The financing scenario in the road sector continues to look grim. An increased focus on the engineering, procurement and construction (EPC) mode has stepped up the need for government funds. That said, bond financing has also emerged as an important source of funding for the National Highways Authority of India (NHAI). Interest in build-operate-transfer (BOT) projects is also growing after the initiation of conducive policy measures and initiatives to revive investor confidence. G. Suresh, chief general manager, NHAI, shares his views on the current financial scenario in the national highways segment. Excerpts…
How has been the overall experience in terms of project awards?
From 2009 till 2012, as a matter of government policy, the BOT model dominated the implementation mix of road projects. However, since 2012-13 it is observed that the uptake of awards under the BOT mode has been very limited. Several issues such as decelerating GDP growth rates and lower-than-projected revenue realisation under many projects led to a decrease in interest in BOT projects in 2012-13 and 2013-14. Therefore, NHAI has reshifted focus to the EPC mode of award and the majority of the projects awarded during 2014-15 and 2015-16 (till the second quarter) have been under this mode. However, there appears to be some revival in project uptake on BOT basis, with one-third of the projects being awarded during the current year on this basis. There is also a surge in project awards, with NHAI along with the Ministry of Road Transport and Highways (MoRTH) targeting the award of 10,000 km during 2015-16. Once the implementation of these projects gathers pace, borrowing requirements will increase.
How has been NHAI’s financing experience in the recent past?
In 2012 itself NHAI had identified the lack of liquidity, in particular lack of equity funding with developers, as a prime reason for the unfolding crisis in the sector. Most developers are predominantly family-controlled business entities, with a low capital base. The special purpose vehicle (SPV) structure of project execution, mandatory in BOT, often masks the real availability of capital with developers. Often, debt raised by the developer is used to subscribe to the equity of the SPVs. The economic downturn of the last few years has led to revenue realisation at much lower rates than was anticipated. Many developers had assumed higher revenues and undertaken a correspondingly higher level of equity obligations. As revenues crashed, the availability of equity even to meet existing commitments became inadequate, and none was left for future projects. Hence many BOT projects did not elicit responses from bidders. Anticipating high levels of revenue growth many developers had undertaken future obligations, which created overleveraging of their balance sheets. Reduced revenue realisations affected debt servicing by concessionaires as the contracted debt servicing obligations could not be met. This caused widespread default in debt accounts. When the entire industry was affected, the lenders’ debt portfolio for roads began to have a disproportionately high level of default. Hence, road sector lending was red-flagged by lenders.
NHAI’s financing plans are underpinned by central government budgetary allocations from fuel cess and NHAI’s cash flows through tolling and premium payments. For the differential funds, NHAI plans to tap the debt market with bond issues including tax-free bonds and capital gains exemption bonds. Another source is institutions like the Life Insurance Corporation and Employees’ Provident Fund Organisation with which private placement of bonds is being contemplated. Due to delays in project preparedness and consequently project awards, borrowing for this fiscal is likely to be Rs 200 billion-Rs 250 billion as against the projected Rs 430 billion. For tax-free bonds during 2011-12 we had offered 8.2 per cent for a maturity period of 10 years and 8.3 per cent for a maturity period of 15 years. In subsequent years, the rates were higher by almost 50 basis points (bps). This year the rates offered are expected to fall by nearly 150 bps from the earlier highs.
NHAI’s exposure to commercial bank debt is very limited. There are no plans to increase borrowing from commercial banks due to the high costs of these loans. The authority will be structuring its debt portfolio to be in tandem with anticipated flows from budgetary and other sources. The investor profile in our bonds has mainly comprised corporates, high networth individuals and qualified institutional buyers with retail investors lagging behind. NHAI is not considering the issuance of masala bonds in the near future.
What is NHAI’s overall financing need for 2015-16 and 2016-17?
During 2015-16, NHAI’s borrowing was projected at about Rs 430 billion, considering that cess and internal accruals would yield about Rs 140 billion and Rs 65 billion respectively. Going forward, the majority of projects are expected to be awarded on EPC basis and the balance will be bid out on BOT basis. As per the latest evaluation, Rs 200 billion-250 billion of debt will be required, most of it being raised through the issuance of tax-free bonds and the remaining through the issue of capital gains exemption bonds. The overall borrowing is expected to peak in 2016-17 at around Rs 700 billion. At that stage, to meet the borrowing requirements, NHAI may raise funds through normal bond issues.
How feasible is it for private players to tap the bond market?
The availability of finance is a major problem in BOT projects. The cost of raising funds through 10-year paper hovers around 8 per cent for NHAI; however, it is much higher for private companies at 11-13 per cent. The gestation period in infrastructure projects is very long; the projects encounter two to three economic cycles during the period between commencement and maturity. It is important that market players devise mechanisms to deal with the risks that surface in the interim during the down cycles. What we saw in 2012-13 and later is a panic situation when lenders were clueless about how to deal with the downtrend. Their reaction to project funding has been a see-saw experience. They over-lent during the high GDP growth period and became tight-fisted during the downtrend.
The Indian bond market is yet to develop. It does not have the required depth or breadth. Umpteen committees have been appointed to suggest ways and means of making the debt market robust. But no worthwhile steps have been taken to implement the recommendations of these committees. The debt market is illiquid; there is no mechanism whereby an investor can withdraw from the market in an emergency. The transaction costs and holding costs are hence very high. Unless measures are taken to resolve these issues, the potential of the bond market for the private sector is likely to remain restricted and expensive. In the present scenario, difficulty is faced by developers in convincing lenders to extend sufficient finance for completing even under-execution projects. However, the securitisation of annuity has been easy for players who have completed their projects.
What is the thought process behind the proposed monetisation of toll road assets?
Since the market was not responding well to BOT projects, NHAI floated an idea of reviving the market through the process of monetisation of operational assets, through a toll-operate-transfer (TOT) model. The authority intends to seek upfront payment to sell its operational toll plazas to investors. We have roughly 104 tolling plazas. Whether each of these toll plazas will be given out as single projects or in bunches of four-five is to be decided. Since the concession period for this TOT model is likely to be high at 25-30 years, upgradation during the concession period will be required and funding for this will be provided by NHAI or the MoRTH.
What are the key reasons for the failure of BOT projects in the road sector?
The silo-style functioning of various government departments during 2011-12 and 2012-13 led to several problems. For instance, the BOT model collapsed due to the restrictions placed by the Ministry of Environment and Forests, which did not provide timely clearances to many projects. This happened when the market had a bullish sentiment for BOT projects. While projects garnered a lot of interest from both lenders and developers, delays in approvals dampened the market spirit. Since projects were bid with very thin margins, developers could not afford any delays and associated time/cost overruns. In addition, the rise in the costs of inputs such as bitumen, cement and steel led to cost escalations. Given the non-availability of unencumbered land for project execution, the costs escalated further and ultimately, projects became non-viable. A major learning has been that for successful execution of projects, the various ministries and departments should not work in silos.
For developers who had already commenced execution in various projects, it meant a huge loss. On the one hand, they had to pay interest on the funds borrowed and on the other, the concession agreements did not provide for compensation due to the delays attributable to the government. Lenders are more used to asset-based financing than cash-flow-based funding needed for concessions. Moreover, the risk pricing was not done properly by developers and hence bids were not made rationally. Economic cycles, delays in execution, lower revenues and requirement of further finance were not factored in.
What are the key measures initiated to deal with languishing projects?
Several measures have been initiated. The central government has now allowed 100 per cent stake divestment during the concession period and also during construction. Deferment of premium payments for projects that did not witness expected cash flows and were awarded on a premium basis has been permitted. This will help the lenders recover money before NHAI.
Besides this, one-time fund infusion by NHAI has been permitted for languishing projects. This, however, is subject to the condition that NHAI will have the first right to recover the money. Amendments have been made in the concession agreement to address the concerns of lenders and concessionaires. NHAI is permitted to extend the concession period wherever the default is attributable to the concessionaire. One measure which has not been successful is the creation of an asset reconstruction company whereby NHAI planned to take over the project and complete it using its technical know-how. Under this, after completion projects were planned to be put up in the market. NHAI proposed to provide the required seed money, with the condition that lenders would come on board. However, due to the lukewarm response from lenders, this initiative could not take off.