India’s Construction Boom: Boon or Bust?

P.M.S. Prasad is not a man you would expect to be worried. The CEO and president of Reliance Industries’ oil and gas business is in the enviable position of having a long list of buyers lined up to purchase natural gas from its record-breaking discovery in the Krishna Godavari basin, off India’s east coast.

But at a recent press conference, Prasad’s worry showed through as he was forced to admit that the prospecting program of India’s largest private-sector holder of oil and gas blocks was delayed because of the unavailability of rigs. “The commercial production of gas from the discovered fields in the Krishna Godavari basin will not be affected, as we will divert some of the rigs from exploration into production, to make good the shortfall in rig availability in the global markets,” Prasad assured reporters. For a company known for quick execution, it was a rare public setback.

Reliance is not alone: Almost every Indian company — big or small — that has some expertise in construction finds itself flooded with orders that are nearly three to four times its annual sales. The size and pace of orders could threaten the development of the country’s already creaking and short-supplied infrastructure. “Execution is the biggest issue in India today, especially on time and within budget,” says Pratyush Kumar, president and chief executive officer of GE Infrastructure, India.

Although construction companies are prepared to spend money to raise their production capacities, experts say that a shortage of skilled talent and the limited ability of capital equipment suppliers to meet demand mean that skillful project management and innovative solutions will be necessary to prevent bottlenecks.

India’s planned infrastructure outlay over the next five years has been revised upward by various government authorities, from $150 billion to almost $475 billion. The country currently spends around $21 billion a year on infrastructure, compared to China’s $150 billion. Corporate capital spending tracked by research firms like the Centre for Monitoring Indian Economy (CMIE) is at a multi-year high in India. The effect of all of this demand can be seen in the order books of infrastructure builders, which have also reached a multi-year high.

Consider just a few examples: Punj Lloyd, one of the country’s largest engineering, procurement and construction (EPC) companies, earned 72% more income for the quarter ended June 2007, at Rs 1,4179.5 million ($359.43 million). Yet, its order backlog rose to Rs 152,250 million ($3,859.32 million). Larsen & Toubro, one of Asia’s largest vertically integrated engineering and construction companies, announced that gross sales rose 47% in the quarter ended September 2007 to Rs 55.74 billion ($1.41 billion), and yet its order backlog rose to a record Rs 400 billion ($10.14 billion). At Wartsila India, which had an order book of one times sales in 2003, the backlogs have risen to almost three times that amount. And Patel Engineering, which expects to close the current year with sales of Rs 16,000 million ($405.58 million) has an order book of Rs 54,000 million ($1.37 billion).

Rupen Patel, managing director of Patel Engineering, says that alone, the planned roll-out of highways by the National Highways Authority of India (NHAI) over the course of the next 10 years exceeds the total turnover of all construction companies in India today. “Construction companies have never seen such a boom in India. Even if [they all] did only road projects and left all work on building airports and power plants aside, NHAI still has more work to offer than firms can take,” he says.

“The turnover of all construction companies in India last year was around $15 billion. This year it may rise to $20 billion. But a total of $50 billion is [slated] to be spent on construction every year in India, which requires a capability of 2.5 times the sector’s size,” says a senior executive at IVRCL Infrastructures who did not wish to be named. India will need several billion-dollar, pure-play construction companies to be able to execute such projects, but it has only a couple of such companies, calling into question the ability of the private sector to build out infrastructure in a public-private partnership mode.

Foreign firms might view the huge gap between the sector’s existing capabilities and those required as an opportunity to make their mark in India. Indeed, the infrastructure spending boom in India has benefited a bevy of overseas companies, such as Dongfang Electric Corporation in China and Doosan Heavy Industries and Construction Company in Korea, who are filling orders for turbines used to generate power. A number of leading global construction companies, such as Australia’s Leighton Holdings and Italian-Thai Development Public Company, have also entered India.

Skilled-labor Shortage

It’s difficult to fathom the words “talent shortage” in a country of a billion people that’s getting younger over time. But speak to any infrastructure builder, and you hear anecdotes about shortages of trained fitters, welders, masons and plumbers. “Whether we will get the people necessary to support the growth is the real challenge. Both engineering and blue-collared skilled workers are in short supply. Fitters and welders are not available in the numbers you want. The industry also needs mechanical engineers who have worked in capital goods industries and would like to pursue a career [in that sector] rather than switch into software,” says Allen Antao, vice president, process equipment, at Godrej & Boyce Manufacturing Company.  

“Once, India had such a supply of labor that we never thought we’d run out, but today things are certainly moving towards that,” says Satish Magar, chairman and managing director of Magarpatta Township Development & Construction Company, which has developed a 250-acre plot near the city of Pune in western India.

According to Magar, semi-skilled labor was once brought in from the neighboring south Indian states of Andhra Pradesh and Karnataka, but now projects in the west Indian state of Maharashtra are pulling in laborers from far flung Eastern states of Orissa and West Bengal where surplus laborers are still available. Importing lower-skilled workers from overseas would be too problematic, “given the significant wage differentials and the effect such inflated costs would have on a project’s viability,” says Patel.

The construction industry remains one of India’s largest employers. Realizing the need for skilled vocational staff, the industry has begun collaborating with academic institutions to either train staff for plumbing and masonry type work, or to set up in-house training programs. “We are tying up with industrial training institutes for education and vocational development as well as organizing local training at our school,” says Godrej’s Antao.

Training is important, because by mechanizing their operations, companies have needed to substitute low-end, semi-skilled artisans with comparatively high-end machine operators who are in short supply. As a result, wages for crane operators and others with higher levels of expertise have risen faster than the average for other industrial workers. For instance, Sanjay Verma, head of ship power for Wartsila India, estimates that welders have seen their wages rise by 30% to 40%, while those for traditionally well-compensated naval architects and marine engineers have risen by 50% over a 3-4 year period. 

Antao says that the appreciation of the rupee and the rise in wages are happening so quickly that their effect on costs cannot be countered with a rise in productivity. “If margins drop as a result, companies may not be able to commit large sums for capital investments with the same freedom as we would otherwise.” 

One area of shortage which hurts all infrastructure builders is the availability of skilled project managers. In the case of many developers, “there may not be that level of experience available to execute the size of the projects [that are] planned,” says Aniruddha Joshi, executive vice president of the Hiranandani family-controlled Hirco Group, which has large realty projects underway in India. India hasn’t seen many large projects until very recently, and the country has traditionally not produced enough skilled project managers to coordinate multiple vendors and optimal allocation of resources.

For prospective engineering students, civil engineering had lost its charm and was seen as a low-growth area, where progress would be limited and the hours long and hard. In comparison, many males who completed computer engineering programs found jobs as code writers in India’s burgeoning software services industry. These jobs, which came with a possibility of overseas placements, also made the men good prospects in the traditional Indian marriage market. But with the construction boom, “salaries for civil engineers from reputed colleges, which averaged around Rs 7,000 ($190) a month three years ago, have risen to around Rs 25,000 ($600) a month now, which makes them comparable to what software engineers get. As a result, we are seeing engineering colleges report a higher percentage of students opting for civil engineering courses after several years of relative drought,” says Patel.

Many companies have turned to acquisitions to cover their short-term labor needs. Punj Lloyd has acquired Singapore’s Sembawang E&C to help provide expertise in EPC projects, while Patel Engineering has bought U.S.-based Westcon Microtunneling to build on its construction expertise. Many firms are also hiring expatriate project managers to take charge of projects and train juniors to assume such positions over time.

Verma feels that the high wages for such positions in India may help in attracting talent from other areas like Eastern Europe and Japan. Patel says skilled project managers and planning engineers could be hired from outside India as well. Reliance Industries, for instance, has an expatriate as its chief of drilling services, who helps train its drillers and rig operators to meet target dates for commercial production of gas. 

Joshi sees a silver lining in the shortage of human resources as well. He cites the example of Japan, where construction companies adopted a “top-down” method that helped attract talent to the industry — one that Japanese society considered a “tough, dangerous and dirty” profession. “It’s good to have constraints; it forces you to come up with new solutions,” says Joshi.

Wanted: Equipment (and Capital)

At the lower end of the skills chain, companies are responding to labor shortages by automating parts of the production process, which makes them less susceptible to shortages of vocational staff. As a result of this, and partly in response to customer demand for faster build-outs, construction companies that once relied on an army of cheap labor now employ a variety of equipment, from low-end concrete mixers to goods elevators and tipper trucks for transporting materials, tower cranes, tunnel-boring machines, robotic drills and hydraulic excavators.

Patel, for instance, has spent Rs 600 million to Rs 800 million ($ 20.28 million) so far to build an equipment bank, while IVRCL estimates it has invested between Rs 2,500 million to Rs 2,750 million ($69.71 million) in equipment so far. “We even think about having a second set of fall-back equipment ready for certain contracts. We now need national equipment yards, as high-end equipment required for finishing jobs in time is not available for hire,” says one official from IVRCL.

“A lot of this equipment could be rented at some point, but these days many companies, including ours, have been purchasing used equipment. Often, the required machinery is not available at the right price and within the desired time frames,” says Patel. The boom in building activity in Asia and the Middle East has not only increased demand for such building equipment but also resulted in a rise in lease rentals and forced many companies to own equipment. This has made the operations of such companies far more capital intensive.

As companies take on larger size projects, the capital intensity of their operations increases, forcing many companies to rely on private equity or the public markets. So far, the Indian capital markets have been supportive of this, with DLF Ltd. — one of India’s largest real estate developers — raising capital in a record-breaking IPO earlier this year. Many realty companies also managed to raise funds on London’s Alternative Investment Market for investing in projects in India.

Lately, as real estate stocks have come under increasing pressure, many companies have begun to reassess the premiums they can hope to receive when they go public. Infrastructure builders, however, have discovered that the stock market is still receptive, with Mundra Port & Special Economic Zone becoming the first SEZ developer to go public in October this year.

While funds can be raised, companies have also been rethinking their work methods and the building materials they use. Many companies now employ ready-mix concrete rather than prepare a cement and sand mixture on site. This helps speed up production since ready-made cement can be poured faster and in a uniform consistency to lay out foundations and pillars. Companies have also started employing prefabricated materials — like brick wall sections or Siporex blocks for ceilings — to help speed things up while using less manual labor. “India may soon move to [another] stage of mechanization, where developers use completely knock-down assembly components to build projects,” says Magar.

One of the reasons for using alternative materials is the reduced availability of materials like clay bricks and sand which traditionally came from the outskirts of a city. With cities expanding, the typical 50 kilometres distance of such brick kilns from a city centre work site no longer holds true. “Thanks to India’s huge foreign exchange reserves, import of goods has been liberalised so supply side constraints in the domestic market can be compensated with global sourcing,” says Joshi. This has not come a moment too soon: Companies want their projects built in much shorter times than what it historically took in India.

Challenges on the Supply Side

At this point in time, many of India’s capital equipment and shipbuilding firms face a Hobson’s choice: There is great demand for their products and services and a global shortage of available capacity, but forecasting future demand is difficult. “Putting up a manufacturing facility for turbines, for instance, requires a couple of years, and by the time the project starts commercial production, we expect China to have surplus production capacity seeking global markets,” says GE’s Kumar.  

Dhananjay Nalwade, president and CEO of GE Equipment & Services, India, also raises the issue of how fast firms can digest new technology required to set up advanced manufacturing facilities that can meet market demand. “You need a local supply chain which supports this technology transfer into India. This process takes time and a huge investment on the part of the suppliers to implement modern manufacturing techniques, such as Six Sigma.”

“In the case of our investment in Titagarh Wagons, for instance, we will hire people well before the factory is built, train them in our U.S. factories to build the products that will be manufactured in India and then bring them back to India to train other staff in turn,” says Kumar. However, GE says some of its partners are reluctant to transfer designs to Indian companies as there is no patent protection available here.

Despite these limitations, firms have been expanding capacity. But several capital equipment and shipbuilding firms find that their component suppliers who have gone from one shift to three and de-bottlenecked their facilities can no longer expand capacity without fresh investments. “With demand showing continued growth, delivery lead times have lengthened. For instance, a ship engine which could be delivered in as little as four to six months from the date of the order could now take as long as 24 to 30 months to arrive,” says Verma. According to Antao, “Steel suppliers can’t match demand for the exotic grades of steel firms such as ours use. As a result, project timelines have almost doubled. But expanding capacity at the supplier’s end requires high capital expenditure, and these firms are afraid that [the demand] bubble may burst and they may not recover their investments.” 

In the meanwhile, equipment manufacturers are coping with lengthened delivery times by becoming far more choosy about what orders they take. “One prioritizes customers whom one has a long history of working with, and new markets where one may seek to establish oneself,” says Wartsila’s Verma. “We are going slow on taking fresh orders until our new capacity is ready. Our order book has already doubled in the last year,” says Prakash Chandra Kapur, managing director of Bharati Shipyard.

“Contractors these days want to work with companies who will be a source of repeat business and will be regular in paying dues. In the past, it was difficult for these firms to be choosy about their clientele, but today, when they have people knocking on their door, they would prefer to work with people who will be around in the long term too,” says Joshi.

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