For several decades, road construction projects in the country were largely based on the EPC model, where private developers were paid by the government on a project basis.
In 2016, in an attempt to bring down its outlay on road construction projects, the Centre launched the hybrid annuity model (HAM). The model tried to increase private players’ participation. But three years after its introduction, data reveal that the share of the model is declining following multiple challenges. The engineering procurement and construction (EPC) model, wherein the developer takes on lower risk, is making a comeback.
What is HAM? Why was it introduced?
Prior to the HAM model in January 2016, the contracting models for highway construction were either the EPC model or the build-operate-transfer (BoT) model (through toll or annuity). The former is a plain vanilla construction contract, transferring no rights whatsoever to the developer over the road constructed.
Since these yielded lower margins for the developers, the BoT model was looked at as an alternative where the developer was rewarded with toll collections on the highway constructed. Either the developer could collect the toll or it was paid a pre-determined annuity by the National Highways Authority of India (NHAI). BoT gives the developer ownership of the highway constructed for a fixed period, after which it passes back to the NHAI.
Though the BoT models seem lucrative on the IRRs (internal rate of return) they generate, the developers were faced with huge losses on account of financing risk, issues in land acquisition and even inadequate toll collection, leading to considerable project delays. Road-projects saw significant delays due to the entire onus of raising funds being put on the developer. The Centre then intervened and brought in HAM as a solution.
The HAM essentially is a combination of the EPC (40 per cent) and BOT-Annuity (60 per cent). The developer (or the concessionaire) receives from NHAI 40 per cent of the project cost in five equal instalments, linked to project completion milestones, and has to arrange the remaining 60 per cent of the funding. Upon completion of the project, NHAI collects the toll and pays the developer annuities over a pre-determined period.
Has it really helped?
Though HAM was intended to ease bank funding, problems persist for the developers, predominantly on fund-raising. Most developers even face the brunt of bid cancellation due to delay in financial closure after signing the concession agreement (CA). The CA is an agreement between the developer’s company and the government (NHAI) for the construction of the road under EPC/HAM/BoT model, and the financial closure is a date agreed upon by both parties in the CA, latest by which the developer is required to get the required debt sanctions.
Developers are finding it difficult to raise even the remaining 60 per cent of project costs due to lack of equity and their overly leveraged balance sheets. For instance, Ashoka Buildcon, which had a roads order backlog of ₹46,200 crore as at the end of March 2019 ( 69 per cent is HAM/BOT), has a debt equity ratio of above 19X on the consolidated balance sheet.
That apart, institutions are now wary of lending to these companies, given the current economic slowdown impacting toll revenues and causing financial distress for many players in the road construction space. Even the public sector banks (PSUs) are very selective in their lending, and due to such stiff competition, developers either face delays due to non-availability of funds or end up taking a beating on their margins on account of higher finance costs.
Data on industrial deployment of credit by state cooperative banks (SCBs), compiled from the RBI website, shows that credit to road infrastructure fell 7.5 per cent in FY18 to ₹1.67 lakh crore from ₹1.87 lakh crore in FY17. Despite a low base, credit to the road infrastructure segment saw an uptick of only 12.2 per cent YoY in FY19 to ₹1.86 lakh crore (as on March 29, 2019).
Heading back to EPC model?
The EPC model, which contributed 65-70 per cent of the total projects awarded by NHAI during FY14-16, had taken a back-seat post the introduction of the HAM model, and contributed only 37.5 per cent in FY18. However, given the scenario of stiff competition facing the already debt-ridden developer companies, in terms of raising further funds for upcoming projects, a shift back to the basic EPC model is expected.
Accordingly, EPC projects inched up to 58.3 per cent of the total project costs awarded by NHAI in FY19. In the projects awarded so far in FY20 (up to August 2019) totalling ₹5,042 crore, 60.7 per cent constitute projects under the EPC model and the remaining 39.3 per cent were awarded on an item rate basis, leaving little scope for the HAM or BoT models.