Construction Constraints: Sector awaits a kick-start in activity

Sector awaits a kick-start in activity

India’s construction sector is an important determinant of its economic growth as it provides employment on a large scale and has a multiplier effect due to the creation of infrastructure assets. The sector provides employment to about 40 million people and accounts for nearly 8 per cent of the country’s GDP. The limited construction activity witnessed so far in 2016-17 has been the result of several factors. These include ambiguity around the possible impact of the goods and services tax, sluggish project execution, prolonged monsoon showers and a general slowdown in economic activity, all of which resulted in muted demand.

However, there is much optimism for the near term, as a number of programmes such as Make in India and the Smart Cities Mission are expected to provide a fillip to the demand for construction activity. In the core infrastructure space, sectors such as roads and urban infrastructure are likely to offer significant construction opportunity.

Current scenario

Considering the sector’s quarterly gross value addition (GVA) at basic prices (2011-12), 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 has been witnessed in the preceding two quarters. Key sector indicators, namely, 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, as compared to 1.4 per cent and 5.6 per cent respectively, in the first quarter of 2015-16.

Factors impacting growth

In the past 12-15 months, the performance of the sector has been influenced by a number of factors. Sluggish growth in bank credit, for instance, has been a key inhibitor. The stretched balance sheet of banks due to the high level of stressed assets has resulted in limited room for fresh lending, especially to infrastructure projects, thereby choking off the demand for construction works. In effect, limited equity coupled with constrained debt availability has impacted the construction sector to a significant extent.

The financial position of construction companies has also been a key determinant of tepid growth in the sector. The recent annual financial performance of 15 key construction companies reflects this fact too. With respect to the total income of the selected companies, the aggregate revenue for the year 2015-16 was

Rs 1,615.67 billion, a subdued increase of 3.52 per cent over the Rs 1,560.72 billion recorded in 2014-15. While debt has been difficult to secure owing to constrained bank lending, high outstanding debt has prevented promoters from infusing fresh equity. A number of players such as NCC Infra Limited, Gayatri Projects Limited, Madhucon Infra Limited, Gammon Infrastructure Projects Limited and PNC Infratech Limited adopted an asset-light approach to pare debt. Besides, many players such as Madhucon Projects, Supreme Infrastructure and IVRCL experienced a dip in their order book position during 2015-16, as compared to the preceding fiscal year. Ashoka Buildcon, Hindustan Construction Company (HCC) Limited and Gayatri Projects were among the few players that witnessed some growth in orders.

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 over the past fiscal year, they have not really been transmitted to the 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 remained in the range of 9-10 per cent. However, after the adoption of the marginal cost of funds-based lending rate from April 2016, borrowing costs for many corporate term loans are expected to reduce. In May 2016, the prime lending rate stood at 9.3 per cent, down from 9.75 per cent a year earlier.

Equipment and material market

As far as the construction equipment segment is concerned, after the sluggish growth in sales witnessed during 2013-15, the year 2016 witnessed a marked improvement. According to industry estimates, sales volumes have risen by 25-30 per cent during the year. The government’s current focus on infrastructure development also augurs well for equipment manufacturers looking to expand their business in domestic markets. Further, initiatives such as Make in India that are encouraging domestic production are also nudging these firms to export their equipment to overseas markets. Some of the emerging trends in the segment include a growing focus on precast technology, slow growth in the adoption of technically-advanced equipment and increasing focus of equipment manufacturers on enhancing the customer experience to retain their market share. While there are issues pertaining to stiff competition from cheaper imported equipment and the non-availability of spare parts, these are being overcome by the players, albeit at a slow pace.

With respect to construction materials, the cement market, for instance, is suffering from a demand-supply imbalance, with significant excess supply. The industry, with an installed capacity of 405 million tonnes per annum produced 289 million tonnes (mt) of cement in 2015-16, registering a growth of 6.7 per cent over the previous year. Cement consumption increased to 267 mt in 2015-16, witnessing a year-on-year (YoY) growth of 3.3 per cent over 2014-15. The demand for cement has been weak from end-user industries.

For steel, the total installed capacity of production stood at 118.2 mt in 2015-16, recording a YoY growth of 7.6 per cent. During the year, steel production and consumption stood at 90.4 mt and 80.5 mt respectively. In the past five years, production growth has witnessed a downward trend with the YoY growth rate becoming negative in 2015-16.

Key policy measures

On the policy front, some recent announcements made by the government bode well for the sector. 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 contractors in case of any dispute, to clear liabilities and to ensure the completion of projects. 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 procedure, which is cheaper and faster.

Another significant step is the plan to set up conciliation councils by state-owned companies and government departments. These councils will have independent experts to ensure the speedy disposal of pending cases as well as new ones. The transfer of pending claims under the amended Arbitration Act can lower the claim settlement time to 12-18 months from the average seven years at present. While the exact contours of the process are yet to be firmed up, the policy decision will significantly aid construction companies with stretched balance sheets by improving their profit margins. It was also 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.

Outlook

There is little doubt regarding the government’s objective of fuelling the economic growth engine through infrastructure development. This, in turn, bodes well for the construction industry. In addition, the strong pipeline of infrastructure projects also appears encouraging. However, to tap this opportunity, infrastructure companies must have a sound financial standing. At present, their stretched balance sheets are a key area of concern.

On the policy side, the government’s intent is evident, but needs to be translated into action. Equally important will be to ensure policy implementation. While steps such as the recent cabinet decision to fast-track arbitration and the injection of fresh liquidity (75 per cent of project cost) by government agencies into contracting firms are welcome, measures towards streamlining the procedure for securing regulatory clearances need to be taken. Mega programmes such as such as Make in India and the Smart Cities Mission are expected to fuel the construction business, and will provide immense opportunity, both, in the near-to-medium and long term. Also, the range of works will be wide, from the development of factories, roads and flyovers, to the setting up of water treatment plants.

Land acquisition issues, however, must be addressed urgently, as a number of projects are stalled due to this. It would also be fruitful for the government to adopt a strategy wherein projects are bid out to private sector players only after 100 per cent of the land is acquired for a project. Thresolution of this issues will increase construction activity significantly.