Safeguard infra projects from cost overruns

Davinder Sandhu | Updated on May 20, 2021

Spikes in steel and cement prices can derail projects. Policies that promote the use of alternative inputs will help lower costs

National infrastructure plans reflect the country’s growth priorities, improve the quality of life, and aids the process of economic growth. In a globalised world, sustained infrastructural development has become synonymous with pragmatic planning. The Indian economic model is also predicated on provisioning robust and inclusive infrastructure development.

Several steps have been taken in this direction in terms of realignment of policies, greater budgetary allocations, roll out of special funds, and identification of priority areas. With the announcement of new initiatives like National Infrastructure Pipeline and India’s own Development Finance Institution, infrastructure development is being pursued with renewed commitment.

Infrastructure development projects across all sectors are long term in nature. As per the latest data available, 1,687 projects are currently on-going across 23 sectors, of which, 450 are estimated to face cost overruns of close to 20 per cent of the original anticipated cost — that is, from ₹21,44,627.66 crore to ₹25,72,670.28 crore.

The reasons for cost overruns are many. These include time overruns, under estimation of original costs, unanticipated higher costs of rehabilitation measures and inflation. The time from gestation to delivery varies between years to decades, and even when projects are not delayed, market forces can also be the cause of cost overruns. Thus, a major factor that affects this equilibrium of feasibility and financial viability is inflation. With cement and steel prices on an upswing in the last two quarters, project balance sheets are coming under stress for cases which are still under construction.

The unique feature of rise in cost of input factors is the domino effect that it creates. Even a minuscule rise in any one factor never just affects one industry alone, it often creates ripples across multiple sectors. For example, a rise in fuel prices makes the movement of raw material/goods expensive and thus there is a proportionate rise in the overall cost which may or may not be passed on to every level of the supply chain.

Input prices

Another case to quantify this scenario is the recent hike in the prices of cement and steel. Dearer procurement of cement and steel affects the construction sector in a big way thus slowing down the pace of commercial and developmental works alike. Steel prices are currently riding at a 12-year high at a time when markets are recovering from the setbacks of a world struck by the pandemic.

After the price hike in April 2021, the wholesale price of HRC (ex-Mumbai) is around ₹59,000 per tonne, the highest since 2008. The price was around 61 per cent higher than that of July 2020. Cement too has been riding high with a month-on-month price rise of 4.7 per cent on a pan-India level.

While legitimate rise of prices is often inevitable and justified to maintain a healthy equilibrium between demand and supply across various levels, it is such disproportionate rise in input factors that causes turbulence.

In commercial operations, fixed price contracts have become more prevalent than the ones which provide any sort of respite to the contractor. The risk of price fluctuation is expected to be borne by the contractor which, in turn, may lead to compromise in quality of delivery. While such clauses do exist in EPC contracts, the extent to which prices are fluctuating currently may not be sufficient. The actual cost immunity calculated based on a pre-determined fixed formula thus ends up doing little good.

At a time when India is promoting a greater infrastructure push nationally, any rise in indispensable input factors such as steel and cement can derail plans and slow down the pace of development. The government of India is mulling options like allowing alternative materials and adopting best practices for construction, forming a regulatory commission for industry supplying basic raw materials, etc. Having a proper policy in place with enough room for exigencies stirs innovative thinking and with the use of alternative input factors such sudden rises can be absorbed in a better way.

A case in point is the recommendation of the Ministry of Environment, Forest and Climate Change to use fly-ash in the construction of roads and flyovers.

As a measure to promote the use of this by-product, the government has mandated thermal power plants (TPP) to bear the cost of transportation of fly-ash if the site of construction is within 100 km of the plant, and to be shared between the user and coal/lignite based TPP if within 100-300 km. There should be strong focus on implementation of this mandate, as fly-ash can be a viable alternative to costlier raw materials.

Innovation in terms of use of alternative sources of raw material also helps in keeping technical monopolies in check and thus maintains a fair progress in innovative technologies that lower cost and enhance customer value.

Institutional mechanism

There has also been a vociferous demand from industrial associations in support of allowing the use of imported coal and bitumen.

A move that has been largely appreciated is the consent to use secondary steel in developmental and infrastructural projects in light of the incessant rise in prices. However, there is a need to have an institutional mechanism to simplify and expedite procurement of such items. A friendly policy regime can provide a big relief to the developers.

With rising demand, necessary steps should be taken to expedite the flow across supply chains. One such area is BIS certification, which is mandatory for importing reinforcement steel. At present, there are only three certified sources — in Ukraine, the UAE and Oman — and with increasing demand, it would be appropriate that more mills should be certified.

These steps will go a long way in aiding speedy provisioning of modern infrastructure for the Indian economy.

The writer is an independent consultant, with prior experience of serving at the Prime Minister’s Office, and at the Executive Board of the World Bank Group

Published on May 20, 2021

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