Projects having loans with floating interest to take the hit.
Hindustan Construction Company (HCC), GVK Group and other construction firms may have to settle for lower returns from their projects as rising interest rates are expected to hurt profitability of roads, power, ports and airports.
Rising interest rates, for instance, will affect build, operate and transfer (BOT) projects where the loan is on a variable interest rate basis. In such projects, the interest rate risk is on the developer.
Consider how interest costs will impact the Badarpur elevated flyover project, which HCC won a few weeks earlier. The project will cost Rs 550 crore: the engineering, procurement and construction (EPC) cost of Rs 494 crore and the interest during construction (IDC) of Rs 56 crore.
With interest rates going up, not only the IDC will go up, but HCC will also have to bear higher interest rates on servicing the entire debt of, say, Rs 380 crore.
The company won’t be able to recover the higher interest costs as the toll on the road project is fixed for the concession period. The EPC cost is also fixed and, if at all, it could go up if there is a further increase in the cost of inputs such as steel.
As a result, HCC will take a hit on its internal rate of return (IRR) from its equity contribution to the project. The company’s IRR is likely to fall from 16-17 per cent to 13 per cent. Similarly, the returns will get squeezed in several power plants and port projects (Mundra) being set up on a merchant basis.
Four months ago, banks were charging 11-12 per cent interest (higher in case of fixed rate on loans) but now the same has gone up to 14 per cent. “If interest rates rise further, I may get further impacted. With inflation at about 13 per cent, I expect interest rates to go up further by 1-1.5 per cent,’’ said Praveen Sood, CFO, HCC, a Mumbai-based construction firm.
Indian banks have increased their prime lending rates (PLRs) by 175-400 basis points after the Reserve Bank of India (RBI) increased key interest rates to curb inflation at home.
“We will take a marginal hit (200 basis points) wherever we are exposed on the variable interest rates and wherever we cannot pass on the interest rate hike in the non-regulated part of the businesses,” said GVK CFO Issac George.
GVK will be hurt in a few road and power projects (like 464-MW Gautami Power Project), where the loans are on variable interest rates. But it will not be hit on the 228-MW Jagarpadu Power Project or a road project in Jaipur, where it has fixed the rate on loans at 8 and 8.75 per cent respectively for five years, or in power projects that are on a cost-plus formula, where higher costs will be a pass-through in tariff.
“We have tried to lock in our variable costs wherever possible. It cuts both ways. We will lose on the upside if interest rates go down,” said George.
But he fixed the interest rates for only five years on these projects, beyond which the interest risks persist on them. George is trying to fix the interest rate on the Gautami project.
Airports have two streams of income: aeronautical revenues like parking and landing charges, determined by the regulator, and non-aeronautical sources like shop rentals, advertising space and duty-free shops. Non-aeronautical revenues can be as high as 70 per cent as in case of Heathrow, though it is 65 per cent for the Mumbai airport.
Airports are protected on aeronautical revenues as higher costs will be a pass-through. “The regulator will figure out the capital expenditure and then fix the aeronautical revenues. The higher costs will be recovered through increased charges for parking and landing,” said George.
Their ability to pass on the hike to the non-aero side of the business depends on the market scenario. Given that airports are monopolies, this should not be a problem.
