Investing in Road Construction: Issues and incentives

4.87 Million Km, that is the length of the world’s second largest road network that is spread across length and width of India. Its not just the length but the density of the road network too that India boasts of. While 1.42 kilometres of roads for each square kilometre of land is good number, it is still far too small as compared to the developed nations of the world that we look up to. While India’s road network is huge, 60% of the network is rural in rural India and mostly unpaved. The road network accounts for 80% of all passenger traffic and 60% of all freight traffic in India.

The Modi government has increased the road construction budget by 12% bringing it up to 64,900 crore INR for the fiscal year. Add to that the introduction of various incentives and legislative reforms and we are looking at a much faster rate of road development. The government plans on bringing the rate of road construction up to 40 Km per day form the current 23 Km per day which is a humongous task in itself. Now that we know we are on the right track for a faster and stronger road network, lets look into the issues and incentives that surround the road construction industry.

Public Private Partnership model Amendments

High risk ventures, delays, land acquisition and environmental disputes are all considered to be signature characteristics of the traditional Public Private Partnership models in the area of road construction. To create a better environment and mitigate these issues the NHAI has re- modelled the model concession agreement to introduce the hybrid annuity model (“HAM”). In the traditional arrangement, it was the concessionaire who had to bear the larger share of the project risk. Under HAM, the developer usually shared 60% of the expense while the government paid the remaining 40% of the project cost. NHAI absorbed the traffic risk by collecting the toll while the developer got steady inflow of revenue and profit through annuity payments.

Earlier the OMT (Operate maintain transfer) model was in place and meant that the bidder maintained the project for a shorter tenure resulting in poor maintenance while the annual payouts to NHAI kept on piling up without the changes in traffic flow and revenue of the investors being taken into consideration. The newly approved TOT (Toll operate transfer) model involves 30 year leasing of toll collection and operation duties on highways operated by the NHAI for more than 2 years, to investors that include foreign funds in consideration of upfront payments made to NHAI by the investor.

Land acquisition Issues:

Public pitting against land acquisition for roads and illegal encroachments have always been a major issue for developers involved in construction of roads. These time consuming issues have repeatedly caused delays and losses to the developers. Land acquisition still remains a huge issue for developers despite the Right to fair compensation and transparency in the land acquisition, Rehabilitation and Resettlement Act, 2013 has attempted to address the issue. The act attempted to elaborate on the pubic interest aspect of the project and limited the role of the government to that of a facilitator in the land acquisition process.

Lock in period issues

The concessionaire was required to maintain a minimum 26% stake for the entire concession period for projects awarded before 2009. The stake had to be maintained irrespective of the revenue earned by the investor or their financial status resulting in compounding of debt and financial issues for the developers. the government’s decision to allow developers to divest 100%stake after 2 years of commissioning of the project has attracted interest from the PE’s preferring to hold larger stakes in projects.

Fiscal Incentives

Government has allowed 100 % FDI through automatic route in the roads and also up to 100% FDI for the support services to road sector; 100% exemption in taxes for 5 years and 30% for another 5 years, duty free imports of high capacity construction equipment and viability gap funding up to 40% of project cost to enhance viability on a case to case basis.

Introduction of the Infrastructure Investment Trusts

InvIT (Infrastructure Investment trusts) is the new way by means of which the government seeks to facilitate investment in the infrastructure sector. InvIT’s are created to facilitate raising of funds for lending and investing in infra projects. The is likely to ensure renewed investments in new projects will simultaneously unburdening the existing developers from their debts.

With these and other mitigates like delayed clearances, one sided agreements favouring the NHAI, problems in raising funds and inadequate traffic on highways being in process of being taken care of, the future of developers invested in road construction seems very bright. The measures brought in by the government will provide the much needed encouragement to the investors to invest in a brighter future for India.