View | Infrastructure sector reforms – building India at scale

In the last upcycle -- from FY05-FY08 -- companies in the infrastructure sector witnessed very strong ordering. This led to increased risk appetite and aggressive bidding for new orders. 

Companies started venturing into unrelated sectors such as Power Assets, Roads Build Operate and Transfer (BOT), Real Estate Development, and Airports where they didn’t have the experience to execute. What used to be an Engineering Procurement & Construction (EPC) business became asset heavy and companies ignored project specific risks such as land acquisitions, delays in getting environment/forest clearance which led to time and cost overruns. 

When the 2008 recession hit, bad project choices led to defaults. Aggressive bidding led to cracks in the margins. Infrastructure ordering was severely impacted as developer’s balancesheet expanded and stuck projects piled up and banks refrained from financing new projects. This led to a long and painful period of consolidation during which India’s investment cycle went through its weakest phase.

In order to restart the infrastructure cycle, the government implemented multiple reforms from FY14. Time and cost overruns have led to an approximately 40% rise in net investments by the government, as per the Ministry of Statistics and Programme Implementation (MOSPI). 

Exhibit 1: Cost and time overruns for delayed projects of the central government (%)

 

 

 

 

 

 

Key reforms implemented by the government were ~80/90 percent land to be in place before the project gets awarded, introduction of annuity based models such as Hybrid Annuity Model (HAM) to lower the risk for developers with the Centre having skin in the game by contributing 40% equity to the project, low interest mobilisation advances and timely payment by central government authorities like National Highways Authority of India (NHAI) and early completion bonuses. 

The process of reforms continues with new announcements by the Ministry of Finance in October 2021 which are applicable to central ministries/departments or Central Public Sector Enterprises (CPSEs). While these are not mandatory for states, they could take some of these best practices and implement in their contracts too.

In this bidding method, up to 30 percent weight can be assigned to non-financial parameters (the balance 70 percent being for the price bid submitted). In the traditional L1 system, decision is made solely on the price bids submitted by the bidders who have been pre-qualified. We believe this is a gamechanger as it reduces competition from companies taking orders only based on lower pricing without focus on the quality aspect. When bids are based only on pricing it is the quality which suffers, specifically in the case of equipment supplies or execution of complex projects.   

In the past, we have seen projects getting cancelled or delayed due to single bids as many players may not have the capabilities or technology to execute them. The government has changed this practice and allowed a single bid to be considered valid if due process and transparency was followed and discovered bid price is reasonable vis-à-vis market values. we believe that this will lead to improved conversion of projects from tendering to execution as we move towards execution of more complex projects and new age technologies.

Timely payments to the contractors is the most critical aspect of project execution and helps them manage their cash flows well. We see the government not only focussing on timely execution but also on timely payments. 

As part of these recent reforms, the  government has allowed ad hoc payments of at least 75 percent of eligible running bill/stage payments to be made within 10 working days of bill submission and certification by the engineer in-charge. Balance payment can be made after final checking within 28 working days of bill submission. In case the payments are delayed there will be provision for payment of interest for payments delayed beyond 30 days, this has been unheard of. Also officers concerned to be held responsible in case of unwarranted delays. The final bill must be paid to the contractor within three months of completion of work.   

We believe all these reforms are positive for the infrastructure/construction and capital goods sector as it shifts focus on quality of execution, gives importance to the fact that there could be a few companies to execute technologically complex projects and timely payments. Investors have been always wary of these risks in the infrastructure/construction space. These reforms can ensure the pace of execution picks up for the projects and balancesheets of the contractors remain strong. We believe key beneficiaries likely be construction companies and capital equipment suppliers.

— The author, Charanjit Singh, is a Fund Manager with DSP Investment Managers. The views expressed are personal.