India Economy

Tripping on enthusiasm

Sandip Sabharwal | Updated on January 04, 2014 Published on January 04, 2014

Power sector is the most blatant example of aggressive bidding.

The corporate sector, which blames the Government for all its ills, needs to introspect a little over its past excesses.



Over the last five years, we have seen a collapse of private investments in India. Gross capital formation peaked at 34 per cent of GDP in 2009-10 and has since come down to 28 per cent. The fall in private sector investments has been sharper. From a growth rate of 20 per cent during the years 2004-07, it has declined to zero now.

The reasons given for the collapse in the investment cycle are: collapse of governance under UPA-II, global slowdown, high interest rates and environmental issues.

However, the corporate sector is as much to blame for the mess. Large established groups such as Tatas, Birla and Mahindras did not take big risks during the boom years of 2003-07. As a result, they have done well during the current slowdown.

The economic boom that started in 2003 saw sectors such as roads, power, construction and urban infrastructure being opened up. This led to the emergence of new companies such as GMR, GVK, Lanco, Suzlon, IVRCL and NCC, among others. These were very small firms that grew aggressively to became large infrastructure companies in the 2003-08 period. However, most of them did not focus on generating cash flows and had no experience in dealing with a major economic downturn.

As we moved from pessimism to euphoria, competitive intensity grew. Companies started bidding for projects just to build their order books with unrealistic profit expectations. This was a period of debt-funded boom. High valuations being ascribed to companies based on their order flows made them bid even more aggressively. Let’s look at some examples.

Transmission Towers

At one point in time, there were three main companies operating in this field — KEC International, Jyoti Structures and Kalpataru Power Transmission.

During the boom years of 2005-07, single projects sometimes attracted as many as 20-30 bidders. This took industry margins down from 12-14 per cent to as low as 8 per cent. At these margins, projects with large working-capital requirements clearly became unviable. Worse, the new bidders with no experience in setting up such projects did not deliver on time and slipped into losses.

However, the cycle is turning now with just four to six serious bidders per project.

Airports

GMR promised to pay 45.99 per cent of gross revenues from the Delhi airport project to the Government. It underestimated the project cost and overestimated the revenues and went into losses. Similarly, GVK promised to pay 38 per cent of gross revenues arising out of the Mumbai airport project. No surprises on who the second highest bidder was — GMR with 33 per cent. Reliance had bid just 21 per cent. Low revenue growth and poor financials led to the projects remaining incomplete. The burden was shifted to the passengers and airlines in the form of higher fees and charges.

Power

The power sector is the most blatant example of aggressive bidding. As a result, 33,000 MW of projects, involving more than Rs 1,00,000 crore, are stuck. Aggressive bidding was seen not only in the case of independent power producers (IPPs) and ultra mega power projects (UMPPs) but also in the supply of equipment to NTPC and State electricity boards (SEBs).

Most private sector power plants were bid at an extremely low cost of power to the customers with unrealistic estimation of project returns. The assumption of a continuously appreciating rupee combined with improper forecast of coal prices and availability made most IPP and UMPPs unviable. Increasing interest costs and non-availability of equity too hurt companies.

Roads

It was the same story with road projects in the PPP space, where companies made unrealistic estimates relating to traffic growth, costs and equity funds availability. A large number of players began bidding for PPP road projects; at one point in time there were as many as 25-30 bidders for a single project.

In projects where NHAI thought it would have to provide viability gap funding, it actually started getting a positive grant. This was combined with the advent of the environment license Raj, which saw two-three years pass by between the time of bidding for the project till its initiation.

Project awards had gone up to nearly 7,000 km per year and were projected to touch 9,500 km. Last year, 1,116 km of road projects were awarded to just one PPP project.

Notably, all these have nothing to do with the RBI’s monetary policy, increase in domestic rates or Government policy making.

Unrealistic expectations of 8 per cent growth increasing further to double-digits in 2007 led to unrealistic investment plans. Equity funding slowed down from public as well as private markets. Low operating leverage, high-cost overruns and lower capacity utilisation led to losses. This was further worsened by high debt.

The contribution of banks in creating this mess via either active connivance or poor project evaluation skills can hardly be under-emphasised.

As a result, they are straddled with thousands of crores in non-performing assets.

Clearly, the corporate sector, which blames the Government for all its ills, needs to introspect a little over its past excesses.

(The author is a business consultant.)

Published on January 04, 2014
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