Infrastructure

Sector Update
Road development in India

September 7, 2010 Implementation of reco. by B.K. Chaturvedi driving the new awards
Adoption of the B.K. Chaturvedi report recommendations has cleared the long pending
Ajit Motwani
issue related to MCA & RFP, RFQ. Consequently, the road sector has seen a significant
ajit.motwani@emkayglobal.com
pick up in the awarding activity- 4,940 km of new projects being awarded over the last 9
+91 22 6612 1255
months compared to just 1,877 km in FY08-09. This yields a monthly run rate of close to
550 kms of new project awards. The run rate has further increased to 700 kms With
Jitesh Bhanot
2871 kms of new project awards, in the first 4 months of FY11 itself.
jitesh.bhanot@emkayglobal.com
+91 22 6624 2491 NHAI expects to award 18,000 kms over FY11-12
NHAI’s FY11 target stands at 11599 kms of new awards. Add to it the 8250 km as spill
over from FY10 targets, the cumulative target stands at 19856 kms of new awards.
Though such a steep target is unlikely to be achieved over FY11, we would like to that
the 8250 kms spil over from FY10 targets already have the requisite clearances and are
ready for awards. NHAI expects to award ~9000 kms each in FY11E & FY12E, taking
the overall tally to 18,000kms on new road awards over FY11-12. However, based on
the monthly run rate of ~550km/per month over the last 9 months and ~700 km for YTD
FY11, we expect NHAI to award 7000-7500 kms in FY11E.

Developers maintain positive stance on the sector despite some lingering issues
Developers are optimistic on the outlook and opportunities in road sector, despite the
sector being plagued by key issues like:
Difference in project cost estimated by NHAI and developers: leading to lower VGF/
termination payments as these are calculated based on NHAI’s own estimates of TPC.
Land acquisition: Inability of the Govt in timely completion of land acquisition resulting
in significant time and cost overruns.
Removal of utilities: Removal of utilities, inordinate delays in obtaining forest
clearances and approval for Railway over bridge (ROBs) impacts execution.
Lack of succession planning: The current NHAI chairman was supposed to retire in
Aug’10 and the ministry is yet to appoint his successor. This lack of succession planning
is affecting the pace of project awards (last 3 months has seen few projects awards).

Developers opine funding cost still high. Lenders differ- Rates to harden
Even though liquidity constraints have significantly eased over the last year, developers
opine that the rates at 9.5%-12.5% (depending on project feasibility) are still high.
However, lenders to road projects are of the view that the road sector was actually
getting subsidized with lower rate of interest on account of lenders intentionally reducing
their weightage on the power sector. With RBI adopting tighter monetary policy, lenders
have started signaling that cheaper interest rate scenario is set to change, with interest
rates expected to move up between 100 to 150 bps by the end of the fiscal.

Increasing competitive intensity leading to lower IRRs

Developer friendly initiatives adopted by the Govt over the last 12 months have resulted
in significant pick up in investor interest. This has lead to increasing competitive
intensity, evident from the fact that a lot of projects in FY11 are bagged by developers
by paying premium to NHAI, as opposed to them receiving VGF in FY10. Consequently,
developers/lenders have seen comparatively lower project IRR’s. The trend suggests a
gradual move towards higher premium being paid by bidders.

Our view
We believe NHAI will award 7000-7500 kms of new road projects in FY11 as significant
projects from work plan for 2009-10 already have requisite clearance & approvals,. We
believe positive macro economic scenario, and political commitment will lead to
significant growth opportunities for PPP investment in road sector. This, coupled with
Govt’s willingness to resolve issues hampering private investment will lead to steep
growth trajectory in the Indian road sector.

Emkay Global Financial Services Ltd 1

 Infrastructure Sector Update

New project awards gain momentum- 4,940 kms awarded in last 9 months…

FY2010 saw strong revival of speed and momentum in road development (new project
awards of 3,361 kms) triggered by the re-election of Congress led UPA Govt & dynamic
minister, Mr. Kamalnath taking charge of the road sector. With renewed vigor and
ministers’ ambitious target of 20/km day, the government resolved most of the long pending
issues related to MCA & RFP, RFQ documents by adopting the recommendations of the BK
Chaturvedi (BKC) report in Nov 2009. Developers welcomed the same and consequently,
we have seen a significant pick up in the awarding activity with close to 4,940 km of new
projects being awarded by NHAI from November 2009 –till date i.e. over last 9 months as
compared to a miniscule 1877 km over FY08 & 09. Yielding a run rate of ~550 kms/month
of project award over the last nine month. With 2,871 kms of new project awards in the first
4 months of FY11, the run rate of project award has increased to ~700 kms/month.

Project awards during the year

10,000

7,500 9000

7,500 9000
8,000

6,000
kms

4,740
4,000

3,361
1,734

2,871
1,305
2,000

1,234
677

643
312

FY11E

FY12E
Till July
FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

2010
A w ard of contracts NHAI Targets Emkay forecast

Source: NHAI, Emkay Research

…led by adoption of B.K. Chaturvedi report

The initial (FY08-09) period of the 11th five year plan was pretty unimpressive for road
development in India as the period saw just 1,877 kms of new roads being awarded as
compared to ~6,474 km awarded in FY06&07. Issues with multiple clauses in the Model
Concession Agreement (MCA) & RFP, RFQ documents, rendering investment in roads
unremunerative to developers, were cited as the key hindrance for road development.
Further, the economic slowdown and the liquidity crunch took its toll on the road sector.
The Govt appointed Mr B.K Chaturvedi to suggest recommendations for reviving PPP
investment in road sector. The recommendations of the BK Chaturvedi report were finaly
adopted by the Govt in Nov 2009. Exhibit 1 highlights key modifications post adoption of
BKC report recommendations.

Emkay Research 7 September 2010 2

 Infrastructure Sector Update

Exhibit1: Recommendations accepted from BK Chaturvedi report

Key changes Earlier Now Impact

Termination clause The developer would have to The developer will get an option for Earlier, lenders were not comfortable due to
expand the lanes or else, the augmentation of lane capacity with an non-availability of upside to developers. Now,
concessions would get terminated assured IRR of 16%. This is provided developers have incentives for capacity
by extending the concession period augmentation. This also provides comfort to
subject to a maximum of 5 years lenders

Exit clause Developers were required to hold Developers are required to hold 51% This can eventually free up capital for
51% in SPVs till the construction stake in the SPV and the new clause developers to bid for other projects. Also, the
period. Minimum 26% holding till empowers NHAI to permit complete stake can be divested to companies that
the end of the concession period divestment two years post-completion specialise in O&M of road works, thereby
of construction after a No Objection ensuring proper maintenance of roads after
Certificate (NOC) has been obtained COD. Moreover, the amendment is expected
from the lenders. to encourage financial investors take up stake
in operational projects, as the construction
risk will be eliminated post-COD.
Conflict of Interest If common shareholders have more The limit triggering conflict of interest Apart from other developers, this should also
clause than 5% stake in two bids, the bids has been raised to 25% raise the interest from other investors such as
will get disqualified private equity players
Pre-qualification criteria Developers should have executed Developer should have executed This would allow more players to participate
projects 2x the bid size in the last projects 1x the bid size of projects in in the bidding process
five years the last five years
Extension of overall 5% for the entire six laning program 10% for the entire six laning program Increase the scope of overall funding for
cap on VGF (5080 kms) (5080 kms) unviable six laning projects

VGF extension VGF is paid equally (20% each) Entire 40% VGF is paid upfront Front-ended cash flow to improve IRR for
during the construction and O&M (during the construction period) developers
period
Bidding method flow First bid out on BOT toll basis. On Depending upon financial viability & Significant time saved in the bidding process
failure, bid out on BOT annuity threshold traffic volume, concurrent
basis and then on EPC basis bidding in all modes is possible
Cap on number of Top 6 applicants short listed based All applicants meeting the threshold Improving the competitive landscape for the
bidders eligible for a on qualification criteria were eligible financial and technical criteria are sector leading to heightened competition
project to submit the financial bids for the eligible for bidding
project
Single bid Tenders, which received single bid NHAI Board is now empowered to Should speed up the process for awarding
were rejected accept a single bid after examining its projects
reasonableness
Security for lenders Since the developer does not have Now, provision in MCA allows lenders To result in lower cost of funds for developers
ownership, the loan was classified to create charge on the escrow
as unsecured by bank, which led to account maintained for toll collection
higher cost of funds for developer
Source: NHAI, MoRTH, Emkay Research

Emkay Research 7 September 2010 3

 Infrastructure Sector Update

NHAI expects to award 18,000 kms over FY11-12

As mentioned earlier, during FY10, NHAI awarded 3,361 kms against the work plan target
of 11,618 kms. Since majority of the issues relating to MCA, RFP & RFQ documents were
resolved only in later half of 2010 (Nov09 - adoption of BKC report), the FY10 targets holds
little relevance. The under achievement in the last year’s work plan – FY10 meant an spill
over of ~8250 kms. NHAI’s FY11 target stands at 11599 kms of new awards. Add to it the
8250 km as spill over from FY10 targets, the cumulative target stands at 19856 kms of new
awards.. Though such a steep target is unlikely to be achieved in FY11, we would like to
highlight that a significant number of projects have the requisite clearances and are ready
for awards. NHAI expects to award ~9000 kms each in FY11E & FY12E, taking the overall
tally to 18,000 on new road awards over FY11-12. However, based on the run rate of
~550km/per month over the last 9 months and ~700km/per month for YTD FY11, we expect
NHAI to award 7000-7500 kms in FY11E.

FY13 could see a construction target of 20km/day

The award of 7500 km/per year will take them very close to their target of 20 km/day by
FY13E. There are number of positives which support our hypothesis, they are:
n Assuming an average completion time of three years for a project, overall road
development should be 22000 kms over the next 3 years to achieve 20 km/day. A
pipeline of 9,133 kms under implementation has ensured that NHAI requires an overall
award of another ~12750 kms over the coming two years.
n In addition, NHDP IV, the awards of which, are expected to commence in big
way in FY12 are two laning projects in low density areas which are relatively
easier for execution

Progress so far on National Highway Development Program

Government’s flagship program, National Highway Development Program (NHDP)
envisages upgrading close to 50,000 kms of roads in 7 phases. Till date, 28.6% (14,315
kms) of the total length has been completed and 18.3% (9,133 kms) is under
implementation. This leaves us with 52.8% of total length or 26,381 kms yet to be awarded.
We estimate additional capex of ~Rs 2,615 bn to be incurred for completion of remaining
NHDP plan based on FY11 cost estimates.

Phases Description Length Completed Under Balance to Cost Capex (Rs Bn)
NHDP (kms) (kms) implement be (Rs Mn/
ation(kms) awarded per km) Balance to Under
Total
(kms) be awarded implementation
I Golden Quadrilateral 5846 5796 53 0 87 0.0 3.9 3.9
Port connectivity 380 289 85 6 87 0.5 6.3 6.8
Other NH 965 918 27 20 87 1.7 2.0 3.7
II NSEW Corridor 7300 5205 1443 494 87 43.0 106.7 149.7
III A&B 12109 1805 5201 5103 105 535.8 464.2 1000.0
IV 2 laning 14799 176 14623 32 467.9 4.8 472.7
V 6 laning 6500 302 1998 4200 120 504.0 203.8 707.8
VI Expressways 1000 1000 158 158.0 0.0 158.0
VII Ring Roads 700 41 659 105 69.2 3.7 72.9
SARDP - NE 388 112 276 105 29.0 10.0 39.0
Total 49987 14315 9133 26381 1809.2 805.3 2614.5
Source: NHAI, CRISIL, Emkay Research

Emkay Research 7 September 2010 4

 Infrastructure Sector Update

Industry perspective on policy initiatives

Developers are optimistic on the outlook of road sector. Despite this, the sector plagued by
key issues like massive differences in the estimates of total project cost (TPC) by NHAI &
developers, cumbersome process of land acquisition and utility shifting etc. Some of these
issues are briefly discussed hereunder.
Difference in project cost estimated by NHAI and developers
Massive differential in the estimates of total project cost (TPC) by NHAI and by developers
continues to remain a lingering issue. The classic example of this is the TPC of 4 projects
that IRB won last year. The TPC of these projects was Rs25.35 bn as per NHAI while IRB
has estimated TPC of Rs43 bn, i.e. a difference of more than 40% between the two
estimates. One of the reasons pointed out by the developer was the outdated DPRs
prepared by consultants. The NHAI estimates are based on DPRs prepared before 2006 &
2007- grossly underestimating current TPC estimates. Further, earlier as consultants were
largely selected on the basis of financial consideration, the quality of estimates in DPRs is
found to be severely lacking. The huge difference in the TPC and the realistic TPC leads to
lower VGF to the developers as NHAI grants VGF on its own estimates of TPC. Hence,
certain low traffic density projects become economically unviable even after 40% VGF.
Also, such a large difference in TPC leads to inhibitions by developers, as in the event of
termination of concession, the termination payment is made to developer on the basis of
NHAI TPC estimates.
Land acquisition- still a major concern
Land acquisition is the biggest road bock for execution of PPPs in India. The key reason
being- Unwillingness of owner/incumbent to yield control. Unattractive prices of land are
also cited as the major issue for land acquisition. This inability of the Govt in timely
completion of land acquisition results in significant time and cost overruns, which in turn,
negatively impacts project’s economic viability.
In order to expedite the land acquisition process, NHAI has already established ~80 special
land acquisition units (SLAU) out of the overall 190 SLAUs. As indicated by NHAI, the
progress is also visible and area notified by NHAI under Section 3A (first stage of land
acquisition) for acquisition of land and compared to an average of 6000 acre of area notified
over the last 3 years, NHAI has been able to issue 3A this year to the tune of 23,360 acres.
Removal of utilities - non adherence to state support agreement
Removal of utilities and cumbersome clearance required for the same is cited as another
major hindrance in timely execution of road projects. This is even after the concessionaires
have the requisite state support agreements. Moreover, the inordinate delays in obtaining
forest clearances and approval for Railway Over-Bridge (ROBs) further impacts execution
resulting in significant cost overruns. Developers also pointed out that the NHAI
underestimates cost of shifting utilities and hence, eventually in the interest of timely
completion, the developers end up bearing the higher cost of shifting these utilities.
Policy changes –risk inconceivable to price in
Since infrastructure projects like road are essentially long gestation projects, the biggest
risk these projects carry are the policy changes. For example, the proposed increase of
MAT rate from 18% to 20% under the new Direct Tax Code will negatively impact
profitability of a lot of existing and under construction road BOT projects. Such risks are
practically inconceivable to price in and hence, can render a significant blow to the interest
of developers and lenders.

Emkay Research 7 September 2010 5

 Infrastructure Sector Update

NHAI faces manpower crunch to handle massive programme like NHDP

NHDP is a massive programme entailing construction/upgradation of ~50,000 kms. Such a
programme requires huge manpower to seamlessly handle functional tasks such as
preparation of DPRs, evaluating technical feasibility, short listing bidders, awarding &
resolving disputes etc. Developers highlighted that for such a large & complex road
development programme, NHAI has awfully inadequate manpower, creating further
hindrances and affecting the pace of project awarding.
Lack of succession planning intermittently affects pace of project awarding
Another concern highlighted by the investor community was lack of succession planning at
NHAI. For example, the current NHAI chairman (Mr. Brijeshwar Singh) was supposed to
retire on Aug 31, 2010 and the ministry is yet to appoint his successor. Consequently, in the
interim period, NHAI has granted extension of 3 months to the retiring chairman. This lack
of succession planning is affecting the pace of project awarding. For example out of the
2,873 kms of new projects awarded in FY11, majority of the projects were awarded in the
first two months where as the last 3 months has seen little projects awards. Further, as the
key posts in the nodal agency are managed on deputation basis, this leads to lack of
ownership.

Emkay Research 7 September 2010 6

 Infrastructure Sector Update

Funding issues for road PPPs

Since road projects are inherently long gestation projects, the funding for these projects are
typically debt intensive, making the execution prone to funding risk. Assuming a leverage of
70:30, our estimates of total investment of ~Rs 2,614 bn in NHDP would require equity
funding of Rs784 bn and a massive debt funding of Rs1,830 bn. With the impact of
economic slowdown gradually subsiding, the funding scenario looks quite favourable.
However some of the key funding issues plaguing investing community are:
Difference in total project cost leads to difficulty in achieving financial closure
As mentioned earlier, there exists a massive differential in the estimates of TPC by NHAI
and developers. Such a large difference creates difficulty in the smooth financial closure of
road projects, since the lender, in order to ensure reliability of both estimates reconciles the
difference. Also, such a large difference in TPC leads to inhibitions by lenders- as in the
event of termination of concession, the termination payment is made to the developer on
the basis of NHAI TPC estimates. Further, as the termination payment is made on NHAI
TPC, for the debt differential between two estimates, lenders typically ask for recourse to
parent company’s balance sheet. Such recourse provided to lenders will increase holding
company liabilities (which as of now are shown in contingent liabilities) and developers are
apprehensive about the additional pressure that these recourses will create post
implementation of IFRS by Indian Inc.
Developers opine cost of funding still high. Lenders differ
Even though the liquidity constraints have significantly eased over the past 12 months, the
developers opined that the sector still has to receive the full benefit of easing liquidity. The
developers are borrowing money between 9.5%-12.5% depending on project feasibility.
However, lenders to road projects opined that the road sector was actually getting
subsidized with lower rate of interest on account of lenders intentionally reducing their
weightage on the power sector.
Rates set to harden further
With RBI adopting tighter monetary policy, lenders have started signaling that cheaper
interest rate scenario is set to change over the coming year. Further, they believe once the
lending achieves significant size, the spread between power sector lending vis-à-vis road
sector will narrow over the coming years. The pickup in the awarding facility will offer ample
opportunity to the banking system and the discount of sectoral preference for roads is
expected to shrink.
IIFCL - funding costly - structure not accommodative
The initial euphoria on setting up of IIFCL seems to be settling down- with developers
realizing that the rates on funding from IIFCL is as high as banks. Also, with concessionaire
required to repay 60% of the funded amount within the first 10 years, the structure of loan
from IIFCL is more or less similar to banks.
Pension funds and insurance companies not allowed to invest in PPPs
Since the road projects are inherently long gestation projects, the funding required for these
projects also need to be long term in nature. However, banks are reluctant to provide
reasonably cheap finance for such a long term. Consequently, there is need for long term
capital provided by pension funds and insurance companies to be allowed to invest directly
in PPP projects. However, as of now, these institutions are restricted from the same.
Implementation of IFRS - leading to balance sheet pressures
Developers are also apprehensive about the additional pressure that will be visible on the
parent company’s balance sheet post the implementation of IFRS. The debt at several
SPV’s will be visible on the consolidated books, leading to comparatively higher leverage
ratios for the holding company.

Emkay Research 7 September 2010 7

 Infrastructure Sector Update

Absence of active bond market

Absence of active bond market, which could be ideal for tapping cash rich corporate and
massive retail saving, is an impediment for providing large long term capital required for
road PPPs.
Increasing competitive intensity leading to lower IRRs
With key developer friendly initiatives adopted by the Govt, the sector saw significant pick
up in investor interest over last 12 months. This has lead to increasing competitive intensity,
particularly for high density traffic corridors. The competitive intensity is also evident from
the fact that a lot of projects in FY11 are bagged by developers on premium as opposed to
majority of the projects being awarded by NHAI on VGF in FY10. Consequently, developers
/lenders have seen comparatively lower project IRR’s. The trend suggests a gradual move
towards higher premium being paid by bidders.
Building in an aggressive base case assumption in bidding leaves little upside
Lenders have started building 8-8.5% growth in volumes, which leaves very little room for
upside from the concession agreement. Building in aggressive base significantly increases
the risk of the project. The projects are very sensitive to the traffic growth assumption and
any delays in project execution or ramp up in volumes of traffic growth curtails the project
valuation significantly.
Lenders optimistic on sector prospects
Though the sector is facing some niggling issues on funding of projects, on the optimistic
side, it is noteworthy that over the past one year; most of the road concessions have
achieved financial closure. This reflects increasing willingness and confidence of lenders to
finance road PPPs. Some of the key financing institutions also expressed their view that
‘money is available, what we need is effective mechanism and instruments to tap it’.

Emkay Research 7 September 2010 8

 Infrastructure Sector Update

Initiatives required for gaining momentum in road development

Some of the key steps that were suggested by developers to accelerate the speed and
momentum in road development are listed below
Decentralization- a step in the right direction
NHAI has set up 10 regional offices headed by CGM level officers. Early signs of
decentralization are already visible and the authorities should up their efforts to improve the
process further. The decentralization helps in close monitoring and coordination with the
state level authorities.
Historical trends in traffic data required forbetter evaluation of projects
Government at this point in time, is using the seven day count adjusting for seasonal factors
to determine the traffic assessment. Developers and lenders who are willing to take
execution risks, need assurance of trustworthy underlying traffic numbers to evaluate
project prospects in a better manner. Also, the developers and lenders would find
significant comfort if the traffic assessments are available for a larger duration (2-3 years of
historical traffic data)
Single window clearance for shifting of utilities, forest clearance and ROBs
Removal of utilities, and cumbersome clearance required for the same is cited as another
major issue for timely execution of road projects. This is even after the concession
agreement having the requisite state support agreements. Inordinate delays for obtaining
forest clearances and approval for railway over bridge (ROBs) further extends construction
period, resulting in cost overruns. Some developers pointed out that sometimes each
clearance requires 20-25 signatures of various authorities. The developer also pointed out
that the NHAI underestimates cost of shifting utilities and hence, eventually in the interest of
timely completion, the developers end up bearing higher cost of shifting these utilities.
Allowing insurance companies and pension funds to directly invest in PPPs
A PPP project needs capital with different degree of risk appetite at different stages, with
high risk appetite capital coming in at the initial stages. Since pension fund and insurance
companies typically have lower risk appetite, these institutions can actually take entire
equity stake in PPPs once the project starts earning cash flows and resultant free up capital
to fund other project.
Opening up ECB window for road PPPs
As financing cost of External commercial borrowing (ECB) is always cheaper than the
domestic one, it is advisable to entirely open up the ECB window for the road sector, as it
not only bridges the financing deficit gap but the lower cost also significantly improves
project economics. Further, refinancing of ECB is relatively much easier and re-financing
cost cheaper, because of efficient risk pricing

Government willing to resolve issue

Developers are still concerned over lot of lingering issues, particularly issues like land
acquisition, utility shifting, dispute resolution & differential in TPC. Government remains
committed and focused towards creating world class road infrastructure. This is clearly
manifested in its intention to resolve key issues hampering private sector investment.

Our view
We believe NHAI will award 7000-7500 kms of new road projects in FY11 as significant
projects from work plan for 2009-10 already have requisite clearance & approvals,. We
believe positive macro economic scenario, and political commitment will lead to significant
growth opportunities for PPP investment in road sector. This, coupled with Govt’s
willingness to resolve issues hampering private investment will lead to steep growth
trajectory in the Indian road sector.

Emkay Research 7 September 2010 9

 Infrastructure Sector Update

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Emkay Research 7 September 2010 10