NHAI’s Road Construction Drive Set To Hit A Debt Speed Bump
The solution to the road construction crisis in the first term of the Narendra Modi government has now turned into a problem.
The Hybrid Annuity Model, devised to shift the financing burden off over-leveraged private balance sheets, has now led to a ballooning of debt at the government-owned National Highway Authority of India—enough for the Prime Minister’s Office to say that “road infrastructure has become financially unviable”, and that NHAI is “totally log jammed with unplanned and excessive expansion of roads", in a letter to the Ministry of Road, Transport and Highways.
Written by Nripendra Misra, principal secretary to the PMO, the letter, a copy of which has been reviewed by BloombergQuint, makes a few suggestions that analysts say will prompt a substantial slowdown in road construction projects.
A UBS research note said the NHAI project awards declined 70 percent over the previous year in financial year 2018-19 after a strong FY16-18. Given the PMO’s suggestion for a review, tepid highway awards could contribute to sluggishness in overall order inflows, he said in a note.
“We believe that the ability of the roads sector to raise funds either as equity or debt is highly constrained, and if these measures were indeed to be enforced, then we may see a substantial slowdown in ordering from levels of 15,000 km we had assumed for FY20 and beyond,” said Nomura analysts in a note.
The Nitin Gadkari-led roads ministry is credited with increasing the pace of road ordering. And the government’s spending on roads and bridges supported the economy when private investments were yet to pick up due to excess capacity and lack of credit from banks saddled with bad loans.
The PMO, however, called the Hybrid Annuity Model—where the government bears 40 percent of the costs linked to milestones—and the engineering, procurement and construction model or hiring contractors to build highways—where the government bears 100 percent of the costs—“unsustainable”.
In the letter, first reported on by The Times of India, the PMO recommended three changes to the highway ministry:
Reorganising NHAI and its portfolio of roads
- NHAI to be transformed into a road asset management company.
- NHAI needs to prepare a national highway grid blueprint for all roads that need to be taken up as National Highways until 2030.
NHAI to relook at commercial orientation of projects
- NHAI to stop construction of road projects.
- NHAI to reorganise each road stretch project as a separate special purpose vehicle and structure it as a financially viable project which can be bid out on a build-operate-transfer basis.
Aggressive monetisation of NHAI assets
- NHAI to structure all existing completed or ongoing projects on this principle and financially viable SPVs.
- All these projects will be monetised by giving out of toll operate transfer model or infrastructure investment trusts.
The highways ministry declined to comment on BloombergQuint’s queries. NHAI’s chairman, too, didn’t return BloombergQuint’s calls.
Gadkari’s private secretary Vaibhav Dange didn’t want to comment, saying the letter is not in public domain. But consultations on PMO’s suggestions are on, he said over the phone.
What’s Prompted This Review
Simply put—rising debt at NHAI.
The pace of national highway construction has more than doubled to 27 km/day in FY19 from 12km/day in FY14, Antique Stock Broking said in a note.
And so has its debt—from Rs 40,000 crore to Rs 1.78 lakh crore during the period. The brokerage expects the highway authority’s debt to further rise to Rs 3.3 lakh crore by FY23. That’s 8.2 times in under a decade.
“Also, this assumes equity base of Rs 5.4 lakh crore in FY23, or equity accruals or support of Rs 84,900 crore, on an average, every year,” said Antique Stock Broking in the note. “In comparison to this staggering amount, NHAI earns budgetary support of Rs 37,000 crore. Even after adding cess support of Rs 18,000 crore, there is widening gap of equity+debt service scheduled.”
Much of this has been due to a shift from the Build-Operate-Transfer model to EPC and HAM. This was intentionally done by the ministry so as to ramp up the pace of road construction at a time construction companies’ balance sheets were already over leveraged.
The shift in models meant the government shouldered more of the project cost, especially aspects like land acquisition. According to an estimate by ratings agency ICRA Ltd., land acquisition accounts for 30 percent of the total expenses of the NHAI.
The change in models meant private investment in road construction fell from a peak of 43 percent in FY13 to 16 percent in FY19, the Antique Stock Broking note said.
Much of NHAI’s spend on roads, up to 70 percent of it, was via debt, said a UBS research note.
However, according to a PTI report, Gadkari said, “The NHAI is a ‘AAA’-rated entity and there is no dearth of money. In the past 20 days alone, I have got a funding commitment of Rs 1.75 trillion (Rs 1.75 lakh crore) from various financial institutions. LIC alone has committed to Rs 1.25 trillion (Rs 1.25 lakh crore), while banks have agreed to give Rs 50,000 crore. So money is available.”
According to the PMO, that would involve two key things—that NHAI would stop road construction and evolve into an asset management company. But according to a Nomura research report, that’s easier said than done. Here’s why...
The return to the BOT model may not find much acceptability as the infrastructure space continues to be highly leveraged and low-levered companies lack the appetite for equity investments bearing traffic risk.
- Interest costs for developers are significantly higher than the NHAI which will increase the cost of BOT projects, the report acknowledged.
- Road sector gross bank credit, excluding the Rs 25,000 crore SBI loan to NHAI, is shrinking, highlighting difficulty in arranging bank financing.
- Slowing traffic growth in recent times will not add comfort on BOT tendering for developers.
As for asset monetisation, UBS estimates NHAI has over 230 operational projects with an approximate cost of Rs 1.7 lakh crore, which could be potentially divested. But...
After laying out divestment plans through the toll-operate-transfer model in FY17, NHAI monetised first bundle of projects totalling Rs 9,700 crore in FY19. Second bundle didn’t elicit expected response and has been postponed. The third bundle totalling ~Rs 5,000 crore is in bidding stage. We think an acceleration in pace of monetisation is needed.UBS Research Report
Yet some road companies believe a turnaround is possible.
Virendra Mhaiskar, chairman and managing director at IRB Infrastructure Developers Ltd., said the PMO’s idea is “rational”. The government does need to spend judiciously, given the resources it can allocate for the sector, and take up projects on BOT wherever feasible by asking private sector to chip in, he told BloombergQuint.
Impact On Bharatmala Project
The PMO’s concerns do not augur well for the Bharatmala project. The phase-I pipeline may not fit into the threshold of financial viability and may be at risk if PMO’s views and suggestions are implemented, said the Nomura note. A fresh review of project reports may lead to 12-18-month delay in pick-up in tendering activity.
The brokerage, however, said NHAI officials don’t see any risk for Bharatmala at the moment, though costs may rise. The NHAI feels that the PMO’s observations largely relate to “in-principle” approvals of state-to-national highways and that Bharatmala will likely continue in its current form since the projects are approved by the CCEA, it said in the report.
The NHAI is left with two options—to go slow on project awards or increase the mix of BOT (toll) awards, according to an ICRA note.
Given the ambitious targets of the Bharatmala project, NHAI will be required to increase the mix of BOT (toll) awards, ICRA said. And a new BOT model may need devising.
“The risk sharing is not balanced in the current BOT (toll) model. Therefore, it is time to devise a new model on the lines of HAM to reduce the upfront equity contribution for private developers to an extent,” said Rajeshwar Burla, vice president and associate head (corporate ratings) at ICRA.
“Also, the new model should have provision to re-negotiate contracts to protect the returns of developers in case of lower-than-anticipated traffic performance especially given the challenges in traffic forecasting currently on account of likely shift to other competing modes."