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Lower costs make road projects more viable
Ranju Sarkar in Mumbai
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February 26, 2009 10:06 IST

The fall in commodity prices (steel, bitumen, cement and diesel) has reduced the construction costs in road projects by 20 per cent. This will improve margins in existing projects and make new projects more viable.

The prices of construction steel have come down nearly 37 per cent from Rs 52,000 per tonne around this time last year to Rs 33,000 per tonne today. Similarly, the price of bitumen has come down by 22 per cent since mid-November, while diesel and cement prices have come down by 10 per cent.

GMR infrastructure [Get Quote] CFO A Subba Rao estimates that construction costs have come down by 20 per cent. Construction costs account for 70-75 per cent of the project costs; the other significant variable being interest costs.

"Lower construction costs will improve net margins by 1.5-2 per cent, depending on when the contracts were signed and the stage of execution/ construction," said Janardhan Reddy, director with Hyderabad-based KNR Constructions.

Developers have a combination of projects that are old, new and in the midst of construction. They may gain if they signed contracts when the input prices were at its peak. While the contracts signed two years back may have just become viable, they may be sitting on a loss if they had executed projects when input prices were at its peak.

With the project parameters improving, the new road projects being offered by the National Highways Authority of India could see more developers bidding for them, feels Lanco Infratech [Get Quote] CFO Venkatesh Babu, unlike in the last six months.

The spike in commodity prices and interest costs following the credit crunch saw many developers shying away from road projects offered by National Highways Authority of India since the last quarter of 2008. Thirty projects that were offered saw one or two bidders while another 30 are in the midst of bidding process.

"There is a dearth of bankable projects. Many of these projects were not viable in terms of revenue, cost structure or the returns they offered. The slowdown is also taking a toll on road traffic which is dwindling by the day," said GMR's Rao.

In BOOT (build, own, operate and transfer) projects, the risk lies with the developer, and traffic potential determines the financial viability of the project. If the numbers don't add up, the government chips in by providing a viability gap funding.

There was a lull in activity between end-2007 and end-2008 when the NHAI tried to change the bid criteria or the concession period, which was resisted by bidders. In the last six months, the government has tried to push projects by increasing the base project costs and VGF to 40 per cent of the project cost.

Sops and lower construction costs will improve viability, but many projects are fundamentally unviable and will find few takers. "If you take 100 new projects, 20 will be viable, 40 will be on the border (could become viable with VGF or higher project cost) while another 40 will have traffic issues," said Ankineedu Maganti, director, Soma Enterprises, a Hyderabad-based infrastructure company.

In some cases, a VGF of 30-40 per cent has made a difference. But for projects which are fundamentally unviable, the government may have to consider other methods for implementing them like cash contracts or annuity model, or clubbing viable projects with unviable projects. But financing remains a key challenge.

Also, the interest costs (12.5 per cent) remain high. But developers say money is available for viable projects and lenders are just trying to make sure of that. Lenders are also seeking comfort and asking developers to bring in more equity, said Amitabh Das Mundra, director, Simplex Infrastructure. In the past, the projects have been completed with a debt-equity ratio of 80:20; today lenders insist on a debt-equity ratio of 70:30. Given the cash crunch, many developers may find it difficult to bring in the equity.

"The measures taken by the government are too little and too late to overcome the negative sentiments, which got consolidated over the last 15-18 months. It will take a long time before the sentiments recovers. The government needs to update the project configuration and project costs to win back confidence," said Parvesh Minocha, managing director, (engineering and project management division) Feedback Ventures, an infrastructure consulting company.

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