What's Wrong With India's Infrastructure Sector?
The brightly lit Bandra-Worli sea link in Mumbai.
A few years ago, pre 2008, to be precise, India’s infrastructure sector was supposedly booming. The then minister of road transport and highways, Mr. TR Baalu and then subsequently, Mr. Kamal Nath, set over optimistic targets of building 20km of highways everyday. The UPA government was aggressively wooing the private players to take up projects on the PPP model, and in turn, nearly all the incumbents and new entrants in the infrastructure segment were aggressively bidding and bagging projects left right and centre.
Well, at that time, this seemed a logical thing to do, in order to maintain the GDP growth at around the 9% mark, but did it pay off in the next few years? The answer can be clearly inferred by looking at the plight of the entire sector, including all players and stakeholders. The situation is so bad that nine of the top ten construction companies are making heavy losses and on the other hand, the exposure of debt by the various banks to this sector is the highest among all sectors. So, why did things go wrong and is the proposed $ 1 trillion investment in the infrastructure segment in the 12th five year plan, the only solution to get the sector back on track ? Well, let’s analyze:
Need vs Greed: The infrastructure players had been waiting for such an opportunity for many years now, and they pounced on these projects like a predator does on his prey. This sudden aggression shown by these contractors and developers was driven not only by the ambitions of the promoters, but also to some extent by the fear of missing out. They felt that if they did not be a part of this pie, then they might not be able to qualify for future projects and might eventually be wiped out of the market. But, now it seems as though they had bitten more than they could chew. Although they had picked up the projects and signed the contracts, but they were clearly not geared for such a mushroomed growth. In addition to this there were many other unforeseen factors that these companies had not accounted for at that time.
Labor shortage: It is rather ironical, unbelievable and at the same time unfortunate that India today is facing a shortage of labor. The construction sector, is the second largest employer in the country today, and till only a few years ago, it seemed that there was plenty of labor available for building the infrastructure of the nation. However, there are certain reasons that today this sector faces this kind of shortage which is leading to the delays in execution of projects which in turn is causing huge operational losses to these companies.
First and foremost is the fact that there is absolutely no emphasis on skill development. This means that there is no differentiation of a mason from a non mason or for that matter of a mason from a plumber. This has resulted, quite surprisingly in the import of skilled labor from countries such as Philippines, Bangladesh etc. Even, in the recent budget, emphasis has been laid on developing AIIMS and IIT’s, whereas, an equal, if not more importance should have been given to skill development institutes like ITI’s. Here, it is very important to understand that Indians are in no way less than anybody else in the world. In fact, given proper training and an environment to work, they can do wonders. The core of the entire development in the middle east has been dominated by Indians, be it labour, engineers, mechanics, operators etc.
Second is the socio economic factors that arise out of the populist measures that the central government has undertaken in order to garner votes. An excellent example of this is the MGNREGA or the Mahatma Gandhi National Rural Employment Guarantee Act. Under this act of the central government, unemployed villagers are guaranteed employment for 100 days wherein they have to do unskilled manual work. So, all the surplus unskilled labor which earlier used to work for the construction sector now work in or around their native village. So, that’s why its ironical and unfortunate because, on one hand the government is announcing project after project and on the other hand it is creating labor shortage by launching such populist schemes and acts.
Policy Paralysis :The infrastructure companies bagged these prestigious projects, thinking that they will get the government’s support in land acquisition , payments etc which are the lifeline of any infrastructure project and without this no contractor is able to sustain , leave alone complete the project. But after the CAG’s crackdown on the government, which unveiled scam after scam like a can of worms, there was a complete policy paralysis. No government official was willing to put pen on paper because they are afraid that they will be dug out of their graves and be questioned. So, for example, if a contractor goes to the chief engineer or any other official to get his final bill certified, the answer is a polite no. In addition the officials often refer such cases to arbitration on the pretext that they will pass whatever amount the arbitrators decide. The result of such paralysis of the government machinery is that today a mind boggling Rs 1,40,000 crores (roughly $20 billion)of contractors’ payments is held with the various departments , and in turn the exposure of banks to these firms is increasing by the day . So, as a result, the government is also losing money and the contractors are also suffering.
A weak dispute resolution mechanism: It is but obvious that if there are contracts, there have to be disputes and in turn, there has to be a strong mechanism to resolve these disputes. Generally, in construction contracts, if there is any dispute, then to resolve that, these have to be referred to arbitration. Now, worldwide, if any dispute is referred to the arbitration tribunal, it is sorted out within three months and that too, to the satisfaction of both parties. But so weak is the Indian judicial system and so many are the interpretations and loopholes in the jurisprudence that the average time of dispute resolution once referred to arbitration is seven years ! So, all in all, a contractor would rather accept lesser payment than getting into a dispute with the client. Not only this, the contracts that are being made are increasingly becoming one sided. In addition , there is either no or an un-empathetic response to contractors claims plea even if the contractor is not at fault , rather an unusual threat of encashment of Bank guarantees has become the latest fad here . It is rather surprising that even in Libya, which underwent such a huge political turmoil in the recent past, all the contracts were renegotiated and the contractors’ claims were duly settled and their losses compensated.
High Interest rates : The cost of capital in India is one of the highest in the world . Many BOT projects that were awarded during the infrastructure boom, assumed the cost of capital to be around 6 % as against the prevailing 12-13%. This gap in the cost of capital itself makes the projects unviable. As a result, many large companies like reliance infrastructure, GMR etc are either selling these projects or writing these off rather than going through and booking heavy losses. So, the bottomline is that in order to build world class infrastructure, either interest rates need to be brought down or local players should be allowed to source cheaper capital from outside for the purpose of building infrastructure .
It can be clearly seen that there are many problems facing the entire sector today and these seem to have percolated into the private companies and developers as well.
However, everything is not grey yet, there is still a ray of hope. The Delhi Metro, is a shining example of world class infrastructure being built on time, despite all these hurdles. The main reason for that project to succeed was that firstly, all the stakeholders were completely committed to building such a project and secondly, complete autonomy was given to the DMRC chief. Having said this, I do not suggest that the model be replicated blindly, to all other verticals such as highways and railways. However, it is a model worth studying and then applying to other areas.
Finally, it should be noted that awarding contracts and investing billions of dollars into the infrastructure sector is not the solution for building India. In fact, working in such a disjointed manner will only lead to more disputes and further aggravate the present situation.
The formation of the BJP led Modi government has definitely improved the market sentiment and it has taken some basic steps like making a separate ministry for Infrastructure, which is encouraging. However, how this government focuses on the above mentioned issues is what time will tell.
(The author is Executive Director, GSBA Builders)