Prime Minister Narendra Modi has laid out a fierce ambition for India’s infrastructure. The finance minister has opened multiple funding spigots. But despite their best intentions, infrastructure development in India cannot hit escape velocity until structural problems facing construction companies are addressed. Unless these are tackled, India’s new growth cycle will end in tears once again.
Construction companies are the plumbing of infrastructure. In India, these pipes have been blown apart by a hostile contracting, financing, payment, and arbitration regime. This has led to an astounding casualty: hundreds of mid-to-large EPC companies are in insolvency, numerous others have been liquidated for less than 1% of their original value, and hundreds of thousands of crores of disputed claims are meandering aimlessly in arbitration. This is an astonishing waste that needs prime ministerial level attention.
Construction and infrastructure companies are jet-fuel for low to middle-income economies. In post-war Asia, each of Japan, Korea, and China created national champions in construction. Companies in each of these countries benefited from massive government support, and, in turn, played a central role in rebuilding their domestic economies. Over time, these behemoths fuelled their country’s international foreign policy ambitions.
In comparison, many of India’s construction leaders are wasting in bankruptcy. Companies that were once multi-billion-dollar, blue-chip multinationals, now face liquidation for pennies on the dollar. This is not a moral tale of negligent promoters, or fraud, or a free-market rendering its inevitable outcome; this is an outcome created due to an adversarial regulatory regime, delays from government clients, and a criminally slow arbitration regime.
Indian GDP cannot grow at double digits unless the problems that afflict construction companies are addressed. Until that happens, India’s infrastructure ambitions will merely grind ahead; at an above-average rate (perhaps) due to the amount of capital that will now be thrown at the sector, but never at the inflation-free 10%-12% GDP growth that is possible.
The problem sounds daunting, but this is one of those rare instances where it isn’t necessarily so. Payard Investments’ participation in a multi-billion-dollar corporate resolution reveals that even a limited set of regulatory changes could create exponential macro benefits for India: the rise of dozens of mini-L&Ts (and possibly, a handful of equally large competitors), hundreds of smaller contenders, and, for the first time, the release of idle capital that can finance a 5x-10x growth in the development of infrastructure. Best of all, none of these changes involve financial outlays from the government, or tread on entrenched interests which would make success improbable.
First, save the jewels of Indian construction companies from liquidation: as of today, valuable construction equipment is rusting in equipment yards, arbitration claims of hundreds of thousands of crores are sitting unaddressed, tens of thousands of mid-career professionals have lost jobs, and execution capability in India has been eviscerated. This at a time when India is embarking on its golden period of infrastructure development.
But here’s the rub: because the NCLT process is inscrutably complex and expensive, there are hardly any resolution applicants seeking to acquire insolvent construction companies. When banks finally receive legally compliant resolution plans (itself a minor miracle given the arcane input of obstreperous lawyers), the straitjacket requirements of IBC provide little flexibility to overburdened creditor committees.
As a result, Indian bankers, savvy professionals at par with any in the world, struggle to accept the sort of haircuts required to return insolvent companies to commercially feasibility. The alternative is the Hobson’s choice of liquidation.
Liquidations of any company in any sector yield suboptimal outcomes, but for EPC companies, they yield train wrecks. In a landmark case in which Payard Investments is deeply involved, after three years of liquidation efforts, the lenders received less than Rs 50 crore instead of the expected Rs 1,250 crore; several thousand crores of arbitrations resulted in Rs 20 lakh of awards. And the costs? A staggering Rs 80 crore. When these results are multiplied across an entire spectrum of EPC companies of various sizes, the true scale of the systemic losses becomes visible. If this doesn’t rile up the PMO, nothing will.
But here’s an alternative: Were the PM to create an “infrastructure czar” mandated to coral stakeholders into a common purpose, it would drive the creation of dozens of high-quality, mid-size jewels from this cesspool. In its simplest form, this process would involve pre-packing insolvent companies into debt-free and arbitration-free special-purpose vehicles, and then inviting high-quality, entrepreneurial teams to bid for equity ownership of the companies through structures that create an alignment of interests with the banks.
By shifting one’s approach, one would align the interests of entrepreneurs, professionals, risk-capital, and lenders. This would catalyse the emergence of bidders for dozens of mid-to-large platform companies with pre-existing capabilities, qualifications, employees, and construction equipment.
The same strategy could be applied to manufacturing, which would end the hollowing-out of Indian manufacturing presently underway. Instead of the scrap dealers who hover around insolvency processes at present, India would finally begin to see the entry of the serious investors and entrepreneurs from around the world. Instead of liquidation, the unintended and disconsolate corollary of the IBC, the BJP’s otherwise magisterial achievement, India will finally witness high-velocity rescue financing and operational turnarounds.
In this article, I have sought to extrapolate Payard’s experiences in the insolvency regime to propose a capacity-building solution for Indian infrastructure. In part II, I will propose sector-specific solutions for the construction industry, and which can release idle-capital and expand India’s construction capacity by 5x-10x. I will also propose how India can achieve the holy grail of infrastructure ambition: a financing structure that does not require balance-sheet financing by the GoI.
India needs an innovative and exponential approach to create the growth that the country requires to lift hundreds of millions out of poverty, to create infrastructure projects that can inspire future generations, and to set the nation on a trajectory of high-quality, double-digit growth for decades to come.
Everything is at stake. The time to act is now.
(This is Part-1 of a two-part series)
Annat Jain is the founder of Acropolis Capital Group, a private equity firm that invests in India. Views expressed are personal.