To spur economic growth, boosting investment in infrastructure has been a key focus area for the Government of India in recent years. Around INR 25 lakh crore is expected to be ploughed into transportation infrastructure alone in the next five years. Such an unprecedented scale and pace of investment demands focused and coordinated actions from a variety of ecosystem stakeholders – government agencies, concessionaires and contractors to financial institutions.

Implications for the Government

Timely and cost-efficient completion of projects is the biggest challenge for the Government in implementing infrastructure projects of such large magnitude. Engineering, Procurement and Construction (EPC) contracting is the preferred mode of project execution to enable rapid deployment of relatively low-risk capital.

The EPC mode overcomes the challenges and delays faced by the concessionaires in raising capital as in the case of PPP projects (especially in an uncertain macroeconomic environment), thereby enabling faster and smoother project execution. Nearly 90 percent of the investment plan in transport infrastructure outlined above is expected to be deployed in the EPC mode.

However, as EPC projects are completely funded by the Government, raising requisite capital upfront without upsetting government finances is a delicate balance. Relying solely on budgetary resources will constrain the government’s ability to plan and execute large scale infrastructure programs. Alternate and innovative sources of raising capital is the need of the hour.

The government is rightfully exploring multiple options to bridge the gap between capital requirement and available budgetary resources, such as market borrowings through bonds, loans, asset rotation, capturing increase in land valuation due to infrastructure development and other related mechanisms.

There is in fact a significant opportunity for raising additional capital through bonds by leveraging the strong balance sheets of Government agencies. For instance, Indian Railways recently raised INR 1.5 Lakh crore from LIC recently through bonds issued by IRFC. Similarly, NHAI is planning to raise INR 10,000 Cr from retail investors through bonds.

Asset rotation, where revenue from already completed projects is capitalized by transferring the rights to levy user fees to private investors, is also being explored. A Toll-Operate-Transfer (ToT) model eliminates the construction risk for the financial investor, while providing significant return on investment through expected traffic growth. Such an asset class is well suited for infrastructure-focused private equity and sovereign wealth funds as the construction risk is eliminated, and the base traffic is already established, thereby minimizing the revenue risk to a greater extent. A case in point is the first round of ToT auctions, successfully completed by Ministry of Road Transport and Highways (MoRTH), which fetched about INR 9,700 Crore: nearly 50 percent more than the expected value.

Prioritizing assets to be put on block and ensuring availability of good quality data is essential to ensure successful bidding and discovery of fair price.

Authorities are also exploring capturing value of increased real estate activity with development of major urban infrastructure projects. For instance, the stamp duty in the influence area of 500 m along Nagpur Metro has been increased by one percentage point, and the surcharge collected is being shared equally between Nagpur Metro Rail Corporation Limited and Nagpur Municipal Corporation.

We believe that the success of EPC projects is heavily dependent on efficient execution with minimal cost and time overruns. Here, the government will need to ensure sufficient preparedness before contracting through thorough pre-project preparation activities, such as preparation of high-quality detailed project report, ensuring availability of land and requisite clearances for the contractor.

The government will further need to ensure sufficient checks and balances are in place, such as increasing the defect liability period or warranty or bundling maintenance of the asset for a fixed period along with the EPC contract, to ensure high quality of construction.

While EPC is expected to be the most preferred mode of execution of infrastructure projects, the government will have to be cautious in selecting assets for execution in the Public Private Partnerships (PPP) mode and handling its associated risk. Success of a PPP project depends on three factors: an optimal allocation of risk among stakeholders, quality of the asset and a strong ecosystem for operators. The government will also need to promote competition in the ecosystem by optimizing the lot sizes of the projects. It will further have to balance the goal of promoting new entrants through smaller lot sizes, and the need to have larger lot sizes in order to achieve economies of scale.

Implications for concessionaires or contractors

With the increasing focus of EPC mode of project implementation, there are two major expectations for concessionaires or contractors: ensuring quality of output and timeliness of project delivery.

Concessionaires must focus on developing strong project management capabilities to ensure timely completion of projects, which in turn enables faster realization of returns.

This would entail a thorough risk assessment to proactively identify risks associated with construction, and development of mitigation strategies to counter the same. For example, undertaking a thorough on-ground investigation through adoption of advanced techniques such as LiDAR or Ground Penetration Radar, before commencement of work, will minimize uncertainties during project execution. Similarly, optimizing the capital equipment deployment plan and aligning it to material availability and overall project completion schedule will enable the contractors to manage their working capital cycles better.

Implication for financiers

FDI in infrastructure sector has been growing at a rate of close to 35 percent CAGR over the last five years and the trend is expected to continue, driven by the increased infrastructure spending of the government. This clearly shows that Indian infrastructure growth story is fast emerging as an attractive investment opportunity for global financiers.

The emergence of new financing and operating models for infrastructure projects means that financiers will have to thoroughly evaluate the risk return profile of the different asset classes. Specifically, the risks and the sensitivities associated with the user fee collection, which forms the basic source of returns, must be evaluated in detail to ensure guaranteed returns. In addition, the financial institutions must work closely with the Government in fine-tuning the contracting terms, project packaging and in designing alternate financing options for asset rotation. Financial institutions will also have to be mindful of the cash flow cycles of their investment portfolio to balance the risks associated with re-financing, as is typically needed in capital heavy projects.

Overall, India is at the cusp of undertaking investment in transportation infrastructure at unprecedented scale and pace. While all the basics are in place, concerted and timely actions by all ecosystem stakeholders; government, contractors and financiers; will be a huge step forward in ensuring a timely and cost-effective deployment of this plan.