The macroeconomic data shows the construction sector held up relatively well in the September quarter, with a year-on-year (y-o-y) growth of 9.7%. But as the sector depends on loans, the liquidity crunch is certain to have a severe impact. Add to that the sharp deterioration in the real estate sector and postponement of capital expenditure plans, and construction firms will be hit badly.

How badly? To get an idea, take a look at what happened during the last downturn of 2001-03. In 2000-01, the disaggregated gross domestic product (GDP) data shows that y-o-y growth in the construction sector was 12.3% in the first quarter and 9.8% in the second. Compare that with the current year’s growth of 11.4% in the first quarter and 9.7% in the second. In the third quarter of 2000-01, y-o-y growth in construction fell to 7%.

Thereafter, the decline was swift and sudden, with growth falling to -1.2% in the fourth quarter of 2000-01, 0.1% in the first quarter of 2001-02, 1.3% in the second quarter and 5.5% in December quarter of that year. It was only in the fourth quarter of 2001-02 that the base effect kicked in and growth revived to 9.1%. Construction is, thus, a volatile sector and changes can be dramatic.

Goldman Sachs Group Inc. economist Tushar Poddar has written in a research report: “Although the direct impact of construction is 7.3% of GDP, we estimate the indirect impact through backward linkages in terms of the sector’s usage of iron, steel, cement, etc., to be roughly 12% of GDP in FY08."

He estimates construction, along with its linkages, will subtract about 700 basis points (bps) from GDP in FY09 relative to the previous year, and a further 400 bps in FY10.

The funding crunch hits construction firms hard because they don’t have free cash flow and most rely on short-term debt. As Motilal Oswal Securities Ltd’s survey of the September quarter results of construction firms shows, interest cost for the sector is up 74% y-o-y.

Though a fall in commodity prices will help these firms, analysts say the benefits will be seen only from the fourth quarter. Moreover, their problems have been compounded by the fact that several firms have expanded into real estate.

It’s no wonder that stocks in the construction sector have been massacred, with prices dropping 75-90% this year. Stocks in companies such as Gammon India Ltd, Hindustan Construction Co. Ltd, IVRCL Infrastructures and Projects Ltd, Nagarjuna Construction Co. Ltd, Patel Engineering Ltd and Simplex Infrastructure Ltd have lost between 40% and 70% of their value since the beginning of this quarter, underperforming the market.

Government spending could be the silver lining for the sector, but any real boost on that account is unlikely to happen before a new government is in place in New Delhi.

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