India Ratings and Research (Ind-Ra) believes that the increased competition in the roads sector in FY21, resulting from the National Highways Authority of India’s (NHAI) initiative to reduce prequalification requirements, may ultimately lead to a moderation in the quality of the roads. The NHAI’s stated plan of action to monitor the execution closely, especially in cases of abnormally low bids (ALBs), needs to be implemented strictly to maintain the quality of roads.
Competition on account of Lower Counterparty Credit Risk: Ind-Ra in its Project Tracker for FY21 had stated that the order awards in the
road sector had increased by 72% yoy to INR 3,183 billion, constituting around
27% of the overall order allocations in the EPC space in FY21. Along with the higher
order inflows, the sector has also witnessed an increase in competition, resulting
in lower-than-expected bid prices. As detailed in its Construction TrackerInd-Ra has monitored the gap between L1-L2 players and the number
of players participating in bids to assess the competition index.
The above chart shows that the roads sector recorded an increase in competition on a qoq basis in FY21, led by the steady rise in the number of bidders. The share of orders in which seven or more players participated increased to 42.3% in 2HFY21 from 17.7% in 1HFY21. The engineering, procurement and construction (EPC) players have been trying to increase their order book visibilities, backed by strong counterparties, to avoid the working capital lockups that could result from delayed realisations. Hence, Ind-Ra believes that the EPC players have started increasing their order books towards central government/public sector entities who have better financial profiles and are more prompt with respect to making payments. This along with the increase in budgetary allocations by the central government in its finance budget towards the road space and the fact that the NHAI (‘IND AAA’/Stable) is regarded as one of the most reputed counterparties had heightened the competition in the sector.
Increase in Competition from 2HFY21 Onwards; Players Floating ALBs: Considering the impact of pandemic-led disruptions on liquidity and operational performance during 1HFY21, the NHAI introduced a slew of measures during November 2020-July 2021 in its circulars, including the following:
· reducing the performance security (performance bank guarantee (PBG)) to 3% of the value of the contract from earlier 5%-10% for all the tenders to be floated till 31 December 2021. The reduced percentage of performance guarantee shall continue the entire duration of the contract, and subsequently, an increase in the PBG beyond 31 December 2021 is not warranted.
· regulations regarding bid securities/earnest money deposits have been revised to permit bidders to sign a bid security declaration instead of placing earnest money deposits or bid bond guarantees to the extent of 1% of the overall tender value. The declaration states that in case the contractors withdraw or modify the bids during the period, they will be suspended for the time specified in the tender documents. release of retention money in proportion to the work already executed and no reduction of retention money from the bills raised by the contractor until 30 September 2021.
· for hybrid annuity models and build-operate-transfer projects, the PBGs have to be released on a pro-rata basis in line with the contract
Along with these measures, relaxations were also given in the prequalification requirements, as mentioned in the market wire published by Ind-Ra in December 2020.
In FY21, the ability of EPC players to avail the desired enhancements had been affected due to the lower than expected run-rates on account of the pandemic-related challenges. With bank guarantees (BGs) comprising around 90% of the overall working capital limits, and with the aforesaid measures proposed by the NHAI and other road-based agencies, the participation in bidding had increased, and eventually led to players floating lower-than-expected bid prices. Thus, though the companies benefited by way of increased revenue visibility, the bidding discipline was adversely affected. Ind-Ra believes that this would ultimately lead to cash flow mismatches in such bids and would lead to deterioration in the quality of the roads, which would result in the incurring of higher costs on maintenance activities.
Impact of Floating ALBs: With the reduction in the prequalification requirements, the EPC players who are mainly dependent on subcontracting have gained direct access to participate in the bidding channels of NHAI. Ind-Ra believes, to establish their presence, these players have quoted lower-than-expected prices and some players have even quoted ALBs. In the wake of the pandemic, a few players in the sector continue to face issues such as difficulties in mobilising labour, delays in tying up the required bank enhancements, and lower-than-expected run rates due to the impact of the second wave of COVID-19 would ultimately result in deterioration in their respective operational efficiencies. Consequently, the agency believes the players who have quoted ALBs would face challenges related to execution over the short-to-medium term, which could impact the quality of the roads. However, there have been instances in the past wherein even well-established players placed lower quotes to gain the tenders in anticipation of the terms of the tenders being favourable and the potential for positive cash flows, which would bring down the working capital requirement, thereby leading to lower finance costs.
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