National highway plays a vital role in the social and economic integration and development of the country. Total budgetary spending in the road sector has increased by more than eight times to Rs.2.6 trillion in FY2023BE over FY2014 at a CAGR of more than 20 per cent. The road sector is likely to continue to be a torch bearer for investments for the government, says Vishal Kotecha, Director, India Ratings & Research.The government's focus on infrastructure spending is visible given its multiplier effect of 2.5x -3x on GDP. Realizing the infrastructure-backed growth, the government announced the National Infrastructure Plan (NIP) and the National Monetization Plan (NMP). The road sector accounts for a significant proportion of the NIP and NMP as it is critical for economic development in the country. With the contribution of 65 per cent and 90 per cent of countrywide freight traffic and passenger traffic respectively, road sector contributes to 3.2 per cent of the GVA. National highway plays a vital role in social and economic integration and development of the country as it caters to almost 40 per cent of the road traffic despite constituting only 2 per cent of the road network.Figure 1: Budgetary allocation for the road sectorRoad sector: Forefront for infrastructure investmentsThe importance of the sector for the nation’s development can be underpinned through the government's increased allocation towards the sector. Total budgetary spending has increased by more than eight times to Rs.2.6 trillion in FY2023BE over FY2014 at a CAGR of more than 20 per cent. Furthermore, the policy initiatives in the road sector have enabled a significant rise in infrastructure investment in the country. The road sector has been the front runner to attract Public-private partnership in 2006 upon standardisation of the concession frameworks. The government policies have been rather proactive in meeting the ever-evolving needs to attract private capital. The investment journey in the sector has had its share of ebbs and flows with euphoria in 2011-12 and gloom during the 2013-16 period. The government took the right measures to revive the sector by addressing issues plaguing the sector and the concerns of various stakeholders. The concession of HAM projects which have revived investments in the road sector has been mirrored for investments in other asset classes. Over the years, with the right policy measures, there has been a significant increase in foreign capital vying for investments in the road sector. The road sector is also leading the wave in terms of asset monetization with initiative on Toll Operate Transfer for operational projects and NHAI INVITs. Private sector INVITs in the road sector form a significant chunk in the overall INVIT market. Figure 2: Roads developed under Bharatamala Pariyogna and contribution of HAM modelProject awards poised for consistent growth after brief setbacksAward activities significantly dried our subsequent to the euphoria of 2010-12 when toll projects had a dominant share. Issues like economic slowdown, aggressive bidding, land acquisition issues and funding issues due to banking sector NPAs marred awards activity in the sector. Private participation dried out and only government funding led to award activity during 2013-16 period. In 2017, Bharatamala Pariyogna provided the boost for increasing activity in the sector. A de-risked HAM model was introduced to fund higher investment requirement and revive private participation. The HAM model addressed various risk areas prevalent in the erstwhile BOT Model, addressing the issues of various stakeholders (concessionaire, NHAI and Lender) interest in mind. Toll revenue growth to moderate in FY2024 Toll roads revenue growth has mirrored the GVA for manufacturing, mining and construction in the past. Toll revenues growth are expected to grow at around 9.5 per cent in the range of 9-10 per cent in FY24 compared to stellar growth of more than 20 per cent in FY23. The toll growth in FY25 would subside on the easing of WPI, the inflation linked toll hike is relatively modest at 1.3 per cent to 5 per cent in FY 2025. The toll road sector saw multiple disruptions between FY16-FY23, backed by demonetisation-led cash erosion, goods and service tax implementation, alignment of axle load norms for commercial vehicles in line with global standards and COVID-19 pandemic induced mobility and supply chain disruptions. Toll revenue witnessed healthy growth in FY23, backed by the toll rate hikes linked to inflation based on WPI performance, improved economic activity and lower base of FY22. The traffic recovery was led by the removal of pandemic-induced travel restrictions, revival of economic activity and enhanced work-related and leisure travel. The toll collection for 5M-FY24 grew by approximately 10.5 per cent YoY across the Ind-Ra rated portfolio, supported by the 5 per cent increase in toll rates and the balance being traffic growth. The toll revenues for 26 per cent of the Ind-Ra rated portfolio saw healthy growth of more than 13 per cent aided by a boost in the tourist traffic, re-opening of offices, lifting of sand mining ban and incremental traffic from completion of contiguous stretches. However, 26 per cent of the Ind-Ra rated portfolio faced headwinds in toll revenue as a result of traffic de-growth ranging between 5-20 per cent due to the diversion of traffic to the alternative routes. Figure 3: Toll revenue from FY17 to FY25Figure 4: Toll revenue growth for period 5M FY24 vs 5M FY23Increased competitiveness remains monitorable for HAM projectsWitnessing the track record of execution and increasing lender appetite for the HAM mode, the number of participants for HAM projects has been on the rise over the last few years. Post FY21, small developers predominantly operating in the EPC space increased participation in HAM projects subsequent to the relaxation of bidder eligibility norms from NHAI. The average bidders for HAM projects surged to 12 in FY22 from 5 in FY20. While NHAI reinstated the EMD requirement, participation and winning projects by new sponsors continued to rise. FY23 saw newer players, who had not even participated in FY22. Achievement of financial closure and project execution for sponsors with limited financial capability could be challenging. Furthermore, with the rising competition, there have been increasing instances, where projects are awarded at a discount to authority cost. Figure 5: Share of new sponsors in HAM projects and competition in the sector *image*Construction pace more than doubled over last 7 yearsThe government’s policy changes have focused on mitigating the issues which had plagued the sector in the past leading to more than doubling of pace of construction per day since FY15. Policy measures like one-time fund infusion schemes, premium deferment, and relaxation of exit norms were catalysts for addressing various risks plaguing the sector. NHAI recognised the delays attributable to the Authority and compensated for such delays by EOT/missed annuities. The release of 75 per cent of an arbitral award against bank guarantees eased liquidity for developers. Land acquisition issues which were the prime reason for projects getting stuck in the past were addressed by the policy of awarding appointed dates only after 80-90 per cent land acquisition.While extended monsoon over the last two years, surge in input prices of cement, steel and bitumen, which constitute 35-40 per cent of the total project cost have been headwinds for construction progress, the overall construction pace has been at around 30 kms/day. The sponsor’s financial profile is critical for project progress. Projects owned by strong and medium sponsors tend to face lower execution challenges as compared to weaker sponsors. Key reasons for delays include a delayed appointment date due to right-of-way issues, descoping of unavailable land, and the achievement of financial closure. Of the 35 per cent projects facing delays, 17 per cent were due to force majeure events, 9 per cent due to delays in land and approvals and 9 per cent due to sponsor-related issues. With a number of new sponsors winning projects in FY22 and FY23, timely completion of the projects would be a monitorable for the sector.HAM and TOT/INVIT to be key driverDifferent stakeholders have different interests in a project lifecycle. Given the significant need for dry powder to build infrastructure assets, churning of assets is very important for contractors and developers. M&A activity in the road sector is driven by developers needing to unlock the equity to bid for new projects and to improve liquidity. The road sector provides avenues for significant size and a large number of stable and predictable cash-generating assets. These attract large institutional investors, such as pension and sovereign wealth funds, as they generate long-term yield-generating assets. The consolidation in the sector is likely to continue to garner traction with various HAM projects operational and available for sale. Furthermore, there could be various stressed assets with banks which may look to change sponsors and be sold through harmonious substitution and/or NCLT. Monetisation by NHAI is expected to gain traction in FY24. NHAI has indicated to monetise 2612 km of projects in FY24 as against 2250 km monetised till date. The road sector is likely to continue to be a torch bearer for investments for the government. The traction is likely or continue over the next few years both in terms of project awards and construction. HAM mode is expected to continue to garner higher share with a handful of toll projects being awarded. Allied highway projects like wayside amenities are likely to see more projects with various expressways and highways being developed. Furthermore, consolidation in the form of M&A transactions as well as asset monetisation for NHAI through toll-operated Transfer routes and INVITs are to further gain prominence given the increasing operationalisation of projects.About the author:Vishal Kotecha is a Director at India Ratings and presently heads the Infrastructure practice. In his current role, he has been involved in rating large project finance issuers across sectors like power, and transportation including metros and social infrastructure. He has around 15 years of experience in the infrastructure sector.