The construction sector recovered from the impact of Covid-19 in the second half of 2020-21, with the pace of execution crossing pre-Covid levels. This recovery was impacted in the first quarter of 2021-22 due to the second wave. However, the sector witnessed sharp growth in the first quarter of 2021-22 in comparison to the corresponding period of the previous year due to a low base effect. The impact of the second wave on the construction industry was less severe than that of the first wave due to localised lockdowns. While the risk of Omicron remains, the credit profiles of most construction companies are expected to remain resilient, supported by the government’s liquidity-boosting measures coupled with contractors’ ability to ramp up execution as the economy stabilises. Construction gross value added, which declined in 2020-21, is expected to register a growth of 10.7 per cent in 2021-22.
The stress on the state governments’ finances due to the first wave of the Covid-19 pandemic impacted projects directly funded by the state governments with lower infrastructure capex in the medium term, and extended the receivable cycle for contractors with high concentration on such projects. During the second wave, contractors were better prepared, hence the impact on project execution was milder. Construction activities were permitted, labourers were allowed to stay and work at sites, and liquidity relief measures continued to be provided. With higher vaccination and lower hospitalisation, the impact of the third wave is expected to be much milder.
Competitive intensity
Competitive intensity for engineering, procurement and construction (EPC) projects has been heightened in the recent past. Given the limited fiscal balance of state governments, project tendering is expected to be subdued over the medium term. Increased competition, along with a sharp hike in raw material prices, could weigh on the profitability of contractors. The rise in commodity prices, if sustained, can impact contractors’ profitability by 1-4 per cent. The overall inflow of new orders is likely to slow down due to the disruption caused by the pandemic. In the last four to five quarters, the average number of bidders increased for EPC projects, reaching as high as 40. The relaxation in bidding criteria by the Ministry of Road Transport and Highways enabled medium-sized players to bid for road projects. The increased competition has resulted in a discount of 30-35 per cent on the NHAI’s estimated cost. Heightened competition can also be seen in the hybrid annuity model, with the average number of bidders increasing to 10-15 from 6-7 in the past, and the average premium to NHAI reducing substantially to 7-12 per cent from as high as 30 per cent. Thus, bidding discipline is crucial, and projects bid at deep discounts will be monitored by NHAI.
Growth drivers
The pace of infrastructure investment is expected to double under the National Infrastructure Pipeline (NIP) and drive construction activities. The central government has planned an investment outlay of Rs 111 trillion during 2019-20 to 2024-25. This translates into an annual investment of Rs 18.5 trillion, as against the less than Rs 10 trillion annual infrastructure investment in the previous five-year period (2013-14 to 2018-19). Due to the slower than expected start to the NIP owing to the pandemic, the government needs to step up investments in the subsequent years to achieve its targets. This requires an expenditure of Rs 20 trillion-Rs 25 trillion per annum towards infrastructure projects. The existing financing sources will be able to meet 83-85 per cent of the NIP’s capital expenditure. The newly set up development financial institution and asset monetisation are expected to bridge the funding gap to a certain extent.
Asset monetisation can improve financing prospects. While earlier bilateral sale of assets was the primary mode of asset monetisation, over the last few years infrastructure investment trusts have emerged as an attractive vehicle, bringing in capital from multiple long-term investors. The government is also looking at monetising operational assets and has identified a National Monetisation Pipeline worth around Rs 6 trillion over 2021-22 to 2024-25. This can fund about 5.4 per cent of the total NIP outlay. Given the opportunities, the outlook for the construction sector is stable, supported by healthy order inflows.
Based on a presentation by Rajeshwar Burla, Group Head and Vice President, Corporate Ratings, ICRA, at an “Infrabuild India” event