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Construction: Building India! - Views on News from Equitymaster

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Construction: Building India!

Mar 27, 2006

World-class infrastructure has emerged as a fuel to power long-term and sustainable growth of economies, especially emerging economies, which are witnessing faster growth in demand for infrastructure and construction services. As far as the Indian economy is concerned, while the populace have been deprived of even a decent infrastructure setup (due to government's slackness), what we are witnessing now is a kind of a revolution as far as the changes taking place in the industry are concerned. The construction industry received a fillip beginning FY03, with the government showing increased focus towards developing a strong and sound infrastructure setup in the country. In India, the construction industry is the second largest economic activity after agriculture, estimated to grow at an average rate of 9.5% during FY02 to FY06, against 8.6% average growth for the services sector. The availability of the cheap labour makes the industry largely labour-intensive. The industry is not fixed capital intensive; it is working capital intensive in terms of the gross working capital requirements. The initial gross working capital requirement depends on the type of projects (road projects have lesser working capital requirements as compared with building projects).

The construction sector forms around 12.8% of the GDP and 52% of gross fixed capital formation. Investments in the sector have a domino effect on supplier industries there by giving a way to economic development and futher leading to the growth of the other sub-industries, which are dependent on this sector (like cement, steel and chemicals). Interestingly, the industry supports 32 upstream industries and 72 downstream industries.

Of changing times…
In the past, private sector participation in most of the infrastructure projects was nil, or minimal. The government used to dominate this segment. However, times have been changing with the government now focusing greater on a private public partnership model (PPP) for infrastructure creation. This has seen a host of private sector constriction players investing in the sector, mainly through the BOT model (Build-Operate-Transfer).

In the BOT model, which is basically used in road construction, the private firm builds and operates a toll road till it recovers the investments and earns a profit. This is a typical BOT contract. Another type of BOT contact is based on annuity, wherein the concessionaire (private party) gets a fixed amount annually from the government to recover his investment up to the agreed concession period. In this case, the government does the toll collection. One of the best examples of PPP based BOT model in India is the planned upgradation of the New Delhi and Mumbai airports.

Roads are, however, the biggest of India's PPP infrastructure projects. Indeed, among other projects, roads have evinced maximum interest and optimism among private players for PPP. Even the government has outlined some policy initiatives in order to attract private investments in road infrastructure projects. As per National Highways Authority of India (NHAI), some of these incentives are:

  • Government will carry out all preparatory work including land acquisition and utility removal. Right of way to be made available to concessionaires free from all encumbrances.

  • NHAI/Government of India to provide capital grant up to 40% of project cost to enhance viability on a case-to-case basis.

  • 100% tax exemption for 10 years.

  • Concession period allowed up to 30 years.

  • In BOT projects, the entrepreneur is allowed to collect and retain tolls.

  • Duty free import of specified modern high capacity equipment for highway construction.

As per the NHAI, over the next ten years, about 32,000 km of national and 25,000 km of state highways need to be widened, at a cost of some Rs 1,700 bn, and highway maintenance will require over Rs 950 bn. NHAI is also preparing the four-laning of 10,000 km of national highways outside NHDP (National Highway Development Program). The current thinking suggests that most sections would be toll-based BOT, with less viable routes awarded through cash contracts or annuities. Public support will be capped at 40% of project cost (25% during construction and 15% over the concession period). The future of companies in this business thus appears bright. Project execution skills and scalability, will however be very critical in the differentiating successful companies from the rest.

Growth is also expected in other segments of the construction sector, more importantly in real estate, where easy availability of home loans, low interest rate and demographic factors have led to higher demand for better quality housing.

According to the latest economic survey, India has the potential to absorb US$ 150 bn of foreign direct investment in the next five years in the infrastructure sector alone, of which a large part is expected to go towards construction activities (both road and housing development). Considering the present rate of growth and the untapped demand of better housing and road from the semi-urban and rural areas, we believe that contribution from the construction sector to the GDP shall rise further in the future. Importantly, the government is showing the way!


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