Construction activity, which lies at the core of infrastructure development, has been cyclical at best for the past few years. Stymied by a host of factors such as regulatory bottlenecks, land-related issues, difficulties in financing, legal challenges and overall investor diffidence, the country’s construction sector has been struggling to take off. While there are sectors such as roads and highways that have been witnessing increasing activity (since 2014-15), muted demand from sectors such as housing, real estate, power and airports has pulled down the growth numbers in construction. Besides, exogenous factors such as a better-than-expected monsoon in some and floods in other parts of the country has impeded construction works.
Considering the sector’s quarterly gross value addition (GVA) at 2011-12 base prices, the trend has been mixed during the past three fiscal years (2013-14 to 2015-16). This has continued in 2016-17, as the year’s first quarter growth declined to 1.5 per cent from the flattish level of 4.5-4.6 per cent that was witnessed in the preceding two quarters. Key indicators for the sector, the production of cement and the consumption of finished steel, registered growth rates of 5.7 per cent and 0.3 per cent, respectively, during the first quarter of 2016-17, compared to 1.4 per cent and 5.6 per cent, respectively, in the corresponding period of 2015-16.
- Credit crunch: Bank credit, the mainstay of India’s infrastructure financing, has been severely impacted by banks’ balance sheets that are weighed down by non-performing/ stressed assets, most of which belong to the infrastructure sector. This has resulted in limited room for fresh lending, thereby impacting the uptake of construction activity. In effect, limited equity coupled with constrained debt availability has impacted the construction sector to a great extent.
- Stretched balance sheets of contractors/developers: While debt has become difficult to secure, fresh equity is also difficult to come by, owing to the stretched balance sheets of contractors. Poor cash flows, stalled projects and high debt servicing costs have left a number of players with no more equity to put into projects. To pare debt, a number of companies have resorted to the sale of operational assets. These include Jaiprakash Power Ventures Limited, IL&FS Transportation Networks Limited, NCC Infra Limited, Gayatri Projects Limited, Madhucon Infra Limited, Gammon Infrastructure Projects Limited and PNC Infratech Limited.
- High interest costs: The high cost of borrowing has also been a major contributor to the sluggish growth witnessed in the construction space. While there have been downward revisions of policy rates in various instances over the past fiscal year, these are believed to have not been transmitted to borrowers. Sticky lending rates, thus, have been a problem area. Data from the Reserve Bank of India (RBI) shows that during 2013-15, the prime lending rate (PLR) remained in the range of 9-10 per cent. However, after the adoption of the marginal cost of fund-based lending rate from April 2016, borrowing costs for many corporate term loans are expected to reduce. In May 2016, the PLR stood at 9.3 per cent, down from 9.75 per cent a year earlier.
- Policy laggard: Issues pertaining to land acquisition and securing of regulatory clearances are perennial. While policy attempts have been made to address these concerns, stalled projects still block massive investments. As of February 2016, over 300 projects involving an investment of over Rs 12 trillion remain stalled, and are with the Project Management Group of the Prime Minister’s Cabinet Secretariat for fast-tracking.
- Sector-specific issues: Sector-specific factors have also impacted (both positively and negatively) construction activity in a big way. Considering the positive impacts, road and highway development, for instance, witnessed increased attempts by the government to resolve issues to fast-track projects that have been languishing for a long time. On the other hand, airport development remained stunted, with mega projects such as the Navi Mumbai airport project still not seeing the light of day. The supply glut in real estate and the high cost of borrowing (for home loans, etc.) have created a capacity overhang in the sector, prodding developers to pursue other plans, until a market correction is visible.
Some bright spots
Amidst all this, there are some bright spots that spell hope for the construction sector. Most of these stem from the government’s intent to boost infrastructure development in the country so as to clock a higher economic growth rate. To this end, a number of announcements made by the government in the past 12-15 months bode well for the sector.
- Policy rescue: Recently, in September 2016, the Cabinet Committee on Economic Affairs cleared several measures proposed by the NITI Aayog to revive the construction sector. One of the measures mandates that government agencies and public bodies pay 75 per cent of the project cost to the contractors in case of any dispute, so as to limit liability and ensure project completion. It has also been decided that whenever there are disputes pending between public bodies and construction contractors under the old arbitration procedure, there will be an option to shift to the new arbitration method, which is cheaper and faster. The transfer of pending claims under the amended Arbitration Act can lower the claim settlement time to 12-18 months from the current average of seven years. While the exact contours of the process are yet to be firmed up, the policy decision will significantly reduce the woes of construction companies with stretched balance sheets by improving their profit margins. (According to the Financial Stability Report published by RBI, profitability in the construction sector is relatively low, bogged down by high leverage ratios.) Another significant step is the setting up of conciliation councils by state-owned companies and government departments. These councils will have independent experts to ensure speedy disposal of cases. It has also been decided that item-rate contracts between parties could be substituted with engineering, procurement and construction contracts. Meanwhile, the Department of Financial Services and RBI have been tasked with suggesting a new policy to deal with stressed assets in the construction sector.
- Eased foreign direct investment (FDI) norms: In November 2015, the government announced the easing and simplification of FDI rules in the construction sector, wherein the conditions of restricting floor area to 20,000 square metres in construction development projects and a minimum capitalisation of $5 million (to be brought in within six months of the commencement of business) were removed. While this is not a large-scale reform, it is believed to have reduced hindrances in investment flows into the construction sector.
- Government programmes: The government’s big-ticket initiatives such as Make in India and the Smart Cities Mission are expected to ratchet up the construction business significantly. These programmes will provide immense opportunity in the next few years. Also, the range of works will be wide, from the development of factories, roads and flyovers to the establishment of water treatment plants.
- Robust project pipeline: India Infrastructure Research has tracked over 400 ongoing projects across seven infrastructure sectors. These are worth at least Rs 15 trillion. In terms of project cost, the maximum share is that of power projects at 57 per cent, followed by roads at 15 per cent and metro rail at about 13 per cent. With respect to recently awarded projects, 79 key projects have been tracked, of which the power sector entails the highest investment of Rs 1.5 trillion, followed by ports (Rs 463 billion), water supply and sewerage (Rs 401 billion), roads (Rs 369 billion) and urban rail (Rs 332 billion). While this analysis is as of February 2016, it gives a fair sense of opportunities for the construction industry.
In Union Budget 2016-17, over two-thirds of the central plan outlay was made towards infrastructure development. Thus, there is little doubt regarding the government’s intent and commitment towards the sector. This, in turn, is good news for the construction business. The demand for construction is high too, as reflected by robust project pipelines across infrastructure sectors.
However, the supply side (construction companies) is mired in problems at various levels. One, securing project land is not only time-consuming but is also cost-pushing. Two, timelines and costs are further stretched in the process of securing regulatory clearances. Three, stuck projects have now put construction companies financial stress . Four, fresh credit from banks is getting more difficult to come by. Five, pending arbitration cases have locked in massive capital, adding to the woes of the already cash-strapped companies.
The solution lies in appropriate policy design that resolves these issues. As the government’s intent is in place, the correct formulation of policy is a natural next step. Ensuring its implementation will be equally important. While steps such as the recent cabinet decisions to fast-track arbitration and the injection of fresh liquidity (75 per cent of project cost) by government agencies into contracting companies is welcome, steps towards streamlining the procedure of securing regulatory clearances need to be taken. It would also be fruitful for the government to adopt a strategy wherein projects are bid out to private players only if 100 per cent of the project land is acquired. But all this must be done in a timely manner, given the forward linkages the construction industry has with other infrastructure sectors, which in turn will impact overall economic activity.