Madam Finance Minister, Give us the Bounce

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Reduce companies’ balance sheet to Increase their capacity

The Hon’ble Finance Minister would right now be busy constructing the Budget for FY2024. While she does so, she would be aware that investment let growth shall continue to play a dominant role in FY24 as well. The Union Budget for FY2023 reflected a hard pivot towards infrastructure investment. The announcement was followed by Hon’ble Prime Minister’s meeting with infra industry leaders, wherein he urged the private sector and government agencies to register a ‘historic jump’ in implementation of budget initiatives for the Infrastructure sector.


The investment in infrastructure sector, however, remains dominated by central and state governments with private sector participation remaining largely subdued. Infrastructure investment over last two decades has shown us that financial investors have limited capacity to invest in greenfield assets. Due to unavailability of equity capital, India has also seen few pure play developers in this segment. This gap has been largely filled by EPC companies taking up infrastructure investment as backward integration to their core activity. As these investments were in the past funded on the back of increased leverage, they didn’t have the ability to absorb unforeseen regulatory/ execution challenges during project development. We have had as a result large NPAs within the banking system and reluctance on the part of EPC companies to take up new investments.


To reduce development risk and revive private sector participation in infrastructure investment, the Government has on one hand launched Hybrid Annuity Model based PPP, while also simultaneously increased its investment into greenfield projects. National Infrastructure Pipeline estimates that 19% of US$ 1.8 trillion would be invested by private sector. This is substantially higher than the investment done by private sector during last 5 years. While the efforts of Government in increasing infrastructure investment is laudable, the capacity of private sector EPC companies to invest in infrastructure sector must get substantially enhanced for a sustainable solution to India’s infrastructure needs.


For the private infrastructure investment to rejuvenate, it requires concentrated effort on three levels:

  1. Improving financial capacity,
  2. Timely and non-confrontational dispute resolution, and
  3. Reducing execution uncertainties.

The financial capacity of Indian EPC companies can be improved by shrinking the operating assets that they are forced to carry in the course of business. Unlike other service sectors like IT, Telecom and Engineering, the operating assets i.e. Gross Current Assets that the EPC companies hold in their balance sheet are considerably higher at almost equal to their annual revenue. Further, due to milestone based payment schedules and reluctance to resolve disputes, some part of these current assets age over 6 months. Under existing lending norms, banks remain unwilling to finance long duration current assets which inevitably suppresses cashflows of the EPC companies. Monetizing these current assets would make EPC companies’ balance sheet robust and allow them to take project development risks. The Government has setup National Bank for Financing Infrastructure Development(NaBFID) to support the development of long-term infrastructure financing and one hopes that NaBFID would take up financing of these assets. A sustainable solution would however be to make payment milestones aligned with project requirement and a surgical strike on dispute resolution period within our country.


SectorGross Current Assets*

* average as % of annual revenue

While several steps have been taken to incentivize and facilitate investment in India -contract enforcement progress continues to be a major constraint. As per the 2020 ranking, time taken to enforce contracts in India is 3x while cost incurred is 2x than that in China. Due to inherent nature of long duration infrastructure projects, there is often large gap between planning data vs realities on ground leading to disputes between Authorities and EPC companies. Many a times, dispute resolution process runs into 8-10 years slowly progressing through successive levels of appeal clogging balance sheet of EPC companies in the meantime.


There have been several steps under taken to improve this contract enforcement aspect. These include formalizing alternative dispute resolution mechanisms by the Arbitration and Conciliation Act, 1996, compulsory pre-institution mediation under the Commercial Courts Act, online dispute resolution and Conciliation Mechanism proposed under last Budget for quick resolution of contractual disputes with Government and CPSEs. Further under the principle of “Pay First Protest Later”, Cabinet has also adopted Niti Aayog’s recommendation of Government entity paying 75% of award if the arbitral award is being challenged.


The progressive initiatives taken on improving contract enforcement have however beenthwartedbypatchy implementation or follow-up appeals. Some of the alternate dispute resolution mechanisms like Dispute Resolution Board have not been impactful as the awards are not enforceable. The Arbitration and Conciliation Act, 1996 provides for timebound dispute resolution with arbitration expected to be completed within 12-18 months. In practice, situation has not changed materially as the Arbitral awards are almost always challenged in courts, delaying the enforcement by an average of 5-6 years after arbitration award.


During the post-budget discussion with heads of infrastructure departments and private players on laying roadmap for implementation of budget for FY23, Hon’ble Prime Minister highlighted the need for completing projects without delay and exhorted authorities to have an open mind in addressing disputes with private players. Need of the hour is to resolve contract variations or disputes pro actively within contractual framework without need for Dispute Adjudication Board or Arbitration. In cases where, the disputes do get referred, the awards should be promptly enforced.


The third pillar in furthering private investment is to reduce execution uncertainties on account of approvals/ local issues that delay project. Considerable progress has been made by making approvals/ substantive land acquisition conditions precedent to Concession Agreement and having provision for descoping or compensationin the event of delay. In practice, enforcement of these mitigants has been a challenge with Authorities pushing back against descoping/ compensation.


Timely support of State Government in resolving provincial issues is also critical to seamless execution of these long gestation projects. For all projects undertaken on PPP basis, State Support Agreement with service level agreement for timebound resolution of identified issues is required. This would also involve single window clearance for all Right of Way or land acquisition issues.


In conclusion, the natural fit for taking up greenfield infrastructure projects are EPC companies due to core role played by them in execution. The EPC companies however need to be strengthened by helping them reduce their operating assets, by way of on ground support, speedy dispute resolution and availability of long-term funding. These assets once commissioned can be divested to financial investors perpetuating a virtuous cycle of asset creation in India.


Himanshu Chaturvedi,
Chief Strategy and Growth Officer,
Tata Projects Limited
Simplify. Create.

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