The road development sector received a big boost recently with the Ministry of Roads and Highways amending the terms for awarding projects to private developers. Road building garners a lot of attention, and rightfully so — roads are the foundation of a country’s growth. India ranks second in the world, after the US, in the length of roads. Its 4.8-million-km road length is equivalent to 0.66 km of road per square km of land, very close to that of the US (0.65) and much higher than that of China (0.16).
From 2004-05, the National Highway Authority of India (NHAI) and various State agencies have been awarding contracts in a big way to private developers to rev up road development. But the innovative model of Build, Operate and Transfer (BOT) fell flat after all parties got burnt by it. So, what’s behind the recent policy move on BOT and what is the model’s likely future?
How it works
In a BOT model, a private contractor is given the responsibility to build the road, maintain it for a certain period — typically 20 to 30 years — and then transfer the ownership of the road to the Government. In return, the operator can collect vehicle tolls.
For this purpose, a new special purpose vehicle (SPV) is created for each project. The SPV takes equity and debt funding and receives toll revenue. The government authority in charge of the road monitors proper maintenance and ensures the terms of the contract are complied with.
It also sets the toll rates and terms of increase. For example, the fee rules from the NHAI state that the base toll rate will be increased by 3 per cent annually, without compounding. Additionally, 40 per cent of the increase in Wholesale Price Index (WPI) inflation numbers is also added to the toll increase. There are variations to the fee structure — with no WPI component and others where the revenue is not based on toll collection but is a fixed annuity payment.
Bumpy road
The model was simple enough and on the back of traffic growth projections of 13 per cent or so annually many players took this road. The auctions witnessed aggressive bidding, with 25 to 30 bidders per project in 2011-12. There was heavy price undercutting — as gauged by the wide spread between the lowest and highest bid.
But those who won the contract faced a winner’s curse. For one, project completions were not easy due to land acquisition issues. As per data from CRISIL, almost half the projects awarded between 2011 and 2013 had to be terminated because of delays in land acquisition and other clearances. And many more have schedule over-runs leading to cost escalations. India Ratings estimates that one-year delay adds ₹1.25 crore per km.
Two, road construction projects require a lot of capital. For example, it costs about ₹35 crore to construct one km of single lane. Also a large share of revenue — up to 45 per cent in some cases — was to be shared with NHAI. And earning profits, with thin margins and revenue share, was many years away.
Three, toll revenues did not grow as expected as traffic growth was under 5 per cent in many projects — not altogether surprising given that the projections were not based on actual data. Returns in toll projects are very sensitive to assumptions on traffic growth, given the long life of the project.
Four, developers had borrowed heavily to fund the projects. The SPV was debt funded to the tune of 75 per cent; the equity portion was also funded through promoter-level borrowing. The interest rate on these loans was reset every year and in many cases rates shot up from 8 per cent to 15 per cent over an 8-10 year period. This stressed the interest coverage ratio to dangerous zones of below one time. And banks have turned cautious — lending growth to the sector has more than halved in the past two years, compared with the preceding five years, as per data from CRISIL.
Five, toll rates were linked to WPI inflation and when WPI turned negative, there is concern about toll rate increases and future revenue growth.
Six, there have been policy risks faced by toll road operators. Recently, the Government of Maharashtra proposed closing toll plazas and exempting cars from paying toll. Private toll operators who have invested money may face loss of revenue or experience delays in collecting payments from the State. For example, Ashoka Buildcon’s Ahmednagar Aurangabad project receives 20 per cent share of its revenue from cars and may be impacted due to the policy change.
Turning a bend
Even with these problems, BOT cannot be written off as it has the potential to improve a lot. After the learning experience of the last few years, all stakeholders are (hopefully) much wiser and rational. The Government plans to lay 30 km of road per day — a big jump from the current plan of 11 km per day. But in 2014-15, only 4.1 km was laid on average per day — much lower than the all-time high of 7.4 km in 2012-13, as per data from India Ratings. Execution has to pick up pace to meet the goals.
And with many players leaving the scene due to distress, the number of qualified bidders has whittled down. Only about ten players are qualified to bid for project size of over ₹2,000 crore – aiding margins for developers.
A few policy initiatives taken this year can help the sector in a big way. One, the recent policy amendment delays premium payment by developers to the fourth year after completion, instead of the earlier requirement of payment starting from the first year. Two, it is required to install mechanisms to obtain real-time traffic data count, aiding reliable traffic projections. Three, the equity contribution by the NHAI has been doubled — from 20 per cent or equal to promoter’s stake to 40 per cent or twice the promoter’s stake.
But what about support for the existing BOT projects? The policy change in May and August 2015 allows developers to exit highway projects two years after completion; this will help unlock funds that can be deployed in other projects or pay off loans. NHAI will also provide loans to projects that are stuck due to various delays. In March 2014, the authority restructured payment dues from stressed projects to ease their financial burden. All these smoothen the road ahead for BOT projects.