Timeline extension on project execution, release of bank guarantee to boost liquidity in construction sector: ICRA
Unveiling the first tranche of mega economic package on wednesday, Finance Minister Nirmala Sitharaman said all central agencies will provide an extension of up to 6 months to contactors without levying any additional cost or obligation on them for completion of work.
This extension will cover all central agencies like -- Railways, Ministry of Road Transport and Highways, Central Public Works Department, etc.
Other measures for contractors include an extension of up to six months in the timelines for work completion, intermediate milestone, and extension of the concession period in the PPP contracts.
"ICRA expects the recent measures announced by the Finance Minister for the contractors - primarily extension of the timeline for project execution by up to six months, and a partial release of bank guarantees (BGs) - to provide some respite to the construction companies," ICRA said in a statement.
It said partial release of BGs (to the extent contracts are complete) is a positive step and can help release some liquidity for contractors which is blocked in the margin money against these bank guarantees.
Shubham Jain, Senior Vice-President and Group Head, Corporate Ratings, ICRA, said "BGs play an essential role in the contract execution and a sizeable quantum of BGs are required by contractors, therefore non-availability of adequate BGs can constraint a contractor's ability to bid for projects or efficiently execute projects."
Over the last few years, the enhancement in the BG limits has remained challenging for many contractors and some had to avail of the BG against 100 per cent margin, thereby significantly blocking their capital, he said.
The provision of a partial release of the BGs can help reduce contractor's overall requirement, and consequently enhance their ability to take up projects, Jain added.
Typically, a construction company requires BGs equivalent to 15-20 per cent of its contract value. These are in the form of performance bank guarantees, a guarantee for availing of the mobilisation advance, a guarantee for release of the retention money, earnest money guarantee, etc.
Generally, for issuing the BGs, banks keep a margin money of 10-20 per ceny, and additional collateral security. Thus, for a construction company, sizeable funds get blocked as margin money against the BGs.
As per a study conducted by ICRA on a sample of its rated entities, the margin money blocked against the BGs was 24 per cent of the aggregate net worth.
Depending on the stage of the order execution, the partial release of the BG can have a significant positive impact on the liquidity of construction companies, it said adding, for the sample set, a release of 10 per cent of the BGs could boost their liquidity by 14 per cent from the current levels by freeing up the margin money.
The impact could be much higher for companies which, in the absence of adequate BG limits, had to avail of the BGs against a 100 per cent margin, it said.
Jain added: "The total outstanding bank guarantees for construction and infrastructure sectors is estimated to be in the range of Rs 4 to 5 lakh crore. A release of 5 per cent of these guarantees can provide contractors a liquidity of Rs 2000-3000 crore and increase their ability to take up new projects worth Rs 2 lakh crore."
On the flip side, while this is a positive, there will be operational challenges in getting the partial release of the BGs as in most cases the existing BG issued must have been in a single tranche, ICRA said adding, hence, for availing a partial release a new BG of a lower amount will need to be provided, post which the existing BGs can be returned.
Besides the BG release, other measures for contractors include an extension of up to six months in the timelines for work completion, intermediate milestone, and extension of the concession period in the PPP contracts.
This will provide some respite to contractors who have suffered loss of execution time during the lockdown and likely to see moderation in execution in the near term due to labour and raw material constraints, the statement said.
It said the loss of revenue for contractors on account of lockdown and gradual ramp-up is expected to have a significant impact on their scale and cash generation ability. NAM MKJ