India: Opportunities in the Indian Construction Industry

Last Updated: 25 May 2006
Article by Sachin Kerur

The decision of the Indian Government early last year to liberalise regulations governing foreign investment in India's construction and real estate market has been one of the most significant policy shifts to come out of New Delhi during the last ten years. This is no small feat given that during the decade there has been a succession of reform programmes across the Indian economy. So why are the construction reforms so important?

Construction activity in India is worth $50 billion per annum and accounts for around 6% of Indian GDP. The construction sector in India employs around 40 million people. However the Indian construction process has traditionally been characterised by bureaucracy, red tape and erratically enforced regulations. Time and cost overruns are prevalent in the industry. Years of government monopoly over construction have meant that management and performance standards are often out-moded. The contracting workforce is largely informal and untrained, consisting of many small-sized firms with low skill levels. There are only a few Indian contractors well-organised and capable enough to undertake significant national capital asset projects.

However of late there have been changes for the good appearing in the Indian construction industry. The granting of industry status to the Indian construction industry has resulted in fast tracking procurement procedures and has enabled construction companies to obtain crucial working capital at market rates. In addition a re-rating of Indian construction stocks by institutional investors because of this new industry status and the many joint ventures being arranged with foreign construction companies, has made Indian construction companies themselves more attractive investment propositions. A consequently larger equity base has been good for the financial strength of Indian construction companies, making successful bidding for projects more likely and accessing conventional debt easier.

But it is the opening of the sector to foreign investment which is set to ignite the sector like never before. Until recently foreign direct investment in real estate and construction was highly regulated. Significant foreign money was only permitted in four areas: hospitality, technology parks, integrated townships and special economic zones. However even in these areas acreage requirements kept foreign investment in India's real estate market at bay. For example, threshold requirements requiring a minimum of 100 acres of development and a minimum 2000 dwellings put off wary foreign developers and contractors. But as of last year, 100% foreign investment was allowed across the sector as a whole and acreage restrictions for integrated townships were relaxed. In addition venture funds can now invest in real estate. All of these changes together with the repealing of antiquated land acquisition and rent control laws and a rationalisation of property taxes are expected to trigger $4 billion of annual investment into the construction industry.

That being said, there are minimum capitalisation requirements that any prospective foreign investor needs to be aware of - $10 million for a wholly-owned foreign company and $5 million if venturing with an Indian partner. In addition, capital must be invested for three years and each development must be 50% complete within five years of the start of the project. And for the present only greenfield developments benefit from the policy changes.

What have been the drivers for the change? Firstly, commercial space requirements for India's booming economy is at an all time high. There is also a nationwide shortage of housing prompted by population growth, social change and a growing middle class. As mortgage financing becomes more accessible and cheaper, more and more Indians want to own their own brand new homes. With the growth of the economy, Indians have more disposable income than ever before and are spending as never before. In the past, most equity for funding real estate development in India was raised from small wealthy Indian investors and private sources, thereby limiting the ability of developers to raise sufficient capital required to develop mega projects. However due to a massive demand in India for large-scale retail and entertainment malls which require new sources of finance and development experience, the Indian government has responded with the recent policy initiatives. Internationally also there have been demands on India by various international players and bilateral trading partners such as Singapore and Malaysia to open up the market and to remove the acreage requirements.

Whilst foreign investors do not need local partners, some form of strategic assistance agreement with a local associate is always essential to assist in building a robust supply chain network, introduce the investor to strategic contacts in business and government and to afford the investor in-depth market knowledge. The real estate and property market in India needs to be approached with care and a thorough due diligence of all aspects of the market needs to be carried out before committing to it. Land titles are not clear and there are no standardised uniform building codes across the sector, making a contractor's execution of works mixed with uncertainty. Indeed regulations in India are notoriously subject to changes and it makes sense to maintain a presence in New Delhi to keep on top of the changes. It also pays to employ an excellent local auditor and company secretary to take care of essential statutory compliance needs.

Foreign investors cannot think of India as a uniform investment hub and must target particular states which offer the best rewards. Indeed a quarter of the Indian states take 80% of all annual foreign investment in the country. Whilst India's large base of English-speaking skilled manpower in industry and services is renowned and the cost of construction labour is generally lower than other parts of Asia, one has to consider productivity and trade union influence. Indeed because it can be difficult to rationalise or lay off a labour force without the approval of the relevant State Government, this can make restructuring difficult and choosing a State that is well-disposed to your operations is important. The location of the project site is critical. India often suffers terrible delays at her ports and traffic between State borders is still a problem. If plant and materials have to be moved between States consider whether the intra-state traffic will be moving between States that have good relationships. Currently India has a very fluid labour market which is an important consideration when hiring estimators and site management. It also pays to be strict when setting out credit limits and payment terms.

India's construction and real estate market now offers significant returns to those foreign investors who know the market, understand the risks and take care and due diligence. And for those moving in now, there is an opportunity to gain a permanent foothold into this massive market.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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