Construction-sector_update-Oct-09

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Executive Summary

Executive Summary

Indias road infrastructure woefully inadequate

As per the Global Competitiveness Report 2008-09, inadequate infrastructure is the

biggest stumbling block in Indias economic growth. While India has the second largest

road network in the world, the report ranks it at a dismal 87 th spot as far as quality

of roads is concerned, way below neighbours China, Pakistan, and Sri Lanka.

With the kind of multiplier effect that roads have on economic growth, a quantum

increase in investments in roads is paramount to achieve long-term growth targets.

Light at the end of the tunnel

The National Highway Development Programme (NHDP) is Indias flagship and the

worlds largest PPP road development programme. It had hit speed bumps in 2006-

08, primarily due to frequent changes in the regulatory framework and economic slowdown.

However, 2009 has come as a breath of fresh air; since December 2008, the National

Highway Authority of India (NHAI) has awarded (or is evaluating bids for) 24

projects worth INR 228 bn. NHAI has an ambitious target of awarding 23,000 km

of roads during the next two years. It expects to receive bids for 49 projects

spread over 5,074 km, worth INR 511 bn by 2009 end. The government has set an

ambitious target of building 20 km of road per day. Amidst all this, encouraging signs on

credit availability, interest rates and capital markets mean that achieving financial closure

(FC) on projects has become considerably easier compared to last year. This infuses us

with the confidence that the travails of the past three years are behind us and the project

award process is likely to be on the fast track.

Size of opportunity at central and state level-humungous

The chronic underinvestment in roads over the past 60 years has meant that huge

investment is required over the next couple of years to prop up the road infrastructure.At the national level, of the total 54,454 km under the NHDP (including the

NHDP Phase IV), 36,926 km of roads are still to be awarded. Overall, the NHAI

expects to spend about INR 3,315 bn on completion of the balance part of NHDP. This is

in addition to the huge opportunity available for road development at the state level with

states like Karnataka (INR 1,770 bn opportunity in 2009-15), Andhra Pradesh, and

Gujarat taking steps to improve road infrastructure.

Outlook: Good long-term opportunity

The governments seriousness towards road development is evident from the steps taken

in the past couple of months to make projects more commercially viable. The major

stumbling block now is getting the funding required for the ambitious plans announced-

both debt and equity. In our view, cracking the funding code is the key to

unlocking the PPP opportunity in the medium term. The sheer scale of government

plans means that there are likely to be ample opportunities for every player in the road

segment. We initiate coverage on IRB Infrastructure, the leader in the Indian road

BOT space, with a BUY recommendation. While past has been good, the future

promises to be better than ever for the company which has built up an impressive

portfolio of lucrative projects. With the focus of this report being on developers, we also

feature IVRCL (BUY), Nagarjuna (BUY), GMR (REDUCE), Reliance Infra (BUY),

Gammon (HOLD), Sadbhav Engineering (NOT RATED), Madhucon Projects (NOT

RATED), and Gayatri Projects (NOT RATED) in this report.


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Contents

At a glance ................................................................................................................. 3

Road infrastructure woefully inadequate ......................................................................... 4

Light at end of tunnel .................................................................................................. 6

Huge opportunity at centre and state levels .................................................................. 18

Time To Think About The Constraints ........................................................................... 26

Foreign Companies in NHDP: Changing Scenario ........................................................... 33

Annexure I: Frequent policy changes and their impact on project award .................... 35

Annexure II: Steps taken to attract more interest for NHDP projects ......................... 36

Annexure III: Work plan (for Aug-09 Jul 10) for ministry of roads .......................... 37

Annexure IV: National highway opportunity (phase wise) ......................................... 38

BOT Projects Snapshot ............................................................................................... 39

Companies

IRB Infrastructure ............................................................................................... 41

Gammon India .................................................................................................... 63

Gayatri Projects .................................................................................................. 71

GMR Infrastructure .............................................................................................. 77

IVRCL Infrastructure ............................................................................................ 83

Madhucon Projects .............................................................................................. 89

Nagarjuna Construction ....................................................................................... 95

Reliance Infrastructure ...................................................................................... 101

Sadbhav Engineering ......................................................................................... 107


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Road Infrastructure Woefully Inadequate

As per the Global Competitiveness Report 2008-09, inadequate infrastructure is the biggest

stumbling block in Indias economic growth. While India has the second largest road system

in the world at 3.3 mn km, the report ranks the country at a dismal 87 th position as far

as the quality of roads is concerned, way below neighbours China, Pakistan, and Sri

Lanka.

Table 1: India ranks w ay below in quality of roads

Country Ranking for quality of roads

France 1

Switzerland 2

USA 8

Malaysia 17

Japan 19

UK 24

South Africa 40

China 51

Sri Lanka 63

Pakistan 69

India 87

Source: World Economic Forum, Global Competitiveness Report 2008-09, Edelweiss research

The inadequacy issue becomes evident from the fact that the average distance covered on

roads by truck in India is less than 250 km per day compared to ~1,000 km per day in the

US. While the high volume of vehicles on Indian highways, various tax regimes, and frequent

check posts on state borders are also culprits, a major portion of the blame lies with the

inferior quality of roads.

Table 2: China versus I ndiaA case study in r oad quality and impl ementation success

China India

In 1988, China did not have an inch of expressway. The

original plan, considered ambitious at that time, was to build

upto 35,000 km of National Trunk Highway System (NTHS),

of which 70% was to be expressways, before 2020. The

NTHS was completed by the end of 2007, 13 years

ahead of the original plan.

Expressways in India with a length of 200 km form a

minuscule share of the overall road network; national

highways (NHs) and state highways (SHs) at 2% and 4%

respectively, do not fare much better. Also, while NHs

carry 40% o f the overall roadtraffic, only 14% of

them are 4/6/ 8 laned. SHs, of which only 0.6% are 4-

laned, are in a worse situation.

At the end of 2008, the Chinese national expressway

network stood at 60,300 km (of which 6,433 km was built in

2008). This makes it the world's second longest

expressway network, after the United States and roughly

equal to that of Canada, Germany, and France combined.

The NHDP has repeatedly suffered cost and time overruns

over its lifetime. NHDP Phase I and II, originally

intended to be completed by 2003 and 2004 ,

respectively, are still not completed and are likely to

miss their revised timelines too. The same is likely to betrue for Phase III and V.

The plan is to increase the total length of expressways to

65,000 km by 2010, 85,000 kilometers by 2020, 120,000

km by 2030, and 175,000 km by 2050. By 2010, the

Chinese expressway network will connect all provincial

capitals and cities with at least half-a-million population, as

well as some with population ranging between 200,000 and

500,000. The annual investment between 2010 and

2020 is projected at USD 12 bn.

Between 1951 and 2006, the vehicle population grew at a

CAGR of close to 11%; the freight and passenger traffic

carried by roads grew at a CAGR of 10%. On the other hand,

the total road length grew at a CAGR of 3.9% with the NH

segment increasing by a mere 2.2 %. Also, it is estimated

that 50% of state and district roads (forming 18% of

the overall road network) are of poor quality, causing

a loss of INR 60 bn per annum.

Source: Edelweiss research

Quality of Indian roads hasbeen judged poorercompared to neighbours like

China, Pakistan and SriLanka

China is much ahead ofIndia, both in terms ofquality as well asimplementation success inroad development


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While quality continues to be an issue, road transport has emerged as the dominant segment

in Indias transportation sector. The entire increase in the transportation sectors share in the

GDP between 1999-2000 and 2004-05 came from the road segment. During the past few

years, road transport has grown at a much higher rate compared to other competing modes

like inland waterways, railways, and airways.

All this makes it imperative for a quantum increase in road investments, which is also

necessary to achieve the countrys long-term growth targets. An INR 1 mn investment in

roads (at constant 1993 prices) helps 165 persons cross the poverty line. A World Bank study

has assessed that every rupee invested in the highways sector yields 7x returns in economic

value. With this kind of multiplier effect, it is high time for India to increase its investment in

improving its road network, both in terms of length and quality.


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Light At End Of Tunnel

The National Highway Development Programme (NHDP), Indias flagship highway programme,

had hit speed bumps in 2006-08, first due to frequent changes in the regulatory framework

(p lease r e fe r A nnex u r e I ) and later due to an economic slowdown. The project award by

NHAI, which had touched new highs during 2005-06, progressively slowed down in the past

three years.

Chart 1: NHAI project award and implementation in various years

0

1,000

2,000

3,000

4,000

5,000

1999-00

2000-01

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08

2008-09

(km)

Project awarded Completed

Source: Government documents, Edelweiss research

The implementation of the new Model Concession Agreement (MCA) affected project awards

in 2006 and 2007. As against the original target of awarding projects spanning 10,641 km in

2008-09, the revised plan had envisaged NHAI awarding 60 BOT projects spread across

6,412 km. These projects worth ~INR 700 bn were to be awarded before March 2009.However, the imbroglio over the new pre qualification guidelines derailed the plans in H1CY08

and the economic slump and the liquidity crunch scuppered the dream in H2CY08. The NHAI

awarded eight projects spanning 643 km, worth INR 86 bn in FY09 under NHDP.

Table 3: NHDP targets and achievements in past two years

Target

(km)

Achievement

(%)

Target

(km)

Achievement

(%)

Completion 437 49 220 60

Tolling 1,869 55 2,003 61

Phase II Completion 2,013 55 2,522 61

Phase III Award of project 3,278 9 6,047 10

Phase V Contract 2,995 29 3,754 0

2007-08 2008-09

Phase I

NHDP Phase Category


What has changed?

With the NHDP suffering setbacks, the government took a series of steps to improve the

attractiveness of NHAI projects and address concerns of the road developer fraternity

(p lease r e fe r A nnex u r e I I ). The positive effect of these measures is trickling in now.

Regulatory issues andeconomic slump affectedproject award adversely


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Also, the liquidity crunch which had plagued the corporate world in the last quarter of 2008 is

now a thing of the past.

Chart 2: Net reverse repo position

(1,200)

(600)

0

600

1,200

1,800

Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09

(INRbn)

Net reverse repo

Source: Bloomberg, Edelweiss research

The Reserve Bank of India (RBI ) has taken various measures since September 2008,

which have resulted in augmentation of actual/potential liquidity of over INR 4,220

bn . In addition, the permanent reduction in the SLR by 1.0% of NDTL (net demand and time

liabilities) has made available liquid funds of INR 400 bn for credit expansion.

Table 4: RBI measures to boost liquidity

Sl. No. Measure Amount (INR bn)

1 CRR reduction 1,600

2 Unwinding/Buyback/De-sequestering of MSS securities 978

3 Term repo facility 6004 Increase in export credit refinance 255

5 Special refinance facility for SCBs (Non-RRBs) 385

6 Refinance facility for SIDBI/NHB/EXIM Bank 160

7 Liquidity facility for NBFCs through SPV 250

Total 4,228

Source: RBI, Edelweiss research

Another helping hand was lent by the cooling down of soaring interest rates, which had

adversely impacted project viability. RBI has cut the repo rate by 425bps and the reverse

repo rate by 275bps since September 2008, thus sending a strong signal to banks to reduce

interest rates. Reduction in the reverse repo rate was also a step towards discouraging banks

from parking their surplus funds with the central bank. This resulted in banks cutting their

lending rates with the prime lending rate of State Bank of India falling by 200bps since

September 2008.

Liquidity situation hasconsiderably improved ascompared to last year


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Chart 3: Reduction in interes t rates

3.0

5.3

7.6

9.9

12.2

14.5

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

Apr-09

May-09

Jun-09

Jul-09

Aug-09

(%)

SBI prime lending rate Repo rate


The risk aversion of lenders to BOT projects (which are typically long term in nature) has also

decreased. Further, projects that are being awarded now will come up for financial closure

(FC) only towards the latter part of H2FY10 after completing various formalities. We expect

the situation on the FC front to improve by then.

And, last, business confidence has also recovered, with signs of a turnaround, rally in equity

markets across the globe, and a positive election outcome. The governments stated

objective of increased spending on infra projects (which was evident in the increased

allocation for various infra schemes in Budget 2009-10) has also come like a shot in the arm

for companies in the sector.

The effect is visible

Amidst all this, FY10 came as a breath of fresh air. Project award has resumed; since

December 2008, the NHAI has aw arded (or is evaluating bids for) 24 projects worth

INR 228 bn.

Interest rate reduction to

help BOT developers


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Table 5: Projects awarded/ bids under evaluation by NHAI

S. No. Project

Length

(km)

Total project

cost (INR bn)

VGF/ revenue

share Phase Developer

1 Vadakkancherry - Thrissur 30 6.2 VGF II KMC - CR18G Consortium

2 Pune Sholapur Pkg-I 110 11.1 VGF III Navinya Buildcon - Atlantia Spa

(JV)

3 Gujarat/Mh border - Surat -Hazira Port Section

133 15.1 VGF III Soma - Isolux Corsanconsortium

4 Pimpalgaon-Nashik Gonde 60 9.4 Revenue share III L&T - Ashoka Buildcon

consortium

5 MP/Mh Border-Dhule 97 8.4 Revenue share III HCC - John Laing - Sadbhav

Engg consortium

6 Cuddapah-Mydukur-Kurnool 189 15.9 VGF III KMC - IVRCL consortium

7 Elevated road from Chennai

Port-Maduravoyal

19 13.5 VGF VII Soma Enterprises

8 Kishangarh-Beawar 94 8.0 Revenue share III Soma - Isolux Corsan

consortium

9 Hyderabad-Vijayawada 181 17.4 Revenue share III GMR-Punj Lloyd consortium

10 Armur-Adloor-Yellareddy 60 4.9 VGF II Navyuga-KPCL consortium

11 Goa-Karnataka border to Panaji 65 4.7 VGF III IRB Infra

12 Amritsar-Pathankot 102 7.1 VGF III IRB Infra

13 Jaipur-Deoli 146 11.8 VGF III IRB Infra

14 Talegaon-Amravati 67 5.7 VGF III IRB Infra

15 Ghaziabad-Aligarh 126 11.4 VGF III PNC Infratech - SREI - Galfar

16 Kannur-Kuttipuram Pkg - I 83 13.7 VGF III KMC - CR18G Consortium

17 Kannur-Kuttipuram Pkg - II 82 13.1 VGF III KMC - CR18G Consortium

18 Pune Sholapur Pkg-II 110 8.4 VGF III IL&FS - ITNL

19 Hazaribagh-Ranchi 71 6.3 Annuity project III IL&FS - Punj Lloyd

20 MP/Mh border-Nagpur section 95 11.7 NA II Oriental Structural Engineers

21 Jaipur-Reengus 52 3.8 NA III Reliance Infra Source: NHAI, News reports, Edelweiss research

What the future holds in store?

NHAI has an ambitious target of awarding 23,000 km of roads in the next two years. This

involves inviting bids for projects spread over 13,000 km of roads in the next year

with an investment of ~ INR 1 tn.

Table 6: NHAI plan for next one year

NHDP phase No. of projects Length (km) Cost (INR bn)

Phase II 12 700 139

Phase III 96 8,825 602

Phase V 18 2,403 240

OMT projects 9 1,466 11

Total 135 13,394 993

Source: NHAI, Edelweiss research

Of the INR 982 bn required for the 126 projects under Phase II, III, and V, INR 546 bn is

expected to come from the private sector and the balance from the government.

Overall, a total investment of USD 70 bn is envisaged in the road sector in the next

three years. The private sector is expected to contribute USD 40 bn, of w hich USD

NHAI has ambitious plansfor project award in nextcouple of years


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10 bn is expected from foreign investors. Of this, USD 3-4 bn is expected in equity,

while for the balance, the government is looking at creating new debt instruments like

infrastructure bonds, securitising receivables, accessing the capital market, etc.

NHAI plans to seek bids for 71 projects spread over 7,987 km in the next two quarters worth

INR 616 bn.

Table 7: NHAI plan for next two quarters

NHDP phase No. of projects Length (km) Cost (INR bn)

Phase II 9 447 122

Phase III 43 4,261 339

Phase V 12 1,833 137

Phase VII 1 22 7

OMT projects 6 1,424 11

Total 71 7,987 616


NHAI expects to receive bids for 49 projects spread over 5,074 km worth INR 511 bn by

2009 end. News reports suggest that response to some of these projects has beenenthusiastic with an average of 15 bidders expressing interest.

These projects include an INR 95 bn plan to enhance road connectivity in Jammu & Kashmir

by undertaking four laning of the Jammu-Srinagar national highway on BOT-annuity basis.

Ministry of Roads also emerging as a big aw ardee

In addition to the NHAI, the road ministry also has a large list of projects that it expects to

award on a PPP basis. It has chalked up a plan to aw ard 58 projects worth INR 188 bn

by July 2010 on BOT basis (please see Annexure III). These projects involve building

7,515 km roads in various states and largely relate to converting existing roads into two

lanes in various states. The ministry will award these projects either by itself or through

respective state governments.

It has also received clearance for two laning of the trans-Arunachal highway from Nechipu to

Hoj (311 km) and Potin to Pangin (407 km) estimated at INR 14.3 bn and INR 19.1 bn,

respectively, both on BOT annuity basis. This is part of the ministrys INR 134 bn plan of road

development in J&K and North-East, as per its 100-day agenda submitted to the Prime

Ministers Office.

News reports suggest that the World Bank has agreed to lend USD 3 bn to the

government to develop 5,937 km of highw ays. The proposed loan will cover 70% of the

project cost, while government will provide the balance. These roads have low traffic and are

not viable on PPP basis; these roads are likely to be constructed with full government funding.

These highways are not part of NHDP . The government has identified 6,376 km of roads

to be developed over the next few years with government funding, of which 5,937 km will bedeveloped using the World Bank fund.

News reports suggest that the Ministry has also approved 63 projects that will connect the

most populated cities in country to national highways. These projects stretched over 8,982

km will be taken up next year under NHDP phase IV.

Apart from NHAI, Ministry of

Roads also has largenumber of projects to beawarded


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New government, new deal for road projects

Keeping the sluggish progress on the road project award scenario in 2006-08 in mind,

the new government post election responded by appointing Mr. Kamal Nath (earlier the

Minister for Commerce and Industry) as the Minister for Road Transport & Highways

Ministry. He has announced an ambitious target of building 20 km of roads per day.

Many initiatives have been taken since then to speed up the progress in the roads space.

A summary of the same is given below:

The erstwhile Ministry of Shipping, Road Transport and Highways has been

bifurcated into separate departments under different ministersMinistry of Ports and

Shipping and Ministry of Roads and Surface Transport to ensure focused efforts on

development of both sectors.

NHAI has been asked to finalise a framework for better execution of projects; this

will include establishing a unity of command for proper delegation of power and

better internal communication within NHAI.

NHAI has decided to issue the letter of award (LoA) only after it has

acquired 80% of the land required for a project and notification for acquiring

the balance has been issued. The balance 20% will have to be handed before FC. Till

now, NHAI used to award the project after acquiring 50% of land. This is likely to

reduce delays due to land acquisition.

Budget 2009-10 has increased the allocation for NHAI by 23% to INR 85.8

bn compared to last years allocation of ~ INR 70 bn . The government has also

proposed an investment of INR 41.4 bn in 2009-10 for developing national highways,

besides those built by NHAI.

The 2009-10 budget has exempted highway developers from the 8% excise duty on

goods manufactured at work sites.

The budget has also allowed India Infrastructure Finance (IIFCL) to refinance 60%

of commercial bank loans for PPP projects. Also, IIFCL has been mandated to evolve

'takeout financing schemes with banks through which it will pick up infrastructure

loans from banks books.

The Prime Minister had set up a committee to suggest fast-track mechanisms to

improve inter-ministerial coordination for speeding up road projects. The

committees mandate was to examine ways to expedite award of projects, financing

road projects, restructuring of 4/6 laning projects based on traffic requirements and

those in backward areas and to make suggestions for making projects attractive for

banks and private investors. The committee has recently submitted its report to the

Prime Minister.

News reports suggest that the committee has recommended that government

should support NHAI in its borrowing programmes by offering sovereign guarantee.

This is likely to make it easier for NHAI to raise loans from international

organisations as well as lowering the rate of interest on its loans.

It has also recommended delegation of power to the road ministry on issues related

to MCA, RFQ, and RFP.

The government has approved the formation of an empowered group of ministers

(EGoM) to fast-track road projects. The EGoM will remove various policy bottlenecks

which do not require approval of the Cabinet or Cabinet Committee on Infrastructure

(CCI). The EGoM has the power to fine-tune regulations and change the bidding

norms for road projects if required.

Governments commitment toroad development shows inincreased allocation for roadprojects and other regulatoryreforms


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Proposed measures:

Along with the above mentioned initiatives, news reports suggest that several

measures are in the pipeline to achieve greater progress on road development front:

Proposal to amend the cross holding clause: The revised RFQ guidelines issued

by the Ministry of Finance in May 2009 had raised the earlier limit of 1% related to

conflict of interest to 5%. In essence, the new guidelines state that a bid will be

disqualified if an investor or its associate holds more than 5% (directly or indirectly)

in another company which is applying for the same project. The new RFQ guidelines

also state that this clause is not applicable for ownership by banks, insurance

companies, pension funds, and public financial companies.

Our interaction with ministry officials suggests that the government is considering a

proposal by way of which the conflict of interest margin may be raised

substantially from the current 5%. Government may also limit provisions of the

clause to direct holding. News reports suggest that the limit has been raised to

25%.

Our take: More than equity stake, management control should be the determining

factor. With most companies bidding in consortia, the 5% clause invariably crops up.

News reports suggest that INR 100 bn of investment in roads sector has been

blocked due to this rule. With the amount of investment that the government is

targeting in road projects, a fast resolution of this concern is necessary.

Proposal to amend the threshold technical capacityclause: The revised RFQ

guidelines had also doubled the threshold technical capacity required to bid for a

project. This means that to bid for a project of a certain total cost, the bidder

should have the experience of implementing projects at least twice that

cost in the preceding five years, i.e., to be eligible to bid for an INR 5 bn project,

he should have implemented projects worth INR 10 bn in the previous five years. As

per the old RFQ norms, the limit was set up at 100% of the project cost.

Many smaller developers opposed this saying that the revised norms will benefit

bigger developers and foreign companies and thus will leave smaller companies in adisadvantageous position. This will also limit competition as only a few developers

will be able to put in their bids.


proposal to roll back the change in regulations so that the old RFQ norms come into

place again.

Our take: Considering the large number of projects that the government is planning

to award, it needs to use the services of every developer available. A larger number

of developers will ensure better competition; more so considering the fact that most

projects awarded in the past eight-nine months have seen bids from only 2/3

bidders.

Proposal to amend the termination clause: This has been a major eyesore for

many developers. This clause states that in case the traffic on any BOT project

exceeds the design capacity for four years at a stretch, NHAI may terminate the

concession agreement unless the developer agrees to enhance the projects capacity.

For e.g., in case of a four-lane project, if the traffic exceeds the design

capacity for four consecutive years, NHAI may terminate the agreement

unless the developer agrees to enhance the roads capacity to six lanes.


proposal to amend this clause and introduce a more developer-friendly mechanism.

Our take: This clause created uncertainties regarding the eventual duration of the

concession period as well as cash flows from projects. With the upsides on traffic

Government looking to makeregulatory framework morefavourable for developers

Many steps being taken togenerate more developerinterest for roads


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capped (by linking it to concession period duration), developers were naturally not

enamored with this clause.

Proposal to provide an exit clause for the lead member: Currently, the lead

member in a consortium has to maintain 26% stake in the project SPV even after

completion of the project. News reports suggest that government is considering a

proposal to relax this clause so that developers can sell their stake and use thefunds for developing new projects.

Our take: As the project goes through different stages, different type of investors

would be interested in it. Once a project has been developed, the developer should

not be constrained in a major way to remain attached to the project. Allowing him to

sell stake and use the funds for new projects will be more beneficial. Once the

project is complete, more risk averse investors and pension funds will be willing to

come in. This will ease funding pains for the developer community.

Proposal to vest ownership of roads with NHAI: The government is considering

a proposal to vest the ownership of roads with NHAI; it will then be leased out to

developers who will then raise loans against them. Currently, roads are not owned

by NHAI; it only allows developers to collect toll on them. Thus, developers cannot

use roads as collateral while borrowing from banks and other f inancial institutions.

Our take: While this will be a novel way to ease financing concerns, legal issues

(such as stamp duties and taxes to be paid) will have to looked into first.

Setting up of special land acquisition units: TheNHAI has decided to set up 150

special land acquisition units across various states to deal with land acquisition

problems. These units will be developed for each project in respective states; it is

proposed that they will comprise state government officials, who will carry out the

entire land acquisition process on behalf of NHAI. Currently, land acquisition

typically takes 24 months; NHAI plans to pare this time to 11 months.

To push the land acquisition process, responsibility has been fixed on project

directors, chief general managers (CGMs), and members of NHAI. Ten such units are

coming up in Rajasthan, 13 in Bihar, 25 in Uttar Pradesh, seven in Gujarat, 11 inOrissa, 13 in West Bengal, four in Jharkhand, 11 in Maharashtra and five in Assam.

Around 40 are already operational in Tamil Nadu and Karnataka and sanction has

been received for Goa. The NHAI has also started the process of setting up 10

regional centers to be headed by CGMs in Lucknow, Patna, Jammu & Kashmir,

Chennai, Guwahati, Delhi (Haryana & Punjab), Nagpur, Bangalore, and Kolkata.

Our take: Land acquisition is the biggest factor responsible for delays in project

implementation. As per a recent survey of major infrastructure projects facing

delays, land acquisition problems were responsible in 70% of cases. Also, news

reports suggest that NHAI was unable to acquire land in eight states in Q1FY10.

With NHAI now deciding to award LoA only after 80% of land acquisition is

completed, efforts on this front need to be increased to speed up execution.

Proposal to set up an expressway authority: The government intends to createa separate expressways authority, on the lines of NHAI, which will singularly

concentrate on construction of expressways across the country. Such a move is

likely to give an impetus to the construction of expressways in the country. The

government intends to take up construction of about 1,000 km of expressways in

four identified stretches under NHDP Phase VI. The proposed stretches are: Delhi-

Meerut (66 km), Vadodara-Mumbai (400 km), Kolkata-Dhanbad (277 km), and

Bangalore-Chennai (260 km).

News reports suggest that the governmentis also contemplating building a

network of expressways spanning 17,661 km by 2022 (end of the

Thirteenth Five Year Plan). A draft report has suggested that the expressways be

Government taking steps toensure administrative issueslike land acquisition are handled

efficiently

Government undertakingmeasures to improve viability ofroad projects


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built as per the following two schedules: (a) 2,665 km by 2012, 3,690 km by 2017,

and 6,031 km by 2022 on toll basis; or (b) 2,665 km by 2012 in the first phase and

9,721 km by 2017 in the second phase on toll basis. Along with either of the two

options above, the report has suggested building 5,275 km of roads on an annuity

basis till 2022.

Proposal to classify toll receipts as tangible assets: Currently, many banksclassify toll receipts as intangible assets which results in project loans to developers

being classified as unsecured loans. This attracts higher provisioning charges and

hence, the cost of loans for borrowers goes up. The government is studying a

proposal to classify toll receipts as tangible assets which will help developers

mobilise finance.

Proposal to seek foreign funds for road projects: The government recently

indicated that it is looking at sovereign wealth funds, private equity funds, and

pension funds to fund road building in India. The roads minister has already

undertaken road shows to meet investors to discuss which financing platforms would

be most effective. The government has earmarked USD 20 bn per year for road

building and expects foreign investors to fund half of this. The government aims to

reform policy and ease investment rules for infrastructure projects in an effort to

attract foreign capital.

Setting up a forum to address developer concerns: The government has

agreed to institutionalise a CII-Ministry of Roads-NHAI forum, as a mechanism to

address industry concerns. This forum will meet every month under the leadership

of secretary, Ministry of Roads, and report back to the minister on the progress

made on various issues.

Proposal to securitise cess and toll revenues: The government is considering a

proposal to securitise the cess that it levies on petrol and diesel and the toll it

collects from tolling bridges and bypasses on NHs (these two sources together

contributed INR 87 bn in FY09). This will help the government augment its resources

for road development.

Proposal to exempt SPVs from dividend distribution tax (DDT): News reports

suggest that the Roads Ministry is asking for an exemption from the dividend

distribution tax (DDT) for SPVs which are developing highways. Under the existing

income tax laws, both the SPVs and the holding company pay taxes when they

declare dividends. This is a major disincentive for developers. The ministrys

proposal is aimed at reducing the cascading tax effect.

Proposal to set up an independent regulator for highways to oversee all NHDP

phases. The regulator will examine problems faced in implementing NHDP projects

including land acquisition or disputes arising during the bidding process.

Proposal to make the toll collection process automated in projects executed through

the PPP mechanism. This is because it is felt that leakages under the manual system

of toll collection undermine the viability of road projects for government and

developers.

Proposal to set up an arbitration body for roads that will be an institutional set up to

deal with disputes between contractors and NHAI. As per Government estimates, as

much as INR 100 bn worth funds are stuck because of disputes between developers

and the NHAI.

Other measures that can be looked into:

Mix of annuity and toll: While currently, there are two clear models under the PPP

mechanismtoll and annuitythere is no model which encompasses the

Willingness on part ofGovernment to listen todeveloper concerns


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characteristics of both. Such a model may well emerge as a win-win proposition for

all stakeholders.

NHAI had some time ago proposed a new hybrid BOT model which combined the

characteristics of both the toll as well as annuity payment models. A draft MCA was

designed for this purpose and a communiqu was circulated among developers

seeking their feedback on the same.

Currently, under the BOT (annuity) model, no viability gap funding (VGF) is made

available to the developer and he has to bear the entire project cost. The project

cost/investment is recouped by the developer through annuity payments made by

NHAI after the construction is over, while the toll collected goes to the NHAI.

However, under the BOT (toll) model, the developer has to recover his investments

through toll collection. Depending upon the viability of the project, he may ask for a

viability gap funding (currently capped at 40% of the project cost) from the NHAI or

may agree to share revenues with the NHAI.

The hybrid model had proposed that in case the amount of VGF quoted by

the developer is more than 40% of the project cost, the funding

requirement in excess of 40% of the cost would be paid to the developer in

the form of annuity payments. Significantly, even while the incremental payment

would have been made by the government, the developer would have been allowed

to collect the toll through the concession period.

However, the government has rejected the hybrid model and has decided to go

along with the current annuity and toll models.

Our take: Our interaction with developers suggests that they were in favour of the

hybrid model. The new model would have reduced the financial risk for the

developer in case toll collection was not as per expectations since he would have

received an assured annuity payment from the government. Many projects in the

past couple of months could not be awarded as the VGF quoted by developers

exceeded the 40% cap. The new model would have made these projects viable and

increased the pace of project awards.

The government would also have had to pay only the incremental amount as annuity

under this model (against the earlier practice of paying the entire annuity amount

under the BOT-annuity model). This would have had the advantage of reducing

annuity payments significantly as well as transferring the commercial risk from NHAI

to the developer.

Another method that can be tried is to allow a project to run on the annuity mode till

the time the traffic on the project reaches such a level that it becomes viable under

the toll mode. This will lessen the burden of annuity payment that the government

has to bear.

Relook at the waterfall mechanism: Under the current waterfall mechanism

followed by NHAI, a project is first invited under the BOT-toll mode. In case of

inadequate response, the BOTannuity mode is used. In case even this fails, the

project is given on cash contract basis.

Our take: While theoretically, letting market forces determine the viability of a

project is the right way, the current method takes a long award time in case the

project is not viable under the PPP mode.

A faster way to award projects could be to assess the viability of awarding a contract

on the BOT-toll model before the tender is invited. In case a project is not

considered viable under the BOT-toll method, the annuity-based method could be

used directly without going through the bidding process.

Flexible approach needed tospur road development

Measures to fast track roadproject award and removeirritants in current processneed to be taken


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In a way, the government has already started working on this. It has decided that

project development mode will be decided as per the vehicular traffic on the road as

shown below:

Table 8: Project development mode

Vehucular traffic (in PCUs) Project development mode

> 15,000 BOT-toll10,000 - 15,000 BOT-annuity

< 10,000 EPC


News reports suggest that the Government is considering a new policy under which

all road highway projects are to be earmarked from the beginning to one of three

processes of bidding, on the basis of its financial viability. NHAI has, under the new

policy, identified 6,831 km to be bid on toll, 1,143 km on annuity and 3,954 km on

EPC in FY10.

Updated cost estimates for projects: A major grouse that developers hold

against NHAI is that project cost estimates are woefully outdated and totally out of

sync with the current ground situation. A comparison of the estimated cost of someprojects as per NHAI and developers is pertinent in this respect:

Table 9: Variation between NHAI and developer cost estimates

Project

NHAI cost

estimate (INR bn) Developer

Developer cost

estimate (INR bn)

Variation

(%)

Talegaon-Amravati 5.7 IRB infra 8.5 50.6

Goa/KNT border - Panaji 4.7 IRB infra 8.4 77.4

MP/Maharashtra border - Dhule 8.4 HCC/John Laing/Sadbhav 14.2 69.5

Hyderabad-Vijaywada 17.4 GMR/Punj Lloyd 22.0 26.4


While the government has taken measures to ensure that cost estimates are more

in tune with ground realities, a lot more needs to be done to reduce the variation.

Setting up a system of empanelled developers: The roads ministry has decided

to set up a system of empanelled developers by pre qualifying them for a period of

one year. This will be done by establishing their qualification strengths. We believe

such a step should be used for NHAI projects as well since it will streamline and

simplify the process of qualification of bidders as well as save time taken to arrive at

the bidding stage.

Our take: Government seriousness shows through even if target is

daunting: The target that the government has set for itselfbuilding 20 km of roads

per dayis definitely daunting, considering the fact that the current execution rate is

not even half of that. The NHAI chairman has said that achieving such a target will

take atleast 18 months. Even then, it will require a massive capacity enhancement

exercise at NHAI, developers, contractors, banks/financial institutions, and state

governments (responsible for land acquisition) to achieve the target.

The government has taken a plethora of steps in the past three-four months to

make the sector more commercially attractive. It recently said that all amendments

to the MCA will be completed by September 2009 end to attract investments. With

the government seriously showing its intent to address grievances of all

stakeholders involvedNHAI, developers, banks/financial institutions, among others-

and establishing a definite time frame to solve various issues, its commitment to

achieving a substantial jump in the pace of road development is evident.

Government committed to aquantum improvement incountrys road infrastructure


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Outlook: Future looks bright

The NHDP had run aground in the past three years, entangled in a maze of regulations

and unfavourable economic scenario. With both these irritants out of the way, we expect

a faster pace of project awards. With the government willing to look into the problems of

developers and taking steps to remove the roadblocks, things definitely look better than

a year ago. This makes us believe that the travails of the past three years are behind us

and we are well on the road to seeing some heightened activity on the project awards

scene. To conclude, it looks like there definitely is light at the end of the tunnel as far as

the road development space is concerned.


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Huge Opportunity At Centre And State Levels

Road projects have been at the forefront of the privatisation move in the Indian infra sector.

BOT road projects account for 81% of total PPP projects awarded in India, as far as number

of projects is concerned. This shows the rapid strides made as far as popularising the PPP

route in the road sector. The heartening thing is that the past has been good and the future

promises to be even better.

If there is one word to describe the opportunity in the Indian roads space, it is humongous.

While the expected investment in NHDP is INR 3,315 bn during 2006-17, it is not the only

place where the action is happening. The NHDP accounts for only 47% of the total road

sector investment in the Eleventh Five Year P lan. State roads, at 37% of the investment,

also form an important segment for any developer/contractor in the road space. Also, as far

as rural roads are concerned, the Eleventh Plan envisages spending over INR 400 bn on them

(investment on rural roads is sourced from the Prime Ministers Grameen Sadak Yojna,

(PMGSY) under the Bharat Nirman Programme). With the public sector contributing a

majority of funding for state roads and completely for rural roads, opportunities in these

segments are available more for contractors than developers.

We take a look at the upcoming road opportunity at the central level as well as the initiatives

taken by various state governments to foster road development. Our focus is on the PPP

opportunity at the central and state levels, since privatisation is the buzzword in the Indian

road sector today.

NHDP: Developing the countrys arterial network

NHDP, launched in 1998-99, has seen its scope getting enhanced from the two phases

envisaged initially to seven phases covering more than 54,000 km (p lease re fer

annex u r e I V fo r de ta i l s o f v a r i ous phases ).

Table 10: Various phases of NHDP

Phase Length (km) Date of approval Original approvedcost (INR bn)

Phase - I 7498 * Dec-00 303

Phase - II 6647 ** Dec-03 343

Phase - III A 4,815 Mar-05 330

Phase - III B 7,294 Apr-07 476

Phase - IV 20,000 Jul-08 *** 278

Phase - V 6,500 Oct-06 412

Phase - VI 1,000 Nov-06 167

Phase - VII 700 Dec-07 167

Total 54,454 2,476


Note: * Includes 5,846 km of GQ, 981 km of NSEW, 356 km of port connectivity, and 315 km of other roads** Includes 6,161 km of NSEW and 486 km of other NHs

*** 5,000 km were approved by CCEA in July 2008

While the NHDP started with awarding projects on cash contracting basis, the focus has

progressively shifted towards the PPP approach. The government in 2005 decided to

award all projects in NHDP Ph III-VII using the PPP approach. Since then, the BOT

approach has been the predominant mode of award. The status of BOT projects in NHDP

till date is summarised below:

Huge opportunity both atcentral and state level

NHDP Worlds largestPPP road developmentprogramme


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Chart 4: BOT toll projects in NHDP

77

26

5,677

1,171

456

87

0 1,000 2,000 3,000 4,000 5,000 6,000

Awarded

Completed

Cost (INR bn) Total length (km) No. of concessions


Chart 5: BOT annuity pro jects in NHDP

25

11

1,376

713

94

38

0 300 600 900 1,200 1,500

Awarded

Completed

Cost (INR bn) Total length (km) No. of concessions


Over the years, delays in implementation and restructuring in certain cases has meant

that the cost of NHDP has been revised upwards many times. The revised cost estimates

for various phases are as follows:

Table 11: Cost of NHDP phases (2006-17) (INR bn)

NHDP phase Modified cost estimates

Phase I and II (balance work) 684Phase III 1,143

Phase -IV 393

Phase -V 515

Phase -VI 229

Phase -VII 167

SARDP-NE, ICTT Cochin and others 184

Total 3,315


PPP approach gainingacceptance in NHDP


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As is evident, the NHDP involves an investment of INR 3,315 bn during 2006-17. The

expected funding for the same is shown below:

Chart 6: Funding sources of NHDP phases (2006-17) (I NR bn)

243

723

274

444

136

104

46

441

420

119

71

93

63

138

0 200 400 600 800 1,000 1,200 1,400

I and II (Balance work)

III

IV

V

VI

VII

SARDP-NE, ICTT Cochin & others

(INR bn)

Private Sector Public Sector


A significant portion of the opportunity still remains to be tapped. Substantial completion

has been achieved only on the initial two phases. The main focus currently is on

completing these two phases and to award project under Phases III and V.

Table12: Status of various NHDP phases

PhaseTotal

length (km)

Already

4-laned (km)

Under implementation

(km)

Balance for

award (km)Likely completion date

Phase I 7,498 7,227 265 6 Substantially completed

Phase II 6,647 3,451 2,444 752 Dec-10

Phase III 12,109 937 2,155 9,017 Dec-13

Phase IV 20,000 0 0 20,000 Dec-16

Phase V 6,500 131 899 5,470 Dec-13

Phase VI 1,000 0 0 1,000 Dec-16

Phase VII 700 0 19 681 Dec-15

Total 54,454 11,746 5,782 36,926


As can be seen above, of the total 54,454 km under the NHDP (including NHDP Phase IV

which will be implemented by Ministry of Roads), 36,926 km of roads are still to be

awarded. Of the seven phases, NHDP Phase IV and VI are yet to see any action on

ground while awarding under Phase VII has just begun. This means that there is a huge

opportunity waiting to be tapped by developers as far as NHDP is concerned.

PPP opportunity at state level: The undiscovered paradise

While NHDP hogs most of the spotlight, many states have been quietly and steadily

drawing up the roadmap for PPP projects in the road sector. In fact, the phenomena of

state PPP projects is old, with states like Rajasthan passing enabling resolution for

inviting private participation in roads way back in 1994. Other states like Gujarat had

started awarding PPP projects (like the Vadodara-Halol project which was completed in

2000) much before the turn of the century when NHDP projects picked pace.

NHDP entails huge fundingrequirements

PPP opportunity at state levelis probably bigger than NHDP


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The reason why the state PPP scene attracts relatively less attention than the NHDP is

because of the comparatively dispersed scene of action. Also, the level of activity differs

from state to state. While states like Maharashtra, Gujarat, and Rajasthan are active as

far as attracting private investments is concerned, there are many states which do not

have a PPP policy and a PPP cell even today. Also, the regulatory frameworks vary with

states having their own MCAs.

The level of investment at the state level till now is also low . Part of it can be

blamed on the slackness of states to take steps to set up the necessary

regulatory framework. Also, there have been apprehensions regarding the credit

worthiness of the involved state bodies (against NHAI, which is a AAA (Ind) rated

entity).

However, things seem to be changing now. State governments seem to have realized the

enormous potential of the private sector as far as developing the road network is

concerned. Also, increasing awareness about the positive impact of a robust

infrastructure network seems to be trickling in. All in all, we are set to see an enhanced

level of activity as far as the state PPP scene is concerned. We present the future

opportunity available in major states.

Karnataka: INR 1,770 bn opportunity

Karnataka has decided to develop a Core Road Network (CRN) spanning

66,000 km at an estimated cost of INR 1,770 bn under the PP P mode (BOT-

toll) over the next six years (2009-15). The CRN is to be developed in three

phases: (i) first phase involving the development of 10,000 km of state highways

(SHs) and major district roads (MDR) and 12,600 kms of village roads (VRs). The

estimated cost of developing state highways and MDR is INR 314 bn; (ii) second

phase with 40,000 km of roads to be developed at an estimated cost of INR 1,088

bn; and (iii) third phase comprising 16,000 km with an investment of INR 368 bn.

The CRN will connect the major IT centre of Bangalore with other IT hubs such as

Mysore, Hassan, Davangere, Hubli, Dharwad, and Mangalore to promote industrialand urban development besides integrating economically backward and remote

areas. It will be an all weather, smooth, speedy flowing road network with minimum

two lane carriageway including feeder roads and four-six lanes near urban

settlements.

The concession agreement initially developed for these roads had innovative

features like award of land pockets to developers to set up roadside amenities like

restaurants, which was to be an additional source of revenue for companies. It

proposed that developers would be eligible for one acre of wayside amenity land for

every 5 km of project road (SHs//MDR plus VRs). Land acquisition and development

was to be undertaken by developers. However, most of the developers that evinced

interest in the programme were uncomfortable with land acquisition. Upon their

requests, the government has now decided to acquire the land required for thedevelopment of these roads on its own.

Also, the state government has drawn up a plan for the overall development of

Bangalore with an outlay of INR 220 bn. The plan includes 12 major signal-free

corridors, three elevated corridors, strengthening of arterial and sub-arterial roads,

construction of 40 railway over and under bridges, etc.

Meanwhile, the much delayed Peripheral Ring Road in Bangalore is also expected to

see the light of the day. The state government has given the go-ahead for the first

phase of the project. It will be implemented by the Bangalore Development

Karnataka plans to spendINR 1,770 bn on roaddevelopment through PPPapproach in 20009-15


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Authority (BDA) in partnership with private companies. The road, once it fully

encircles the city, will be 116 km long and is expected to cost upwards of INR 30 bn.

Gujarat: The early mover

The Gujarat government has been active as far as PPP projects in the road sector

are concerned. It was the first state in India to have a law governing BOT

projects and such other arrangements along with private participation in

infrastructure projects. The state witnessed the completion of the Vadodara-Halol

and Ahmadabad-Mehsana toll projects in 2000 and 2003, respectively. The Gujarat

State Road Development Corporation (GSRDC) had last year signed a concession

agreement with Larsen and Toubro (L&T) for construction of three road corridors in

the state with a total length of 485 km and a project cost of INR 43 bn.

The state government has now plans to undertake improvement of roads with

private investment of about INR 90 bn. This involves developing 2,600 km of roads

with an investment of INR 30 bn on annuity basis and of 1,000 km of roads with an

investment of INR 60 bn on toll basis. The government has started with the projects

on annuity basis which would ensure a fixed stream of revenues for companies. Also,

the state government is assuring developers that 95% of the land will be made

available to them at the beginning of the project. This compares favourably with 50-

60% that most companies usually get in NHAI projects.

Also, the government has drawn up an ambitious plan for road development in the

state. The proposed investment is ~ INR 300 bn in 2010-12 and ~ INR 200

bn in 2012-17. PPP w ill be the major source of funding, contributing ~ INR

110 bn in 2010-12 and ~ INR 120 bn in 2012-17.

Andhra Pradesh: The programme approach

The state government has to its credit successful highway development programmes

such as the World Bank funded Andhra Pradesh State Highway Project (APSHP). The

government has already awarded 38 road projects on BOT basis worth INR 77 bn.

With the success of APSHP, the state government has now proposed a second

project, i.e., AP Road Sector Project (APRSP) for improvement and better

management of roads. The programme involves four laning of 1,252 km of roads

under the PPP basis; it also includes upgradation and improvement of 600 km of

roads and long-term performance based maintenance contract (LTPBMC) for 6,523

km of roads. Apart from this, there are 15 projects currently in the pipeline to be

awarded under the BOT model.

Madhya P radesh: The BOND-BOT approach

Madhya Pradesh (MP) has taken some innovative steps to foster the development of

the road network through the PPP route. It initiated the Bond-BOT scheme to

develop 2,000 km of state roads on BOT basis. The projects were aided by the state

government through a subsidy of INR 5 bn, which was raised by a bond issue underthe Madhya Pradesh Infrastructure Investment Fund Scheme. The projects

developed during the scheme included the likes of the 203 km Indore-Edalabad

project and the 247 km long Rewa-Amarkantak project.

MP was als o the first state to receive VGF from the central government. The

state has also been able to award BOT projects on a negative

grant/ revenue sharing basis, indicating the attractiveness of the stretches.

The state has completed projects spread over 1,532 km on BOT basis while projects

spanning 965 km on BOT basis are under development.

Gujarat ambitious roaddevelopment plans


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DBFOT model on an annuity basis. Land acquisition for phase I of the ORR from

Vandalur to Nemilichery has been completed. GMR Infrastructure recently won the

bid to develop this 29.65 km stretch at a cost of ~ INR 11 bn.

Apart from this, a road network development scheme for Chennai under the second

master plan has also been conceptualised. This plan, called the Chennai

Elevated Expressways, is to be developed at a cost of INR 130 bn. A total of

nine elevated corridors have been proposed in the medium term while 12 corridors

have been proposed in the long term. The overall project is to be completed by

2019-20.

Also, recently the state government stated that it proposes to develop and upgrade

12,000 km of road at an outlay of ~ INR 40 bn. While 5,500 km roads will be

widened, maintenance work will be carried out on 6,500 km roads. During the past

three years, the government had upgraded 3,270 km of major district and other

district roads into state highways.

Maharashtra: Leading the pack

Maharashtra is the leader as far as attracting private investment in road projects is

concerned. It formulated a policy in 1996 to finance road development projects

through private sector participation. A cabinet sub-committee has been formed to

take fast decisions related to infrastructure projects. The state has already

completed 16 major projects costing INR 54 bn. Further, 14 projects costing INR

108 bn are under development.

The state has ambitious plans regarding future projects. Upcoming projects include

the Worli-Nariman Point Sea Link, integrated road development programmes in

many cities, widening of various state highways on BOT basis, among others.

Punjab: Expressway all the way

The Punjab Industrial Development Board (PIDB) is the nodal body for infra

development in the state and is designated as the PPP cell for infrastructuredevelopment in Punjab. The state has already completed nine BOT projects in the

road sector.

The PIDB has an ambitious programme as far as future PPP projects are concerned.

Future projects include five ambitious expressw ays, viz., Mohali-Phagwara

Expressway (INR 25 bn), expressway around Mohali (INR 23 bn),

expressway for Amritsar Airport, Pathankot-Ajmer Expressway (INR 86 bn),

and expressway in Ropar along Sidhwan Canal up to Ludhiana. Other PPP

projects included two ring roads (the Amritsar ring road at a cost of INR 20 bn and

the Ludhiana ring road to be built at an estimated cost of INR 30 bn) apart from

various other road projects.

Haryana: Venturing out

The state government has approved the improvement of the Gurgaon-Faridabad

road, Ballabhgarh-Pali-Dhauj-Sohna road, Chandimandir-Jallah road, Bhuria-Khadri-

Deodha Nainawali road, and Yamunanagar-Ladwa-Karnal road on PPP basis. Of this,

the Gurgaon-Faridabad project has been already awarded to Reliance Infra. The

government is also planning a North-South and East-West corridor at an estimated

cost of INR 40 bn.

New entrants looking to catch upwith early movers


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Orissa: Taking first steps

Orissa has a road network of around 2.38 lakh km (including 3,100 km of NHs). The

state has embarked on an ambitious plan for improving road connectivity through

the PPP route.

Upcoming projects include the Capital Region Ring Road (INR 3 bn), Bhubaneswar-Paradeep Road (INR 5.6 bn), four Laning of Sambalpur-Rourkela Road (INR 12.7 bn),

Koira-Tensa-Lahunipara Road (INR 4 bn), among others.

Summary

The opportunity at the state level for the PPP route is abundant. The overall quantum

rivals that of the NHDP and is perhaps even bigger than it. However, the opportunity is

spread across a wide spectrum and the level of preparedness for PPP projects across

various states is also different. While some like Gujarat and Rajasthan are old hands at

the game, others like Orissa are in unchartered territory. The PPP framework and the

associated regulations also differ across states; this, along with the myriad agencies with

which companies will have to deal at the state level, is likely to ensure that there will be

misses along with hits on the way. However, it can be safely said that the state road PPP

scene is now ready for a quantum leap. Over the long term, it will ensure that there is noshortage of work for any participant in the infrastructure space.


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Time To Think About The Constraints

While no one doubts the huge opportunity in store, it is also prudent to keep the constraints

in mind. As far as the road development scene is concerned, the obvious constraints are:

1. Execution capability of contractors.

2. Amount of money the government (NHAI) can put in.

3. Debt funding from banks and other financial entities.

4. Capability of developers to provide the equity portion of funding.

We take a look at these factors involved:

1. Execution capability: A spending of INR 1 tn every year means that developers

alone will not be able to execute projects on their own; a significant chunk of the

work will have to be outsourced to third part contractors as well. But even then, a

look at the revenues earned by roads divisions of various contractors in FY09 reveals

that it appears unlikely that this much quantum of work can be handled.

Table 13: Order book/ execution ratio of various contractors

Company Order book/execution ratio (FY09 end)

IVRCL Infra 2.8

Nagarjuna Construction 2.6

Patel Engg 2.9

Simplex Infra 2.1

Gammon India 3.5

Hindustan Construction 4.9

Sadbhav Engg 4.6

Madhucon Projects 5.2

Gayatri Projects 5.7

Punj Lloyd 1.7

Source: Company, Edelweiss research

With the spurt in order awards in the past six months, most contractors currently

have a robust order book (>3x FY09 revenues). With the overall focus on

infrastructure development, there are going to be opportunities in other

infra segments as well. In this context, building 20 km of roads every day is

a tough task to achieve.

While the government has stated its intention to focus on capacity augmentation of

contractors, it is going to be a gradual progress rather than a fast one. The

government is also looking at getting the help of foreign players to achieve its

objective. While foreign players may be able to help in funding aspects and projectmanagement skills, it yet remains to be seen how many of them will be willing to get

their hands dirty doing the actual contracting work.

To conclude, even though projects awarded now will enter the execution stage after

only a year or so, we believe that execution is going to be an issue, atleast in

the medium term. The fact that many states are also becoming active as far as

road development is concerned is going to further test the execution abilities of

contractors.

Are there enough contractorsto build 7000 km of roadsevery year?


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2. Does the government have the money?: The proposed funding plan for NHDP

amounting to INR 1,735 bn in the Eleventh Five Year Plan is as follows:

Chart 7: Funding plan for NHDP in 11th plan

Cess21%

Externalassistance

2%

Borrowings byNHAI24%

Surplus fromuser fee

2%

Share of privatesector51%

Source: Working Group report on roads for the Eleventh Five Year Plan, Edelweiss research

As is evident, the private sector is expected to provide more than half of the funds

required. However, with the sluggish pace of project award in the first two years of

the plan, achieving this target is going to be an uphill task. Currently, it looks like

that the government may have to put more on the table than what was envisaged.

We take a look at various funding sources being utilised by NHAI over the

past few years:

Table 14: Funding sources utilised by NHAI (INR bn)

Borro- Budgetary Toll TotalYear Cess Grants Loans wings support collection

1999-00 10 5 0 7 0 0 22

2000-01 18 5 1 8 0 0 32

2001-02 21 9 1 56 0 0 87

2002-03 20 12 3 0 0 3 38

2003-04 20 12 3 0 0 4 38

2004-05 18 12 4 0 0 5 39

2005-06 33 24 5 13 7 8 90

2006-07 64 16 4 15 1 11 111

2007-08 65 18 4 20 3 14 125

2008-09 70 15 4 11 2 17 118

Total 340 127 29 129 12 61 699

External assistance


The amount collected from cess on diesel and petrol of INR 135 bn during the first

two years of the plan is more or less as per estimates. It goes into a non lapsable

fund to be used for highway development.

On the other hand, external assistance has reached INR 41 bn in the first two years

itself against projections of INR 45 bn over the plan period. This signifies the

emphasis being put by the government on road development.

Does the government haveenough money to back up itsambitious plans?


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As far as NHAI borrowings are concerned, there is still a lot of leeway left

with the agency: As against the planned figure of more than INR 400 bn of

borrowings, NHAI has borrowed only INR 31 bn in the past two years. There is

expected to be a sharp uptick in borrowings going ahead with the NHAI planning to

borrow INR 50 bn in FY10. News articles suggest, of this, INR 5 bn is proposed to be

raised from a multilateral agency and negotiations are going on with ADB for a USD

100 mn loan. The balance is proposed to be raised through tax-free bonds, which

are already available in the market. NHAI is also in talks with the World Bank to

restructure an earlier loan of USD 400 mn.

NHAI toll collection has also jumped to INR 17 bn this year. About 7,560 km of NHs

have been completed and are under tolling. However, 3,476 km of NHs are only

partially complete and hence are not under tolling. The toll collection could be

expected to jump further on completion of these projects.

Also, recent news reports suggest that the government is considering a move to

transfer a part of the INR 100 bn tax-free bonds raised by IIFCL to NHAI for

refinancing of road projects.

To summarise, the oft repeated statement from government that it will not allow

money to hinder road development is true to some extent. In the near term, it

seems that NHAI has adequate funds at its disposal to carry out its plans .

However, the picture over the medium term is muddled and will depend

upon several factors:

(i) How fast is the government able to remove bottlenecks and what will be the

success rate in awarding projects over the next two years.

(ii) How much will the government be able to support NHAI, constrained that it is

due to considerations about fiscal deficit.

(iii) How fast the economy recovers, for it will improve project viability by boosting

traffic and reduce dependence of developers on VGF (or conversely, how soon

will we see the return of developers willing to share revenues with Government).

3. Funding conundrum: Will the flood of liquidity translate into financial

closures: With no dearth of projects to choose from, liquidity situation improving,

and regulatory framework also turning favourable, the only stumbling block in

the way of a marked improvement in project awards, in our view, is funding .

Also, with increasing commoditization of the sector, the extent to which project

economics can be improved will increasingly depend upon innovative funding

structure along with design and execution capabilities.

In such a scenario, the extent of the companies participation in future BOT projects

(and the success of the overall PPP plan in roads) will depend upon the confidencewhich companies have in achieving FC on projects. Thus, cracking the funding

code is the key to unlocking the PPP opportunity, in our view.

There are two major questions which will determine the success of the Indian PPP

road projects in the medium term: (a) how much risk aversion from banks will the

BOT projects face, keeping in mind the worries on asset quality (toll revenues being

lower than estimates on some projects) and asset-liability mismatch (concession

period being increased for many projects); and (b) where will the required equity for

projects come from?

Can NHAI finances stand up tothe increased demand for

government funding?

Will funding emerge as thedeal-breaker?


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In order to get answers to these questions, we have interacted with banks,

financial institutions, private equity players as w ell as major developers in

the road BOT space. We present our analysis of the situation:

Banks turning sympathetic towards BOT projects .

Various steps taken by the government to improve the viability of BOT projects havefound favour with banks. While a return of the 80:20 D/E structure for road BOT

projects is still far, banks are comfortable funding a 70:30 project structure (which

may go up to 75:25 in case the project is very lucrative).

Also, most banks do not have preferences regarding whether the project is a

NHAI/state project or the mode of project (toll/annuity). The paramount factor

determining lending decisions is viability of the project. As far as sectoral lending

caps are concerned, these can be changed internally in case a host of viable projects

are available in any particular sector.

Interest rates, on the other hand, present an interesting conundrum. The latter part

of the last year saw interest rates shooting up, making many projects unviable.

While rates have dropped significantly since then (currently at 11-12% level forproject finance proposals), most banks are of the view that we are near the end of

the interest rate cut cycle.

In fact post the budget, there have been apprehensions that the sheer size of

government borrowing will crowd out private players, driving interest rates higher by

the start of next year. This may well coincide with the time when majority of the

road BOT projects awarded this year are expected to come up for FC. How long will

developers get to enjoy a favourable interest rate environment has emerged as an

important point to ponder over.

.but, can they support long term funding r equirement

The problem with BOT project funding is not limited to tying up initial funds. Theirlong tenure creates headache of asset-liability mismatch for banks. Recognising this,

the government has been trying to take the help of IIFCL for this purpose.

In Budget 2009-10, the government has proposed release of long-term funds by

IIFCL for projects; IIFCL will also refinance 60% of bank loans for PPP in

critical sectors over 15- 18 months. It will provide refinance at 7.85%,

which banks can on-lend at 10.35%.

The World Bank has recently sanctioned a USD 1.2 bn loan to IIFCL. This loan is

designed to support IIFCLs role to catalyse private financing for PPP projects in

infrastructure and to stimulate the development of a long-term local currency debt

financing market.

The government has also mooted the idea of take-out financing which basically

involves securitising of infrastructure advances by primary financiers, especially

banks, in favour of long-term financial institutions. IIFCL recently indicated that

it has deployable funds of around INR 100 bn, a part of which has been

raised for 10-25 years. Thus, it is in a position to offer take-out financing.

However, it yet remains to be seen whether take-out financing will work. It has

been tried in the past too when SBI had tied up with IDFC, while IDBI had tied up

with LIC for take-out financing. But these arrangements could not work.

Banks shedding theirapprehension towards roadprojects

But do the banks have enoughlong term resources


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Anyways, IIFCLs overall exposure to the roads sector is low compared to the

requirements. For the roads sector, the quantum of IIFCLs disbursal in FY09

stood at INR 12.9 bn, which even though w as more than double the INR 5.8

bn achieved in previous year, is still on the lower side . Also, while IIFCL had

raised INR 100 bn earlier this year to refinance highways and port projects, it has

not received a single proposal till date for funding. The pace of project awards in the

time to come will determine whether IIFCL can achieve its target of lending INR 1 tn

over the next five years.

and, how much can they support

Even assuming that banks aided by IIFCL are willing to fund projects, the sheer

quantum of funds required means that doubts will continue to linger.

Chart 8: Banking sector exposure to roads and ports sector

0.0

6.0

12.0

18.0

24.0

30.0

0

100

200

300

400

500

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

(%)

(INRbn)

Roads/ports sector exposure As % of overall infra portfolio


As shown in chart 8, total banking sector exposure to the roads and port

sector was ~INR 470 bn at FY09 end. The share of the roads/ports sector in the

overall infra portfolio of banks has been hovering around 17% for the past four

years.

We attempt a small exercise to ascertain the quantum of roads which can be funded

in the current scheme of things. The banking sector exposure to infrastructure at the

end of FY09 was ~ INR 2,700 bn.

Assumptions:

1. Banks credit to infra sector grows by 32% in FY10.

2. Roads/ports sector share in overall infra portfolio of banks is 17% in FY09; itrises to 20% in FY10 with increased thrust on the sector.

.and more importantly, howmuch can banks support roadprojects?


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Table 15: Incremental fund availability to roads sector

Particulars Funding

Banking sector exposure to infra at FY09 end (INR bn) A 2,700

Credit growth assumption for infra sector in FY10 (%) B 32

Banking sector exposure to infra at FY10 end (INR bn) C = A*(1+B) 3,564

Share of roads/ports sector in infra portfolio at FY09 end (%) D 17

Share of roads/ports sector assumed in infra portfolio at FY10 end (%) E 20

Incremental credit available for roads/ports sector in FY10 (INR bn) F = C*E-A*D 254

Assumed share of roads in incremental credit (%) G 75

Incremental credit available for roads in FY10 (INR bn) H = G*F 190

Assumed debt funding for a typical road project (%) I 70

Amount of road projects that can be funded (INR bn) J = H/I 272


Table 15 shows that if the current scenario continues, only ~ INR 272 bn of

road projects will be able to get funding. This needs to be juxtaposed with

the ambitious plans of the central and state governments as far as the road

development scene is concerned.

The projects awarded on an EPC business will not face much problems; similarly,

annuity based projects are also likely to face comparatively less problems due to

absence of revenue risks. However, toll projects will pose a dilemma for banks due

to associated toll risks. In any case, bank funding to the sector will have to take a

quantum leap. In case the projects come up in a bunch, there is high probability that

some of them will face funding delays.

4. Equity commitment still the biggest worry and may emerge as the party

pooper: The bigger worry for BOT projects, in our view, is the equity commitment

required. With project sizes increasing and banks asking promoters to put in ahigher share of equity, the equity required for projects has increased substantially

when compared to projects awarded two-three years ago.

Coupled with this, the downtrend in equity markets (during the past one year) and

drying up of private equity options had soured the pitch. PE funds were reluctant to

invest as securitising toll fees and selling down to global pension funds as an option

had disappeared for some time. Compounding the problem was the fact that

the core contracting business (which anyways is a negative operating cash

flow business) for most companies had taken a hit last year due to increase

in commodity prices, interest rates, and slowdown in order intake, thus limiting the

parents ability to pump in money.

Many companies which had won projects in the 2005-07 period had hoped to sellstake in projects once they were complete and utilize the fund infusion to bid for

future projects. Even as these projects became operational/achieved completion, the

equity markets plunge poured cold water on such hopes.

As per the Economic Survey 2008-09, infrastructure companies raised less money

through public and rights issues in 2008-09 compared to the previous year. Public

share sales and rights issues fell from INR 870 bn in 2007-08 to INR 147 bn

in 2008-09.

Equity commitment fromdevelopers side may createroadblocks


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A ray of hope is, however, the signs of recovery in equity markets. Many companies

have announced fund raising plans. A summary of the fund raising plans of major

infra companies is given below:

Table 16: Fund raising by companies

Company

Fund raising by

companies (INRbn) Status

HCC 4.8 QIP completed

GVK 7.2 QIP completed

Punj Lloyd 6.7 QIP completed

Lanco 7.3 QIP completed

Nagarjuna Construction 3.7 QIP completed

Era Infra 3.0 Warrants allotted

Reliance Infra 39.8 Warrants allotted

Gammon Infrastructure 10.0 Shareholders's approval received

Sadbhav Engg 1.3 Shareholders's approval received

Unity Infraprojects 2.5 Shareholders's approval received

Gammon India 9.6 Board approval received Source: Edelweiss research

However, the amount of equity required for road projects is large. Assuming an

equity contribution of 30% for road projects, ~ INR 200-300 bn of funds will be

required for the equity commitment in upcoming road projects. Amidst such a

scenario, it surely is advantageous for companies with low leverage levels which are

in a better position to fulfill their equity commitment.

Possible options to help solve the funding cononundrum

Some of the options that can be tapped to ease funding pangs are:

1. Long-term loans provided on reimbursable basis by the government.

2. Multilateral funding institutions like the Asian Development Bank (ADB),

International Finance Corporation (IFC), and DEG, can lend a helping hand.

3. Currently, IIFCL can refinance only commercial banks. The facility can be extended

to NBFCs and other institutions lending to the infrastructure sector. Also, IIFCL can

finance only 20% of the project cost and 60% of debt has to be repaid in the first 10

years of the project. A removal of these restrictions will ensure that more projects

will achieve FC.

4. Currently, ECBs can be used only for refinancing old ECBs at better terms or for

undertaking capex. Allowing developers to access ECBs for repaying old rupee term

loans on operational projects will help repay high-cost funds a

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Construction-sector_update-Oct-09