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September 11, 2017

Sector Report: Roads and Highways

This report is available to users in India for ₹40,000 + applicable taxes


New funding mechanisms to support project execution


Project execution by National Highways Authority of India (NHAI) is expected to reach 3,010 km in 2017-18 and over 3,500 km in the next comingfiscal, from 2,625 km in 2016-17. The pace of execution will involve sizeable increase in investments. In fact, over the next five years, overallinvestment is expected to rise 2.8 times. With public investment constituting a considerable 57% of the total investment in national highways, thefunding needs of the NHAI - the key implementing agency - is set to rise. While cess used to be NHAIs biggest source of funding, the model isundergoing a change, with NHAI supporting project execution through higher external borrowings.


In 2016-17, while NHAI had budgeted Rs 121 billion of cess funds, it is estimated to have utilised only ~Rs 75 billion. The agency instead raised fundsfrom institutional investors, such as Life Insurance Corporation (LIC; Rs 85 billion) and Employees' Provident Fund Organisation (EPFO; Rs 100billion). As NHAI has the ability to raise funds from other sources, the remaining portion of the budgetary support was diverted to non-NHAI roadprojects. LIC agreed in-principle to subscribe to NHAI's taxable bonds to the tune of Rs 250 billion over the next 3-4 years. NHAI also raised Rs 50billion on the Bombay Stock Exchange bond platform. In 2017-18, it has raised funds totalling Rs 30 billion on the London Stock Exchange as well, inthe form of masala bonds.


Over next five years, NHAIs funding through cess is expected to remain low at ~18% compared to ~35% in the previous corresponding period. In thisscenario, the ability of NHAI to consistently raise debt through external sources is a key monitorable. Toll-operate-transfer is a new public-privatepartnership model for maintenance that NHAI is pursuing, and which is expected to provide the agency Rs 400 billion over the next 2-3 years.However, reforms such as the Goods and Services Tax and implementation of the dedicated freight corridor may significantly impact trafficcomposition.


Private participation in national highways is expected at 40-42% over the next two years, and 43% over a five-year period. To support this level ofprivate participation, lending support to the sector is required to grow ~14% CAGR over the next five years, which is lower than the expected growth inbank lending to the sector. This shortfall will have to be funded through avenues such as National Infrastructure Investment Fund.


Hybrid annuity model to dominate awarding, promoter contribution may rise for quicker financialclosure


The hybrid annuity model (HAM), which comprised over half of NHAIs awards in 2016-17, is expected to remain steady in 2017-18. As of June 2017,44 projects, aggregating 2,780 km, have been awarded, of which 26 have achieved financial closure. However, at least 10 projects have crossed thelimit of 150 days within which financial closure is required, and three projects have been terminated due to failure to secure funds. Bankers are hesitantto provide funds to less-known developers, as promoter equity in the project is only 12-15% and can be even lower in the case of projects that were bidout considerably above NHAI's estimated cost. We, however, believe that projects awarded to developers with a good track record should not faceissues in securing funding.