Why are Indian infrastructure and construction players unable to realise their potential? Is it as simple as the impact of COVID or have other factors been at play? And with the economy in the doldrums and the country still in the throes of a pandemic, can the industry get back on track? We analyse the past and the present to get some answers for the future. It’s a global whammy no one saw coming. The COVID-19 pandemic has left the world reeling, with most economic and business activities being restricted or at a standstill, leaving an indelible impact. Even the fastest growing economies are finding it hard to recover. Crunching the numbers As expected, the International Monetary Fund (IMF) updated its World Economic Outlook (WEO) in June 2020, revising global GDP growth estimates downwards from the levels announced in April 2020. The WEO categorically indicated that there would be more significant declines in world output and trade volumes owing to COVID-19 and slower global economic recovery in CY20 as a whole. For instance, the WEO June 2020 update forecasts a minus 4.9 per cent degrowth in world output for CY20, 1.9 per cent below the minus 3 per cent it had projected in April. And while CY21 is expected to bring some growth, IMF has again reduced its projected global GDP growth in CY21 from the 5.8 per cent predicted in April to 5.4 per cent. If GDP figures from the April to June 2020 quarter are anything to go by, these projections are likely to come true. In fact, India has been the worst performer in the April to June 2020 quarter, with a decline of over 23.90 per cent in GDP. Other economies also fared poorly during this period, such as Great Britain (minus 20.40 per cent), Spain (minus 18.50 per cent) and Mexico (minus 17.10 per cent). While a few countries opened up early in an attempt to prioritise economic activity, India being the second largest populated country had to opt for stricter and longer lockdowns. The result speaks for itself. And the question on everyone’s lips is this: When will things get back to normal? Above and beyond COVID-19 Everyone is waiting for a vaccine to appear and hoping for an end to the pandemic, expecting it to herald a return to normalcy. But while it is true that COVID-19 precipitated the global economic slowdown, it wasn’t the only factor responsible for India’s poor performance. The signs were there—the pandemic just uncovered them and exacerbated the problems. So, to truly understand where we stand today and what brought us here, we at Construction World believe we have to ‘search yesterday’. Quite often, the process of historical analysis is affected by ‘recency bias’, a tendency to extrapolate recent experience into the future. And when it comes to economic and business analysis, this can have disastrous consequences. Hence, it is important to go further back, analyse the root cause and factors at play over a longer period, and come to the right conclusion. Consider the case of the CW ANNUAL, our yearly ode to consistent wealth creators and star performers from the infrastructure sector. Our increasing difficulty in finding winners in different categories has raised several pertinent concerns. Once, Indian infra companies were flush with funds from domestic and foreign investors. Now, many have had to raise funds by selling assets and borrowing at double the rate charged for personal loans. What led to such a drastic fall? Is it a systemic failure? Was something wrong with the strategy they employed? Did the Government fail to live up to expectations in terms of reforms? Going forward in this article, we will attempt to analyse the scenario in detail and try and answer some of these questions. Hearteningly, though, India still has its share of companies who have soldiered on, converted adversity into opportunity and created wealth for their investors—we salute them in this special issue. That said, let’s turn our eye once more to the bigger picture. Value on the bourses – The reality Equity indices are considered to be the barometer of a country’s financial health and the same is applicable to stock price. A simple investment parameter suggests that if a business is doing well, the stock price reflects this. However, if the performance of leading realty and construction companies on the bourses is anything to go by, it suggests everything is not hunky-dory. To illustrate this, we have provided a comparative market capitalisation of companies in the previous year and now. While benchmark indices are trading at almost similar levels compared to September 2019, the market capitalisation of most infrastructure and realty companies has eroded. In the construction and infrastructure segment, JMC Projects (India), Ramky Infrastructure and RPP Infra Projects have declined over 50 per cent. One may consider that being midsized companies, a not-so-strong balance sheet may have been the reason. But, then, the poster boy of the Indian infrastructure sector L&T has also declined by more than 40 per cent. Slower order inflows in FY19 and FY20, margins remaining under pressure and slower cash generation were the prime factors behind such a poor performance from leading construction players. Delayed payments from the Government (for public work contracts) and slower capex from private players added to the woes. Further aggravating the issue was non-availability of financing as most banks were reeling under pressure from non-performing assets (NPAs). Other domestic financing institutions were also finding it difficult to provide liquidity and funding, even to viable projects. The industry experienced a slowdown owing to a liquidity crunch, weak economic activities and subdued consumer sentiment. The unexpected Covid-19 crisis and the associated lockdown made things worse, leading to widespread disruption and temporary shutdown of construction sites. Moreover, in the near term, the industry will remain heavily affected by the expected delay or cancellation of planned projects. With weak economic activity and unemployment, the residential sector is also likely to struggle despite low interest rates and direct government support. The story in the realty segment was no different in FY20. Volumes had already dried up; with banks and housing finance companies not passing on the rate cuts to end users, demand was not picking up. While affordable housing found some takers, only a few players benefited. As expected with leveraged balance sheets and stagnant volumes and margins, realty players also witnessed decline on the bourses. A struggling economy, even before COVID In a clear case of recency bias, almost everyone is blaming the impact of COVID-19 for the current economic scenario. But, as explained earlier, it is important to analyse historical performance in detail. A closer look at macroeconomic and microeconomic parameters clearly indicates that the Indian economy was already struggling. Let’s start with the most important parameter: GDP growth. GDP growth had already peaked in Q4FY18 when it posted a growth of 8.2 per cent; after that, it has been consistently declining. The bar graph clearly shows how overall GDP growth was on a declining trajectory in FY19 and FY20. The COVID-19 lockdown made things plummet, with Q1FY21 witnessing a negative growth of 23.90 per cent. Evidently, the downfall had already begun at the start of FY19. While other parameters like the current account deficit (CAD) showed improvement over the period when GDP was on the decline, it was mainly on account of the decline in crude price and lower gold imports. Another important factor to analyse is the financial performance of India Inc. Sales growth of benchmark NIFTY constituents had already peaked in Q2FY19 with a topline growth of 25.10 per cent. Since then, there has been a consistent decline: 22.30 per cent in Q3FY19, 10.30 per cent in Q4FY19 and 6.50 per cent in Q1FY20. This was followed by degrowth of 2.4 per cent in Q2FY20, 1.60 in Q3FY20 and 5.10 per cent in Q4FY20. And as expected, Q1FY21 has been the worst quarter on the back of COVID-19. EBITDA growth had also peaked in Q1FY19, going down to 13.40 per cent in Q2FY19 and 6.60 per cent in Q3FY19 with a marginal increase to 6.90 per cent in Q4FY19. Things went downhill in FY20 with 3.20 per cent in Q1FY20 and 2.50 per cent in Q2FY20, followed by degrowth of 4.80 per cent in Q4FY20. With regard to PAT growth, too, Q1FY19 growth has been either lower single digit or lower double digit. The table below shows the deterioration of India Inc’s earning performance, which was reflected on the bourses. Other factors were also indicating a slowdown. Commercial vehicle (CV) sales have been under pressure for many months. The figure below clearly indicates that monthly sales growth has been declining since July 2018 with degrowth after January 2019. CV sales are considered an important indicator to analyse economic performance as they are earning assets directly related to economic activity. Other parameters tell a similar story. The sales of two-wheelers and passenger vehicles have been on the decline since July 2018. This was despite the RBI ensuring sufficient liquidity and moderate lending rates. The following chart illustrates this. The automotive segment aside, other macro indicators have also not been very encouraging. The consumer confidence index was dipping, domestic passenger kilometre growth was stagnant and prospects of growth in employment had plummeted since October 2019. Capacity utilisation was on the lower side and hardly any credit growth was visible. While the current consumer confidence index was flattish, even the future expectation index was lacklustre. All the above factors clearly indicate that the Indian economy was already very fragile; COVID exacerbated the situation. Did the Government do enough? Extraordinary situations require extraordinary actions, they say. And a lot was expected from the Indian Government, especially with other developed economies announcing large stimulus packages. The Government responded with a comprehensive economic package of Rs 20 lakh crore (equivalent to 10 per cent of India’s GDP). Extension of the date for income tax and GST returns provided relief on the process front. The RBI provided much-needed liquidity by cash reserve ratio (CRR) reduction (Rs 137,000 crore) and targeted long-term repo operations (TLTROs) of Rs 100,050 crore. In addition, the Government announced the opening of a special liquidity facility (SLF) of Rs 50,000 crore for mutual funds to alleviate intensified liquidity pressures. Alongside, the Government announced much-awaited liquidity measures for vulnerable businesses like the MSME segment and non-banking financial institutions (NBFCs). The measures announced were: Rs 3 trillion collateral-free automatic loans for businesses, including MSMEs Rs 200 billion subordinate debt for stressed MSMEs Rs 500 billion equity infusion for MSMEs through fund of funds Rs 300 billion special liquidity scheme for NBFCs/housing finance companies (HFCs)/microfinance institutions (MFIs) Rs 450 billion partial credit guarantee scheme 2.0 for NBFCs Rs 900 billion liquidity injection for DISCOMs Another major relief, for corporates and individuals, was a moratorium of six months on payment of instalments and payment of interest on working capital facilities with respect to all term loans—NBFCs, HFCs and MFIs with low credit rating require liquidity for fresh lending to MSMEs and individuals. Real-estate players were granted extension of registration and completion date of projects under RERA. To provide support to small and medium-scale construction players, global tenders were disallowed up to Rs 200 crore. This provided a competitive edge to smaller players. The Government also recommended the release of retention money according to the proportion of work already executed in accordance to the contract specification and further specified that retention money may not be deducted by the bill raised by the contractor from the period from three months up to six months. In addition, for HAM/BOT contracts, performance guarantee was to be released on a pro-rata basis of that provided in the contract, if the concessionaire was not in breach of contract. Further, a relaxation in Schedule-H was provided, under which a monthly payment is to be provided to the contractor for work done and accepted as per the specification of the contractor during the month under EPC/HAM contract. In addition, an extension of three to six months was provided to contractors to meet their obligations under contract. Even the force majeure clause was added. For all national tolling contracts, it was suggested that loss in fee collection be compensated in accordance with the contract. To speed up highway construction, the National Highways Authority of India (NHAI) has agreed to most suggestions made by the National Highways Builders Federation (NHBF), pertaining to areas such as COVID-19 relief, bidding process, contract management, EPC, HAM and BOT agreements and project preparations. Some key suggestions accepted by the NHAI include extension of time to contractors for construction without imposition of any cost or penalty by the project director up to three months, and regional officer for more than three months and up to six months, in view of COVID-19. We believe these measures provided urgent relief to players in the infrastructure sector. Also, the lifting of the lockdown enabled the resumption of construction activities. Other policy reforms In terms of policy reforms, the introduction of commercial mining in the coal sector was an important first step. It was announced that the exploration-cum-production regime for partially explored blocks was to be auctioned, in addition to the earlier provision of auction of fully explored coal blocks. Allowing private-sector participation in exploration will result in production earlier than scheduled, which will be incentivised through rebate in revenue share. Second, the development of more world-class airports through PPP was announced to create greater opportunities in the construction and infrastructure sector. The Airport Authority of India (AAI) has awarded three airports out of six bids for operation and maintenance on PPP basis. Further, six more airports have been identified for the second round. Additional investment of around Rs 13,000 crore by private players is expected in 12 airports in the first and second rounds. Another six airports will bid out in the third round. The question still remains: has all this been enough to help the Indian economy? While the merits of the package can be debated endlessly, we opine that most of the Rs 20 lakh crore package was only number-crunching and cannot be considered as a direct benefit. It was more of an indirect benefit in terms of process relaxation and loans. A few experts have also pointed out that the special COVID-19 package draws from already provisioned money in the Budget, RBI measures or other announcements by the Government. Most were already in place even without COVID-19, when the economy was going downhill. Even industry leaders have objected to the package on the grounds that it is too liquidity-centric while the problem with the Indian economy is not one of liquidity but demand. That said, one must add in all fairness that the Rs 20 lakh crore package is more beneficial in the long term. In simple terms, we may not see the immediate benefits of the stimulus package. But the impact will be seen over the next three years. Future watch Returning to the recency bias we referred to earlier, the impact of COVID-19 is uppermost on the minds of investors. But one must understand that construction and infrastructure are long-term stories—roadblocks and delays of a few months should not be considered a major hindrance. First and foremost, infrastructure is a global play and it is expected that governments across the world will aim to increase spending on infrastructure projects as soon as normalcy returns to reinvigorate the industry. However, with cash incentives to economically weaker segments, the capability to invest in the infrastructure segment is likely to be constrained. Nevertheless, the future of the construction industry looks positive in the long term with opportunities across segments. In terms of real estate, emerging trends include increasing demand for sustainable green construction to reduce the carbon footprint and usage of cost-efficient raw material. Emerging economies are expected to remain the largest markets, fuelled by a growing population, increasing urbanisation, higher expenditure on infrastructure development and affordable housing projects. In India, government projects provide a huge impetus to the construction industry. Initiatives such as the creation of 100 smart cities, world-class highways, shipping infrastructure, railway expansion, housing and urban development have attracted large investments through FDI, private players and government budgets. Construction companies are likely to witness significant opportunities, with key segments being highways, railways, ports, urban infrastructure, metros and airports. The Government is determined to provide a fillip to energy infrastructure, thereby providing investment opportunities worth Rs 21 lakh crore for the sector over the next decade. Between FY 2013-14 and FY 2018-19, India witnessed highway construction growth of 20.57 per cent on a CAGR basis, with 10,855 km of highways being built. Between 2019 and 2023, NHAI is expected to generate an aggregate revenue of around Rs 1 lakh crore. The Rs 111-lakh-crore National Infrastructure Pipeline (NIP) offers immense opportunities for growth—as normalcy returns, infrastructure companies are likely to bounce back ahead of other sectors. Projects under NIP include housing, safe drinking water, affordable energy, healthcare, educational institutes, railway stations, airports, metro, railway transportation, logistics and warehousing, and irrigation projects, among others. Going forward, the Housing for All initiative and smart cities mission are likely to be growth drivers, as are the construction of concrete roads and highways through the Bharatmala project, development of rural roads under the Pradhan Mantri Gram Sadak Yojana and the expansion of the metro network in the country. Further, in the Union Budget 2020-21, the Government has allocated a massive Rs 1,69,637 crore ($ 24.27 billion) to develop transport infrastructure. And an outlay of Rs 27,500 crore has been envisaged under Pradhan Mantri Awas Yojana. Amid scarce resources with the diversion of funds towards COVID relief, PPP will play an even more significant role in the future. By attracting more private-sector investment, especially in sectors like roads and highways, it ensures easier funding for longer-term projects. At the same time, it improves accountability and stimulates the growth and development of the country. Thus, despite the current despondency, there is reason for hope and cause for positivity. To be sure, the initial quarters of FY 2020-21 will be adversely affected by the current upheaval. However, considering the Government’s raft of stimulus measures across various sectors, one can expect green shoots later in the financial year and a revival in the long term.