Challenging year for india
Year 2008-09 will be a challenging year for the Indian
construction industry as higher commodity prices, volatile capital market and
forthcoming elections will leave their mark on the industry, says Harish Rao
The significance of the construction sector in any economy is
well known. In India, it is even more apparent as it provides a large scope for
direct and indirect employment for skilled and unskilled persons. It employs
over 30 million people, many of them women and migrants, and has been growing at
over 10 per cent per year over the last five years. It covers rural and urban
infrastructure, roads, airports, sea ports, and commercial and residential
Infrastructure development has been identified as a major thrust area as
emphasised through such projects as Bharat Nirman, Pradhan Mantri Grameen Sadak
Yojana, the National Highways Development Programme, airport modernisation etc.
In housing also there is a large unmet need and a growing demand due to the
growing working population and nuclear families.
However, 2008-09 will be a challenging year for the Indian construction
industry. Higher commodity prices, volatile capital market and forthcoming
elections - all will have their adverse impact on the performance of
Many states like Karnataka, Madhya Pradesh, Rajasthan and Andhra Pradesh are
going to polls in the coming months. General elections will also be held during
early next year. Project awards could possibly get delayed due to these
forthcoming elections, both at the Centre and in several States.
Elections generally result in business uncertainty, as new governments tend to
re-look at the existing regulatory framework, ongoing projects, etc, there could
be delays in awarding projects. As such elections will be a bad news for
construction companies. It should be remembered that most of the construction
companies derive more than 75 per cent plus of the order book from government projects (both Central and state). In fact,
and Patel Engineering derive 85-90 per cent of their contracts from government.
Among the construction companies, only Simplex Infrastructure gets less than 35
per cent of its business from government agencies.
Elections can delay awarding projects but cannot prevent them: Every political
party in India that has come into power has typically set up a task force in
charge of infrastructure. If the same party comes to power after the elections
also, the process of capital expenditure may not be delayed substantially.
However, if it doesn't happen it may delay the capex programme of the
Typically, a new party coming into power spends most of the initial years in
renaming the old programmes, discontinuing some of the programmes of the
previous government and also restarting some abandoned programmes. Situation
will turn worse if a coalition government is formed at the center as well as at
the state level. A coalition government has to spend most of its time cajoling
its coalition partners than do some constructive work.
The construction sector is facing huge manpower shortage and also high attrition
rate. Robust growth seen in the construction sector during the last few years
has resulted in insatiable demand for manpower from the sector. Further,
increased construction activity in the Middle East has also resulted in large
number of engineers migrating to the Gulf region in pursuit of better
opportunities. In fact, India has become a preferred source of manpower for MNC
contractors working in the Middle East.
The software industry is another big threat to engineering companies, as
engineers typically prefer a higher paying software job than a civil, mechanical
or electrical engineering job.
Acute shortage of manpower in the country has forced the domestic manpower
consultants to look for engineers from other countries. Reliance Industries
embarked upon its massive cross-country pipeline programme with the help of
Chinese engineers and workers. Recently Ma Foi Management Consultants Ltd, a
Chennai-based HR company, formed a joint venture with the UK-based BBT Worldwide
to bring expatriates to work for an interim period (say six months). These
expatriates will be mostly recruited from the UK, Netherlands and Scandinavia.
According to one estimate, there are already 1,800 expatriates working in
various sectors in the country like manufacturing and engineering. This number
is expected to go up to 3000 by the end of this year.
Rising input cost
In the coming months, margins of construction companies are likely to be under
pressure due to ever-increasing material cost. During the last two years, that
is, FY'06-FY'08, operating margins of construction companies went up
substantially due to improved demand dynamics, change in order book composition
towards high margin segments, operating leverage, etc. However, operating
margins may come under pressure in the coming months due to higher commodity
prices and wage inflation.
It should be noted that most of the construction companies have fixed-price
contacts (which may account for 5-20 per cent of the order backlog), where
margins could get affected due to higher input costs. Usually, domestic EPC
contracts and international orders are fixed-price contacts without any cost
escalations. Thus the contractors cannot pass on cost escalations to project
owners. Companies like Gammon, NCC, L&T etc., have large parts of their order
book coming from fixed-price contracts.
Most of the construction companies have negative cash flows and may require to
raise funds from the capital markets. Volatile conditions in the capital market
may create hurdles in their plans to raise money, and also affect their project
completion schedule. Most of the construction companies are frequent visitors of
capital and debt markets (both domestic and international) to raise funds
required for execution of various orders.
Most of the companies have raised funds from the market in the recent past and
may not need funds in the immediate future. However, if the volatility in the
market continues for a longer time, then these construction companies may be in
for trouble. Also, many of these companies are undertaking many BOT projects
with longer gestation period for which they may have to make arrangements for
funds in advance.
It is a well accepted fact that accelerated investments through Public-Private
Partnerships in infrastructure projects require vibrant capital markets, which
is contingent on value unlocking for existing assets and ease in financing for
newer projects. Current volatile capital markets could postpone such
investments, as accessing capital for private players will become challenging.
This may delay plans for several companies in BOT, real estate etc.
For example, Patel Engineering's equity commitment stands at Rs 910 crore
(including Rs 400 crore for thermal power project, Rs 250-300 crore for captive
coal mine acquisition and Rs 130 crore for Gongri HEP). Thus, the company will
need access to capital markets for financing equity investments towards these
projects. On the other hand, for NCC, outstanding equity commitments stand at Rs
560 crore, including Rs 220 crore for HUDA project land cost (which can be
financed through development cash flows of initial phase) and Rs 220 crore for
Himalayan Green HEP (which will be spread over FY09-11) and thus have a
comfortable cash position.
Also, remember that most of the construction companies have plans to venture
into real estate development projects. IVRCL has already hived off and listed
its real estate subsidiary, IVR Prime Urban, in August 2007. Nagarjuna
Construction has consolidated its real estate initiatives under NCC Urban
Infrastructure, and the company holds 80 per cent stake in the subsidiary
The subsidiary company has a land bank of 530 acres of which 267 acres are being
developed currently. It also has consolidated BOT projects under NCC
Infrastructure Projects, with portfolio of nine projects (including
Machillipatnam sea port). The company has plans for fund raising in both the
subsidiaries over the next two years, through either an IPO or Private Equity
investment. Hindustan Construction has set up a subsidiary company Lavasa
Corporation for its Lavasa real estate project near Pune in Maharashtra. HCC has
63 per cent stake in the subsidiary. Lavasa Corporation has successfully
completed phase-I comprising 300 units.
According to the available reports, the company is in talks with various
strategic and financial partners for funding the project. Patel Engineering has
a land bank of 1,000 acres spread across Hyderabad, Mumbai, Bangalore and
Maharashtra (Karjat, Panvel etc.) and development rights for the property is
transferred to Patel Realty India, which is a 100 per cent subsidiary. The
company is looking for funding at the SPV level for certain projects. It is also
looking to raise funds through QIP for its coal mine acquisition and power
These companies can carry forward their plans only when the capital market is
stable and booming. In a volatile market like the current one, it is difficult
to raise money and unlock value of their subsidiaries.
The government has realised that infrastructure inadequacies in both rural and
urban areas are a major factor constraining country's growth. Preliminary
exercises suggest that investment in infrastructure, defined as road, rail, air
and water transport, power generation, transmission and distribution
telecommunication, water supply, irrigation and storage, will need to increase
from 4.6 per cent to around 8 per cent of GDP in the 11th Plan period. In other
words, of the increase of 6 percentage points in total investments needed to
accelerate growth from 7 per cent to 9 per cent, about half should be in
It is not possible to expect the entire investment of this magnitude to come
from the public sector only. Therefore, private sector participation in a
significant manner is necessary to achieve the objective. Most of the
construction companies have already started taking up infrastructure projects by
setting up special purpose vehicles in a major way. IVRCL, Nagarjuna and Gammon
India have taken up several infrastructure projects and implementing them
successfully. In future, this trend is likely to gain more momentum. Current
sluggishness may be a temporary phase and opportunities are aplenty for
construction companies in the days to come.
[May 19-25, 2008]