One of the most often repeated statement that we read or hear these days is ‘private investment is not picking up in India’ – and the current NDA government is not doing enough to scale up investment. One keeps wondering if India is losing a golden opportunity.
With the kind of disruptions (and more importantly uncertainty) taking place across all asset classes globally, it becomes even more difficult to attract private investments. However, personally I am quite impressed with the work that this government is doing in pulling all strings together to get things moving. One keeps reading about several decisions taken by the ruling government. However, most of these decisions by itself appear to be a non-event but when everything is looked holistically, the picture that comes out conveys a vision, a well thought-through plan, objectively defined milestones, decisions for execution leading to meaningful impact.
While a lot of work is being done across multiple sectors, I wish to cover one sector at a time. I had written about railways in my previous blog. In this I wish to discuss the developments that have taken in the road sector. However, before I move to it, it may be useful to quickly give a background as to why I am focusing on the transportation sector.
When I was thinking about private capital and how to bring back momentum in asset creation by private sector, few questions came to my mind:
Firstly, which are the sectors that need maximum investment? It will be an eye-opener to many that in terms of population, India has added an entire USA in just 15 years of this 21st century (Indian population has increased by 300 mn since 2000). It is therefore needless to mention the criticality of fixed asset creation – purely to bring in efficiency and improve productivity. The three most important sectors that consume maximum capital (especially for a growing economy) are Energy, Manufacturing and Transportation (EMT). Transportation includes railways, roads, ports and airports. India is and will be no exception.
Secondly, how much investment does a country like India need? To achieve a GDP growth of about 7.5%, India would need a minimum of 30% of GDP as investment in asset creation. So at a GDP of USD c.2.20 trillion, India needs an annual investment of approximately USD 650 bn. Just imagine the scale. To put this in perspective, as per IMF, there are only 20 countries whose entire GDP is USD 600 bn plus. In FY14, EMT consumed 40% (~USD 250 bn) of total investment. Of this, USD 130 bn (20%) was in manufacturing sector and USD 65 bn (10%) each in energy and transportation sectors.
And finally, who brings in this capital? It’s a very big question. Should it be government (public), private sector or through Public Private Partnerships (PPP)? In the Indian context, dependency increases on private capital because of the sheer fact that a significant portion of government revenues gets channeled towards providing subsidies and high defence expenditure due to it’s geo-political pressures. Indian budget runs a deficit of USD c.85 bn. In fact, the proportion of Plan Expenditure (which is supposedly for productive spending and asset creation) in total expenditure has come down to 25% in FY16 from about 29% in FY07. In absolute terms, Plan Expenditure is less than USD 70 bn. Along with expenditure on defence (USD c.35 bn) and railways (USD c.8-10 bn), total public spending at best gets restricted to about USD 115 bn. I don’t expect the fiscal deficit to come down significantly below 3.7% targeted in FY16. Except for two years viz., FY07 and FY08, deficit has always remained over 4% in last 15 years. So clearly, balance amount of about USD 100-110 bn (about 50% of total infra spend) has to be funded by the private sector. This was 26% of USD c.200 bn in Tenth plan and 36% of USD c.400 bn in Eleventh plan – clearly indicating the increasing dependency on the private sector.
The BIG QUESTION therefore is, how does one attract private capital? However, before we seek to get this answer, it is equally important to understand what went wrong over the last decade.
The reason why private capital started flowing in capital intensive infrastructure sectors over the last 8-10 years were (a) Policy initiatives by government to push private capital in sectors like road and energy (b) Excitement amongst entrepreneurs for getting into new, highly scaleable businesses and (c) Plenty of global liquidity emanating from QE. However, on the government side, policies seem to be rushed into while at the private sector end, exuberance overtook reality in projecting future revenues. As a result, several projects could never take-off, many projects though became operational ended up short on projected revenues as well as profitability and only a few projects ended operating in line with expectations. The outcome of first two meant that companies ended up with significantly higher debts in comparison to its ability to service it, translating into stretched balance sheets and unmanageable debts. Hence two things happened viz., (a) companies’ ability and interest for new projects have come down dramatically and (b) financing for new projects is no more an attraction for lenders / equity participants.
It therefore means that it will take a long while for confidence to return and that the public spending has to play a far larger role in capital formation.
The current NDA government has taken a plethora of measures across several sectors but understanding all of them in one go will not be doing justice. Considering that transportation and energy are two very important sectors, let me write about road sector in this note.
ROADS – BEYOND GREEN SHOOTS
Road sector peaked in FY12 when NHAI awarded a record 6,500 kms of projects. However, this number came down dramatically by 85% in FY13 to only 1,100 kms. Three key reasons being (a) Land acquisitions, which was the responsibility of road developers, became very difficult in the scam-surrounded environment (b) almost about USD 5 bn (Rs 30,000 crores) worth of road projects got stuck in environmental clearances. Even some of the large groups like GMR and GVK cancelled a couple of their concession agreements with NHAI, and (c) Realty started staring at exuberant traffic projections. Toll collections from completed projects were inadequate to service debts.
The impact of all the above was so significant that in FY14, more than 20 projects amounting to roughly USD 4 bn (about Rs 26,000 crores) attracted no bidders.
Measures by NDA government: With such deep scars and the associated pain, it’s obviously a very big challenge for any government to re-attract private capital in such an environment. However, I think the current NDA government has done quite a remarkable job in its first 20 months to improve the environment, build confidence and facilitate growth. Directionally, one could classify the steps taken into three broad buckets viz., (a) Providing support to existing projects (b) creating a platform for private sector to re-participate and (c) scripting a roadmap for future road projects.
Providing support to existing projects – This was one of the most important areas that needed attention to bring in momentum. When the NDA government came into power in May 2014, there were about 384 projects worth approximately USD 65 bn (Rs 3.80 lakh crores) that were stuck up for various reasons – environment clearances, land unavailability and project unviability being top three reasons. Through a combination of several measures, that list has come down in double digits. The government has not only resolved most of the cases but has even gone ahead and taken strong action like terminating at least 40 projects. So what has the government done?
1. Enabling exit for road developers to improve liquidity – In June 2015, the government permitted road developers to divest 100% of their equity in BOT projects if they are in operation for at least two years. The objective was to enable the developers to monetize their operating assets, de-lever their balance sheets, generate liquidity and service debt. The impact was immediate. In August 2015, we saw one of the largest secondary transactions in the Indian infrastructure space. Consortium led by Canada headquartered Brookfield Asset Management company (manages USD 200 bn) purchased 6 operational roads from Gammon Infrastructure (along with 3 power projects, the enterprise value was USD 1 bn or Rs 6,750 crores). Earlier this week, NCC and Soma sold their 76% stake in one of their BOT projects to IDFC Alternatives for an enterprise value of USD 11 mn (Rs 750 crores) and is in advanced discussion with other PE Funds to sell few of their other projects. IL&FS Transportation is in talks with several international pension and private equity funds to sell most of its operational annuity road projects. IRB Infrastructure is setting up Investment Trust to transfer 12-15 of its operational road projects. It’s just about eight months since this announcement but the activity is palpable.
2. NHAI providing bridge finance – Further, in June 2015, NHAI decided to provide bridge finance to those BOT road projects which are more than 50% completed but are languishing, largely due to equity crunch. Government has identified about 18 projects needing about USD 550 mn (Rs 3,500 crores) for this bridge financing.
3. Converting PPP into EPC projects – To kick start some of the projects stuck due to lack of equity, government has decided to convert 34 projects (4,084 kms) worth USD 4 bn (Rs 26,000 crs) from PPP model to EPC mode.
4. Premium re-schedulement – NHAI has allowed 13 out of 23 stressed road projects to reschedule their premium payments, estimated worth being about USD 1 bn (Rs 7,000 crores). These are mainly projects those got delayed for reasons beyond their control.
Impact – Funds to the extent of USD 6-7 bn (~Rs 44,000 crores) has already started moving around and another few billion dollars could flow in through secondary sale of operational road projects. This is a significant 15-20% of total annual expenditure expected in the road sector. Very meaningful, indeed.
Creating platform for re-attracting private players – Considering the scale and importance of investments in road sector (and government’s limited ability to drive investments), sustained capacity creations is possible only through private participation. It is quite heartening to see some out-of-the-box thinking by government in taking decisions for fair distribution of risk – some of them being as under:
1. Eliminating uncertainties – It was extremely necessary to remove the uncertainty around land availability and statutory clearances. So NHAI has decided to award road projects only when it has obtained at least 80% of the project land for BOT projects and 90% for EPC projects. In the first 10 months of FY16, government has already acquired about 9,000 hectares of land. This is one of the highest in any financial year. Some of the other measures taken by the government are de-linking environmental clearances and forest clearances, delegation of powers to regional officers to grant forest clearances and online application for construction of rail under / over bridges (a lot of these go unnoticed).
2. Increasing public spending to get back private sector confidence – Considering that public spending is needed to bring back confidence, in the budget for FY16, Mr Nitin Gadkari managed to increase budgetary resources by a whopping 51% to USD 8.5 bn (Rs 54,000 crs). He has already started pitching for USD 13 bn (Rs 86,000 crores) in FY17. Further, lower crude prices is giving an additional opportunity for incremental funds through cess on fuel. The allocation to roads and highways is expected to go upto USD 6.5 bn (Rs 42,000 crores) in FY17. Cumulatively, this total of USD 19.5 bn (Rs 1,28,000 crores) in FY17 would translate to a 149% increase over FY13 and about 50% of estimated total investment on roads. This has given the ability to implement its strategy of awarding more road projects through EPC route. In the first 8 months of FY16, out of the total projects of 2,651 kms awarded by NHAI, close to 70% are under EPC.
3. Creating alternate financing models – In July 2015, government initiated a novel Hybrid Annuity Model (HAM). This appears to be very well thought through from all perspectives. The broad features are (i) government will provide 40% cost of the project to the developer upfront (ii) balance 60% has to be through minimum 30% as developer’s equity and balance from bank debt (iii) government will ensure at least 80% land availability, environment and forest clearances and utility shifting (iv) toll will be collected by government (v) developer will be paid annuity. In December 2015, the foundation of the first project under HAM (parts of the Delhi – Meerut road) was laid by Narendra Modi. Government is targeting close to USD 9 bn (Rs 60,000 crores) projects to be awarded under HAM. 100 more projects to be identified in FY17.
4. Toll-Operate-Transfer (TOT) Model – Under this model, the government will award ‘operational’ projects to private parties for an upfront fee. This ensures that the buyer of the project is not running with any regulatory or construction risk. Government has identified 111 completed projects to be awarded under this model. Abu Dhabi Investment Authority (ADIA), one of the largest global sovereign wealth fund has shown an interest for 50 projects for about USD 5 bn. This should further boost the sentiment in the road sector (and resources for government).
5. New Model concession agreement (MCA) – In September 2015, Ministry of Roads amended the model concession agreement. Some of the key changes are (a) start of premium payments from 4th year of operations as against 1st year earlier and (b) automatic termination of project if the project does not commence within one year of award.
Above measures seem to have started having positive implications. Interest in road sector is getting renewed and is reflected in numbers. In the first 8 months of FY16, NHAI has already awarded projects worth close to USD 5 bn (Rs 35,000 crores) and is likely to end FY16 with about USD 10 bn (Rs 70,000 crores). This would translate to about 5,000 kms of fresh projects, a significant jump of 65% over FY15. This is getting very close to the peak levels achieved in FY11 / FY12. Too early to say that the good old days are back, but definitely getting closer.
Scripting a road map with new projects: Vajpayee government had initiated the National Highway Development Project (NHDP) in 1998 which over the years became a 55,000 kms, USD 60 bn project. Almost 75% of the roads under NHDP has been awarded and the balance 14,000 kms would also get awarded over the next few years. It therefore warrants putting in place a fresh 5-10 year plan. I think this NDA government has been reasonably agile and has scripted a plan in less than 18 months. The plan of course looks ambitious (but who thought that NHDP would turn out to be a USD 60 bn project). It’s a little too early to pass a judgement on it but what is gratifying is the efforts spent in identifying and detailing the opportunities. This USD 40 bn (Rs 2.67 lakh crores) plan includes (i) border area roads USD 8.5 bn (Rs 56,000 crores, 4,500 kms) (ii) Coastal roads USD 6.75 bn (Rs 44,000 crores, 3,500 kms) and (iii) linking 100 out of 676 district headquarters USD 9.25 bn (Rs 60,000 crores, 9,000 kms).
To conclude, I would say that the need of the hour was to get things moving. Hence it was necessary to go back to basics and make those structural changes which would bring back confidence (and I think these changes have started having a positive impact). Pain points are being addressed, risks are being re-distributed, balance sheets are showing initial signs of strengthening and foreign capital has started flowing in. In the first 9 months of FY16, we have seen more than a billion dollar of PE transactions in the road sector. Just think about it, in entire FY15, total private equity transactions in road sector was less than USD 100 mn. Interest poured in from both international as well as domestic investors – some of them being Kuwait Investment Authority, Brookfield Asset Management, Fairfax, Macquarie, PE funds of Kotak, IDFC and Tatas – and several others waiting to enter. It’s a great opportunity for any institution having deep pockets and patient capital to pick up some of the great assets at attractive valuation – unfortunate part is that as a country we may lose some of the prized assets to international institutions. But I guess this is the downside of aspiring for high growth with limited financial ability.
Nitin Gadkari is aiming for 2% contribution to India’s GDP by road sector. A far cry as of now – but hopefully we would have a far longer, stronger and smoother road ahead.
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