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 buildings.
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 construction industry.

Poll mode
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, HCC
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 government.
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.

Manpower shortage
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 company.
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 project.
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.

Conclusion
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 infrastructure.
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.