Home >Markets >Mark To Market >Fall in RBI policy rate poses a risk to HAM road project cash flows

When the hybrid annuity model (HAM) for road projects was introduced a few years ago, it was believed that the move would save the sector delays and cost overruns, which had earlier pushed developers into a debt trap. However, some potholes seem to appeared.

HAM projects are in a strange situation where policy rate cuts are bound to have an adverse impact on their cash flows. This is because the developer of a HAM project doesn’t get the benefit of low interest rates on borrowings due to the slow transmission of policy rate cuts on bank lending rates. In contrast, the interest earned by the developer on project completion cost comes down quickly as it is directly linked to the policy rate. The mismatch in cash flow can therefore derail the ability of the developer to service debt.

“On a cumulative basis, for every 25 bps (basis points) decline in bank rate, the cumulative debt-service-coverage ratio (ability to service debt through profits) of the developer reduces by two bps," said Icra Ltd in a note. A basis point is one-hundredth of a percentage point.

Graphic by Naveen Kumar Saini/Mint
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Graphic by Naveen Kumar Saini/Mint

It could have a significant bearing on HAM projects awarded in the last four years, because interest flow is higher than annuities in the first seven years of the project.

Besides, three out of every five HAM road projects have faced delays either due to a hold-up in the commencement of the project and funding constraints, or timeline extensions granted by the government.

“In Q3FY20, execution across construction companies was impacted despite strong order backlog, due to delay in AD (appointed dates) amid land acquisition issues and extended monsoon in October," said a report by Centrum Institutional Equities. A few exceptions, such as PNC Infratech Ltd and KNR Constructions Ltd, reported strong revenue growth.

Meanwhile, the pace of road project awards has fallen to the lowest in six years, which will likely hit revenue traction a couple of years ahead. No wonder road construction stocks have fallen 11-25% since January. That said, some of these firms are sitting pretty on order flows raked in earlier. One hopes that the government will be able to remove the roadblocks on project execution that may slow the pace of road development.

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