right solution for the balance projects as they would not be viable on traffic and grant alone.
What is your outlook on the sector in medium to long term?
I think this sector has to be revived. Otherwise the failure is going to be large. Thus, the government is now striving to resolve the issues. However, at the same time, the challenges are not few.
They need to be certa¡inly overcome through robust plan which is mutually agreed between developers and the government. In present scenario either the lenders has to start investing in it or the equity market has to influence money into the system, these are the primary phases that we should look forward in the sector.