Report No. 46326-IN India Indian Road Construction Industry Capacity Issues, Constraints & Recommendations November 2008 South Asia Region India Country Management Unit Sustainable Development Department Transport Unit Document of the World Bank Acknowledgements The task team would like to acknowledge the timely support, help and advice it received from Messrs. Guang Chen and Michel Audige, previous and present Sector Managers respectively - Transport, South Asia Region. Valuable and expert inputs havebeen provided by Messrs DP Gupta, Peter Copplestone, Hugues Castaing, Harish Chawla, Sujit Das and Jean-Noel Guillosou in preparingthis report as members o f the extended task team. Messrs N S Srinivas and Rajesh B S Dongol provided excellent administrative, editorial and logistic support during the preparation and finalization o fthis report. Data collection, interviews and much o f the analyses and recommendationflow from work done by the two consultant firms Consulting Engineering Services (India) Pvt. Ltd. and ICRA Management Consulting Services Ltd. Quality and peer reviews were done both at the concept stage and final report stage by Messrs Ani1 Bhandari, John Scales, Simon Thomas, h e r Durrani, Mohan Nagarajan and Cesar Queiroz. The team has also shared the draft report with the procurement hub, finance & private sector development unit and the IFC within the Bank.Duringperiodic internal progress reviews, key inputs were provided by Messrs Alok Bansal, Krishnan Srinivasan, Ashok Kumar, Debabrata Chakrabarty and George Tharakan. The task team also wishes to acknowledge the authors o f the various Bank reports which have been referred to inthe study. The task team also wishes to extend its appreciation to Mr GrahamSmith for the final technical editing o fthe report. Thework done bythe consultants andthe study recommendations were sharedwithkey stakeholders from the government and the private sectors during a workshop held on June 13, 2007. Comments and views expressed by the industry and all government agencies during the data collection and interview phase i s gratefully acknowledged by the team. After internal reviews within the Bank the modified report was shared with the Government o f India (Department o f Economic Affairs) in November 2007 for comments. On receiving the Government's response and its valuable observations in September 2008, the report i s now finalized. i Exchange Rate IndianRupees(INR):Rs.45 =US$ 1.OO ListofAcronyms BOT Build, OperateandTransfer BRO Border Roads Organization CAGR Compound AnnualRate of Growth CCF C h e fConservator o f Forests CDC Consultancy Development Council CIDC ConstructionIndustryDevelopment Council CII Confederation of IndianIndustries CFI ConstructionFederation o f India DBMO Design, Build, Maintain and Operate DFO District Forest Officer DP Displacedperson DPR Detailed Project Report DRB DisputeResolutionBoard ESOP Employee Stock OptionPlan FDI Foreign Direct Investment FICCI Federation ofIndian Chambers of Commerce and Industry FIDIC InternationalFederation o f Consulting Engineers GO1 Government o fIndia GPS GlobalPositioning Satellite/System GSHP Gujarat State Highways Project HR HumanResources IRC IndianRoad Congress IT Information Technology Jv Joint Venture LTPBC Long-term Performance-based Contract LA LandAcquisition M C A Model Concession Agreement M H A MalaysianHighway Authority MoEF MinistryofEnvironment andForestry MoSRTH Ministryof Shipping, RoadTransport andHighways NABARD National Bank o fAgriculture and Rural Development N A C National Academy o f Construction NH National Highways NHAI National Highways Authority ofIndia NHDP National Highways Development Project NSE North-South Expressway PAP Project-affected person PMGSY PradhanMantri Gram Sadak Yojana (Prime Minister's Rural Roads Program) PPP Public Private Partnership PWD Public Works Department R&D ResearchandDevelopment R&R Resettlement & Rehabilitation RR RuralRoads SH StateHighways SME Small andmediumenterprises SOE State-owned enterprise SPV Special Purpose Vehicle VAT Value Added Tax VE Value Engineering WCT Works Contract Tax 11 Acknowledgements................................................................................................................................ i L E X E C U T I V E SUMMARY ...................................................................................................................................... 1 A BACKGRO~D ............................................................................................................................................................ 1 B INDUSTRY STRUCTURE AND PROFITABILITY .............................................................................................................. 2 C . KEYCONSTRAINTSFACED THE ROADCONSTRUCTION INDUSTRY BY ....................................................................... 3 C.I Constraints in Investment Climate C.II Supply-side Constraints................ D. KEYRECOMMENDATIONSAND SU D.I Immediate and Short-term Actions (0 to 2 years): .............. ............................................................................. 5 D.II Medium-Term Actions (2 - 5years) .......................................................................................................................... 8 D.III Long-Term Actions (5 - I Oyears)............................................................................................................................. 9 E. SUGGEST10NFORTAKINGFORWARD REC~MMENDAT~~NSTHIS STUDY ....................................................... THE OF 9 F. POSSIBLEAREASFORWORLDBANK'S FUTUREASSISTANCE .................................................................................... 9 2. INTRODUCTION .................................................................................................................................................. 10 2.1 CONTEXT................................................................................................................................................................. 10 2.2 MACRO ECONOMICPERSPECTIVE............................................................................................................................ 10 2.3 DEMAND ROADSOUTSTRIPPING THE SUPPLY............................................................................................... FOR IS 11 2.4 GOVERNMENT'S INITIATIVESPROGRAM..................................................................... AND ROADS DEVELOPMENT 11 2.5 THECURRENT INDUSTRY AHEAD......................................................................... FRAMEWORK CHALLENGES AND 12 2.6 DRIVERAND OBJECTIVES THE STUDY................................................................................................................. OF 13 2.7 STUDY METHODOLOGY ........................................................................................................................................... 14 3. PASTPERFORMANCEOFROAD CONSTRUCTIONINDUSTRY ............................................................. 16 3.1 CONTEXT......................................................................................................... ................................................. 16 3.2 ANALYSISOFTHE PASTDEMAND ............................................................................................................................ 16 3.2.I Comparison of budget allocations and actual expenditure in thepast 16 3.3 INDUSTRY'S ................................................................................................ RESPONSE TO MEET THE PASTDEMAND 16 3.3.I Industry Output / Turnover .. I 7 3.3.2 Utilization of input resources by the industry ......................................................................................................... 17 3.3.3 Contract Size and Framework 3.3.4 Time and Cost Overruns ........ 3.3.5 Participation of Foreign Contractors in the Pas 3.3.6 Migration of Contractorsfrom Other Sectors to ast.............................................................................. 20 3.3.7 Facilitation by Government to Strengthen the Road Construction Industry 20 4. KEYISSUES FOR THE ROADCONSTRUCTIONINDUSTRY .................................................................... 23 4.1 CONTEXT................................................................................................................................................................. 23 4.2 KEYISSUES THEPRIMARY SURVEYS..................................................................................... IDENTIFIED THROUGH 23 4.2.I Issues identified on input resources and operational aspects 23 4.2.2 Issues Identified on Business Environment ............................................................................................................. 24 4.2.3 Perceptions of Foreign Contractors, Consultants and Equipment Manufacturers ... 25 4.2.4 Experience of someAsian Contractors in India...................................................................................................... 27 4.2.5. Entry Barriers Experienced and Perceived by Foreip Construction Firms 28 4.3 CRITICALISSUESPERTAININGTO CAPACITY OF THE ROADCONSTRUCTIONINDUSTRY .......................................... 28 4.4 BUSINESS ENVIRONMENTAND INVESTMENT CLIMATE ISSUES ................................................................................ 28 4.4.I Pre-construction and Implementation Issues 28 4.4.1.1 Pre-construction Activities 29 4.4.1.2 Land Acquisition and Relocation ofDisplaced Persons.............................................................................................................. 29 4.4.1.3 Utility Relocation........................................................................................................................................................................ 31 4.4.1.4 Tree Cutting 4.4.2 Construction an 4.4.2.1 Contract Enforcement and Decision Making 4.4.2.2 Contract Managementby Contractors and Su .......................................................................................... 34 4.4.2.3 Claims and Disputes ................................................................................................................................................................... 34 4.4.3 Investment Climate Issues Affecting Competitivenessofthe Industry................... 35 4.4.3.1 Institutional Structure and Regulation......................................................................................................................................... 36 4.4.3.2 Cost of Funds ................................ 31 4.4.3.3 Tax Structure, Incentives an ies .................................................................. 31 4.4.3.4 Entry barriers to road sector........................................................................................................................................................ 38 4.4.3.5 AdministrativeRroceduralIssues- Licensing, Clearances, Governance, Law and Order 39 4.4.3.6 Profitability and Returns............................................................................................................................................................. 39 4.4.4 Summary of Business Environment &Investment ClimateIssues........................................................................... 40 4.5 SUPPLYCONSTRAINTSFACED THE INDUSTRY BY .................................................................................................... 41 4.5.1 Lack of Contractors- in Numbers and Capacity .................................................................................................... 41 4.5.2 Constraints Directly Related to Road Contracting Industry 4.5.3 Consultant Issues: Surveying, Investigation and Design Issues.............................................................................. 42 4.5.3.1 Quality of Survey Reports and Lack of Modem Surveying Techniques 4.5.3.4 Unrealistically Low Consultant Fees.......................................................................................................................................... 43 4.5.3.5 Lack of Thrust on Quality Control and Optimization of Costs 4.5.3.6 Accountability ofthe ConsultingIndustry.............................................................. .......................................................... 44 4.5.4 Human Resources and Skills Development Issues .................................................................................................. 44 5. ASSESSMENT OFDEMANDOVERTHE MEDIUMTERM ......................................................................... 46 5.1 CONTEXT................................................................................................................................................................. 46 5.2 PROJECTION OF FUTUREDEMAND ........................................................................................................................... 46 5.2.1 The three scenarios ................................................................................................................................................. 46 5.2.2 Items covered in Demand Projections 5.2.3 Projection of Expenditure .......... 5.2.4 Projection on Number of Contra 5.2.5 Projection on Human Resources equirements ............................................................................................. 49 5.2.6 Projection on Key Construction Equipment 49 5.2.7 Projection on Critical Construction Materials ....................................................................................................... 50 5.3 GAPANALYSIS......................................................................................................................................................... 50 5.3.1 Number of Contracts vs. Contractors...................................................................................................................... 50 5.3.2 Human Resources . 51 5.3.3 Key Construction Equipment .................................................................................................................................. 52 5.3.4 Key Construction Materials 52 6. EXPERIENCEONEVOLUTIONOFTHE INDUSTRY .................................................................................. 54 6.1 CONTEXT................................................................................................................................................................. 54 6.2 SELECTION OF COUNTRIES ....................................................................................................................................... 54 6.3 CHINA CASESTUDY ................................................................................................................................................. 54 6.3.I History of Highway Development ... . 54 6.3.2 How Was It Achieved? ............................................................................................................................................ 55 iv 6.3.2.1 BuildingManagement Capacity.................................................................................................................................................. 55 6.3.2.2 Industry Structure ............................ ................... 6.3.2.3 BuildingManpower Capacity ......... ............................. 6.3.2.4 Building Equipment Capacity..................................................................................................................................................... 56 6.3.2.5 MaterialsCapacity 56 6.3.2.6 Regulations and Associations ..................................................................................................................................................... 57 6.3.2.7 FundingRestructuring.................................................................................................................................................... 6.4 MALAYSIA STUDY.......................................................................................................................................... CASE 57 6.4.IHistory ofHighway Development .............................................................................................................................. 57 6.4.2 How was it achieved 6.4.2.1 BuildingManage 6.4.2.2 Industry Structure 6.4.2.3 BuildingManpow ..................................................................................................................................................... 59 6.4.2.4 BuildingEquipment Capacity............... ................................. 6.4.2.5-Materials Capacity 6.4.2.6 Regulations and Associations ..................................................................................................................................................... 59 6.4.2.7 FundingRestructuring.......................... ............................... ...................... 59 6.5 LESSONSLEARNT (FROM CHINA & ...................................................... 59 6.6 CASESTUDY ON FRANCE ......................................................................................................................................... 60 6.6.1 Key Issues of the French Road Construction Industry in the Last Decade 61 6.6.2 Government Policies Implemented to Improve the Construction Sector Capacity ................................................. 61 6.6.3 Internal actions taken by the French road construction industry to improve its capacity 6.6.4. Key issues and strategy of the Road Construction Industry in thepast and nearfuture ... 6.7 CASESTUDY ON GUJARAT-GUJARATSTATE HIGHWAYS PROJECT ........................................................................ 63 7. SUGGESTEDACTIONS & RECOMMENDATIONS ....................................................................................... 65 7.2 KEYAREASOFRECOMMENDATIONS AND SUGGESTED ACTIONS ............................................................................. 65 7.2.I Speeding up Contract Execution through Improved Qualiv at Entry............................................... ...... 65 7.2.1.1 Timely Completion ofPre-Construction Activities .................................................................................................................... 65 7.2.1.2 Strengtheningthe Investment Planningand ProgrammingFunctions of the RoadAgencies.............................. 66 7.2.1.3 StructuringContractor and Consultant ArrangementsDifferently.............................................................................................. 66 7.2.2 Increasing the Number of Contractors and Consultants Working in India's Road Sector ..................................... 67 7.2.2.1 MakingProcurementand SelectionProcessfor Contractors and Consultantsmore Transparent 68 7.2.2.2 EasingBarriersFor New and ForeignFirmsto Enter the RoadConstruction Sector ................................................................. 69 7.2.2.5 AdministrativeProceduralIssues- Licenses, Clearances, Tax Administration and Customs..................................................... 70 7.2.2.6 Institutional Structure and Regulation ............................. 7.2.2.7 Timely Completion of Contracts........................ ............................................................................................................... 71 7.2.3 Improving theA 7.2.3.1 HumanResources 7.2.3.2 Equipment........... 7.2.3.3 Material Resources.......................... ..................... 7.2.4 Marketing Indian Road Sector a ience Sharing within 7.3 EXPECTEDOUTCOMES ............................................................................................................................................. 74 7.4 CONCLUDINGREMARKS .......................................................................................................................................... 75 V Annexes ANNEX I SUMMARYOF THE STUDY ONTHE OPERATIONOFDISPUTERESOLUTIONMECHANISMIN CIVILWORKS ININDIA............................................................................................................................. 1 ANNEX I1 BUILDING THECAPACITYOFTHE INDIANROAD CONSTRUCTIONINDUSTRY........................ 3 ANNEX I11 CAPACITYENHANCEMENTOF HUMANRESOURCESINTHEROADSECTOR........................... 30 ANNEX IV RESEARCH.DEVELOPMENTAND TECHNOLOGY INITIATIVES INTHEROADSECTOR.........42 ANNEXv OTHERTHRUSTAREASFORR&D AND TECHNOLOGYTHE ROADSECTOR ............................................... IN 49 ANNEX VI THE VALUE ENGINEERINGPROCESS.................................................................................................. 51 ANNEX VI1CASE STUDY: ROADAGENCY PRIVATIZATION. EXPERIENCE.................................. ACTUAL 55 vi 1. Executive Summary A Background 1. Over the last few years, the Indian economy has been in a phase o f unparalleled growth o f about 8- 10% per year, malung it one o f the fastest growing economies in the world. Sustaining this rate o f growth will need huge investments inphysical infrastructure such as roads ($75-90 billion according to various reports), water, power and urban sectors. Preliminary estimates suggest that investment in infrastructure would need to increase from the current 4.6% o f GDP to about 8% duringthe 11" Plan. 2. An efficient transportation system i s critical for sustaining economic growth and the burgeoning demand for passenger and freight movement. Recognizing this, the Government o f India (GOI) and several state governments have launched initiatives duringthe past decade to modernize and improve the transport infrastructure. Starting with the 9* Five Year Plan (1997-2002), road sector expenditures have gone up from 3% o f the total Plan expenditure to almost 12% today. These expenditures were primarily for national highway and rural road development programs. In addition, GOI, some state governments and industry associations have taken initiatives such as encouraging private sector participation in highway financing, allowing wholly-owned foreign direct investment in the sector, establishing training centers for construction workers, and devising a gradingrating system for construction firms to foster the growth and efficiency o f the road construction industry. 3. InIndia as elsewhere, the mainelement o froad investment is civil works -typically 95% o fthe road sector budget. The success o f road sector investments therefore depends on the capacity and capability o f the Indian road construction industry. However, even as the magnitude o f works has gone up significantly inthe last decade, the industryhas not kept pace with this growth, as evidenced by the under-utilizationof funds allocated to road projects' and perennial time and cost overruns on national and state highway projects2.The industryi s not yet geared up to meet the potential expanded volume o f work on future road infrastructure projects. Furthermore, it faces evolving demands in the form o f bigger projects involving more demanding technology and complex design, and requiring more sophisticated execution capabilities. At the same time, as it competes for skilled manpower with other booming sectors, the road industry faces increasing turnover o f its experienced staff, dwindling appeal to fresh talent, and several other constraints in investment climate that inhibit its operations and attractiveness to firms, both domestic and foreign. These issues pose major risks to the planned rapid catch-up on road sector investments - risks that need to be addressed if the Government's development objectives are to be met. 4. This study stems partly from GOI's concern regarding the capacity o f the road construction industry to deliver, and partly from the Bank's growing need to understand the impact o f the expanded road investments on the industry's capacity in South Asia. The study attempts to outline the entire gamut o f problems and capacity constraints faced by India's construction industry. It builds on previous studies3,reports and industry-wide stakeholder surveys and workshops. It recommends key actions to the central and state governments and the industryfor enhancing its capacity and efficiency. 'Analysis ofproject allocation and expenditure datafor the past five years on all categories ofroads inIndia consistently shows that actual expenditures fell short ofbudget allocationsby 15-20%. Analysis of data on completed and on-goingnational and statehighwayprojects shows that ninetypercent of all contracts hadatime overrun ofmorethan 25%; fifty-four percent hada cost-overrunofmore than 25%. "Road ConstructionIndustry Study (1999)", "Design and Construction Review Study (draft stage)", "Study on Improving Dispute Resolution Systems inWorks Contracts (draft stage)",and "Study on Delaysdue to Pre-ConstructionActivities inNational Highway Projects(Bank's internal study)",. 1 B Industry StructureandProfitability 5. The Indian road construction industry is highly unorganized and fragmented. Only about 0.4% o f the 250,000 contractors in India can be classed as medium to large firms (based on the number o f people employed per firm). Many o f the medium and large construction firms are still family owned and lack professional management and work culture. While small and medium contractors have mushroomed in the recent past, large contractors have not grown at the same rate either in size (turnover) or number. Consequently, on the medium to large-sized national and state highway projects there are few contractors to choose fi-om; only about 45-50 Indian contractors and about 10-12 foreign contractors. Often these contractors form joint ventures or consortia among themselves to qualify for most o f these contracts in the country. Subsequently, these contractors suffer from insufficient capacity; the result i s time and cost overruns, related disputes and lower quality. As such, there i s a critical need for reversing the slow growth o f the large contractors and for enhancing the capacity o f all sizes o f contracting and consulting firms. 6. Contractors inroad construction make much smaller profits (average typical margins o f 6-10%) than those engaged inconstruction inreal estate (about 20-25%), hydropower and industrial sectors (about 15%). These thin margins are mainly due to the delays inoverall project implementation, investment climate bottlenecks and unhealthy competition. Players from other sectors find the road construction sector relatively unattractive due to its lower profit margins, management by predominantly weak public administrations, frequent contractual disputes, challenging project logstics and contract management arrangements. Consequently, whereas the industry should be gearing up to attract players from other sectors to meet the demand, inreality the reverse i s happening: existingroad firms are expanding their business interests into other, more lucrative sectors. Moreover, an increasing trend in the industry is for contractors to move up the value chain from traditional construction contracts to build-operate-transfer (BOT) type projects, to minimize their risks. This i s creating a vacuum o f good specialist contractors who can support the bigger players inthe industry. 7. It is heartening to note that, inan effort to meet the surge indemand, deployment o fhumanresources and equipment has increased substantially, but a shortfall still manifests itself invarious forms inroad contracts and their procurement. Moreover, the frequent substitution of staff on site (by both contractors and consultants) after contract award points to a shortage o f skilled and semi-skilled manpower, that needs to be addressed. 8. Despite the growing demand, participation o f foreign contractors inIndia has been steadily declining from 2003-04, possibly due to decline intheir annual average turnover from Indian business. About a dozen foreign contractors are operating in India today, but many o f them are not bidding on new contracts. Foreign contractors often face difficulties with taxation and audit procedures, in interacting with sub-contractors and suppliers, and in adjusting to the local work culture. This is a disturbing trend that again highlights an unattractive business environment. On the other hand, the performance o f foreign contractors has also not been upto the mark, raising questions about the value they add. 9. Symptoms o f capacity constraints in both quantity and quality are also evident from the fact that Indian equity research and rating agencies report unexecuted order books o f 5-10 times the annual revenues for some o f the leading construction companies in India to attract potential investors in the company stocks. However, this could mean that, on average, most o f the construction firms would take anywhere between five to ten years to complete their works, which highlights a severe lack o f capacity in the road construction sector. Time and cost overruns much above the original estimates also point to capacity constraints and poor use o f the existing capacity to deliver works on time. 2 C. Key ConstraintsFacedbythe RoadConstructionIndustry 10. From data collected through interviews with both domestic and international contractors, the following have been identified as key constraints: 0 Investment Climate constraints including operational issues, pre-construction activities, contract management and dispute resolution, institutional structure o froad agencies and other entry barriers; and Supply side constraints including qualified human resources, key construction equipment and materials 11. Foreign contractors also perceive cultural insensitivity to timeliness, quality and cost, lack o f innovative approaches and laxity incontract enforcement as major constraints. 12. Road agencies cited as key issues the formation o f so-called paper joint ventures to pre-qualify for contracts, poor quality o f surveys and designs, frequent substitution o f key personnel on site, and poor resourceplanningby contractors. c.1 ConstraintsinInvestmentClimate 13. Investment climate parameters such as availability o f skilled staff, operational issues (land, licenses and clearances, governance) and taxation were perceived as the prime constraints, followed by material costs, contract enforcement and dispute resolution, barriers to entry, and subsidies and fiscal concessions. Foreign contractors who were surveyed cited as the most critical issues cultural bias in project management style, poor governance, bureaucracy and corruption, risk allocationpractices and contract conditions, visa and travel document processing for expatriates, and lack o f information on the road construction industry. Besides these, foreign contractors also perceived some intangible constraints, such as preference given to domestic contractors duringthe biddingprocess. 14. Delays inpre-construction activities are a recurring problem across all road construction contracts. On average for national highway projects it takes 50% more time than scheduled to hand over encumbrance-free land to the contractors. Often, encumbrances such as the extent o f land acquisition, utilities to be shifted and trees to be removed are not clearly identified and dealt with in a timely manner. These activities are also hampered by cumbersome procedures for obtaining the necessary clearances, unclear laws and regulations and a lack o f coordination between the various government departments and levels. There i s a distinct lack of a `spirit o f partnership' between the contractor and the employer. This i s critical to effective project execution, as evidenced inother countries. The result i s time and cost overruns andrelated disputes that invariably end up inlitigation. 15. Although based on the FDIC4 framework, the present form of contract i s inadequate and often contains unclear clauses that are open to interpretation, which subsequently lead to disputes andor rent-seelung behavior. For instance, the role o f the Independent Engineer i s not clear, weak and often circumvented by the employer, violating the conditions o f contract. Most o f the employer's staff and domestic supervision consultants have little experience inFDIC conditions o f contract. For instance, there i s a general lack o f awareness that encashment o f a bank guarantee can be invoked only upon default in the contractor's obligations. Further, the weak accountability framework and an overwhelming fear o f vigilance by auditors (not fully conversant with F D I C and newer forms o f contracts) inhibit quick decision-making on time extensions or variation orders. On the other hand, contractors often try to exploit these weaknesses o f the employer and raise frivolous contract claims that result in waste o f administrative time and resources. Supervision consultants exploit contract Federation Internationale des Ingenieurs-Conseils (International Federation of Consulting Engineers) 3 conditions by delaying decision-malung, work-flow approvals that result in extension o f the civil works, and thereby their time-based consultancy contracts. A related issue i s rampant sub-contracting. Often contractors subcontract works to small local firms that otherwise would not have qualified for the works, either to curry favor with the local politician or due to pressure from the employer. 16. Design variations during construction, delays in pre-construction activities and unrealistic project completion schedules are often the cause of disputes on road construction projects. A rough estimate o f the amount currently blocked in disputes i s around Rs.540 billion ($12 billion) for the entire construction sector in India. About 10-15% o f this amount can easily be attributed to the road sector. While the contracts contain a dispute resolution mechanism, experience shows that in most cases the dispute resolutionboard i s established only when a dispute arises. Recommendations o f the board are oftennot reasoned due to lack o f capacity and knowledge o fthe boardmembers. Furthermore, neither the road administration officials, nor the contractors, hardly accept the recommendations o f the board those have financial implications against the affected parties and invariably appeal for arbitration / legal intervention. The enforcement o f arbitration awards is also time-consuming and often leads to significant delays even much beyond the project completion. This i s a potential deterrent for new entrants inthe industrythat needs to be resolved. 17. The existing institutional structure in many road administration organizations does not provide for clear separation o f owner and provider functions. The absence o f an independent regulator to safeguard the interests o f the various stakeholders, which exists inthe telecom, energy and insurance sectors but not inroad sector, i s also a factor in the sector's slow evolution. Inaddition, some o f the existing customs and foreign investment regulations have adversely affected the sector. On the other hand, the absence of regulation on worker health, safety and environment i s not conducive to the industry'slabor productivity and efficiency. 18. Distortions o f direct and indirect taxes affect both foreign and domestic road contractors. Non- uniformity and multiplicity o f taxes, the high level o f taxes and duties, cumbersome tax assessment and collection procedures, and an absence o f appropriate fiscal concessions have been a serious drag on the efficiency and profitability o fthe sector. 19. Contractors from other sectors face entry barriers such as strict qualification requirements related to previous technical experience inthe sector. Rampant cartelization and collusion among contractors in some states also prevent these contractors and non-regional bidders from even submitting their bids. Furthermore, it is not possible for small and medium contractors to get a rating that would facilitate easier access to credit for expanding their business. The lack of a unified construction law (such as inChina and Singapore) with the requisite legal framework governing all aspects of construction is another barrier to entry for players interested inentering this sector. Such a law would also strengthen the dispute resolution mechanism reducing the burden on the courts and the ensuing delays by satisfactory resolutiono f cases. Inthe year 2000, the Government o f India notified construction as an approved activity under industrial concern but stopped short o f declaring the sector as a full fledged industry. This has limited the sector's opportunity to be brought under industrial regulations and better accessto market finance. c.11 Supply-sideConstraints 20. An analysis o f the number of contracts and contractors shows that even in a medium growth scenario, contractor capacity would have to double immediately to handle the increase in work in 2007-08 and beyond. To meet the needs of the highgrowth scenario, contractor capacity would have to quadruple. But this can happen only with the entry o f large construction companies, other sector players and foreign construction companies into the road sector. A related issue here is the vertically integrated nature o f state road agencies, some o f which may be overstaffed. In this scenario o f 4 increased demand on the industry, this may not be the best structure for taking care o f all aspects o f delivery o froad services. 21. Inadequacy o f skilled humanresources is a major constraint across the road construction industry. Its slow evolution, the rising appeal o f other streams o f engineering such as computer science, the closure o f civil engineering specialization insome institutes, the non-availability o f suitablejobs upon graduation (in some states), and the availability o f more lucrativejobs ininformation technology and financial services are all draining the industry o f civil engineers. The family-owned-and-managed nature o f most o f the medium-sized construction firms i s another impediment to young aspiring civil engineering graduates. While there are limited technical courses for mechanics, welders and operators, there is no classroom or on-the-job training for other semi-skilled workers such as masons, carpenters, and electricians. Figures indicate that the supply o f skilled and semi-skilled workers will barely keep up with the requirements o f even a low-growth scenario. Under a medium-growth scenario, the supply will fall short by about 18-28%, while under a high-growth scenario, the gap will widen considerably from 55 to 64% over the next eight years. To meet this demand, the number o f civil engineering graduates and diploma holders would have to go up by at least a factor o f 3. The industrywill have to take immediate steps to make the profession more attractive and enhance the startingemoluments to attract fi-esh graduates. As will be highlighted later inthe report, there is also a scarcity o f teachers catering to the needs o f this industry. 22. As to key construction equipment, to satisfy the average demand over the next eight years under a medium-growth scenario, the supply needs to increase by about 60%. Under a high-growth scenario, the supply would need to increase by a factor o f 3 to meet the demand. This will require significant enhancement o f production capacities o f the equipment manufacturers and streamlining o f import procedures. Other measures could be to foster the equipment rental market, equipment bank and leasing concepts, to establish an efficient supply-chain for industry spare parts, and to offer operator/technician training. 23. As for keyconstruction materials, while cement and steel requirements are not an issue, there could be a shortages in the availability o f bitumen and stone aggregates. Both would have to increase by a factor o f 2 or 3 under the medium and high-growth scenarios. Stone extraction and aggregate production face constraints in the form o f stringent quarryindmining regulations and capacity constraints o f the crushing plants.These issues need to be addressed to ensure the availability o f these materials. D. KeyRecommendationsand SuggestedActions D.1 ImmediateandShort-termActions (0 to 2 years): 24. Strengthen sector policy, institutional structure and regulation: The Government should strengthen pre-investment planning, enhance project readiness, and improve the investment climate by initiating and implementing actions to: formulate a policy to establish a road user board which will act as a quasi-regulator and advisor for the sector to the governments at central and state levels; enable road sector agencies to undertake a master planning exercise to plan and prioritize investments for at least a three-year horizon; ensure that the schedule o frates are updated every year to reflect realisticallythe market conditions; develop a fi-amework to opt for green-field projects on new alignments wherever economically and technically feasible, and encourage bypasses andexpressways; ensure that at least 50% o f encumbrance-free land i s handed over to the contractor andor concessionaire when signing the agreement, in minimum 10 lun continuous stretches; the remaining landbeinghanded over withina timefi-ame specified inthe agreement; 5 (f) prepare a comprehensive training policy and strategy for the sector which should also cover training to vigdance, audit and accounting staff to help them appreciate modem contractual practices; (8) create an enabling environment for the formation o f trade associations; (h) enact the UnorganizedWorkers Bill; (i) enact the pending LA (amendment) and the Rehabilitationand Resettlement (R&R) Bills; (j) mandate social security schemes for construction workers across the country; and (k) expedite implementationo fthe Construction and Other BuildingWorkers Act (1996) by all states. 25. Promote Indian road sector and knowledge sharing: Primary road sector agencies like the Ministryof Shipping, RoadTransport and Highways (MoSRTH) and the IndianRoads Congress and industry associations like the Construction Industry Development Council (CIDC) should consider actively promoting Indian market opportunities and the Government's investment plans through annual road shows and conferences abroad to attract foreign road contractors. This will also provide a forum for the Indian government to take note o f prevailing concerns o f the international community, and help in attracting persons o f Indian origin working overseas to return home ("reverse brain drain"). Similarly, more knowledge sharing and technology transfer training sessions on best practices in construction, institutional structure, e-procurement, governance and transparency and road safety among road agencies inthe country could be encouraged to increase awareness and attract other players to the industry. 26. Strengthen contract enforcement and dispute resolution: The Government could signal its intent to strengthen the dispute resolution mechanism by making the decisions o f the hierarchical process bindingon each party untilreversed or changed at the next higher level inthe process. Inaddition, it should seriously deliberate on the establishment o f a Road Appellate Tribunal at both the central and state levels for arbitration o f disputes unresolved by the dispute resolution boards. To minimize payment related disputes, insertion o f `promptpayment' contract clauses may be an option, especially instatesthat have ahistory o fpoor payments or those that are inpoor financial condition. 27. Strengthen incentives for on-time completion and use o f alternative contract structures: To reduce the risk o f delays during contract execution, the Government should encourage the inclusion in contracts o f bonus or early completion clauses as an incentive to contractors and consultants to complete works on time. As disincentives for delays, penalties should be enforced strictly on works contracts; accountability clauses should also be introducedfor consultants. The Government may also wish to formulate a policy to enable road agencies to transition to alternative contracting methods such as Design-Build-Maintain, Design-Build and Long-Term Performance-based Contracts. By paying against results, these contract structures allow many lower-level management controls to be transferred from the road administration to the contractor, and offer contractors built-in rewards for timely completion. 28. Streamline pre-constructionclearances and customs: To facilitate the process o f land acquisition and environmental, forest and other clearances, the Government could establish specialized pre- construction units within each implementing agency, along with high-powered coordination committees at both central and state levels. A single-window mechanism should be established for obtaining duty exemptions. Processes for award o f visa, visa extensions and other travel documentation for international staff working on road sector projects should be streamlined. In addition, restrictions on re-expodre-sale o f imported equipment should be eased to reduce contractors' workmg capital requirements. 29. Improve transparency and increase competition in the bidding process: Institutionalizing the use o f e-procurement methods should improve transparency, increase competition, attract other sector 6 players and minimize collusion and cartel formation, provided an independent assessment i s done to establish its readiness in a state / agency.' Industry associations such as CIDC could establish and maintain a web-based contractor database to enable the procuring agencies (for a user fee) to confirm and verify the qualifications and performance o f the contractors and consultants. To prevent misrepresentation o f contractor/consultant qualifications, certification o f their qualifications by the respective industry associations like CIDC or the Consultancy Development Council could be a supporting measure. Entry barriers for foreign firms in the road sector could be eased, if the agencies wish-to, through: (i) allowing the experience o f the parent firms to be used (inthe case o f new Indian subsidiaries o f foreign firms) for evaluating them; (ii) withdrawing requirement o f 51% stake o f the leadpartner throughout the concessionperiod; and (iii) requiringregistration o f JV arrangements with the undertaking o f partners to honor their commitments. Similarly, qualifying criteria requirements for domestic players from other sectors could be eased to ensure that contractors with similar experience and capability in managing and financing contracts o f similar size are gradually able to enter the road sector. 30. Review the effectiveness o f subsidies, fiscal concessions and taxation: The Government should consider: abolishingthe Works Contracts Tax in states where it i s still applied. extending Section 44BBB benefits to road sector projects to give foreign contractors an incentive to enter India. providing duty exemptions to all contractors worhng on contracts above a certain threshold value. reducinghationalizing customs duty on importing o f capital goods and machinery used in road construction from the current level o f 37%. providing deemed export benefits for large road and expressway projects on the lines o f Mega Power policy or by allowing higher depreciationrates on equipment. extending Central Value Added Tax benefits to certain construction equipment like crushing plants. 31. Enhance the capacity o fhumanresources: The following should be considered immediately - (a) Construction industry associations should professionalize management within construction firms by introducing registration/rating/grading and performance management for employees (such as I S 0 9001) and incentive schemes like employee stock options (ESOPs) to retainpeople inthe sector. Public road agencies, like private firms, should introduce merit-based rewards and promotions and other incentive schemes to enhance their attractiveness. Government and industry should conduct active marketing campaigns and provide opportunities for final year civil engineering students to work as interns on live road projects, to attract more fresh talent into the sector. The Government should formulate a policy to establish more training institutions and centers o f excellence to train both unskdledand skilled workers, engineers and managers inthe industry. The Government should expand vocational and technical education systems to the rural areas and set upcenters o fexcellence for specific trades. State-of-the-art training taken by key personnel should be given due importance inbid evaluation. The Government should also create appropriate incentives for periodic training o f its own employees through its performance evaluation process. 32. Ensure availability o f supply of equipment and spares: The equipment manufacturing industry should be encouraged to set up (or strengthen) a dedicated industrybody to foster the development o f a good equipment rental and leasingmarket, which will benefit small and medium road contractors. Inthis regard,the exampleofAndhra Pradesh, whichhasfully adoptede-procurement,isworthy ofemulationbyother states. 7 33. Use of value engineering techniques: Value engineering should be introduced on national and state highway projects (at least on a pilot basis) to ensure sound design, ground truthing o f surveys and cost optimization. In addition, a peer review o f the detailed project reports and a road safety audit at concept and design stage should be made a pre-requisite on all contract sizes larger than Rs 500 million (about $10 million). D.11 Medium-TermActions (2 -5 years) 34. Strengthen sector policy, institutional structure and regulation: The Government should consider- establishing a quasi-regulator cum advisor for the sector, including road user representatives; reviewing options, through engaging specialist services, to restructure government road agencies to enable them to perform their core functions o f policy making, planning and overall sector management better, and spin o f f the remaining functions into autonomous construction and design outfits; implementingthe framework for green-field projects. passing a Construction Law governing all aspects o f construction; implementingthe training policy for the sector and other allied functions; buildinga core cadre o fofficerswithin the National Highway Authority o fIndia; formulating a better research and development policy for the sector to bring the country's construction specifications on a par with international standards for survey, design and construction o froads; and (h) implementinga policy framework on e-procurement and contractor databases. 35. Facilitate access to financehredit: The industry associations should take the initiative to upgrade the industry standards o f accounting and make all transactions more transparent. Registration o f contractors above a certain threshold and ratings for small contractors should be made mandatory. GO1and financial institutions should also take steps such as developing secondary corporate bond markets and introducing new instruments to facilitate long-term finance for project developers and concessionaires. 36. Ensure availability o f key materials: GO1should map key input material sources and disseminate them on the Web, along with conditions and procedures for obtaining licenses for mining and quarrying. It should also review the Bureau o f Indian Standards certification requirement for importing cement to ease imports. 37. Enhance the quality of human resources: Some actions in this regard which can be taken by government and the industryare: Decide on a policy to replicate more training centers such as the National Academy o f Construction (Hyderabad) and National Institute o f Construction Management and Research. Provide specialized, certified Ereshmantraining for graduates joining the road sector. Provide on-the-job training at construction sites with best practices (such as the Delhi Metro) to encourage students to take up the challenges o f mega-construction projects. Introduce new courses at engineering schools to strengthen the project and contract management aspects, publidprivate partnerships (PPP) and other basic aspects o f projecthon-recourse financing. Introduce gradually a system o fperiodic accreditatiodcertification as a basis o f continual assessment o f skills, as i s the international practice. Give some additional weighthncentive for consultants and contractors to position certifiedaccreditedpersons for key positions o fthe project. 38. Adjust provisions o f standard works contracts to focus more on timely achievement o f results: Some key actions that the Government and the industry can take to improve the business climate and profitability for the industryare to: 8 inculcate self-regulation inthe industrythrough industryassociations; increase delegation o f powers to project-level officers to be able to take decisions required by the contract and comply with dispute resolutionboard awards; introduce price escalation clauses inall contracts o f more than three months, linkmgprice increases to more realistic cost indices; and strengthen supply chain by development o f specialist regional sub-contractors, equipment banks etc. Long-TermActions (5 -10years) Inthe longterm, the Government should continue to widen the ambit o freform inthe road sector and implement policies launched in the short and medium terms, by implementing wherever feasible, appropriate actions (as recommended by the specialist services) for the unbundling o f state road agencies, promoting the sector overseas, and setting up more specialized training centers. Suggestionfor TakingForwardthe Recommendationsof This Study The Planning CommissionDepartment o f Economic Affairs could set up a steering committee/workmg group/task force to assess the recommendations o f this study and other similar studies, workshops and conferences, and secure high-level stakeholder commitment and ownership o f the action plan. The task force's terms o f reference would be to look into the detailed recommendation matrix in Chapter 7 and undertake actions which could result in quick wins in the short term and subsequently tackle the difficult ones over the medium to long term. The time duration for this review could be about two months. After the finalization o f the action plan a series o f virtual workshops could be conducted usingthe Bank's Global Development Learning Network with access to the National Informatics Centre Network in the capitals o f states known for innovation, such as Andhra Pradesh, Gujarat, Karnataka and Uttar Pradesh. PossibleAreas ForWorldBank's FutureAssistance The Bank could assist and advise the Government and the industry and work with them in taking forward the findings o fthe study through the following possible interventions: (a) Incorporating some o f the recommendations in the design o f future Bank-funded projects - long- term contracts, creating autonomous road corporations, independent road boards, supporting PPP, etc. (b) Continuing to pursue some o f the study recommendations and reform initiatives through the proposed study / note on `investment climate in the construction industry' requested by Ministry o f Commerce and Industries, Government o f India (c) Helping the central and state governments inimproving governance through advising and helping in such areas as the implementationo f e-governance/procurement, disclosures to comply with the Right to InformationAct, and setting up vendor databaseson qualifications and performance. (d) Facilitating international knowledge transfer and help --especially in key institutional areas like management and financing o froadnetwork assets-- through overseas knowledge sharing trips. (e) Assisting, if required, in piloting the transition from fully government road departments like public works departments to autonomous organizations, by creating public sector undertakmgs which can compete in the domestic market -an experience which has been successfully tried out in countries such as China and the UK. (f) Training and sharing experience in state-of-the-art and best practices in the field of engineering and research --key areas could be new materials, survey techniques like aerial photogrammetry, new geodetic systems, latest construction techniques, value engineering methods, and road safety audits. (g) Assisting, through technical and advisory services, to study some o f the recommendations ingreater depth and in implementing the suggested actions --inareas such as human resources development, equipment pooling and management and management o f scarce natural aggregates. 9 2. Introduction 2.1 Context 1. Against the backdrop o f India's burgeoning macro-economic prospects, the weaknesses o f the road construction industrycreate monumental challenges that it will have to overcome, ifit i s to deliver the desired road development program. This chapter explains why the study was undertaken, its objective and methodology. 2.2 Macro Economic Perspective 2. There has been consistent growth in the Indian economy in the recent past. Untilthe mid-eighties it was growing at about 3% per year. Later, due to liberalized policies adopted by the GO1and partial demolition o f the License Regime (also called License Raj), the economy started looking up and averaged a growth rate o f 5.5% at the beginning of the 2IStcentury. The Indian economy stood at about US$5 10 billion in 2002. Inthe past four years, the GDP growth has hovered around 7-8% and in2006 GDP reachedabout $950 billion. It is expected that duringthe 11' Planperiod (2007-2012) the growth rate may be about 9% p.a. It is well recognized that without investments in energy, water, urban and transport infrastructure it will not be possible to support the present rate o f economic growth. Passenger mobility and goods movements are expected to continue growing at least as fast as the economy as a whole. Focus i s therefore shifting towards infrastructure development, including investments intransport with a view to providingfaster and safer transport services. The investments needed in the various infrastructure sectors have been estimated by workmg groups set up by the Planning Commission for the 1Ith Five-Year Plan and other sources like vision plans and sector demand notes, as well as rating and research agencies. These estimates are brought together inTable 2.1: Totalinvestmentrequired 13,500-17,800 307-405 3. According to recent news items and other sources, to accelerate GDP growth from 7% per year (as in the 10* Plan) to 9% per year (in the ll*Plan), total investment will need to be raised by six percentage points o f GDP. About halfo f this will needto be ininfrastructure: road, rail, air and water transport, power generation, transmission and distribution, telecommunications, water supply, irrigation and storage. Investment in such infrastructure will need to increase from 4.6% o f GDP to around 8% inthe 1lth Plan period, totaling as much as $500 billion over the five years. Within this total, roads will need $75-90 billion, almost all in civil works. The success o f the road investments will dependvery much on the capacity o fthe construction industry. PradhanMantriGramSadak Yojana, the PrimeMinister'sRuralRoadsProgram 10 2.3 Demandfor Roadsis Outstrippingthe Supply 4. Freight traffic (in ton-km) on India's roads i s growing at 13% per year, faster than on the railways (9%)'. Roads now carry about 8045% o f India's passenger traffic and 65-70% o f freight. Passenger traffic is not growing quite as fast, so road traffic as a whole i s growing at 7-10% per year. Such rapid traffic growth has far outstripped the capacity increase o f the main road network, resulting in about 2530% o f national and state highways being heavily congested, with truck speeds hovering about 25-40 km/h. It i s estimated that the average daily distance covered by a truck in India i s about 300 km, far less than the world average o f 600-700 km. This under-utilization of the freight traffic potential on the Indianroads i s partly due to poor roads and unsafe conditions. Other reasons include: (i) mixingonthesameroadsofhigh-speedmodemvehiclesandslow-moving,low-poweredfarm the vehicles as well as animal-hauled carts and pedestrians; (ii) poor maintenance and overloading o f vehicles by the owners; (iii) physical barriers at state and city boundaries for checking and security purposes; and (iv) delays at the terminal points. It will become difficult to sustain the present rate o f economic growth unless immediate action i s taken to provide a good quality roadnetwork throughout the country. There i s an urgent need to construct more roads, increase the carrying capacity o f the existing road network, and improve the quality o f the riding surface. This would mean integrated development o f road networks including National and State Highways, Major District Roads and Other District Roads. In addition, the Rural Roads also have to be constructed as a priority. This would take care o f total transportation from the sources o f production to the marketing points or the export points like the ports. 2.4 Government's Initiatives andRoadsDevelopmentProgram 5. The GO1i s aware o f the urgent need to develop the infrastructure in all sectors, including transport. Investments on roads as a percentage o f total public sector investments declined in successive Plan periods from 7.5% during the Second Plan (1956-61) to about 3% during the Seventh (1985-90). Duringthe EighthFive-Year Plan (1991-96) again 3% o f the Plantotal was spent onroads (Rs. 161 billion), while under the NinthPlan (1997-2002) expenditures on roads picked up to Rs.393 billion (4.6% o fthe Plantotal). 6. The Tenth Five-Year plan (2002-07) stressed the need for improving mobility and easy accessibility; it envisagedbalanced development o f the total roadnetw o f deficiencies inthe existing network, widening and strengthening, improvement, rehabilitation and reconstruction o f weak or dilapidated bridges, adequate maintenance o f the roads, and road safety measures. It also laid stress on improving the riding quality o f the existing national highways and for providing wayside amenities to road users. The national highways make up only 2% o f the network's length but carry 40% o f its traffic. The Bank- supported first and second national highway development projects (NHDP) were launched. The PMGSY program for rural roads was also taken up. Ithas recently been expanded to achieve the Bharat Nirmantarget o f connecting communities o f more than a thousand people (500+ for hilly and tribal areas) with all-weather roads by 2009-10. Inall, the 10thFive-Year Plan provided Rs.595 billion for the road sector, 3.9% of the total Plan expenditure. In2007, roads account for a significant 12%of total government capital expenditure. 'Asper IndianRoadTransport FederationandIndianRailwaysstatistics 11 7. The Approach paper to the 11th Plan suggests a total investment o f Rs.14,500 billion on infrastructure, o f which Rs.2,200 billion (nearly $50 billion) are for roads alone (about 1-1.2% o f GDP). The 1lthPlan is yet to be published; exact figures relating to the planned expenditure during 2007-2012 are not known. Workmg groups on various sectors have already given their recommendations. The sub-group on state roads has suggested an outlay o f Rs.1trillion. 2.5 The Current Industry Frameworkand ChallengesAhead 8. There i s a huge gap between demand and supply for improved roads. The domestic construction industry i s not geared up to meet the future demand. There is a need to bringnew players into the field, both domestic as well as foreign. Duringthe five-year period 2000-2005, o f the Rs.937 billion allocated for roads (all categories) only Rs.814 billion was spent, leaving 13% o fthe budget unspent. Large time over-runs and cost over-runs are endemic inbothnational highway and state roadprojects. This is a major drag on efficiency. Projects are getting larger. The technology i s changing fast. New projects require complex design and execution capabilities. There is, therefore, an urgent need to address these issues. 9. The overall Indian construction industry, o f which the road construction industryi s a subset, i s highly unorganized. There i s no national record o f the number o f contractors, their background or capabilities. The present capability o f delivery o f India's construction industry i s estimated at Rs. 3,100' billion ($70 billion) per year. This works out to 12% o f GDP. It i s estimated that approximately 250,000 contractors provide employment to about 31 million personsg (about 10% o f the total work force) directly or indirectly. There i s an urgent need to build the capabilities o f the contractors and workers. There has been a perceptible capacity building and growth o f medium and small contractors in the past few years. The trend for large contractors, however, has remained somewhat unpredictable. Of the above numbers, it i s reported that only about 25,000-30,000 firms form part o f the formal sector, o f which about 800-1,000 firms can be called medium to large in employment terms, i.e. they employ more than 200 persons. 10. The construction companies inIndia are buildingup gradually. A decade ago only 22 companies were qualified to work on medium-sized road construction projects. The number has gone up since then. On nationalhighway projects and big state highway projects under way, about 60 contractors, Indian and foreign, are working. Many formjoint ventures (JVs) and consortia among themselves to take up all medium to large contracts inthe country, with insufficient capacity to handle them. This is clearly visible from the delays and cost over-runs inprojects. Poor quality i s also witnessed insome cases. 11. Though the relevant legal framework in the country i s reasonably sound, there i s a long felt need to streamline the system in order to more expeditiously respond to the ever increasing demands on the judiciary. The construction industry operates under a large number o f civil laws and this needs simplification. In several foreign countries (for example Singapore and China) there i s a single construction law governing the industry. There i s already a move to bring in a construction law in India also. Dispute resolution mechanisms need to be strengthened, as the intermediate mechanisms (like dispute resolution boards or adjudicators) are virtually ineffective and almost all disputes are referred to the courts, with resolutiontaking three to five years. 12. The present contract procedures andrequirements needmajor modifications, as they do not encourage incorporation o f technological, labor and other major innovations. It i s estimated that the total cost of Reportofthe WorkingGroup on Constructionfor the 1lth Year Plan(2007-12) Five "ConstructionSector Suggestions for FasterImplementationof Infrastructure (2007-12)" -ConstructionFederationof India 12 designs, procurement, monitoring and supervision comes to about 20% o f the cost o f the asset created (government agency and non-government costs). Also, there are loopholes in the evaluation criteria. There are quite a few issues related to contract management, worlung environment and the construction industryitself. 13. Any investment in construction leads to a spurt in the activities o f ancillary industries. Construction activities contribute to almost one third o f the projected GDP growth. As construction activity increases, it stimulates increasedoutput from the manufacturing sector and a very substantial increase in employment. It has been reported" that every rupee invested in construction causes a corresponding increase o f about Rs0.80 in the GDP as against Rs 0.20 and Rs 0.14 in the fields o f agriculture andmanufacturing. 14. Contractors, reportedly, make a muchsmaller profit than those inreal estate, hydropower or industrial sectors. The profit marginsneedto be pushed up to attract more contractors to the road sector. 2.6 Driver and Objectivesof the Study 15. The road construction industry i s a major player in the process o f India's infrastructure development and yet it i s fraught with problems, as outlined above. Even though there has been some increase in the number o f contractors in the road sector, there still i s an acute shortage o f contractors to handle the enormous amount o f work required to be done. There i s a possibility o f some road contractors shifting to other lucrative sectors like real estate development, airports, ports, and oil and gas pipelines. The Government and the Planning Commission need to view the capacity o f the road construction industry as a major risk to the achievement o f the national developmental and economic agenda. To this end, the Bankhas highlighted these issues time and again, and discussed them with the GO1during the periodic portfolio reviews. Later, with the consent o f GOI, this study has been undertaken by the Bank to look into what could be done to improve the prevailing situation in the road construction industry. This will, hopefully, help the country and the associated funding and implementing agencies to be aware o f the risks and to adopt mitigating measures. The present study, built on the previous studies and reports as well as industry-widestakeholder surveys, attempts to more comprehensively capture the whole gamut o f problems plaguing the construction industry and the capacity constraints faced inthe industry.It puts forward recommendations and suggested actions to the central and state governments and to the road construction industry for enhancing its capacity and efficiency. 16. This study also reflects the Bank's growing concern, not only in India but elsewhere in the South Asia and Africa regions, to understand the level o f dependence o f planned investments in the roads sector on the road construction industry capacity. There i s also an urgent need to update the Bank's knowledge on the construction industry issues in India, as the last report produced by Bank titled the "Construction Industryin Development: Issues and Options" dates back to 1999. Further, there i s an emerging interest from other countries in the region (e.g. Pakistan) and some other countries in the Middle East and Africa regions to undertake similar studies on construction industry capacity and constraints. The current study would serve as a model. 17. The objective o f this study has been to answer the main question "How to have a vibrant and strong road construction industry to meet India's needs in the near to medium-term future?" Its main focus i s on delivery o f works contracts, i.e. contractors, manpower, materials, equipment and any other important related factors. The study's ultimate goal has been to examine and recommend lo "Challenges before ConstructionIndustry inIndia" -Laskar andMurty,IIT Kanpur. 13 measures through which GO1 and various stake holders could strengthen the road construction industryto meet the future demands by garnering more resources in terms o f contractors, manpower, equipment, materials, and finance, while improving the business environment. Barriers to entry have also been investigated and recommendations made to ease them, to encourage enhanced entry o f contractors from outside the country and from other sectors. Ways have also been explored to enhance the efficiency o f service delivery by adopting more efficient contractingpractices. 2.7 Study Methodology 18. It was decided to achieve the above objectives in a phased manner through this study and possible follow-on studies. This study was split into two stages. 19. In the first stage, based on the investment needs and projections of the Government under three different scenarios, the consequent demand on the key factors was determined. Operational aspects, resource gaps and investment climate issues have then been identified. The analyses were based mainly on data collected through questionnaires, interviews and focused discussions with some o f the key agencies involved in the road sector development i.e. the Ministry o f Shipping, Road Transport and Highways (MoSRTH), National Highway Authority o f India (NHAI), some o f the state public works departments (PWDs) or equivalent road agencies, rural road agencies at the center and state levels, contractors, consultants, equipment manufacturers, material suppliers, and industry associations. Through such data collection and analyses, an assessment has been made o f the increases in demand on the road construction industry, critical issues and constraints affecting the investment climate in this sector, and capacity enhancement o f the industry to meet the increased demand. 20. Inthe second stage, data were gathered on the actual experience and perceptions of international contractors, consultants and industry associations by engaging two international specialists --one providing inputs from the European market (France, Italy and UK) and the other from comparator countries in South East Asia and the Far East (China and Malaysia). Overall, the primary surveys covered 145 road construction industryentities, representing the entire gamut o f industrysegments as presentedinthe table below. Table ted I BOTConcessionaires I 4 1 5 1 H. I FinancialInstitutions 7 7 Total 87 55 142 21. To further strengthen the understanding o f these complex issues, case studies were undertaken intwo comparator countries (China and Malaysia) and one developed country (France) to assess how the country and the industry overcame various challenges in a period o f rapid growth and transition. The international case studies are presented inChapter 6 and form a basis for study recommendations. 14 22. A stakeholder workshop was conducted on the June 13, 2007. Senior officials o f the GOI, state governments, contractors, industry associations, consultants, equipment manufacturers and material suppliers took part inthis workshop and expressed their views. 23. The participants suggested broad actions and recommendations synthesizing the analyses o f the primary and the secondary data, with due importance to the views o f GO1representatives and other industry stakeholders. The recommendations were categorized into procurement, contract administration and management, tax simplification, financing and equipment leasing and other business environment aspects. The international consultants presented the three country case studies (China, Malaysia and France) and, from their experience in policy formulation for the industry, offered advice on the institutional and corporate culture aspects o f doing business in India and the comparator countries. The above process also helpedinhighlightingthe key areas for further in-depth investigation. 24. The Bank could, if required, further help in facilitating knowledge sharing trips to countries where some o f the recommendations o f this study have been implemented successfully. GO1 could then, based on the recommendations and the shared experience, finally decide to implement the critical actions which it feels merit priority. 15 3. PastPerformanceofRoadConstructionIndustry 3.1 Context 1. This chapter reviews the investment trends and the gap between the budget allocations and actual expenditures in the road sector over the past five years; assesses the construction industry'sresponse inmeetingthe past demands; and analyses the supply constraints faced bythe industry.This analysis provides the necessary basis for: (a) identifying the key operational issues/constraints inhibiting construction industry capacity at present and likely to continue in the foreseeable future; and (b) demand forecasts over the medium term. Some efforts made by the Government and the industry associations are also highlighted. 3.2 Analysisof the PastDemand 3.2.1 Comparison of budget allocations and actual expenditure in the past 2. Budget allocation and expenditure data were collected for the period FY01-05 for all categories o f roads (i.e. national highways, state roads and rural roads). The annual budget allocation and expenditure trend during this period was established for national hghways (executed under NHAI, MoSRTH and the Border Roads Organization), state highways (executed under state governments, data collected fi-om the PlanningCommission) and rural roads (executed under PMGSY, the National Bank o f Apculture and Rural Development, and states' own programs). The allocation/expenditure gap analysis shows that spending always fell short o f allocations for all categories o f roads during FYO1-05.At an aggregate level (national highways, state highways andrural roads combined) the gap between annual allocations (revised estimates) and actual expenditures steadily widened from 9% to 18% over FYO1-04 but then slightly reduced to 15% in FY05. In FY05, the allocation versus expenditure gap was lowest for rural roads (about 5.8%) and highest for national highways (about 24.4%), with the state roads falling in the middle (about 12.1%). This indeed represents a worrying trend, as the Indian government's strategy i s to increase investments in national and state highways massively over the medium term. 3. Table 3.1 and Figure 3.1 below show that during the period 2000-2005 the actual expenditures on every category o f roads fell significantly short o fthe budget allocations. Table 3.1:Allocation vs. Actual Expenditure data (Rs. billion) I Fig 3.1: AilOCatiOn vs. Actual Expenditure IDTotal alloc 2000-01 200162 2002-03 2003-04 2004-05 mar ~ 3.3 Industry's responseto meetthe past demand 16 4. The construction industry's response to the demand over the past five years (FY 01-05) was analyzed inthe following areas- Monetary output / turnover 0 Distribution o f contract sizes 0 Time and cost overruns Capacity and resource base o f the contractors; and Constraints faced by the industryinimplementing the plannedprogram. 3.3.1 IndustryOutput / Turnover 5. From the analysis o f samples o f road contractors, it was noted that turnovers o f contractors o f all sizes, namely large (capable o f implementing contracts more than Rs.1,250 million, i.e. $28 million), medium (capable of implementing contracts in the range o f Rs.400 to 1,250 million), small (capable of implementing contracts in the range o f Rs.50 to 400 million) and very small (implementing contracts less than Rs.50million) grew during the FYO1-05. As evident fi-om the attached Table 3.2 below, the average annual turnover growth was better for very small contractors (about 43%) and medium-sized contractors (about 24%). Turnover of the small contractors grew at about 21% but large domestic contractors at about 4% only. The small and very small contractors grew rapidly riding on the fast-expanding PMGSY program, long-term performance-based contracts in certain states and rapidly expanding sub-contracting practices. The slow growth o f the turnover o f the large domestic contractors represents a worrying trend and this must be reversed if the construction industry i s to meet the major scaling up o f demands in the medium term. The analysis shows that the contractors' response to the increased demand over FYO1-05 has been unsatisfactory, as evident in huge performance lapses intime and cost over-runs. Contractor Sizes Year CAGR 2000-01 I 2001-02 I 2002-03 1 2003-04 I 2004-05 (%I Large domestic 1,650I 1,500 1,490 2,010 1,910 4 Mediumdomestic 520I 650 1,000 1,210 11 1,205 24 Small domestic 230 310 400 490 485 21 .Very small 90 120 190 280 370 43 3.3.2 6. Employment o f human resources and equipment owned or leased were also analyzed over the five years FY01-05 for a sample o fcontractors, stratified by size, as presented below. CAGR= Compoundannual growth rate 17 7. The growth in employment o f human resources was conspicuous across all segments o f the industry and the average compound annual growth rate was about 20%. In deployment of skilled human resources (managers, engineers and other technical support staff), the medium-size contractors registered the fastest growth rate (40%), followed by large domestic contractors (23%), small contractors (22%) and very small contractors (16%). The growthindeployment o f equipment (pavers, graders, crushers, hot-mix and batching plants, and tandem rollers) was also considerable across all segments o f the road construction industry. The small contractors registered the fastest (32%) annual average growth, followed by large domestic contractors (23%), medium contractors (21%) and very small contractors (14%). It was encouraging to note that human resources and equipment deployment have increased inthe industryto respond to the spurt in demand. However, even considering the lead and lag effect o f the resources mobilized vis-a-vis the turnover achieved (typically, about a year, for construction sector), it i s evident that the growth in turnover/financial output was not commensurate with the increased deployment o finputresources, especially for the large contractors. The contractors do not seem to have derived any benefit due to economies in scale and fell significantly short o f effective utilization o f the input resources. This can be attributed to a combination o f factors including (a) poor construction planning by the contractor and (b) implementation delays in the contract due to worlung environment related issues and contract administration issues often beyond the control o f the contractor. It i s evident from actual experience, by the frequent changing and substitution o f staff by both the contractors and the consultants at site and after award o f contracts, that there is an acute scarcity o f slulled and semi-skilled quality manpower which needs to be urgently bridged. 3.3.3 Contract Size and Framework 8. For the purpose o f this study, the contracts have been categorized in four categories: (a) Large ( > Rs.1250 million), (b) Medium (Rs.400 -1250 million), (c) Small (Rs.50 to 400 million) and (d) Very Small (CRs.50 million). Analysis o f the primary data collected from national highways, rural roads and several state highway projects indicate that during FY 01-05, the national highway works were predominantly executed through only large and medium contracts, rural road works were executed through small and very small contracts, and state highway projects were executed through a mix o f medium, small and very small contracts. Over the FY 2001-05 period, an annual average expenditure o f about Rs.50 billion funded about 75 large and 64 medium-sized contracts annually in the national highway sector; for state highways Rs.72 billion were spent annually through implementation o f about 30 medium and 500 small contracts; and the rural road program was implemented through about 4,000 small and very small contracts annually. 9. The majority o fthe contracts were traditional cash contracts except a small percentage (for NHAI and states like Gujarat, Punjab and Rajasthan) which were procured through Build, Operate, Transfer (BOT) -toll and BOT-annuity modes. All large and medium-size contracts inthe national highways and the medium-sized contracts (majority o f those were internationally funded) in the state highway sector were procured through international competitive bidding (ICB) with pre-qualification, while the small contracts inthe state highway sector were generally procured through national competitive bidding (NCB) with post-qualification. Most o f the small contracts in the states' own funded programs were procured through a two-envelope system. The small and very small contracts in the rural roads program were procured through either N C B or through local competitive bidding (limited within the states) usually following a two-envelope system. 10. For the large and medium contracts procured through international competitive bidding, the contracts were based on FDIC, and supervised by Independent Engineers. The small contracts procured through national competitive biddingwere largely based on the respective road administration's own contract document format, with the exception o f those funded by international development organizations, which followed standard bidding documents largely based on FDIC. These contracts were supervised mostly by the road administration staffthemselves. 18 Percentage Overrun CompletedContracts All Contracts (%) NHAI [overtime original estimates of (YO) + and costs] Time cost Time cost <25% 29.4 II (completed+ongoing) 55.8 10.4 II 53.7 State Govt 25-50% 15.0 40.5 9.7 31.6 50-75% 33.0 3.7 38.0 9.7 Contracts 75-100% 15.0 0.0 29.5 5.0 >loo% 7.6 0.0 12.3 0.0 12. About 56% o f the completed national and state highway contracts had cost overruns limited to 25% o f the initial contract price. An alarmingly large 40% o f completed contracts had cost overruns inthe range o f 25-50%. The cost overrun figures for the completed contracts do not include a large portion o fthe pending claims and arbitration orders. Considering that about Rs.540 billion i s currently locked in arbitration and legal proceedings for all sectors combined and the road sector could contribute about 15-20%o f that amount, the cost overrun could easily go up by another 10-15%, if even part o f the disputed amount i s released by virtue o f arbitratiodcourt orders. The cost overruns are largely on account o f poor quality o f designs, large changes in the scope o f work during implementation (often effected to placate local and political demands), price escalation on account o f delays, and an ineffective dispute resolutionsystem. 13. It is worth noting that about 80% of projects (completed + on-going) have time delays o f more than 50% while the same percentage o f contracts have cost overruns o f less than 50%. This can also be interpreted as: (i) time extensions without financial implications are higher because o f delays due to contractors' faults - poor planning, resource mobilization etc.; andor (ii) the contractors are getting squeezed into accepting large time extensions without appropriate compensationby the clients. 3.3.5 Participationof ForeignContractorsinthe Past 14. The foreign contractors started participating in NHDP contracts (and to a limited extent in state highway works) from FY 2000-01.InFY 2000-01, there were about 20 contracts inthe NHDPwhere foreign contractors participated either alone or injoint venture. The number o f contracts with foreign contractors' participation grew to about 32 in 2003-04 but started declining from then to about 11 in FY2005-06. Based on the analysis o f a limited sample o f foreign road contractors, it was also noted that their annual average turnover from Indian business annually declined by about 15% duringFY 01-05. The foreign contractors taking part were from Malaysia, Korea, China, Russia, Turkey, 19 Indonesia, Iranand some niche contractors for specializedjobs from Europe. It i s presently estimated that about a dozen foreign road contractors are operating in India, but many o f them are not bidding for new contracts. The fact that only a few foreign contractors had entered the market in India and some o f them had already left despite the sharp increase inthe demand over this period could largely be attributed to the unattractive business environment and issues such as preference given to domestic contractors duringthe biddingprocess. 15. The experience so far on the few contracts executed by foreign contractors is not encouraging. The average time overrun for a sample of NHDP contracts completed by foreign contractors was as high as 60%. A few contracts managed by foreign contractors were even terminated largely on account o f contractors' non-performance. In many joint ventures between foreign and local contractors, the foreign party was found to be completely absent duringimplementation. The foreign contractors' role in those particular joint ventures was to make the local contractors qualify for the award o f work. Foreign contractors often faced difficulties with taxation and audit procedures, dealing with subcontractors and suppliers. They also found it difficult to get adjusted to the local workmg environment and the culture o f decision making and delegation, interpretation of their contract, and application o f quality control procedures. Moreover, European contractors seem to face further constraints on cost competitiveness compared to the East Asian contractors. Foreign contractors mightbe interestedintakingup BOT schemes where they could control a larger part o fproject risks, but apparently the large international contracting firms were not ready to get involved in pure construction contracts in India, since the risks are large in number with margins which are not commensurate. 3.3.6 Migrationof ContractorsfromOther Sectorsto Roadsin Past 16. Many traditional road contractors have diversified into real estate, hydropower and industrial infrastructure, sensing growth opportunities in those sectors, but contractors traditionally engaged in other infrastructure sectors have not ventured into road construction in a big way. While some o f the large domestic irrigation and railway contractors ventured into road construction in the early and mid 90s due to similarity in the nature o f the works, many o f these contractors did not continue their engagement for long. The entry o f contractors from other sectors to the roads sector i s being inhibited by a variety of factors, among them: (a) low operating profit margins (typically 6-10% ), lower than real estate (about 20-25%) or hydropower (about 15%); (b) management o f the sector predominantly by public road administrations with weak contract administration capacity leading to delayed decision making, delayed payments and a large number o f inordinately delayed unresolved disputes, unlike some other sectors like industrial infiastructure or real estate managed by more professionally runprivate institutions or serving the public directly; and (c) more challenging logistics and elaborate contract management arrangements, as the projects are linear innature. 17. It is estimated that at present the road construction industry represents about 10-15% o f the overall construction industry in India. If the significantly scaled up demand is to be met, attracting contractors from other sectors o f infrastructure to road construction will be critically important. 3.3.7 Facilitationby Governmentto Strengthenthe RoadConstructionIndustry 18. GOI, some o fthe state governments and the other construction industry stakeholders have taken quite a few initiatives to facilitate growth and efficiency of the construction industry inrecent times. A few initiatives are outlinedbelow: (a) Private financing: GO1 is encouraging the upgrading o f main highway corridors through the public/private partnerships (PPP) approach. This would help to supplement financial resources by tapping into the private sector and funds from the market. It is also hoped that implementation on the ground will improve with full utilization o f the managerial expertise of the private 20 entrepreneurs. The model concession agreements stipulate performance-based outputs, which would help the government to shift the design risk to the concessionaires. This would be a welcome move, considering that the current experience o f the road agency getting the detailed project reports" prepared by the design consultants i s not encouraging. The PPP approach would also lend itself more to fixed cosvfixed time construction o f projects with liquidated damages for delay and bonuses for early completion, setting a good example. 100% Foreign Direct Investment (FDI) in infrastructure development: The biggest policy initiative over the past two years has been the cabinet approval for wholly foreign owned direct investment in the road sector. It i s hoped that this initiative will facilitate rapid investments in infrastructure, but the results of the policy will not become apparent for at least three to five years. Mechanism to implement Dispute Review Board (DRB) decisions: NHAI has recently set up a high-level committee to review recommendations of the DRBs which are in favor o f the contractors. It is understood that they have decided in several cases to implement such recommendations and not proceed with further arbitration. This i s a healthy trend and would give a right signal to the contracting industry. Skill upgrading of construction workers: The state governments o f Madhya Pradesh, Rajasthan, Haryana and Bihar have cooperated with the Construction IndustryDevelopment Council (CIDC) to enhance the skills o f construction workers. The workers would then be absorbed in various national and state schemes, such as the National Rural Employment Guarantee Scheme. Training centersfor construction workers: The Government o f Andhra Pradesh, with the support o f construction contractors, took a laudable initiative o f creating a National Academy o f Construction (NAC), with the objective of enhancing the slulls o f construction workers and equipment operators inthe state. The Academy also runs short and long courses on construction management. It i s a model agency worthy o f emulation by other states. Initiatives by the Construction Industry Development Council inrecent times include: Devisinga grading system for construction companies Developing common lendingnorms to facilitate financing Designingquality assurance systems and several programs for upgrading workers skills Formation o f two separate associations by CIDC: the Construction Industry Professional Development Training Association for senior and executive levels and the Construction IndustryVocational Training Association for worker and supervisory levels Setting up a separate body: the Construction Industrial Arbitration Centre in association with Singapore Instituteo f Arbitration 19. Since the preparation o f the first draft which was shared with the government in October-November, 2007, there have been a few more positive initiatives taken by the government and hence the corresponding recommendations made in the first version have been modified or deleted. A few important steps taken are - Approval o f a national policy for Rehabilitation and Resettlement (R&R) o f project affected persons in October 2007. However, the corresponding R&R Bill and amendment to the Land Acquisition Bill (1894) have yet to be enacted by the parliament. Raising the limits o f External Commercial Borrowing (ECB) for infrastructure companies from $100 million to $500 million effective September 2008. The new norms also allow the companies to pay interest on the ECB up to 4.5% above LIBOR (as against the previous ceiling of 3.5%+LIBOR). However, the capacity o f the firms to borrow in outside markets would clearly depend on their rating and the risk perspectives o f doing business inIndia. Standard Indian requirement for a detailed design and engineering report, which includes the social and environmental assessments and all data for estimating the project costs 21 (c) Scrapping the requirements o f upper limits to number o f bidders for PPP projects and concessions. All bidders who meet the minimumqualifying criteria can bid. However, since they are still to be pre-qualifiedthe fear o f cartelization and collusion remain. 20. The above initiatives o fthe Government and the industry are laudable, but there i s a needto speed up their implementation. Moreover, the PPP mode o f road project delivery would help as far as re- distribution o f risks i s concerned, but the actual delivery o f the road works will still depend on the capacity ofthe construction industry int h s sector. 22 . 4. Key issuesfor the RoadConstructionIndustry 4.1 Context 1. This chapter analyses the key issues and constraints faced by the construction industryin the past and likely to continue in future based on the primary surveys o f the stakeholders. The findings form the basis for malung recommendations which GO1 and the stakeholders could adopt to improve the overall efficiency o f the construction sector and satisfactorily meet the projected upsurge indemand. 4.2 Key Issues identified through the Primary Surveys 4.2.1 Issuesidentifiedon inputresourcesandoperationalaspects 2. Fifteen state road authorities, 24 large, medium and small contractors and six consultants were interviewed to assess their perceptions about the key issues and constraints faced by the construction industry in efficient delivery o f the road infrastructure development program inthe past and likely to continue in future. Tables 4.1 and 4.2 (Fig 4.1A and B) below present the severity o f constraints as seen by the contractors and the road agencies indescending order of impact. Table4.1: ConstraintsIdentifiedby Contra tors r Constraints identi led b the contractors Severity I Fig4.1 A: Constraints identifiedby Parameters considered im act jI 16% Delav inhanding over of site 15% 14% ; p 12% P 10% 8% ILL.E 6% ~ 4% 2% 0% Constraints Procurement o f critical materials Table4.2: ConstraintsIdentifiedby Road Fig4.1 0:Constraints identifiedby road Agencies I aaencies Severity Constraints identified by road agencies of Parameters considered ImDact Delay inhanding over of the site I 17% N o n availability of qualified contractors I 15% I Constraints 23 3. As evident from the above analyses, both the contractors and the road agencies have identified the delays in handing over o f the sites (due to delayed pre-construction activities) and delayed decision mahng by the Engineer/Employer as the two most critical issues. Non-availability of experienced staff, delays in allocation o f funds and release o f payments and poor quality o f designs and drawings also feature in the top critical issues and constraints. The constraints can be clubbed into three categories o f (a) pre-construction activities attributable to the employer; (b) other constraints attributable to the Employer/ Engineer; and (c) constraints attributable to the contractors. Based on the discussiodinterviews with the contractors and state road agencies, the range o f severity o f impacts attributable to the above three categories are 27-55%, 12-22% and 33-51% respectively. From a thematic point o f view the most critical constraints perceived by the contractors and road agencies are: (a) design, pre-construction, decision making/approval, timely payments and other project implementation issues; (b) non-availability o f slulled personnel and frequent staff migration/tumover; (c) construction planning and resource management capacity o f the contractors; and (d) to some extent, timelyavailability o fkey construction material andequipment. 4.2.2 Issues Identifiedon BusinessEnvironment 4. A stakeholders' primary survey was conducted with 1national road agency, 2 industry associations, 4 lenders, 21 road contractors, 8 equipment manufacturers and material suppliers and 6 potential new entrants in the sector. The primary objective o f the surveys was to establish an investment climate perceptual map and ranlung, summarizing the perceptions o f various industry stakeholders on the different investment climate/business environment issues, as presentedbelow inFig4.2. Fig 4.2 Perception Matrix I Construction Developers Foreign Equipment Material Potential Companies contractors Suppliers Suppliers Entrants I Operational issues: Land, Licenses, Clearances 0 Sector Policy 8 Institutional Structure Contract enforcement B Dispute Resolution Barriers to Entry Issues Availability of skilled staff Finance cost B availability Materials cost 8 availability Taxation issues Import Procedures infrastructure issues Industry Structure Subsidies B fiscal concessions Major Constraint Minor Constraint 5. The ranlungs o f the various investment climate parameters, as presented in Table 4.3 below, clearly indicate availability o f skilled staff, operational issues (i.e. land, license and clearances, and governance) and taxation as the prime constraints. These are followed by contract enforcement and 24 dispute resolution, and material costs and availability. The barriers to entry issues and subsidies and fiscal concessions also figure relatively highinthe ranking o fperceivedconstraints. Table4.3: InvestmentClimatePerceDtualMaD andRanking Parameters Ranking Availability o f skilled staff 1 herational issues: land. licenses and clearances. eovemance 1 I Taxation issues 1 1 1 Materials cost and availability 2 Contract enforcement and dispute resolution 2 Barriers to entry 3 Subsidies and fiscal concessions 3 Finance cost and availability 4 Sector uolicv and institutional structure 5 I ImDorturocedures 1 6 1 Infrastructure issues 6 4.2.3 PerceptionsofForeignContractors,ConsultantsandEquipmentManufacturers 6. To facilitate participatiodentry o f more contractors it i s essential to look into the entry barrier and investment climate issues. Consequently it was decided to do an in-depth study on these aspects and also carry out a perception survey o f potential large contractors and other industry stakeholders from Europe (France, Italy and the UK) and to a limited extent from comparator Asian countries (China and Malaysia). The survey sample included a cross section o f large international road contractors and equipment manufacturers who already entered India, as well as internationally reputed road contractors and equipment manufacturers not yet active in India. It i s understood that the entry barrier issues and their relative impact reported by the firms already engaged in the Indian market were based more on experience, while those mentionedby the firms not yet involved were based mostly on perception. The sample size included 14 large road construction firms (5 from France, 4 from Italy and 5 from UK), 10 international consultants (5 from France, 2 from Italy and 3 from UK) and 7 large road equipment manufacturers (3 from France, 3 from Italy and 1 from UK). Twelve industry associations and institutions spread over three countries were also interviewed. About 40% o f the firms surveyed had past engagements or are presently active in India either directly or through their associates; the other 60% had never entered the Indian construction market, but many o f them are seriously exploring opportunities inthe fledgling Indianroad construction market. 8. A consolidated mapping o f the significant entry barriers for all European stakeholders combined is presented in Table 4.4 below in descending order o f impact experienced and perceived. The cultural bias in project management style (this encompasses decision making structure and culture, general apathy towards timeliness, quality, cost consciousness and innovative approaches, lack o f enforcement o f contracts and agreements, and the overall responsibility and accountability framework) was perceived as the biggest entry barrier. This was followed by poor governance and bureaucracy, and risk allocation practices and contract conditions (more applicable for BOT projects). The law and order situation and regulatory framework and bottlenecks also featured highinthe list o f barriers. The French contractors, inparticular, expressed concern with profitability and return on investments, as well as visa and travel document processing for their expatriate staff. The contractors and consultants o f Italy and UK mentioned the dispute resolution system as one of the significant entry barriers, possibly due to their earlier bad experience in India. The French construction industry did not seem to consider the dispute resolution mechanism as a significant entry barrier. Table 4.5 below breaks out the opinions o f the European stakeholders not yet active in India (based primarily on their perceptions); while Table 25 4.6 does the same for the European stakeholders previously engaged and still active in India's road construction market (based primarily o n their experience). 9. The three issues rated most critical were consistently: (a) cultural bias inproject management style, (b) poor governance, bureaucracy and corruption, and (c) risk allocation practices and contract conditions. Visa and travel documents processing followed closely. The order for the other barriers is more or less similar. Lack of information on the availability of Indian construction market opportunities was also highlighted as an entry barrier, especially by UK contractors. Table 4.4: ConsolidatedSignificantEntry1 irrierfo: Foreign takeho lers Consolidated Significant EntrvBarriers for Stakeholders France Italy UK Total 1- Culturalbias inproject managementstyles by clients/partnerz 12 3 4 19 2 Poor governance, bureaucracy, corruption - 10 4 4 18 3 - Riskallocation practices and contract conditions 9 3 4 16 4 - Law and order situation to respect/protect signed contracts 6 3 4 13 5 6 2 4 12 6 Profitability andreturn on investment (bidding opportunities) -- Regulatory framework, and bottlenecks 7 2 0 9 7 - Visa and travel documents processing for expatriates 7 2 0 9 8 - Procurement o f works by institutions (NHAI, PWD) 6 1 2 9 9 - Import / export framework, customs clearanceprocedures 7 1 0 8 10-Disputeresolution mechanism 0 3 3 6 11- Prevailing labor laws, equipment leasing practices 0 0 3 3 12- Information availability on construction market inIndia 0 0 3 3 13-Access to input resources(skilled manpower, equipment) 0 0 3 3 Total Frequencies 70 I 24 I 34 I 128 Table 4.5: PerceptionofEntryBarriersof RoadConstructionIndustryPlayersnot activein India Perception of Significant Entry Barriers France Italy U.K. Total 1 Culturalbias inproject management styles by clientdpartners 5 2 1 8 2 Poor governance, bureaucracy, corruption 4 3 1 8 3 Riskallocation practices and contract conditions --- 5 2 1 8 4 - Visa and travel document processing for expatriates 4 2 0 6 5 - Law and order situation to respect /protect signed contracts 2 2 1 5 6 - Regulatory framework andbottlenecks 2 1 1 4 7 - Procurement o fworks by institutions (NHAI, PWD) 2 1 0 3 8 - Import/export framework, customclearanceprocedures 2 1 0 3 9 - Profitability andreturn on investment (bidding opportunities) 1 1 0 2 10-Disputeresolution mechanism 0 2 0 2 11-Prevailing labor laws, equipment leasing practices 0 0 1 1 12-Information availability on construction market inIndia 0 0 1 1 13- Access to inputresources (skilled manpower, equipment) 0 0 0 0 Total Freauencies 27 17 7 51 26 Table 4.6: Experience of EntryBarriers of firms who have already worked or are presently Experience of Significant EntryBarriers France Italy U.K. I Total 1- Culturalbias inproject management styles by clients/partners 7 1 3 11 2- Poor governance, bureaucracy, corruption 6 1 3 10 3- Risk allocation practices and contract conditions 4 1 3 8 4 - Law and order situation to respectlprotectsigned contracts 4 1 3 8 5 - Regulatory framework, and bottlenecks 4 1 3 8 6 - Profitability andreturnon investment (bidding opportunities) 6 1 0 7 7 - Procurementof works by institutions (NHAI,PWD) 4 0 2 6 8 Import/export framework, custom clearance procedures - 5 0 0 5 9 - Dispute resolutionmechanism 0 1 3 4 10-Visa and travel document processingfor expatriates 3 0 0 3 11-Access to inputresources (skilled manpower, equipment) 0 0 3 3 12- Prevailing labor laws, equipment leasingpractices 0 0 2 2 13- Information availability on construction market inIndia 0 0 2 2 I I Total Freauencies 43 1 7 1 2 7 1 77 4.2.4 Experience of some Asian Contractors in India 10. Some large international contractors and industry associations fiom China and Malaysia were also interviewed in connection with the case studies undertaken in those two countries to assess their experience/ perception o f the Indian road construction market. Some o f the comments made by the contractors and industryassociations inthese two countries are reproducedbelow verbatim. 9 ProjectsinIndiaare alwaysdelayedand for manyreasons: badly prepared contract documents lack o f acquisition o frequired land badmanagement o f contract corruption technical problems 9 ProblemsinIndiahavenoresolution. 9 There is no effective dispute resolution process in India and contractors can be hurt badly financially. 9 Indianemployersrefusetoreasonablynegotiateasettlement. 9 Indianworkers have adifferentwork ethic. 9 Itis very difficult to get visas to work inIndia and it can take weeks to get one, whereas to get a visa to work inRussia takes one day. 9 After award of a contract prompt mobilization by the contractor is not possible, since the right of way i s not provided and the land has not been acquired. Insome cases, it i s not possible for the land to be acquired, so the Employer simply makes changes to the line o f the road with no additional payment for delay, or change in scope o f work. The Employer should be obligated to issue a certificate that all the land i s clear for access and has been acquired at the time o f bidding, or at least by start o f the project. 9 Tree cutting along the line of the project becomes a huge contractual issue, since the trees are considered to be in a forest reserve and special permission is required to cut each tree. The subcontractor selection process to cut the trees by the forest department i s non-transparent (involves corruption) and takes a long time. 9 InIndia top-level management may make a decision, but even this is unlikely. Lower down the chain every employer representative i s scared to make a decision because o f the risks o f accusation 27 o f corruptionor inappropriate decisions. P Contractors from Malaysia are normally management contractors who rely on a suitable infrastructure o f subcontractors, specialist contractors, material suppliers and equipment suppliers, but this infrastructure does not exist in India. So international contractors cannot assume that they can administer a project in the same way as in their home country. There are no reliable subcontractors in India and by experience one subcontractor cannot be allowed to be solely responsible for a particular activity, since there is no tendency for subcontractors to honor any contract. 4.2.5.EntryBarriersExperiencedandPerceivedby ForeignConstructionFirms 11. To sum up, the major entry barriers as perceived and experienced by large international contractors, consultants and equipment manufacturers from Europe and Asia, are: weakness o f project administration and governance, cultural insensitivity towards timeliness, quality and cost, lack o f innovative approaches, laxity incontract enforcement, and delays inpre-construction activities. 4.3 CriticalIssuesPertainingto Capacityofthe RoadConstructionIndustry 12. The common strands o f critical issues emerging out o f the primary surveys with road administrations, domestic and foreign constructiodconsultant entities, and industry associations as possible reasons for the unsatisfactory past andpresent performance were: (a) overall contract administration, contract enforcement and pre-construction activities, (b) availability of skilled workforce andresourceplanning and management capacity o fthe contractors, and (c) operational issues, overall business environment and governance. 13. The critical issues can be grouped under (a) business environment and investment climate issues; and (b) supply constraints - i.e. poor performance o f the contractors and consultants, and scarcity o f input resources, especially human resources. The remainder o f this chapter examines these inmore detail. 4.4 BusinessEnvironmentandInvestmentClimateIssues 14. Here the focus will be on (a) quality o f pre-construction activities, projectkontract management, dispute resolution and other implementation issues; and (b) investment climate and barriers to entry issues -procurement, clearances, taxation, incentives and other policyhegulatory issues. 4.4.1 Pre-constructionandImplementationIssues 15. As discussed earlier inthe report, the analysis o f the past five years' data on the gap between budget allocations and actual expenditures shows that the industry was not able to spend its full allocation and fell short by 15 to 20%. Furthermore as discussed in Chapter 3, the analysis o f past contract data reflects that about 70% o f contracts have been delayed and about 50% o f contracts suffer from cost overruns o f more than 25%. The mean delay was about 73% o f the original contract duration. About 70% of the road contractors 'capacity tied up in existing contracts could be released if contracts were completed on time. 16. These statistics raise serious concerns about the industry's existing capacity and efficiency. They call for a through analysis o f the project implementationissues affecting the delivery o f projects. These can be grouped under three categories: (i) pre-construction issues; (ii) surveying, investigations and land design issues; and (iii) construction and contract management issues. 28 17. Some o f the problems related to the design and construction issues would be minimized by adopting options such as design-build (DB), design-build-maintaidoperate (DBMO) or build-operate-transfer (BOT) contracts. Nevertheless, the items discussed below will remain o f concern for the government agencies, irrespective o f the contract delivery type used. The parameters defining the quality o f planning, design and contract management will continue to be set by the government agencies, even though the extent o f involvement may vary. The handing over o f an encumbrance-free site to the contractor/concessionaire will always be the responsibility o f the government. In fact, the role of the planning and scoping phase becomes even more critical as the contract delivery process changes from the traditional contract type to design-build (DB) and warranty contracts including BOT. 4.4.1.1Pre-construction Activities 18. Pre-construction site preparation activities include land acquisition, resettlement o f project-affected persons, tree cutting and utility relocation. Delays in carrying out the pre-construction activities have been affecting several road improvement contracts. As the site was not ready at the time of contract award, the contractors delayed their mobilization while cashing in the advance payment and did not mobilize before a year on average until there were large enough initial works on the fully unencumbered sections. Due to poor quality o f designs and outdated land revenue maps, the extent o f land acquisition i s often not properly identified during designs. Once the limit of land acquisition is transferred to the ground, additional land acquisition requirements become necessary to accommodate the design right o f way. Similarly, often the utilities (especially the underground ones) are not properly mapped and the trees to be cut are not properly demarcated on the design drawings, leading to initiation o f the identification o f such encumbrances only during the implementation stages, resulting in consequent time delays. Moreover, carrying out the pre-construction activities usually involves various levels o f government and several utility departments with cumbersome procedures, and relevant laws and regulations are usually not clear. 19. The analysis o f delays in pre-construction activities presented in this section i s based on 21 on-going and completed multi-lateral funded NHAI contracts (with an average contract duration o f 36 months) through a Bank's in-house study carried out in 2006 (draft report). However, the analysis represents the global scenario inthe country and the situation i s very similar across all categories o froad improvement projects. Itwas observed that on average about 30 months were requiredto hand over the project stretch fully encumbrance free to the contractors although these activities were plannedto be completed inan average o f 20 months. The maximum time taken at one instance was 52 months, about 40% more than the entire contract completionperiod. 20. The Employers failed in large majority o f the cases from one o f their fundamental obligations: handing over encumbrance-free land for the contractually committed first milestone section (about 30% o f the overall length) duringthe award o f the contract. Evenwhen the land was made available, encumbrances o f varying natures constrained the contractor's capacity to undertake work in a continuous unintempted manner. Such delays inpre-construction activities often led to substantial time extensions, consequent cost overruns and in some instances large contract claims on idle resources and perverse opportunities for rent seeking and unjustified compensation demands by the various stakeholders. The extent and reasons for delays for all the four main categories o f pre-construction activities are presented below. 4.4.1.2 Land Acquisition and Relocation of Displaced Persons 21. Land acquisition for highway projects is carried out in accordance with the principles laid down in either the LandAcquisition Act, 1894 or the National Highways Act, 1956 (applicable only to national highways). Insome states there are laws (like Tamil Nadu Highways Act) which are improvements on the 1894 Act. These two acts govern the acquisition o f land under eminent domain for defined public 29 purposes and compensation. To acquire the land, detailed assessments are required and plans are to be prepared to meet requirements o f these laws. The provisions inboth these acts require various stages o f notification, and time for hearing objections from the affected persons and for agreeing on appropriate compensation. Ifall due processes are followed it i s expected that land acquisition following the NHact (or some o f the improved state acts) should take about 15 months and the conventional Land Acquisition Act about 24 to 30 months, depending on the state where the land i s acquired. The long time required for the process warrants starting the acquisitionmuchearlier inthe project life, concurrent withthe project design stage. However, inreality the land acquisition plans arepreparedvery late, often towards the end o f the design phase, and the surveys by the revenue department staff are taken up only when the projects reach the bidding stage or even later. Consequently, the agencies struggle to discharge the fundamental obligation o f malung encumbrance-free land (that too only the first milestone, which is usually about 30% o f the whole stretch) available to the contractor on signing the contract. From the analysis it has been noted that the average time for land acquisition was about 21 months against 15 months originally plannedfor, as presentedbelow inFig4.3. I Fig4.3: LandAcquisition Agrred Time Frameversus Actual Time Taken - IA I0 IC Il-A ICE 11-C lllC IV-A IV-C N-D VA. VE' Vc' ABP I&It AEPIII AD0 22. There are several reasons for this delay inland acquisition, which include: P Outdatedrevenue maps form the basis for preparation o fland acquisition plans. Landrecords often exist in the form o f village maps which present the boundaries o f land parcels including public lands and roads. Details o f each land parcel are available in the form o f field measurement books marlung the exact boundaries and sizes. The maps have been preparedthrough plane table surveys. These records have often not been updated for the last thirty years. 9 The design consultants lack expertise for preparing proper land acquisition plans and ground verification o f the design or the alignment i s not carried out, due to which the plans are often not realistic. P Frequent changes in designs and alignments during implementation result in duplication of resources for land acquisition. Insome cases, discrepancies between the project coordinates and the reference frames that underlie the old revenue land maps lead to land acquisition mismatch and cause redesign o f the alignment. P The project authorities have to depend on already stretched human resources fiom the revenue departments to undertake the land surveys, as well as the shlls and influence o f non-governmental organizations to agree on the valuation and compensation for the land and structures to be acquired. The process o f surveys and registration are often simply delayed in the absence o f any urgency or incentive on the part o f the landrevenue department. 9 Inthe absence of clear guidelines on providing compensation in special cases (e.g. land owners withunclear titles or multiple owners) the process o fsettlement takes very long. 30 65 Fig 1.4: Relocation of PAPs: Agreed time frame \ s Actual time taken r 1- EO 55 Lo 50 5 E"c 43 40 35 E`p 30 25 29 01 15 rE I C 5 23. Among the project-affected persons (PAPs) the most impacted are the physically displaced households. All road improvement projects include the provision of resettlement and relocation of the physically displaced households. The relocationprocess includes: (i) identification o f land (preferably government land) for relocatingthe displaced persons (DPs) within the agreed radius; (iii) transfer o f ownership o f land to the borrower/client; (iv) development of land including marlung o f plots and provision of basic amenities; and (v) allocationo f plots to the DPs. This entire process i s usually planned to be completed over 18 to 24 months, but the analysis shows that it has taken about 28 months, as presented Fig 4.4. The reasons for the delay inresettlement can be summarized as below: (a) Delays infinalization o f alignment and corridor o f impact duringproject preparation stage; (b) List o f titleholders can only be finalized after the declaration o f award by the land acquisition office/competent authority. Since land acquisition i s often delayed, identification and finalization o f the list of DPs cannot be carried out on schedule. (c) The alternative land for relocation during the preparation stage is not firmed up. The relocation sites are often firmed up during project preparation and are developed using the road contractor's resources or employing a nominated sub-contractor. Often the facilities developed at the new site are not adequate (usually the sanitation facilities are ignored) and the affected households/communities refuse to move out, further delaying the whole process. 4.4.1.3 Utility Relocation 24. Inroad improvement contracts utility relocation is usually the employer's responsibility --with a few exceptions in recent times where the road contractors were asked to undertake these activities in a few national and state projects. The utilities are shifted under supervision o f the respective utility departments and often due to poor coordinationbetween the road administration and the various utility departments, the process o f relocation gets unduly delayed. This i s evident from the analyses presented inFigure 4.5 below, where shiftingo f electrical utilitiestook about 33 months, telephone utilities about 31 months and water utilities about 29 months on average, against the planned target o f about 18 months for all these utilities -that is, more than one whole year late. The delays for utilityrelocation are highest among all the pre-construction activities and the reasons can be summarized as: 9 Poor quality of investigations duringproject preparation and poor level of data and details, often leading to the utility agencies `discovering' utilities (especially the underground ones) during the project implementation stage; 9 Poor coordination between road agencies and utility relocation departments; road agencies have very little leverage on the utility agencies to get the works done on an urgent basis. 9 Weak capacity and financial situation of many of the state utility agencies; there are instances of utilizing the deposit money for paying utility staff salaries at the expense o f delaying the relocation process; 9 Insome cases, theroadagencies havenot acquiredmarginlandfor therelocationofutilities, which delayed the relocationprocess. 31 Fig4.5: Total UtilitiesandTime Taken for Shifting 56 1300 52 1200 58 1100 E 5 Q) v) 44 1000 40 900 0 v) + 0 p 8 sa 800 L 0 32 700 2- p .- 28 24 600 20 E =$ 500 16 12 8 200 4 0 0100 I IA IB IC Il-A ICB Il-C Ill-A Ill-C IV-A IV-B IV-C IV-D VA U3 VC ABPl ABP AD01 ADBII ADB ADBV Contract Packaaes all 111 IV Timtakenfor EPs 0TimtakwforTPs E E Z 2 Timtakwfor WPS Total EPs -Total TPs +Total WPr 4.4.1.4 Tree Cutting 25. The process o f tree cutting involves several government agencies, namely the local/district forest department, state forest department and Ministry o f Environment and Forests (MoEF). Normally in a roadproject, two lunds o f forest areas are encountered, namely. protected areas and avenue plantations. The process o f getting clearance for tree cutting in protected areas i s longer than those in avenue plantations. Inprotected areas, the steps followed are: 9 The road agency forwards an application for tree cutting in a prescribed format to the Divisional Forest Officer (DFO). 9 The DFO on receipt of the application arranges for a joint measurement survey, where a representative o f the ForestDepartment and the road agency jointly conduct the survey and arrive at a specific number o ftrees to be cut and classify the trees based on species andby girth size. 9 After ths survey, a Range Forest Officer calculates compensatory planting, the area to be diverted and the net present value, and he forwards the same to the DFO, who in turn forwards it to Chief Conservator o f Forests (CCF). The CCF after scrutiny forwards the application to MoEF. Insome states the forest departments even ask the road agencies to provide 10m wide strips all along the road for compensatory planting o ftrees. 9 MoEF then issues "in principle" clearance in a prescribed format and it goes back to the road agency following the same route. 9 After receiving the clearance from MoEF, the road agency deposits money for formal clearance from MoEF. 9 MoEFthenissuesthe formal clearance, which isroutedtotheDFOthroughthe CCF. 9 The DFOthenissuestreecuttingpermission. 26. This highly cumbersome process o f cutting trees takes anywhere between one to three years to be completed. The delays are often exacerbated by the poor quality o f design, requiring re-enumeration o f trees and re-classification o f foresutrees during project implementation and the road agency engineer's abdication o f responsibilities to facilitate the process. Moreover, although a resettlement implementation plan i s prepared in many projects, implementation plans for utilityrelocation and tree cutting are often not prepared during the project preparation stage and are left to the contractor to manage during implementation. The average time taken for tree cutting is 32 months against a planned target o f about 18 months. The delays in tree cutting are a close second highest to that of utility relocationamong all pre-construction activities. 32 I Fig4.6: Tree Cutting -. Contract Packages 1 .,,.- . &Total (no.) 4.4.2 Construction and Contract Management Issues 4.4.2.1 Contract Enforcement and Decision Making 27. The contract management and enforcement environment i s very weak in the country (The Doing Business 2008 report xompiled by the World Bank group-- ranks India 120th among 178 countries). Although most o f the medium and large contracts are based on the FDIC framework, the role o f the Independent Engineer i s not clear, weak and often circumvented by the Employer, often subverting the conditions o f contract. Moreover, many o f the Employer staff and domestic supervision consultants still do not have the requisite experience in F D I C conditions o f contract, which inhibits decision malung and playing their intended roles in the contract. There i s a lack o f realization that the Government and the contractors both could benefit from speedy and timely project execution and a spirit o f `partnership' should be actively encouraged during the project implementation. There are often unclear contractual clauses, open to too many possible interpretations, which easily give rise to disputes. Many o f the contract conditions on encashment o f guarantees, defaults of contractors and employers, local taxation and price escalation are usually not understood in the same way by the contractors and the employer. For example, there are instances o f threats from the employers to encash the performance securities as a means to deter contractors from submitting claims, including legitimate interest claims on delayed payments. There i s a general lack o f understanding by the employer's staff that encashment o f bank guarantees can be invoked only if there i s a default in the contractor's obligation. Moreover, as the employer usually takes some latitude in fulfilling his obligations under the contract such as timely delivery o f land, timely decision malung on contract variations, malung timely payments, early activation o f dispute resolution mechanism, etc., his leverage in enforcing the contract gets severely diminished. 28. Lack o f decision makmg i s often a recurrent problem inthe contracts. The employer's project-in-charge (or project director) i s often not empowered to take decisions. The weak accountability framework within the road agencies promotes insensitivity to performance and quick decision malung. At the same time, there i s no immunity or protection to officials in respect o f actions taken in good faith. Hence there i s a resistance to accepting the responsibility for any decisions, recommendations or award, even if the case merits such an acceptance. This is further aggravated by the overwhelming fear of `vigilance', investigations by auditors, controllers or review agencies on the decisions taken by the responsible government officials. Such environment encourages the culture o f `passing the buck' at all stages o f decision mahng severely delaying critical decisions. Even decisions like time extension and issuing o f a variation order are inordinately delayed. There are instances when the employer took two years to decide on a 4-month time extension requested by the contractor. It i s not unusual for the contractors to refuse to take up additional works necessary for project completion in absence o f an agreed variation order, thereby causing avoidable time extension and price escalations. The employers have often been known to withhold certified payments for obscure reasons completely violating the principle of F D I C and repeatedly returning the certified invoices to the engineers and contractors seelung explanation. Further, the new version o f FDIC has changed many o f the recognized clauses and would now require further training o f the Engineer and the contractors' staff to fully understand and adequately manage the contracts. 4.4.2.2 Contract Management by Contractors and Supervision Consultants 29. Contractors' performance i s often constrained due to the dearth o f construction management slulls in the country. Lack o f skills and professional management culture affect contractors' work planning, resource and workflow management, cash flow management and the overall project management. Unfortunately, there i s a growing trend among road contractors o f underbidding to win contracts and subsequently malung up the margins through compromised quality, escalation payments on account o f delays and retum on claims. Inorder to make money out o f delays and claims, the contractors often try to exploit the Employer's and Independent Engineer's weakness incontract administration and resort to puttingup a variety o f contract claims often on frivolous grounds. Huge unnecessary correspondence generated by the contractors on potential disputes and claims results in waste o f scarce contract administration time and resources, distracts the key focus from critical issues like time and quality to fault finding and blame gaming, and strains the relationship between the contractual parties. Moreover, contractors --including reputable international firms-- exploit the weakness inthe prevailing regulatory environment on safety and environment and compromise with the workers' health, safety and environment issues, often not realizing that such compromises affect labor productivity at the site, resultingindeterioration intheir own efficiency. 30. Supervision consultants are supposed to act as Independent Engineers in the contracts based on the FDIC framework. The role o f the Engineer in most cases, however, is not clear, weak and often circumvented by the Employer violating the conditions o f contract. The supervision consultancy contracts are time based, which unfortunately creates a perverse incentive to delayed decision making, resultinginextension o f the civil works and the associated supervision consultancy contract. Moreover, many o f the consultant staff are not fully conversant with FDIC procedures and are not up to date with latest quality management techniques and emergmg technologies. Lack o f knowledge and capacity in such areas often constrains the consultants' ability to manage contracts effectively with timely and quality decision malung. Further, there are instances o f serious allegations on consultant staff for seeking rent by delaying work flow approvals (particularly the approval o f requests for inspection certificates) and colluding with contractors by approving poor quality materials and works. Sometimes, government auditors not conversant with newer forms o f contracts raise queries which make the implementingagencies over-cautious. 4.4.2.3 Claims and Disputes 3 1. Design variations during construction, delays in pre-construction activities and unrealistic contract completiondeadlines are often the cause o f disputes on road construction projects. The works contracts generally contain a dispute resolution mechanism which requires that the dispute/claim will be first referred to the Dispute Resolution Board (DRB) or Adjudicator, and then ifnot resolved, to arbitration. However, the use o f dispute resolution provisions i s defective and the parties resort to a variety o f methods to delay resolution. Often, the Capacity o f the DRB members to arrive at an acceptable verdict based on `reasoned recommendation' ina reasonable time frame i s also limited. It was observed that in 50% o f the DRB cases, the average time for reaching a decision was 8 months-whereas the prescribed time period i s 8 weeks. The DRB recommendations are not accepted in about 80% o f cases. The road administrations (employers) do not seem to have inplace an appropriate accountability framework and officials often fear vigilance and audit probes inaccepting the recommendations o f a dispute resolution board that are against the Government. The execution o f the arbitration process in India is again time- consuming, taking anywhere between 1.5 years to 3 years. Setting up the arbitration council through two mutualnominees and a mutually acceptable thirdnominee takes time. Ifthe rulingo f the arbitration 34 process i s not acceptable to one party, the case moves on to the civil court system. With the huge backlog o f cases inthe Indian courts, it i s not easy to obtain a quick decision - again it takes any time between 2 to 20 years, with an average o f 8 years. Experience shows that in many works contracts in India, the DFU3 is not established as per the requirements o f the contract. In most cases, a DRB i s not appointed until a dispute arises. The enforcement o f arbitral awards i s also a time consuming process which often leads to significant delays. It has been reported by various industry associations that about Rs.540 billion are locked indisputes on infrastructure projects inIndia. This is really a worrisome issue for the industry policy makers and can also be viewed as a potential deterrent factor for new entrants into the industry. The Bank has recently carried out a study on enhancing the effectiveness o f the dispute resolution system in construction contracts. A summary o f this study's main findings and recommendations i s presented as Annex 1to this report. 4.4.3 Investment ClimateIssues Affecting Competitiveness of the Industry 32. The preceding sections have identified various entry barriers to India's road construction industry, and problems affecting the implementation o f road projects in India. Together, these are deterring the entry o f contractors from other sectors and from other countries into India's road construction program. To help set priorities for remedial action, the competitiveness o f the road construction industry was assessedon several factors, grouped under appropriate determinants, following a standard template used for any manufacturingor infrastructure industry. The five determinants adopted for this exercise are: (a) industry competency, (b) inputs -materials, equipment, (c) workforce, (d) infrastructure and (e) government role. Each o f the determinants was then subdividedinto four to eight factors. Three ratings were used for assessing the performance o f each factor - unsatisfactory (need to immediately improve), tolerable (need to monitor and findways to improve) and satisfuctory (which can be maintained). Table 4.7 below summarizes the assessment. Table 4.7: Assessment MaDDing on ComDetitiveness Determinants Factors Performance Industry Competency Demand- Supply & capacities Unsatisfactory Financecost and availability Tolerable Industry structure andbarriers to entry Tolerable Profitability Unsatisfactory Quality and delivery system Tolerable Inputs-Material, Availability Tolerable Equipment Cost andprice trends Tolerable Importprocedures Tolerable Quality Satisfactory Taxes and duties Tolerable Workforce Availability of staff Unsatisfactory Educationand skill levels Unsatisfactorv 35 Determinants Factors Performance herational issues 1IUnsatisfactow Incentives and subsidies Law and order I Unsatisfacton, II IITolerable I I Foreign investment relatedrestrictions Tolerable 33. The competitiveness assessmenthighlightsthe following key areas for immediate improvement - 9 Industrycapacity andprofitability 9 Availability ofslulledstaff 9 Absence ofregulatory framework 9 Disputeresolution 9 Operationalissuessuchaslandacquisition, utilityrelocation, clearances, licensesandprocedures 9 Incentives andsubsidies Moreover, the cost o f funds, although assessed as Tolerable at present, may come under some pressure due to the recent upsurge indemand and hardening o f interest rates. 4.4.3.I Institutional Structure and Regulation 34. The implementing agencies discharge an all-encompassing role i.e. they are responsible for both awarding contracts and regulation. There is still no clear separation o f owner and provider functions. In the absence o f an independent oversight mechanism at either the central or state level, there i s hardly any provision to safeguard the interests o f the various stakeholders, which affects the level o f confidence o f the developers/ BOT operators inparticular to make investments and stay engaged inthe sector. The absence o f an independent body/regulator, who should be in regular communication with the industry, provide advice and support and collate and distribute relevant data connected with the industry, i s often felt. Moreover, some o f the existing regulations regarding customs and other foreign investment-related restrictions have adversely affected the industry. Further, the virtual absence o f regulation on health, safety and environment (other than trees) has also not been conducive to efficiency and growth o f the road construction industry. 35. To send the right signals to the players and balance the interests o f all stakeholders, there i s need for a fair and independent body, more in the form o f a road authorityhser board rather than a complete economic regulator (similar to telecom, energy and insurance sectors). This will act as a quasi-regulator and assume enhanced importance in view o f the emerging hopes for a publidprivate participation framework as the preferred mechanism for developing the national highway network. Inthe absence o f any independent oversightkontrol mechanism, the toll rates may be set so high as to deter many users, or without reference to the economic benefits and costs arising through externalities and social considerations. This i s all the more important keeping in mind the vulnerabilities o f public/private participation as experienced particularly in Latin America and Central Europe. 2004 to 2006). 36 billionto the infrastructuresector durino FY06. 36. The absence o f a construction law to govern the setting up and operation of construction firms, modes o f procurement, dispute resolution, legal liabilities, quality control and management, i s a big lacuna in the industry. Moreover, although the Government o f India has notified construction as an approved activity under `industrial concern' in2000, the sector has not been accorded full-fledged industry status. There i s an immediate need for transparency and increased efficiency inthe procurement o f contractors and consultants. It has been observed that there i s rampant cartelization and collusion among contractors, often with tacit support from road agency officers in providing access to bidding documents. This possibly is also acting as a barrier to entry for some o f the local small and very small contractors entering the road sector. The above paragraphs clearly point to a lack of political commitment -or a champion-- to reform policies and results, supported by incentives and penalties to shape behavior. 4.4.3.2 Cost of Funds 37. As a definite shift towards BOT contracts is envisaged in the medium term, given the need for long- term funds for such contracts, availability o f funds might become an issue, particularly so with the looming global financial crisis. According to analysis carried out under a study done for India Infrastructure Finance Corporation Limited, it i s estimated that the Indian financial system could disburse about Rs. 7,300 billion over the next five years, resulting in an infrastructure lending gap o f about Rs. 1,300 billion. T h ~ would affect the road construction industry as well as other infrastructure s sectors. 38. The working capital cycle i s typically not very long inroad construction projects (unless the contract payments are severely delayed) and not a major issue for large organized players. Besides fund-based limits, most construction companies also seek significant levels o f non-fund-based products, such as letters o f credit and performance guarantees. However, availability o f working capital is more o f a problem for smaller players. They often cannot afford to buy equipment and therefore need substantial workmg capital for renting equipment. Moreover, the increasing interest rates on workmg capital loans (current rates are around 11.5%) are likely to put pressure on the margins o f the contractors. The cost o f long-term debt has also risen significantly --from 9.25% to around 11.5% for national highway projects. Moreover, lenders lack the comfort that might be gained from a rating system o f road contractors and developers by independent accredited agencies. 4.4.3.3 TaxStructure, Incentives and Subsidies 39. The distortions o f direct and indirect taxes affect both foreign and domestic road contractors. In a nutshell, non-uniformity and multiplicity o f taxes, the high level o f taxes and duties, cumbersome tax assessment and collection procedures, and an absence o f appropriate fiscal concessions, are having a serious drag on the profitability o fthe industry. 40. Direct tuxes: Only BOT operators are now eligible for tax benefits under Section 80-IA o f the Income Tax Act, which provides for 100 percent deduction o f profits for any ten consecutive years out o f fifteen, starting from the year o f operation. Budget 2007-2008 has clarified that the construction companies claiming Section 8044 benefits will have to provide for full tax on contracting profits with retro-active effect from April 1, 2000. This would have an especially negative impact on those contractors who had been claiming 80-IA benefits for the last six years. Foreign contractors engaged in road construction are not eligble to claim tax benefits as per Section 44BBB o f the Income Tax Act, which i s applicable to foreign companies engaged in turnkey power projects. The taxable profit inthis case i s assumed to equal 10% o f the contract amount, but foreign road contractors are ineligible to pay taxes as per this simplified system. Even the domestic contractors engaged in civil construction are eligble for presumptive taxation benefit as per Section 44AD o f the income tax act (which allows for 8% o f the gross receipts paid or payable to the assessor to be treated as profit), but only if the gross 37 receipts o f the contractors do not exceed Rs.4 million. Intoday's fast emerging context o f very large- value contracts, such low limits are not justified. Further, the Section lO(23)G benefit o f tax exemption available for investments in infrastructure projects has now been done away with and there i s a request that itbe re-instated and extendedto roadprojects. 41. Indirect taxes: Among indirect taxes, the works contract tax (WCT) i s worth mentioning. It is applied on the material portion o f the contract value. Works contracts o f purely labor and services are exempt fiom WCT. WCT tax rates vary from state to state and no input tax credit i s available under WCT in general. WCT has been merged into sales tax or value added tax (VAT) inmany states. InVAT states, input credit is provided on locally purchased construction materials. However, the contractor has to adhere to very complicated compliance requirements involving maintaining books o f accounts with actual calculation o f material and labor portions in the contract. Calculation and application o f WCT i s inurgentneedofstreamlining. 42. Import beneJits: Deemed export benefits were extended to Mega Power Policy projects but not to the large national highway projects. Customs levies on road construction equipment have gradually been reduced over the years but still remain high (currently about 37%) compared to many East Asian emerging economies. The customs and excise duty exemption was only extended to internationally fundedprojects, butthe exemption requiredissuingo fproject authority certificates, which were delayed on several occasions leading to time delays inthe project. Moreover, although liberal imports o f road construction equipment and excise duty exemptions are being allowed, there seem to be some restrictions on re-sale and re-exporting o f the importedequipment. As much o f the equipment i s used in a project for only 2-3 years, this provision i s actually forcing many contractors to charge o f f the full cost o f the equipment, ultimately resulting inincreased project costs. The absence o f a good leasing or rental market for equipment may be part o f the problem 4.4.3.4 Entry barriers to road sector 43. Foreign contractors have often faced artificial barriers o f entry due to (a) stringent qualification requirements and absence o f any provision for the Indian subsidiary o f the foreign firms to be able to use the parent company's experience for getting pre-qualified; (b) absence o f a level playing field by use o f a restrictive domestic preference clause to protect the interest o f domestic contractors; (c) stringent visa and travel documentation procedures for international staffi and (d) absence o f incentives for technical innovation, efficient implementation management systems and mismatch o f the technical specifications and standards with the prevailing international standards. Domestic contractors from other sectors have also faced entry barriers due to stiff qualification requirements related to previous technical experience in the sector. In some states with poor law and order situation contractors have even alleged that they have been unable to buy the bid documents or submit the bids due to poor governance and the formation o f contractors' cartels. Moreover, it has been difficult for the medium and small contractors to move up the value chain due to the scarcity o f workmg capital finance'*. The sector being unorganized, it has not beenpossible for these smaller players to get an SME rating, which would have given them easier access to finance. 44. Inthe case of conventional works contracts, the pre-qualificationprocess when adopted seems to have increased the chances o f collusion. As a result, many firms choose not to bid, thus reducing competition. Inaddition, many Contractors have managed to circumvent the spirit o f pre-qualification by sub-contracting an excessive portion o f their contract to incapable subcontractors. In some other cases, the same parties have succeeded in getting pre-qualified through different combinations o fjoint ventures, effectively reducing the number o f active parties, as a firm can bid through one joint venture only. The prequalification process has often been time-consuming, and there has usually been a large In Chinathe interestonworkingcapitalis intherangeof45% dependingupontheratingofthe corporation, muchlowerthan India. 38 time gap between prequalificationand actual tendering, requiringelaborate updating o f prequalification data. 45. A widespread lack o f innovative approaches in construction and an aversion to adopting cost-saving cutting edge technologies and trying out unconventional innovative materials inroad construction, on a par with international standards, i s also an impediment for the industry. This was cited as one o f the reasons by some o f the international stakeholders for not entering India. The issues in research and development opportunities andrecommendations are presentedindetail inAnnex IV to this report. 4.4.3.5 Administrative/Procedural Issues -Licensing, Clearances, Governance, Law and Order 46. Setting up a business and obtaining requisite licenses for operation have always remained difficult issues inIndia with mynadpre- and post-incorporation procedures, excessive time required to complete the registration process, and many payments, both regular and irregular. These issues have also been seriously affecting the road construction industry. The delays in clearance from state and district forest officials on tree cutting, and clearance from state pollution control boards on establishment and operating the quarries and construction plants, have often contributed to considerable delays inproject implementation. Inthe absence o f a clear policy or law governing construction labor, contractors have had to manage with a large unskilled and migratory workforce, operating under poor working conditions and exploited by petty labor contractors, unprotected by any form o f social security system. These weaknesses have often contributed to low productivity. In some pockets of India the law and order situation has been poor. The contractors operating in these areas have had to pay protection money to the local mafias and to risk the life and limb o f their workers, ending up paying higher risk premiums to the insurance c~mpanies''~and further cutting into their limited profits. Inareas with poor law and order, several cases o f mining quarries being taken over by mafia gangs have been reported, which reduced the supply o f key aggregates and pushed up their price. There are instances when the contractors had to placate the wishes o f local politicians and powerful local groups by sharing their equipment and resources for free to take up local works beyond the scope o f the contract. Overall, the cumbersome administrative procedures and poor governance and law and order situation in some parts o fthe country have also been a deterrent to efficiency and growth o f the road construction industry. 47. On average about 11 steps/procedures are needed for setting up a new business in India. For a foreign company a couple more may be required. The standard requirements for a firm wishing to bid for a road contract take about 70 days, far higher than the 30 days required in South East Asia on an average for about 8 clearances. 4.4.3.6Profitability and Returns 48. Profitability and retum on capital have been an issue in this sector. Operating profit margins (6-10% typically) are considerably lower than in real estate (about 20-25%), hydropower (about 15%) and other comparable sectors o f infrastructure. These low margins can be attributed to delays in overall project implementation, inefficiencies in overall investment climate, and unhealthy competition. It i s also speculated that the low margins are usually made up through a compromise in quality, delays and through claims. Analysis o f balance sheets from a few selected construction firms in2006, showed that some mid-size road construction companies were actually destroying value (i.e. the cost o f capital was greater than the return on capital employed, or the cost o f equity was greater than the return on equity). However, it could not be ascertained whether this value erosion was exclusively on account o f road construction business, as these companies had other lines o f business too. Improving operating profit margins will be critical to attract investments and new construction companies inthis sector. Moreover, the inherent risks and low profitability o f the road construction l3Insurancecompanies charge extrapremiumof about 0.5% inareas affectedbypoor law andorder-CFI Reporton Construction Sector Suggestionsfor faster implementationof infrastructure 39 sector make compelling arguments for extending some tax breaks or other fiscal incentives to the industry and accelerating reforms inthe sector. 4.4.4 SummaryofBusinessEnvironment& InvestmentClimateIssues 49. The investment climate issues mentioned inthis chapter affect the various segments of the industry with different degrees of impact. Keeping this issue of differential impact on different segments in mind, a n effort has been made to summarize the k e y investment climate issues relevant for each stakeholder segment, as presented inTable 4.8. Table .. Withdrawal o f Section 80-IA income tax benefits and other taxation issues like TDS Section 10(23)G, andjoint venture partners being charged tax on their joint income for the project. Payment o f WCT applicable indifferent states has a cascading impact due to unavailability Construction o f input on tax credit, except in cases where inputs are purchased locally and proper companies accounts are maintained. (conventional Availability o f working capital finance a constraint, especially for smaller, unorganized contracts) players Unavailability o f import duty exemption on import o f specified equipment inmost cases Unavailability o f skilled staff at various levels Unavailability o f adequate road construction materials and price increases on steel and cement Law and order - a deterrent incertain eastern and north-east states Issues with model concession agreement: restriction on increase in tolls may limit returns from BOTprojects Serious constraints inavailability o f skilledpersonnel and semi-skilledunskilled labor Project Issues with land acquisition and obtaining encumbrance-free land Developers Ineffective dispute resolution process; role o f IndependentEngineer unclear and weak Issues with DPRquality and changes inDPRs Availability o f adequate road construction materials; price escalation not fully compensated Availability and cost o f long-term debt Entryissues: Experience o fparentcompany not counted as part o fthat o fthe Indianfirm Availability of encumbrance-free land: acts as an entry bottleneck Foreign Difficulty inobtaining visas for expatriate staff contractorst Difficulty inobtaining documentation required for substantiating international experience developers .... ................Lack of scope for innovation and rigid specifications inIndia act as a deterrent to bringing innewtechnology andknow-how. ExtendingSection44BBB benefits available for power sector to roads also Unavailability o f spare parts for equipment Pricing competition from foreign players Highimport duty onequipment sourcedfrom abroad (31-32% plus cost o ffreight) Equipment Non-uniformity o f tax rates (e.g. state sales tax, central sales tax, octroi) across states Suppliers making inter-state movement o f equipment cumbersome Some equipment (e.g. crushers) denied CENVAT benefits, as the plants are used in production o f aggregates, which is not "goods" as per current laws Availability andretention o f qualityhained manpower Absence o f any strong industry bodytassociationto protect the interests o f the industry Material Quarrying rights on aggregates; control o f mines by mafia Suppliers Issue with quality standards for steel used inroad construction Increasingprices o f key inputs such as cement, steel affect contractorstdevelopers Potential Availability o f encumbrance-free land Entrants ......... Entryissues because o fqualification criteria facing foreign and other sector contractors Skilled manpower constraint 40 4.5 SupplyConstraintsFacedbythe Industry 50. This section deals with the reasons directly attributable to contractors or consultants for delays in delivery o f works. The problems due to scarcity o f human resources have also been highlighted. The contractor's construction planning and construction management issues have also been identified as a key constraint, but it can be argued that this i s primarily on account o f poor quality o f human resources and some investment climate issues. 4.5.1 Lack of Contractors-in NumbersandCapacity 51. The road construction industry i s highly fragmented. From a sample o f listed companies, it seems that about 86%14 o f the road construction market i s dominated by a few large road construction firms (20-25 innumber). The rest o f the market is controlledby a few foreign contractors with limitedpresence in India and several thousand small to medium construction f m s . Limited participation o f foreign contractors and limited migration o f contractors from other sectors o f infrastructure did not help in widening the contracting capacity base either. There i s also an increasing trend in the industry to move up the value chain from traditional construction contracts to BOT (both annuity and toll) project operators/developers, as the BOT framework i s seen as giving the contractors more control over key risks. The project implementing agencies' increasing preference for BOT over conventional contracts (more significantly for national highways) i s also actively supporting this trend. This trend, though healthy, i s clearly creating a vacuum o f good specialist road contractors or sub-contractors who can support the bigger players and foreign contractors indelivery o f works to quality, time and budget. 52. The capacity constraint in the industry i s evident from the high time and cost overruns in recent road projects and contractors' turnover not commensurate with the input resources mobilized. The road contractors, across the spectrum, suffer from a varying degree o fpoor construction planning and project management, work methods, sequencing o f operations and effective utilization o f machinery and other input resources. The capacity constraint can be traced back inhistory. Before the late 199Os, demand was both low and unpredictable in the road construction sector, and force account was still extensively used by many state road administrations. With a few exceptions, the Construction industry was opportunistic, responding to openings as they arose. Nevertheless, while Indian contractors can try to increase their capacity, time i s needed to acquire construction management slulls and reach the level o f mechanization andproductivity neededto meet the demands o f a large road construction program. 4.5.2 ConstraintsDirectlyRelatedto RoadContractingIndustry 53. Many o f the medium-sized and a few large road construction firms are still family-owned enterprises and suffer from a serious lack o f professional management structure and culture. These contractors usuallyhave lackedthe expertise o fproject management and administration, including the right slulls to carry out proper cash flow analysis, and planning for use o f equipment and manpower. Many such contractors have runinto serious cash flow problems and use their inputsinefficiently as manpower sits idle due to lack o f equipment or vice-versa. The contractors often seem to misuse the mobilization and l4Onan analysis of25 companies available on the Capital Linedatabase, it was notedthat largecompanies (turnover >Rs.10billion) account for as much as 86% o fthe market size on the basis of turnover 41 equipment advances paid to them by diverting them to other projects and this results inmajor cash flow problems later duringthe execution o fprojects. 54. At the technical level the contractors lack staff experienced incontract execution andmanagement. Due to the late development o f the road construction industry,the construction firms have had to largely rely on fresh inexperienced civil engmeering professionals and some retired engineering professionals from the road administrations. The senior staff who have spent a large part o f their career with the road administrations have little understanding o f the intricacies o f contract management and running a construction firm, as they were mostly accustomed to the force account method o f implementation. In several projects, even large Indian contractors found it hard to mobilize and retain professional and skilled staff capable o f managing large road contracts. In the absence o f a mature supply chain, the contractors often struggled to establish their own stone crushing, hot mix and concrete batching plants and keep them effectively operational and utilized. Insome projects average utilization o f plant was as low as 40-50%. Although many contractors procured advanced construction equipment taking advantage o f exemption o f excise and customs duty (applicable for externally aided projects), the contractors did not make adequate provision for spares and inventories, and there was an acute lack o f trained operators and maintenance technicians. 55. Contractors have misused the legal option o f joint ventures (JVs). Many JVs have been formed for executing large and medium-sized contracts. From a review o f 107 on-going NHAIcontracts inMarch 2005, it was revealed that 53 (49% o f total) contracts were awarded to joint ventures. Twenty-six percent o f those involved an international contractor as the lead partner in the JV. The JVs were often formed to allow one o f the partners (in most cases the junior partner) to pre-qualify for the work, without the senior partner expecting to participate substantially in actual implementation of the works. The spirit o fjoint and several responsibility was commonly flouted, the lead partner being completely absent duringimplementation, leavingpractically all the works to the JV's minor partner(s), who lacked the capacity inmanaging and implementing such large contracts for which the JV was pre-qualified. 56. Subcontracting was also a rampant issue. Inmany cases, the contractor became a management company subcontracting nearly all works to small local firms with sometimes no experience whatsoever inroad construction. Even more serious, payments were sometimes not disbursed to subcontractors from the main contractor, leading to obstruction of project sites by subcontractor workers. Inother cases, it was the Employer who imposed on the contractor to employ specific subcontractors for parts of the works, either frustrated by slow progress o f works or other reasons. Indeed, it was also not unusual for subcontractors to work directly with the Employer, circumventing both the main contractor and the engineer. 4.5.3 ConsultantIssues:Surveying,InvestigationandDesignIssues 4.5.3.I Quality of Survey Reports and Lack of Modern Surveying Techniques 57. The topographical survey i s the most critical activity in project preparation, on which rests project execution. But the quality o f survey work is often poor, resulting in several design variations duringthe execution o f projects. In general, the basic concepts o f checking and rechecking are not adhered to. Consequently, large errors inthe survey results are passed on undetected from the design consultants to the contractors. 58. The quality o f the survey reports that summarize the vertical and horizontal survey controls is often substandard. The data from the leveling surveys and GPS surveys performed inthe design phase, which establish vertical and horizontal controls for the contractor, are poorly reported on. The report lacks information on accuracy estimates o f the produced results (coordinates and heights), units, reference system indicators, controlling reference benchmarks and control points. Use o f the GPS surveys has 42 become normal practice for horizontal controls, but information about the GPS survey method followed (i.e. the occupation time, type o f receivers, software, types o f antennas, fixed-height tripods, etc.) is not provided in the survey reports. Design consultants often sublet the survey work to the surveying companies and do not take adequate care to ensure quality control. Aerial surveys, even if feasible and o f sufficient accuracy, are never undertaken for road projects. Aerial mapping i s not possible in the security and sensitive zones. 4.5.3.2Investigations 59. Subsoil, pavement, material and hydraulic investigations, which form the basis o f good engineering design, are often carried out by semi-skdled professionals sub-contracted by the design consultants. Poor and inaccurate levels o f details often cause problems during implementation and sometimes necessitate repetition o f these activities during project implementation and consequent disputes and delays. The use o f modern and faster investigation techniques and instruments such as falling weight deflectometers, road profilometers, or nuclear density gauges, i s also very limited and constrains the designer's ability to accurately assess the materialproperties, proper treatment type and quantities. 4.5.3.3 SubstandardQuality of Design 60. The poor quality o f designs, prone to several variations during the construction, i s also one o f the reasons for delays in project delivery. In many cases, under time and cost pressures designs are not carried out and consultants fail to anticipate the field conditions with reasonable accuracy. Nor do they explore alternative designs insufficient detail to determine cost-effectiveness. 61. Inthe present (conventional) system of contract delivery- engineering, procurement and construction, the contractor and supervision consultant are left to solve problems without the benefit o f the background knowledge the design consultant had obtained through public consultation, study o f the general area and deliberation with state and local governmental officials. The design consultant may have made design decisions based on information o f which the contractor and supervision consultant i s unaware. Some way to retain the design consultant during the construction phase, as was done in the Bank-fundedstate highway projects, needs to be lookedat. 4.5.3.4 Unrealistically Low Consultant Fees 62. There i s a tendency among consultants to quote low prices, expecting to cut comers at the survey, investigations and design stages (probably to be consistent with some outdated rules o f thumb). The norm i s to limit design services, even for very complex projects, to no more than 12-18 months, sometimes leaving the consultant too little time to estimate properly the construction inputs needed without compromising on quality. The limited time and cost resources restrict consultants' ability to accurately design, innovate and apply modern techniques in the design process. Many consultants under-estimate the time needed for construction, requiringmultiple time extensions, due to ignorance or neglect o f site-specific conditions and complexities. The contract period is often dictated by the pressure on the implementing agencies to build the road in a constrained time fi-ame decided with an eye on the next election at the state or central levels. 4.5.3.5Lack of Thrust on Quality Control and Optimization of Costs 63. There appears to be no routine design review, constructability check or ground verification o f designs preparedby the consultants. The implementing agencies lack in-houseresources and capacity for design review and checks, which results in design variations during the construction and causes delays that could have been avoided. It is often observed that no efforts have been put in by the consultants to 43 optimize design. A recent design and construction review undertaken on a sample of contracts also indicates that there i s scope for improving designs inroad projects. This issue can be largely addressed by adopting a tool called "value engineering (VE)" in the design process. Value engineering i s a detailed and systematic review o f the design carried out by industry experts and selected stakeholders, which improves the quality o f design and constructability as well as reduces the life cycle cost o f the project. The concept o f VE i s well known in the highway industries o f the developed countries but i s relatively unknown in India. A detailed note on the value engineering process and its benefits is attached as ANNEX V to this report. 4.5.3.6Accountability of the ConsultingIndustry 64. There i s a general lack o f accountability and professionalism at all levels in the consulting industry. Design and supervision consultants are not held accountable for their performance; no performance management system exists in India to measure their performance. There i s also no form o f liability on the consultants for the costs incurred by the nation due to poor quality o f work rendered by them at design and supervision stages. 4.5.4 Human Resources and Skills Development Issues 65. Both the investment climate surveys and the surveys on input resources highlighted the shortages o f skilled persons as the most critical input factor for the construction industry. These shortages are prominent across all segments o f the human resources engaged in the construction industry. Although the industry has a cheap labor advantage, the fact that productivity i s lowl5 and the equipment downtime i s high is a manifestation itself o f low level o f skills even for the masons, welders, mechanics, electricians, carpenters, bar benders and machine operators. No classroom or on-the-job training courses are offered, though a system o f certification and registration is available for masons, carpenters, and electricians. Limited IndustrialTraining Institute courses are offered for some slulls like mechanics, welders and operators. The opportunity for enhancing skills for these semi-skilled professions also gets constrained due to the highlevel o f illiteracy among the construction workers and the prevailing culture o f general lack o f appreciation towards quality and good workmanship in road construction. At the other end of the spectrum, the contractors suffer from lack o f quality construction managers and planners, skilled accountants and finance managers and even sometimes experienced and average skilled construction engineers and foremen. Due to the late development o f India's road construction industry, very few engineers experienced in road construction are available in the market and the contractors have to depend largely on retired executives from the road administrations and fresh inexperienced engineering graduates. After obtaining the initial academic qualifications and degrees/diplomas there i s no system o f periodic re-evaluation o f technical personnel to validate their appropriateness for thejob. 66. Only 3% teaching in the country addresses the direct need o f the construction industry. `%Vhy? The profession o f civil engineering lost some o f its sheen in the past decades (eighties and nineties) due to evolving competition from other sectors o f engineering like electronics, telecommunications and computer science, where the entry-level emoluments have been much higher and the quality o f life better. Surprisingly, even inlast ten years while the demand for civil engineers has sharply risen due to the spurt ininfrastructure investments, the entry-level salaries for civil engineers have not significantly improved, offering young aspiring students little incentive to join this stream. Even today the more Accordingto anMIT studyquotedinthe ConstructionFederationofIndia Study on "Construction Sector Suggestionsfor Faster ImplementationofInfrastructure", againstahumanProductivityIndexof 100inthe USA, Japanis 52, Egypt 10and India apoor 3. l6 14* Engineering Congress on HumanCapita Development, January 2002, as quoted inthe paper by Laskar and Murty referredto inChapter 2. 44 talented civil engineers are migrating to IT and other more attractive services. Many o f India's mid- sized road contracting firms are family-managed firms and not professionally run.The engineers do not find adequate opportunities for advancing their careers in such family-run businesses and therefore abstain from joining them. So much so, that some engineering colleges have now discontinued their degrees in civil engmeering. Overall, the dearth o f s h l l at the senior technical and management level i s as acute as that o f the operators and semi-skilledworkers. 67. Other studies done for some specific states show that quite a proportion o f civil engineers do not get a job immediately after graduation and hence are forced to change their areas o f work. This has been attributed to: (i) an acute shortfall o f trained faculty, which results inpoor level o f s h l l s and knowledge in fresh graduates; and (ii)a large disconnect between the academic curricula and the industry requirements. 68. Increasing use o f private financing and public-private partnerships would add many challenges to the sector's knowledge gap. Skills are and will be required not only in technical designs but also inproject management, financial and legal aspects, and social and environmental aspects. The inevitable increase inprojectkontract size will addfurther complexities. While the government agencies dealing withroads will increasingly face the challenge o f rational planning, project identification and development, efficient and transparent contract procurement, administration, operation and management o f roads to give road users a good quality o f service, the contractors will be facing difficulties in getting skilled workers, equipment operators and quality construction managers. The consultants would also face shortage o f experienced and skdled personnel for design and engineering for undertalung feasibility studies, as well as preparation o f detailed project reports and for supervision o f projects during construction. 69. One of the aspects noted duringthe limited data collection process i s that the state road agencies and the rural road agencies have a much higher level o f staffing than most contractors. Are these agencies overstaffed v i s - h i s the responsibilities and work to be done inthe respective areas? This could be an area which needs to be looked at by the government with a view to re-allocating people to more useful areas. Some countries have tried this out - China, New Zealand and Shropshre county inthe UK. 70. Capacity building through training o f various stakeholders in the road sector thus leaves a lot to be desired and it i s now posing one o f the formidable challenges to meet the needs o f several ambitious programs announced by the Government. It is, therefore, imperative that the central and state governments attach highpriority to the need for training inthe highway sector. A detailed note on skill development and training issues and recommendations i s attached as Annex 111to this report. 45 5. AssessmentofDemandover the MediumTerm 5.1 Context 1. This chapter forecasts the demand likely to be generated in road construction over the medium term under three different scenarios and analyses the gap between demand and supply of critical input resources and number o f contracts/contractors in each scenario. We also keep in mind the possible marketingo f India's road sector and construction industryprogram over the next 5-8 years. 5.2 Projection of Future Demand 5.2.1 The three scenarios 2. Based on the issues and the constraints highlighted in Chapter 4, an assessment o f demand has been made for the eight-year period from 2007-08 to 2014-15. Three typical scenarios considered are: (i) Scenario 1 - Growth rate extrapolated as per achievement in the last five years (2000-01 to 2004-05), i.e. lower growth rate; (ii) states and the country; and (iii)Scenario 3 - High growth scenario incorporating the massive Scenario 2 - Medium growth scenario as per the vision documents o f the investments innationalhighways and rural roads announced by GOI. 3. For Scenario 1, the trend o f total annual road sector expenditures over five recent years (FYO1-05) was extrapolated by regression analysis. This scenario represents the likely investments based on the past growth trend and can be considered as the lower bound projection. For Scenario 2, a medium growth scenario, the expenditure projections were based on the planned projections by the various road authorities/departments and the vision documents publishedby GOI. An assumption o f 10% annual growth was made for the national highway (NH) works under MoSRTH and the Border Roads Organization (BRO), as separate planned projections were not available for these sectors. Scenario 2 represents a combination of (a) N H A I ' s own projection for NH works under its jurisdiction, (b) 10% annual growth for other NJ3works under MoSRTH, (c) 10% annual growth for NHworks under BRO, (d) state highway projection from the Vision 2021 documents, and (e) rural roads projection from the Vision 2025 document. Scenario 3, a highly optimistic scenario, incorporates (a) the massive investments in national highways to achieve accelerated growth during the 1lth Plan period by 2012, and (b) announced expenditure o f Rs. 480 billion on rural roads under "Bharat Nirman Scheme" for the period 2005-2009. For national highways under MoSRTH and BRO and for the state highways the projections under this scenario are identicalwith Scenario 2. 4. Scenario (Low Growth) Scenario I1(Medium growth) Scenario I11(High Growth) NHAI'sownprojection NHAI's accelerated growth + projection + Extrapolated from 2001-05 10% annual growthfor other NH 10% annual growth for other NH expenditure on underMOSRTH under MOSRTH National Highways (NH), + + StateHighways (SH) and 10% annual growthfor NHunder 10% annual growth for NHunder Rural Roads (RR) BRO BRO + + Vision Document 2021for SH Vision Document 2021for SH I I 46 + + Vision Document2025 for RR Bharat NirmanScheme for RRs 5.2.2 Itemscovered inDemandProjections 5. The main items for which the demand projections have been carried out are (i) monetary values o f projected expenditure for the entire road sector; (ii)distribution o f probable contract sizes being executed each year and therefore the need o f the corresponding sizes and numbers o f contractors; (iii) human resources; (iv) key road construction equipment; and (v) critical input materials like cement, bitumen, steel and aggregates. The above assessment also includes an estimate for maintenance requirements for the investment plans -though only ina very rough manner. 5.2.3 Projectionof Expenditure 6. The expenditure projections (Rs. billion) inthe sector over the period 2007-15 projectedunder the three scenarios are shown in Table 5.2 below. The first three rows o f the table give the capital works investments under the three scenarios, whereas the last three rows add inthe maintenance expenditures. For a realistic estimate o f maintenance on national highways, it has been assumed to grow annually by lo%, keeping up with the growth inthe network. For state highways, the maintenance expenses have been assumed to grow annually by 5% from the level stipulated in 12thFinance Commission Report. 7. The accelerated national highways and Bharat Nirman Program (for rural roads) are planned to be substantially completed by 2011-12. Therefore, in Scenario 3 for capital works investments, the projection beyond 2011-12 has been made to account for only some residual limited capital investments, and full maintenance investments for the assets created. The projected figures are marginally lower than Scenario 2 in 2012-15. From the analysis, it i s evident that the present level o f capital expenditures will have to be more than trebled over 2008-2011 under Scenario 3, which will indeed be a very tall order. Even under Scenario 2, the capital expenditures will be increased by about 80% from the present level duringyears 2012-15. The expenditures actually incurred during FY 2006- 07 and FY 2007-08 for national highways and rural roads have been around the Scenario 2 values predicted for these two years. Table 5.2: ProiectedCaDital Investments inthe Road Sector lbillion ruDees) Year 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 Scenario 1 199.8 204.2 208.5 212.9 217.3 221.6 226.0 230.4 Scenario 2 285.3 303.5 310.3 330.6 362.4 395.6 429.6 465.4 Scenario 3 5 16.3 667.2 777.5 881.9 840.3 400.0 400.0 400.0 I Maintrea I 70.2 I 72.8 I 75.6 I 79.7 I 84.1 I 88.7 I 93.5 I 98.6 I Sc-l+Maint 267.0 I 277.0 284.2 292.6 301.3 310.3 I 319.5 329.0 Sc-Z+Maint. I1 II II 1 355.5 I I 376.3 I II 385.9 I II 410.3 I 446.4 II I 484.3 I1 523.1 I 564.1 ~~ ~ r s c 3 + ~ a i n t 586.5 740.0 853.1 861.6 874.4 488.7 493.5 498.6 47 - I+M req 1 120,000 Fig 5.1: Monetary Requirements 100,000 E 80,000 0 ff 60,000 40,000 20,000 0 I 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 I 8. The above analysis (Fig 5.1) shows that the industry capacity will have to gear up to respond to the increased demands. The reforms in the sector need to be accelerated also to enhance the road construction industry's efficiency to meet the investment targets set by the country's planningbodies. 5.2.4 Projection on Number of Contracts 9. It is obvious that to deliver the increased capital investments the number o f contracts every year will significantly increase. Based on the past trend o f contract size mix in various categories o f road works (i.e. NH, S H and RR) the total number of contracts for all categories o f road works was projectedup to 2015, under the different scenarios. The contract sizes assumed for this analysis are large (> Rs 1,250 million, i.e. $28 million), medium (Rs 400-1250 million), small (Rs 50-400 million) and very small (< Rs 50 million). The contract sizes were kept the same as the past performance analyses for ease of comparison, although it is envisaged that with the present focus on PPP in both national and state highway sectors, the contract sizes will become larger, and inany program the mix of contracts will be skewed more towards larger contracts. The projection, presented in the table below, shows that under Scenario 2, by 2015 the average number o f large and medium contracts being executed every year will be more than double the present level and would be more than four times under Scenario 3. The total number o f contracts will grow from the present level by about 80% under Scenario 2 and 125% under Scenario 3. Table 5.3: Annual Average Numbers of Contracts of Different Sizes (2007-815) Contract sizes Scenario 1 Scenario 2 Scenario 3 Large 90 1so 400 Medium 100 250 550 Small 2,800 5,100 6,600 Very small 4,100 7,100 8,800 Total approx 7,100 approx 12,600 approx 16,400 10. Considering the present trend o f outsourcing periodic maintenance works, it i s envisaged that about 30% o fperiodic maintenance works will be procured through contracting inthe study horizon o f 2008- 14. In that case the total investments to be executed through maintenance contracts will grow from about Rs. 140,000 million ($3 billion) in 2006-07 to about Rs. 270,000 million in 2014-15. This could translate to addition o f about another 4,000-5,000 small contracts by 2014-15. The detailed input resources analyses for the maintenance contracts have been kept outside the purview o f this study, considering that there could be some freed up capacity from small contractors engaged in state highways and the rural sector to participate in such contracts by the time this concept takes root. However, the industry has to remain prepared to cater to the additional demands generated from such maintenance needs also. 48 5.2.5 Projectionon HumanResources (HR) Requirements 11. The HRprojection includes those o froad agencies at the center and state levels, the contractors and the consultants. It includes the full range o f slulled staff from engineers to surveyors and operators. The HR information furnished by the various road agencies, contractors and consultants formed the basis for projection. Since staffing needed for contractors i s closely correlated with their turnover and the road agency and consultants' supervisory manpower with the level o f investments made, our projections were made using a regression model. The results (Table 5.4) were then verified for reasonableness against the number o f contracts and the typical manpower structure for execution o f such contracts. Year 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 Scenario 1 116.5 123.5 130.5 137.5 148 158.5 169 180 Scenario 2 141 152 160 171.5 190.5 210 229 249 Scenario 3 258 319 356 382 339.5 200 200 200 12. It canbe observed (inTable 5.5) that the annual average skilled staffrequirement under Scenario 2 will be about 200,000, while under Scenario 3, the annual average requirements during the peak demand period o f 2007-2012 will be a whopping 330,000. This would represent about 30% and 120% increases respectively from Scenario 1. Skilled HR Reqd- Annual Average Scenario 1 Scenario 2 Scenario 3 Total (approx) 150,000 200,000 330,000* 5.2.6 Projectionon Key ConstructionEquipment 13. The key equipment considered for this study include items like pavers (electrical and mechanical) for bituminous and concrete pavements, hot-mix plants, concrete batching plants, motor graders, tandem rollers and crusher plants. Like human resources, it was also observed that the total major equipment requirement could be correlated with the contractors' turnover through a regression equation (R' inthe range o f 0.86 to 0.98). The projections (Table 5.6) were made individually for separate categories o f equipment and then combined to develop a total projection scenario. These numbers were then verified from the aspect o f expected average equipment usage for contracts with respect to the projectednumber o f contracts under the various scenarios. As presented in Table 5.7 below, the annual average requirement in Scenario 2 will be about 60% higher than Scenario 1. The equipment requirement in Scenario 3, over the peak period o f 2007-12, will be about 3 times Scenario 1, which would indeedbe a challenge to meet. Table 5.6: KevEauiDmentReauirements(000 units) Year 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 sc-1 27.7 28.3 28.9 29.5 30.1 30.7 31.3 31.9 sc - 2 40.5 43.4 45.0 48.5 53.3 56.8 64.0 70.0 sc-3 83.6 111.3 114.6 109.2 100.2 55.0 56.0 58.0 Key EquiptReq'd- Annual Average Scenario 1 Scenario 2 Scenario 3 Total (approx) 35.0 55.0 100.0* 49 5.2.7 Projection on Critical ConstructionMaterials 14. Requirements for critical road construction materials, i.e. bitumen, cement, steel and stone metallaggregates, were projected for the period 2007-15 under the three scenarios. The estimate was based on case studies carried out for different types of works under national highways, state highways and rural roads. The estimated material consumption was then correlated with the number and size of contracts and inturn the level o f capital investments these contracts support. The projection (Table 5.9) was based on the same rate o f growth as the capital investments. 15. The annual average key material requirements under different scenarios are presented below in Table 5.8. It i s evident that average annual material requirement under Scenario 2 will be increased by about 60-65% over Scenario 1. For Scenario 3 the annual average requirement of key construction material duringthe peak demandperiod o f2007-12 will be 2.6 to 3.2 times the `business as usual' Scenario 1. Materials Required Scenario 1 Scenario 2 Scenario 3* Stone metal 170 280 450 Bitumen 1.25 2.0 4.0 Cement 6.5 10.5 17.0 Steel 1.25 2.03 3.28 5.3 GapAnalysis 5.3.1 Number of Contracts vs. Contractors 16. Data collected from progress reports o f NHAI projects and other state highway projects show that at present approximately 200-220 medium-to-large contracts are under way (excluding contracts whose award took place less than 3 months ago, as well as contracts which are likely to finish inthe next three months). In Scenario 2, the requirement i s increasing the contract numbers to about 400 in 2007-08 to about 500 in2014-15. This calls for an immediate doubling o f contractor capacity. For Scenario 3, this 50 value goes up to about 900 contracts in 2007-08 and to about 1,100 in 2011-12. This implies that the capacity may need to be five times larger if the demands o f the accelerated program are to be met. As mentioned earlier, this range o f contracts are presently being undertaken by a pool o f about 60 contractors (national and international), who are already stretched with unsatisfactory performance levels. 17. Meeting the high demand would only be possible if many o f these large construction companies diversify into the road sector and foreign construction companies also participate in a substantial manner. This increase in demand would also offer an opportunity for innovative arrangements like hiving off independent public sector construction companies from the state road administration organizations (public works departments). Further, as more and more large BOT projects are being mooted in the road sector, in the near future the country will also need to seriously promote participation o f very large conglomerates/joint ventures to deliver contracts o f sizes above Rs. 6 billion (about $130 million). Recent press articles indicate such concessions being let out for Rs.10billion. 18. As o fnow about 6,000-6,500 small and very small contracts are beingexecuted inthe country under the state road agencies and the rural road agencies. This i s expected to substantially increase over the next 8 years by about 100% under Scenario 2 and 150% under Scenario 3. However, it i s estimated that about 27,000 such small contractors are available in the formal sector and over 250,000" small contractors, suppliers and subcontractors are engaged in various sectors o f infrastructure in India in an informal manner. It i s expected that the demands can be met if the work environment i s made more conducive and opportunities for reasonable profits can be facilitated. Many o f them could be trained to become specialist sub-contractors to provide support to the big contractors and strengthen the supply chain. Further detailed recommendations on increasing the number o f contractors are presentedinChapter 7 o f thisreport. 5.3.2 HumanResources 19. It is observed that the numbers o f shlled and semi-skilled persons working inthe road sector are still growing at a moderate pace and could only be able to cope up with Scenario 1. Surveys done show that the number o f such manpower working in the road sector at present i s about 110,000. Data miningand some realistic assumptions suggest that at present about 6,000-7,000 fresh engineers and diploma holders are joining the road sector workforce (replacing retirees from the sector). But this i s not even sufficient to even meet the annual increased requirements o f 7,500-10,000 skilled personnel under Scenario 1 over the next eight years. Under Scenario 2 this annual requirement increases from a minimum o f 10,000 to about 20,000 over the next eight years. The additional annual average requirement o f such persons, whose qualifications are a diploma and above, could be about 50,000 over the period 2007-15. The annual average peak requirement o f such skilled persons increases to about 330,000 during the next five-year plan. The annual increase under Scenario 3 increases from a minimumo fabout 25,000 to amaximum o fabout 60,000. 20. The scarcity o f human resources i s clearly visible in the road sector from the inexperienced staff available at site or retired government officers working on site. Also frequent requests for replacement o f key staff o f contractors and consultants who leave existing assignments for even slightly better emoluments are noteworthy. In order to meet such large increase in the demand, the number o f civil engineering graduates and diploma holders joining the profession after getting their degrees and diplomas should be increased at least 2-3 times by making the civil engineering profession more attractive and by substantial enhancement o f the present level o f market compensation, at least at the entry level. For meetingthe peak demand, as short-term antidotes, it would also be worth exploring the "ConstructionFederationofIndia:ConstructionSectorSuggestionsforFasterImplementationofInfrastructureinthe1lthYear Five Plan 51 opportunity o f hiring engineers from other developing countries and encouraging returning Indian expatriates to participate inthe expanding road construction program (reverse the brain drain). Further detailed recommendations on enhancement o f human resources are presentedinChapter 7. 5.3.3 Key ConstructionEquipment 21. Due to the import incentives being given to contractors and developers, the critical equipment pool available has improved considerably and can be said to be between the needs o f Scenarios 1 and 2. To satisfy the average demand for equipment over the next eight years under Scenario 2, the supply o f major equipment needs to be increased by about 60% from the Scenario 1 base case. Likewise, the average peak demand under Scenario 3 during the coming five-year plan would warrant an almost three-fold increase over Scenario 1inthe supply o f major equipment. 22. Considering the present capacity o f domestic equipment manufacturers, it would be imperative to provide a major boost to their production capacity and also streamline the equipment import procedures to meet such high demands. As enabling measures, it would be essential to encourage the equipment rental market, provide fillip to equipment bank and leasing concepts, promoting setting up o f an efficient supply chain industry for equipment spare parts and improved operator/technician training. Detailedrecommendations to bridge the demand supply are presentedinChapter 7. 23. Another point which needs to be borne inmindand which has been observed duringthe Bank missions, i s the long downtime whenever equipment breaks down. This i s either due to the non-availability o f critical spare parts or the need to fly down the technical support team from abroad or from the regional center. This downtime varies from 15 days to 2 months. The after-sales service and spares could be franchised out to local Indian firms by the international manufacturers to minimize delays due to repairs. 5.3.4 Key Construction Materials 24. A demand-supply gap analysis o fkey construction materials (aggregates, bitumen, cement and steel) is presented inTable 5.10 below. Table 5.10: Materials Neededfor Road Construction I PlannedcaDacitv I Naturallvoccurrin~ I 6.37 I 255 88 I MaximumReqd. (approx) I 550-600 I 4.6-5.2 I 18-20 II 5 I 25. Cement, steel and bitumen are commercially available materials, while the aggregates are naturally occurring. Of the above, except bitumen, there are competing demands from other sectors for these materials. It would be prudent to carry out the demand analysis for commercially available construction materials keeping in mind the total planned capacity o f such materials in the medium term. The road sector represents only a small percentage o f the cement and steel requirements for the overall infrastructure activities inthe country. However, the maximum annual average peak demand o fbitumen would be close to the planned installed capacity and it mightbe necessary to import bitumen from time to time to meet the peak demands, often bunched during the pre-monsoon and the post monsoon dry months o f the year. This is also because, as part o f our analyses, we have not fully taken account of the maintenance requirements. Stone extraction and aggregate production is already facing constraints due to (a) restrictions on quarrying in certain parts o f the country due to stringent mininglquanying regulations and increasing awareness on health and safety issues o f quarry workers, and (b) under utilization o f the crushing plants partly due to weak supply chain management, poor maintenance and 52 upkeep o f the machineries and increasing local protests on quarrying around the habitation and work areas. Unless these issues are dealt appropriately and timely, increasing the present aggregate productionto two to three fold will be a remotepossibility. 26. Bureau o f Indian Standards certification requirement o f foreign cement plants under the Cement Quality Control Act may cause some artificial restrictions to cement import when there i s an increase in demand. This needs to be looked into so as to reduce any artificial barriers to cement import and to introduce an element o f competition. The option o f innovative pavement design (e.g. use o f cement stabilization techniques or in-situ ground improvement techniques to reduce the thickness o f granular pavement layers) needs to be seriously explored to achieve reduction inquantity o f stone aggregates. If the availability o f cement i s eased, it would also make eminent sense to look at cement concrete options at state, urbanandrural road levels along with concepts like white-topping. 53 6. Experience on Evolution of the Industry 6.1 Context 1. As part o f the study to identify ways that could help strengthen the capacity o f the Indian highway construction industry, two developing countries that have experienced recognized success in the development o f their own highway networks were selected as case studies to determine how the network development was achieved. The objectives o fthe case studies were to: (a) understandhow the highway network was developed, (b) understand how the highway construction industries inthe selected countries have strengthened their capacity to meet the requirements o f their governments' highway network expansion plans, and (c) identify what measures were taken by the governments and the industryitself. 2. The case studies provide a list o f lessons learned that may be useful for India to consider as it implements its highway development plans. Similarly a developed country, France, which had undergone considerable reforms inthe road construction sector during the last decade, was selected to identify ways in which the Government provided support to the industry.It did so by strengthening its concession framework, improving infrastructure financing arrangements, streamlining contract administration and enhancing its quality management fi-amework. The industry has responded by adopting innovative technology and management measures, grown in size and capacity through mergers and acquisition, and proactively managed the human resources and slulls challenges. All these reform measures bear significant relevance for India and are immensely useful lessons to learn from. Further, best practices from one Indian state, Gujarat, were also studied to understand how the highway Construction industry has performed more efficiently in that state, achieving quality output with minimal time and cost overruns and contractual disputes. 6.2 Selectionof Countries 3. As comparator developing countries, initially four countries were considered as candidates China, Korea, Malaysia and Vietnam. The final selection was China and Malaysia. China was selected due to its similar size and population to India and because it has demonstrated that it has the capacity to be able to achieve the fastest development o f an integrated highway network in the world. Malaysia was chosen since it has earned itself the reputation o f creating the best expressway network in Southeast Asia and has based the network on the principles o f BOT. The full case study is attached to this report as ANNEX 11. 4. As a developed country comparator, France was a natural choice as the French road construction industry has experienced substantial growth over the last decade and i s globally ranked as the second major exporter, after the United States, interms o fturnover abroad. France i s also home to two top road contracting firms in Europe and has a long-standing tie with India in technology transfer and business delegation exchanges in the road construction sector. Further, France has recently embarked on a serious effort to improve its PPP framework to be more competitive in the larger European Union construction market and the industry itself has undergone substantial reform to adopt innovative technology and management culture and to improve its human capital. 6.3 ChinaCase Study 6.3.1 History of Highway Development 54 5. According to the China Highway Construction Association, the expansion o f the road networks in China has dramatically increased from 0.9 million km in 1978 to 1.7 million km in 2000 and to 3.45 million km in 2006. These figures include expressways, all classes of roads and all unclassifiedroads down to and including, village level. From 1990 to 2006 duringthe period of the eighth, ninthand tenth Five-year Plans, China completed nearly 45,000 km of high-grade toll expressways through the investment o f upwards o f US$40 billion per year. This unprecedented expansion in the expressway network was accompanied by continuing development o f intermediate Class Iand I1roads under the coordinated efforts o f the national government and the governments o f China's 31 provinces and municipalities. No other country has been able to create such a major enhancement to its national road asset base in such a short period. In the initial planning days the traffic use o f roads was very mixed with animal driven carts, cycles, tractors and trucks, resulting in an overall low efficiency. As the master plan was developed, the main deciding factor was not how it would be funded, but what type o f road and what type o f network was needed. After the decision on the type o f roads had been established, the way to raise funds was analyzed and ultimately appropriate financial policies were introduced. 6. The expressway program started gradually from 1988 to 1997, when approximately 10,000 km were completed through the construction o f eight sections o f expressways. After gaining considerable experience the Chinese highway industry was capable o f achieving the rapid development which occurred between 1998 and the present, when nearly 45,000 km of expressways were completed. In 1992 the State Council issued the "5 - 7" Expressway Trunk Highway Network Plan, which was designed to connect all the major cities and provincial capitals with populations greater than 500,000 by the construction o f 12 major expressways - five vertically (north-south) and seven horizontally (east- west). In 2005 the central government revised this plan with the "7-9-18" Expressway Trunk Development Plan. This expanded the initial "5-7" plan to have expressways linking all provincial capitals and all the large and medium-sized cities with populations of more than 200,000. This was to be achieved by the construction o f seven vertical, nine horizontal and 18 expressways linkmgthe others through radial and gridpatterns to maximize coverage and connectivity. 6.3.2 How Was It Achieved? 6.3.2.1 BuildingManagement Capacity 7. At the beginning o f the expressway planning in the late 70s there was little experience within the Chinese road construction industry o f high-quality design, procurement, implementation, construction and management o f highways. The main construction companies inChina were state-owned enterprises (SOEs) with insufficient experience in large highway construction to be competent to undertake the new expressway expansion on their own. The government o f China understood that the international contractors who undertook mainly large scale and technically complicated projects brought to their Chinese counterparts advanced technology, improved management techniques and modern, high tech equipment. They therefore invited the international contracting community to become involved with their initial expressway projects, but with strict requirements that all contractors had to bid the project as a joint venture with local Chinese construction companies as partners. The international contractors who were attracted to China were predominantlyfrom Hong Kong, Japan and South Korea". 8. China recognized from an early stage in the highway development process that it was vital to develop an effective and workable Master Plan. To achieve this goal the provincial governments would need to be fully involved, since they were to be responsible for implementingthe program. At the national level the Ministry of Communications (MOC) established a comprehensive planning department which designed the master plans with inputs from the international community. The M O C organized training Source: ILOpaper "The ConstructionIndustryinChina" October 2001 55 to build capacity in the provincial agencies but each province dispatched study tours to other countries to improve their knowledge. By 1998 they believed that they had mastered both the management and the technology o f the highway construction business and they were well prepared for the rapid expansion. 6.3.2.2Industly Structure 9. In 1978 the Chinese Communist Party announced the decision to shift the focus ofits work from class struggles to economic development. This was the beginning o f major institutional changes. The vast majority o f businesses were SOEs and the government recognized that the policy of using SOEs as a social framework for employment was leading to major inefficiencies and debt due to bloatedpay rolls, redundant construction, and incompetent management. The Government believed that construction could be a profit making industryand they introduced a series o f reform programs, which included the principle that SOEs were to be run on a corporate basis. The speed o f SOE reform substantially accelerated after China's accession to the WTO inDecember 200119and by May, 2003 new regulations were introduced to allow foreign investors to buy blocks o f hitherto non-transferable "state shares" and "legal person shares" inChinese domestically owned companies. 10. Today the industry consists o f large SOEs, some with substantial private ownership through share holdings, small SOEs and small private subcontractors and specialized subcontractors. There i s a comprehensive supply chain. 6.3.2.3BuildingManpower Capacity 11 China enjoys wide manpower resources from the many central and provincial SOEs and it was only up to the midlate 90s that the capacity was considered to be insufficient to meet the demands o f the expressway program. The Chinese highway industry rapidly learned from their international joint venture partners and M O C now reports that it i s now unusual to require the assistance o f the international highway building community on expressways20. Skilled operators for plant and equipment have been trained initially by the international machine manufacturingcompanies who when selling plant and equipment to Chinese companies arranged to either train operators in their own country and/or send trainers to China withtheir equipment to work alongside the trainee operators. 12. There has never been a shortage o f high caliber civil engineers in China. The profession i s highly regarded inthe community and salaries are higher than the average for other professions. There i s great competition for students entering universities, particularly certain institutions and the interest in civil engineering has been defined as "hot''21. 6.3.2.4BuildingEquipment Capacity 13. At the beginningo fthe expressway expansion most hightech and sophisticated construction equipment and plant were imported. Entrepreneurs inChina then obtained the specifications for the machinery and began manufacturing their own, sometimes injoint venture arrangements with foreign manufacturers. 6.3.2.5 Materials Capacity 14. At the beginning o f the expressway program there was a possibility o f a shortage of some materials such as cement, but businessmen became aware o f the potential rewards and invested in new Source: Dr.B.A.Shusongof the FinanceResearchInstitute, State CouncilofP.R. China 2oSource: Interviewwith MOC onMay 31,2007 21Source: Interviewwith CCCC onMay 31,2007 56 manufacturing plants. These companies are generally still SOEs. The only construction material that needs to be imported is bitumen and occasionally some very specific highgrade steel. 6.3.2.6Regulations and Associations 15. The construction industry in China i s regulated by the Ministry o f Construction (MOCn), who applies and monitors regulations and legislation relevant to the industry. It checks the qualifications o f construction companies when bidding for projects; monitors and administers the licensing law; and monitors the construction process and administration o f projects. Major regulation changes have been introduced to assist the development of the industry. The government has encouraged the creation o f trade associations for almost all branches o f construction and these are inclose communication with the MOCnand insome caseshave adopted the responsibilityfor self-regulation. 16. There has been a growing acceptance in China to use other forms o f procurement such as Design BuildRurnkey; and BOT --although the use o f BOT has not been too successful inthe Chinese highway construction market. 6.3.2.7Funding Restructuring 17. Before the adoption o f reform and opening o f China to the outside world, the financing o f highway construction was controlled through the provincial governments. This limited the investment in highways, so at the beginning o f the expressway planning in the 1980s China began to source highway construction from loans provided by local banks and introducing relevant policies, rules and regulations. From the early 1990s China continued with a combined investment system which included investment by central government, local government through their ability to charge tolls, social capital and foreign capital and using the principle o f "build with a loan and repay through charging tolls". In 1998 the Government created a fresh source o f funding by establishing the special fund on infrastructure construction by issuingstate bonds. 18. All expressways are tolled, and all intersections are grade-separated and access is fully controlled. Approximately 60% o f the expressways have been built and managed by the provincial governments. The remaining 40% o f expressways tolls have either been developed under BOT conditions by a concessionaire or the provincial governments have initially coordinated the construction o f the highway and then sold a section to a concessionaire to operate and maintain. 6.4 Malaysia Case Study 6.4.1 History of HighwayDevelopment 19. In the early 1970s road travel in Malaysia was mainly by federal roads. But as the number of cars increased, major ports and airports opened, and major cities grew in population, the federal roads became overcrowded and new highways were needed. The Government initially considered widening existing highways, but this caused substantial social problems with land acquisition and ultimately the Government elected to develop a `greenfield' expressway network to underpin its economic development. The first mega project for the expressway development plan was the 848-km North-South Toll Expressway (NSE), which was started in 1980. The expressway network continued to be developed to connect all major cities and conurbations with a current total length o f 1,192 km.It is now considered the best expressway network in Southeast Asia and third inAsia after Japan and China. 57 6.4.2 How was it achieved? 6.4.2.1BuildingManagement Capacity Once the decision was made to develop the highway network through greenfield expressways, there was a need for the Malaysian government to enact the appropriate policy changes to allow the plan to be implemented. A new government agency, the Malaysian Highway Authority (MHA) was created to supervise the work and at that time MHA was staffed by engineers who were mainly experienced only with the design o f rural roads and not large contracts. To assist MHA, engineers and international design consultants from Japan (JICA), Italy (ANAS) and the UK were invited to Malaysia to help MHA buildtheir capacity in design and implementation. It was accepted that international contractors were vital to fulfill Malaysia's expansion plans and an influx o f foreign contractors into the country had opened the eyes o f local contractors to new construction technology and construction management techniques for delivering projects on time or even ahead o f schedule. The North-South Expressway connected Thailand to Singapore through the length o f Malaysia. The project was started in 1980 using normal type contracts, but in the early 80s public funding was restricted through economic difficulties. The Prime Minister believed that the project was so vital that it could not be delayed and he personally encouraged the immediate use o f privatization. In 1980 the Government launched its "corporatization policy". In 1983 MHA organized an international open competition, inviting consortia to submit proposals to complete the remaining 514kmo f expressway on a privatized BOT basis. Finally the first concession agreement was signed between the Government and M/s PLUS. International contractors and consultants helped to lead the team, which resulted in immense capacity buildingopportunities. M / s PLUS administered the project with an optimal use o f local contractors. They subdivided NSE into 40 main contracts, with some sections having lengths as short as 15 km, which could be competitively bidand completed bythe domestic contractors without overloadingtheir resources. From the early 80s the Malaysian government had understood that ifmoney was spent inconstruction, it would flow directly through the people and improvethe economy o fthe country. After the experience with the initial BOT contract for NSE, further development o f the expressway network continuedwith similar BOT arrangements. The initial PLUS project is recognized as spawning a large number o f contractors and increasing the capacity o f the highway construction industry. The principles o f BOT continued to be used until the late 90s, when the Asian economic depression occurred. At that time it was difficult to raise loans for further private highway construction schemes. Private financing o f the expressways then stopped and the Government, eager to use road buildingto ease the problems o f the recession, continued with the construction o f expressways through conventional priced contracts. This continued until 2006, at which time MHA began to explore possible private finance schemes, which they are currently testing. 6.4.2.2Industry Structure 24. The highway industry structure has not required such a huge institutional change as occurred in China, since even before the development o f the expressway program there was a substantial supply chain o f contractors, specialist subcontractors, and material suppliers. Generally these were small and relatively unsophisticated. The majority o f the construction companies had been privately developed by the Malaysian Chinese from the early days o f economic development in the 19" century. Over time the three major political parties developed ownership o f companies including construction enterprises. Today, thanks mainly to NSE there i s a strong network and supply chain within the industry. There are 58 both large and small private contractors, large government linked companies, private specialized subcontractors, equipment rental companies and a solid support mechanism o f domestic consultants. 6.4.2.3BuildingManpower Capacity 25. The N S E privatized highway project involved considerable technology transfer from foreign to local builders especially in tunneling, bridge construction, slope management, paving technologes, road safety engineering, project management, and flood management. Slulled machine operators were obtained by usinginternational equipment suppliers to supply equipment and training. 26. The principal contractors' civil engineers at the time were supplied by the Chinese, who were considered to be very hard working and efficient. Their capacity was increasedby their interactionwith the international consultants. Civil engineering i s also held in high regard in Malaysia and with the excitement o fthe construction growth there i s a reasonable supply o f new civil engineers. 6.4.2.4BuildingEquipment Capacity 27. Initially international contractors brought sophisticated and hightech equipment and plant to Malaysia. Local contractors then began purchasing the equipment they required and plant hire companies have been established. Unlike China, however, the need for such equipment did not spawn the growth o f home manufacturing companies and currently most equipment i s still imported. 6.4.2.5Materials Capacity 28. The supply of materials has generally not been a problem in Malaysia. The cement industry, entrepreneurial in character, recognized the NSE's potential and increased its manufacturing capacity. The Government, also realizing NSE's potential for increasing economic growth dictated that a certain percentage o f the N S E (30%) had to be concrete pavement, which supported the national cement industry. 6.4.2.6Regulations and Associations 29. All regulations and licensing for companies and individuals inthe Malaysian construction industry are conducted through the Government's Construction IndustryDevelopment Board ( O B ) established in 1996. CIDB established the required regulations and legislation for all phases o f the construction process including design, procurement, award, construction and management. They work closely with the trade associations and organizations that have been established in Malaysia. The Malaysian Master Builder'sAssociation has become the recognized voice o fthe Malaysian construction industry. 6.4.2.7FundingRestructuring 30. Malaysia has relied on BOT forms o f financing for the major section o f the toll road network. To provide the appropriate legal framework to permit the concessionaire groups to operate the Private Management Act was approved in 1981. Group China Malaysia Develop a goodeffective master planfor an Planning integratedhighway network andlinkit through Develop agood, integratedmaster highway regular economicplans. network plan. 59 Group China I Malavsia I Recognize required changes inpolicy and Policy Implementpolicies to facilitate implementation o fplan. implement changes to support the implementation o f the overall plan. Planning Ensure that the plan is formulated mainly by Account- the provincial governments, since they will be Plan developed by MHA. ability responsible for administering the construction process and repaying the loans. Greenfield development is the fastest and most Land productive method o f constructing a new Greenfield development was found to be the Acquisition national network due to the lack o f interference most advantageous with the least social from existine networks. problems. Y International contractors were invited to bring Inthe early days o fdevelopment o fthe network, use the international highway Building advanced technology, improved management construction community for guidance and Highway techniques and modem, hightech equipment. capacity building. Industry Capacity The supply chainwas improved through Divide large projects into appropriate packages institutional reformand privatization to give smaller domestic contractors chance to initiatives. subcontract andbuildsupply chain. Develop appropriate regulations and legislation Establish one government organization to to support and enable the overall policies to be administer regulations. Must have dialogue Regulations implemented. withindustry. and Ensure appropriate agencies are established to Establishedthe MHA specifically to manage Legislation administer policies. the expressway program. Develop clear and transparent RCIregulations. Develop regulations but too cumbersome. Support the growth o ftrade associations. Trade associations help to buildthe capacity o f Trade Ensure open dialogue with government. the industry. Associations Encourage selfregulation by industry. Establish one trade organization (or group of I I associations) to be voice of industry. Used extensively but now they believe that the Not used too successfully inChina. change from totally public to totally private BOT was too fast. Government wants to buyback concessionaires Criticism by the public about the "irritation" o f to reduce tolls. tolls and their level. I Alternative Contract B e open to different contract arrangements. N o w experimenting withprivate financing. Arrangemts Currently exploring private financing. Operation & maintenance Used for about 40% of toll expressways. Vital to complete projects with minimal delay. Building Team approach to resolving problems at site Team approach to resolving problems. National level and no delays inissuing instructions. Asset Base Site staffhas authority to make decisions. Project level staffto make o n site decisions to avoid delay inproject addition to asset base. Dispute Historically not a problembut a new Resolution Not normally a problemdue to team approach. adiudication act i s being considered. 6.6 Case Study on France 31. The French road construction industry has dramatically improved its capacity during the last decade, thanks to government infrastructure policies coupled with strong internal reforms mooted by the 60 construction industryitself. New challenges are ahead now concerning the strategy and the performance o f the Frenchroad construction sector inthe national as well as global market inthe near future. 6.6.1 Key Issues of the FrenchRoadConstructionIndustryin the LastDecade 32. Among the key issues o f the French road construction sector in the last decade, evolution o f large financial structures required to match the investments in concessions was a crucial one. The other significant issue was the necessity o f diversification to meet the scope o f domestic demand in different types of infrastructure: expressways, bridges, tunnel works, decentralized national roads maintenance, urban roads, industrial pavements, etc. Globalization o f economies and international demand o f infrastructure influenced a concentration o f medium and large construction firms into large groups such as Vinci Group (world leader construction group) and Bouygues Group (second largest group in the world) or Eiffage group (currently number seven inEurope). 33. Most of the main road construction firms are branches o f the three first French construction groups mentioned above, including the eight major road construction firms as follows: 9 Bouygues Group : Colas, Screg, Sacer 9 Vinci Group : Eurovia, Jean Lefebvre, Viafrance, Sogea-Satom 9 Eiffage Group: Appia 34. In2006, the overallturnover oftheFrenchroadconstruction industrywas 14.3 billion($18.7 billion), which represents 34.2% o f the total construction industry (41.8 billion or $54.7 billion), with a growth rate o f 6.5% from 2005 to 2006 (10% expected in 2007). The share o f the industry's turnover was 48% fiom new construction works and 52% from rehabilitation and maintenance works. The total manpower workmg in the road construction industry was 103,000 in 2006. In 2006, the French road construction firms produced 8.1 billion ($10.6 billion) turnover abroad, 57% o f its overall turnover. 6.6.2 GovernmentPoliciesImplementedto Improvethe ConstructionSector Capacity 35. The capacity building o f the French construction industry has been largely sustained by main public programs, established within continuous five-year master plans by the Direction de 1'Ame`nagementdu Territoire, a central agency incharge o f infrastructureprogramming, with branches inthe regions. 9 Expressways which are directly owned by the State represent a network 2,625 km long. Total length o f expressways i s 10,805 km, for traffic o f 123 billion veh-km. 9 National roads construction and maintenance are financed jointly by the central state and regions in master plan contracts and project contracts. The total length o f national roads is 90,000 km, carrying traffic o f 96 billion veh-km. 9 Department Roads ("D$arternent" i s an administrative area smaller than a region) connecting national roads with a network o f 383,000 kmand carrying traffic o f 219 billion veh-km. 36. Decentralization policies have been implemented during this decade (200 1-2010). Large budgets transferred to the regions along with a push towards privatization o f road maintenance resulted in a larger market for road construction works. Supportive actions have been taken by the Government in terms o f procurement (Code des Marchis Publics), dispute resolution, more streamlined payment o f invoices, labor protection and training, legal framework, and stronger commitment towards quality, safety and the environment. Moreover, a quality assurance plan, required from contractors when bidding and before the start o f works, was made mandatory to ensure full compliance with quality, safety and environment issues duringthe execution o f contracts. 37. In order to finance the master plans a specific transport infrastructure financing agency was created: "Agence de Financement des Infrastructures de Transport en France". In 2007, this agency i s financing 2.17 billion (roughly $2.9 billion) o f investment for two expressway sections, one canal, and three 61 high-speed railways. The budget planned for 2008-2013 i s 7 billion ($9.3 billion). Moreover, a large state-owned financing agency called the "Caisse des Depots et Consignations" (CDC) i s implementing a special fund dedicated to transport and energy infrastructure. CDC will be granted 2 billion in the context o f a mergingasset management market in Europe and i s posing a serious challenge to existing international funds such as Australian Macquarie, ABN-AMRO, and HSBC. 38. A strong effort is beingmade on improvingthe concessiodPPP contract framework. The law governing the PPP framework, "Contrats de Partenariat", enacted in June 2004, covers partnership contracts between the state or state-owned enterprises and a private partner or between a local authority and a private partner. The law transfers the control o f public assets to the private partner during the concession period, comparable to a BOT or DBFOT framework. 6.6.3 Internalactionstaken by the Frenchroadconstructionindustryto improveits capacity 39. The three following steps have been taken inthe last decade: 9 > Emergence o f conglomerates with huge concentration o f capacity through merger and acquisition Diversification strategies o fmain French contractors 9 Improvement o f performance and productivity (by introduction of SAP-type workflow systems, training o f staff, research and development) 40. Construction o f transport infrastructure i s more demanding now than decades ago, and this requires changes in methods, organization, management and attitudes in the construction industry. Inorder to thrive in a larger but more competitive construction market, the industry has resorted to a variety o f measures including: 9 Enlargement o f expertise base to matchthe technological progress on methods and materials 9 Be more pragmatic, flexible and innovative to match the pressure o f competition 9 Growing effort inResearch and Developmentto match complexity o f works 9 Cost reduction& productivity to match the competition on prices 9 Evolution o f services including PPP and DBOTcontracts to match the emerging PPP culture 41. Inparallel, the influence of professional associations such as the Fdddration Nationale des Travaux Publics has been reinforced, order to give them leverage in negotiations with institutions and local authorities. (Web site is: www.fntp.fi-).Actions in the media led to the creation o f an important editor specialized inthe construction industry:LeMoniteur Group. 6.6.4. Key issuesandstrategy of the RoadConstructionIndustryinthe pastandnear future 42. The main strategic trends observed during the last few years in the road construction sector in France are the following: 9 Acquisition o froad construction firms inCentraland Eastern Europe (EUenlargement) 9 Strong lobbying at the EUinstitutions to participate in30 top priority projects (2007-20) 9 Concession contracts at the international level (bridges :MasanBay inKorea and RioninGreece) 43. It is interesting to observe that other large European construction groups have also followed the same strategy with external expansion based on acquisition o f other road construction firms in their own country and in Central Europe. Central European countries which recently joined the European Union have been granted heavy subsidies to upgrade their transport infrastructure, creating opportunities for the road construction firms to make reasonable profit with limited risks. 44. Road construction is a key economic activity in France. More than a million km o f roads need to be maintained and upgraded and the road construction business, therefore, i s considered to be a worthy and promising profession in the near future. Moreover, the French road construction industry i s at the 62 cutting edge o f technology and innovation and the French construction firms are present worldwide, especially in the niche segments o f road construction. The industry still attracts talented professionals, creates significant numbers o fjobs, and there i s a perceptible sense o f pride within the industry,which has been very healthy for the growth o fthe industry. 45. The main actions currently taken by the construction industry are devoted to facing the challenges mentioned above, but one o f the most crucial ones is hiring and training staff in order to reduce the shortage o f manpower. The strategy for hiring and keeping qualified staff stresses four initiatives: 9 Largeandcostlypublicitycampaignsinthemediatopromote the image ofthe construction industry 9 Increaseofwages of30%inthe five lastyears (inflationrates were under 2%) 9 Partnerships withtechnicalinstitutes andcolleges, active support ofcivil engineeringcolleges 9 Promotionofwomeninthe industry,aimingat an overall20% participation(from presently 10%) 46. However, the challenges ahead for the industry are also significant and can be summed up by various key issues and strategies: 9 Keeping a highlevel o f performance with competition from emerging economies like China and Turkey 9 Hiringandtraining young staffto cope withretirement o fqualified seniors amongthe staff P Innovative services to cope with a reduction o fpublic investment ininfrastructure and demanding clients 9 Complying with environmental requirements considering construction cost reduction objectives P Attracting qualified young civil engineers into the road construction field 47. A new trend derived from studies made by social and economic think tanks isnow influencingthe road construction industry, giving at the same time optimistic expectations for the near future. The key issue i s sustainable development related to environmental issues and climate change concerns: P Energy savings with new materials for pavement and recycling o f existing pavement 9 Recycling o f dirt and industrial waste products into roadpavement materials 9 Reductiono f costs on bituminous products with new technologies usingorganic substitutes 9 Reductiono fnoise pollution withnew materials for pavements, including gumshatex. 6.7 Case Study on Gujarat - Gujarat State Highways Project 48. The World Bank-financed Gujarat State Highways Project (GSHP), implementedby the Government o f Gujarat, stands out as an example o f a well managed road project in India inrecent times. The GSHP has been successful on various counts. This project i s closing inDecember 2007. 49. Contrary to significant cost overrun in almost all highway projects inthe country, GSHP i s expected to be completed with a significant cost savings compared to the originally estimated project cost. The project was originally estimated to cost Rs. 21.2 billion ($533 million) but i s now expected to be completed at a cost o f Rs 17.6 billion, resulting ina net saving o f about 17% o fthe estimate. The saving has been achieved in spite o f marginal increase in the scope o f the project. The upgrading works contracts were signed at an overall 18% lower price than the estimated costs, a significant measure o f the project's procurement efficiency. Moreover, only six o f the 15 upgrading works contracts had an upward variation in contract price during implementation, whereas the remaining nine have been completed at lower than contract price, reflecting adoption o f efficient contract management and cost control measures duringimplementation. 50. The project overall has taken two years more than the originally estimated project period. However, the delays were primarily due to a devastating earthquake in 2001 leading to diversion o f resources to earthquake recovery, and unprecedented rainfall and floods during the years 2005 and 2006, and not 63 due to delays in pre-construction activities or implementation delays usually experienced in other projects inIndia. Many works contracts performed well and were completed without much extension o f the completion date. Four o f the five upgrading works contracts in Phase 1 o f the project were completed within two months o f the original completion date, in spite o f the diversion o f the contractors' equipment for earthquake recovery. One upgrading works contract o f Phase 2 was completed well before the original stipulated completion date. 51. GSHP has been also exceptional in the number o f cases o f contract claims or disputes. Only seven disputes have arisen in 15 upgrading works contracts, out o f which only two cases were referred to arbitration and none was referred to the court. This is exemplary considering that in other large road projects inthe country the number o f disputes for each contract on average would exceed far more than the total number o f disputes inGSHP. 52. Preliminary analyses show that continuity o f a highly motivated and dedicated project team o f the Gujarat government for the entire duration o f the project is one o f the main reasons for such a stupendous success. The project received the full support and attention o f the highest level o f the state government at every stage, helping in smooth interdepartmental coordination and efficient implementation o f the project. 53. Reasonably good business and workmg environment in the state has helped in obtaining competitive bids, often even lower than the estimated costs. Moreover, right from the initial project preparation phase the Government o f Gujarat efficiently handled the project preparatory and pre-construction activities, which contributed to better quality project design and fewer contract variations, faster implementation progress and fewer contract claims and disputes. Further, during the implementation stage, the pragmatic and efficient project management by the state government and a true spirit o f partnership that it fostered among all the three contracting parties (implementing agency, contractors and consultants) have helped in efficient and dispute-free progress o f the works to a high quality standard. The state government's focus on value-for-money, willingness to adopt cost-effective and modem technology and better application o f technical specifications stipulated in the contract also led to cost-effective road construction. Overall, this project demonstrates how a conducive business environment and efficient project administration can create an enabling environment for the construction industryto deliver timely, cost-effective and quality outputs. 64 7. SUGGESTEDACTIONS & RECOMMENDATIONS 7.1 Context 1. This chapter focuses on recommendations basedon the three strategic pillars that have emerged as key to increasing the capacity o f the road construction industry. Some o f these pertainto the general construction industry but are also important for the road sector to flourish. Our analysis o f the data shows that the capacity o f the construction industry, if it continues to increase at the present rate, will hinder India in achieving the targets o f road sector growth in support o f broader economic growth targets. Depending on the growth scenario envisaged for the country, the delays could be anywhere from about 60-75% (Scenario 1) to about 150% (Scenario 3) o f the targeted time o f completion. This does not speak well for the plans or targets. Hence there i s an urgent need for the governments at central and state levels and the industry to take action to improve the capacity o f the road construction industry, without compromising on quality and cost. 2. The recommendations stem from three strategic considerations or principles, which emerge from the previous chapters, for improving the capacity o f road construction sector inIndia. They are: (i)Strengtheningthecapacityoftheindustrythroughtimelycompletionofprojects.Thiswouldhelp to unlock the existing capacity unnecessarily held up in on-going contracts due to time delays in project completion. The delays could be due to poor planning by the implementing agencies as well as the contractors, delays in availability o f encumbrance-free construction sites, poor contract management practices, and governance and corruptionissues before and duringconstruction. (ii)Improvingthesupplyofgoodroadcontractorsandconsultantsinthevarioussizescapableofhelping inthe timely and quality execution ofworks. This is all the morerelevant, keepinginmindthe trendofthe contractors to move up the value chain from small to large and very large contractors and then finally becoming concessionaires in PPP projects. The risk-taking appetite i s increasing, but at the same time it has to be borne inmindthat works on site have to be executed only by civil works contractors, whatever be the source o f financing; and (iii) Thinkingahead on how to address the scarcity of key input resources for road construction likely to be encountered by the contractors, such as key equipment, human resources, construction materials and working capital. Absent such foresight, the resources will probably not be available at the right time inthe rightquantities and ofthe right quality. 7.2 Key Areas of Recommendations and SuggestedActions 3. Recommendations and suggested actions which could be taken up by the governments and the industry associations are presented below. Actions should include ways to improve the planning from the government and contractors' side, investment climate inthe road construction sector, project and contract management, capacity building and training o f human resources, and the promotion o f research and development (R&D) in India's road sector. Inresponse to a specific request from the MoSRTH, we also offer suggestions for improving the quality o f design and supervision 7.2.1 Speedingup ContractExecutionthroughImprovedQuality at Entry 4. This needs to be done with a view to ensuring timely completion o f projects and thereby releasing the lockedup capacity o f the existingcontractors. Some key recommendations to this end are: 7.2.1.1Timely Completion of Pre-Construction Activities 65 5. To enact the pendingLA (amendment) and the new R&R Bills as soon as possible, so that there i s a clear legal framework available in the country to follow where displacements o f people are involved. Ensuring that pre-construction activities like land acquisition, resettlement and rehabilitation, obtaining environmental clearances, and utility shifting, which clearly are the responsibilities o fthe government, are substantially completed before construction sites are handed over to the contractor/developer. The current Model Concession Agreement requirement that at least 50% o f land free o f encumbrances should be ready for handing over to the road developer, at the time o f agreement signing, should also be made applicable to fully conventional item-rate government-funded contracts, with an additional caveat that these stretches should be in continuous stretches not less than 10 km long. The remaining length be handed over within a fixed period (preferably not exceeding 6 months) specified in the contract agreement failing which the road agency will have to bear penalties. 6. Specific recommendations would be: (a) for the road implementing agencies at the center and state to set up dedicated cells adequately staffed from the respective departments like revenue, forests, environment and railways to undertake pre- construction activities andclearances; (b) to create high-powered multi-departmental committees to expedite pre-construction activities; and (c) as a less preferred option: to transfer the responsibilities for utility shifting and tree cutting to the works contractor, who may have better access to get these done and pay for it. (The required clearances will have to be facilitatedby the government agencies.) 7. A small guideline information brochure and a web page highlightingthe procedural steps with expected timelines could be o f help to the implementing agencies, contractors and developers. It would be managed by a high-powered committee comprising all key responsible agencies like revenue, environment and forests and other utility agencies. Also a dialogue could be taken up at senior levels in the concernedministries (e.g. Ministryo f Railways) to discuss ways o f cutting out avoidable delays. 7.2.1.2Strengthening theInvestmentPlanning and Programming Functions of the Road Agencies 8. Using computerized information systems based on electronic data collection systems for road inventory and condition, these agencies must be able to plan and program their investments through 3-year rolling plans. This will enable the agency to then sequentially allocate appropriate time for the proper survey and designs and also take up the necessary pre-construction activities on the finally selected road corridors. Such actions would possibly help in prioritizing the sections for which the pre-construction activities have to be completed, so that they do not delay the project during actual execution. Also this will help inreducing the gap between the budgetary provisions and actual expenditure. Another important step would be for the road agencies at the state level to update the Schedule o f Rates every year to reflect the actual market conditions intheir region. 7.2.1.3 Structuring Contractor and Consultant Arrangements Differently 9. The goal is to minimize variations and disputes duringexecution and consequently to reduce construction time. This could be possible through clear delineation o f risks and responsibilities for activities to be undertaken before start o f construction and then during construction. The present trend o f embracing the PPP concession framework inthe roads sector --wherever found viable and feasible-- is appropriate from both angles of pushing the financing (at least partly) and the performance risks to the private sector. However, even for the fully government-funded projects, it would make eminent sense for the road agencies to gradually move to contracting methods other than the conventional item rate contracts for road construction, rehabilitationand maintenance, after taking some short-term improvement measures as discussed elsewhere in this chapter. Those could be (i) Design-Build-Maintain (DBM) contracts, (ii) Design - Build (DB) contracts and (iii) Long-Tern Performance-based Contracts (LTPB). For DBM 66 contracts (may be about ten-year concessions) the design, construction and consequent performance risk o f the road i s passed on to the contractor. There could be a periodic audit undertaken by the road agency or an independent consultant to check construction quality and compliance with the performance parameters. InDB contracts the design and construction risks are passed on to the contractor, who will be fully liable to produce good designs which will meet with his slulls and resources, leaving little opportunity for variations due to deficiencies in surveys or designs. However, the road agency may still need to proof check the designs, provide value enhancement advice, and then either take up full time supervision or sample audits. This could be done in-house ifthe agency has the requisite s h l l s or through an independent consultant. This activity i s needed because the contractor is now not responsible for the performance o f the road after construction is over. LTPB contracts provide a solution to the DB and item rate contracts for tahng care o f the maintenance aspects after the completion o f the defects liability period. These couldbe taken up on either a network or corridor basis. 10. However, some significant difficulties are foreseen when combining the design and construction responsibilities with the contractor: (i) howthebiddocumentsandthecontract specificationscouldbemadespecific ontheminimum performance and other requirements; (ii)howthebiddingparametersandthebidevaluationcriteriacanbeformulatedandused;and (iii)howthegovernment (employer) willbeabletodischargeoneofitsprimaryresponsibilities of handing over encumbrance-free land, in stages, to the contractor as soon as the design i s completed to enable start o f construction as specified inthe contract. 11. Inthe case o f conventional contracts, the quality o f designs and surveys needs to be improved to prevent delays during contract execution. Independent peer review checlung, including field verification, is important, at least on a sample basis, by either the implementing agency or an independent consultant before approving the designs. Use o f value engineering techniques for ensuring sound design principles and cost optimization could be tried out for contracts larger than Rs.500 million ($11 million). It should be ensured that the plans for the road alignments are on the same platform as the drawing o f the landrevenue and other maps to avoid discrepancies when evaluating impacts. Use o f GIS will help in taking care o f this. 12. A strategic decision in favor o f greenfield projects on new alignments (like bypasses and expressways) wherever economically, financially and technically feasible without much environmental and social distress, will go a long way in speeding up contracts. Time lost in delays during construction on existing alignments like managing traffic, shifting utilities and moving people can all be avoided, once the required land i s acquired. 7.2.2 Increasingthe Numberof ContractorsandConsultantsWorkinginIndia's RoadSector 13. The Government and the industry should focus on ways and means to increase the number o f players o f different sizes inthe road construction industry.This may be done by pursuingthe following strategies: 9 Facilitating setting up of new firms in the sector. This should be done either by new entrepreneurs setting up firms at the lower end, which could then slowly migrate up the value chain, or by creating an environment where already existing large commercial/industrial enterprises could move in with finances to set up construction or concession firms which are higher up the value chain; 9 Attracting larger construction firms from other sectors like real estate, industrial buildings, > irrigation, dams and power, to also work inthe road sector; Creating an environment, free o f any barriers, to enable foreign or international firms to set up shop inIndiaorjust beableto compete andwork inIndia; 67 9 Providing an enabling environment for creation o f trade associations with a free interchange o f views and advice between them and the governments. The trade associations can go a long way inhelping self regulationand debarmenthanctions within their own industry groups and also help inmarketingthe country's needs andbusiness strengths abroad; and finally 9 Taking a close look at the staffing levels in Indian government road agencies and other public sector agencies, to enable them to perform the main role o f policy, planning and overall management functions and then decide whether the other functions o f these agencies can be spun o f f into autonomous construction and design outfits. This might be difficult to achieve in social terms and would need a strong political will to implement. But countries such as China, the UK and New Zealand have tried it out with some success. They could be first made into autonomous public sector undertalungs and then slowly the Government might decide to divest them. This measure, if feasible, would be able to solve some o f the problems o f scarcity o f contractors and the weak supply chain to bigger and international contractors. A case study on hiving off autonomous construction and design outfits from a public road administration organization i s presented as Annex VIto this study. 14. All the above options would depend on the investment climate prevailing in the sector and the country. This would encompass factors like ease o f being able to compete and win jobs, licensing and other clearances required, workmg environment like security (law and order) conditions, timely payments, availability o f input resources, contract management and dispute resolution, subsidies and fiscal concessions, and profitability. Medium- to long-term planning by the Government with assured financing will encourage the road construction industry to develop, with the private players gaining confidence to take risks to set upnew businesses or move infrom other sectors. 7.2.2.1Making Procurement and SelectionProcessfor Contractors and Consultants more Transparent 15. Mandatingaccelerated use of e-procurement methods will go a long way inintroducingtransparency and minimal interference o f external factors inthe selection o f firms, inthe beginning for contracts above a certain threshold value and then for all contracts, provided independent assessments are taken to establish the readiness o f adopting e-procurement in an agency or state. It will also prevent situations where the contractors allege not being able to buy the biddingdocuments and/or not being able to submit their bids(reasons beingthe formation o fcontractors' cartels, collusionbetween client staffandpreferred contractors and poor governance). This should be properly institutionalizedand ensured so that the result thrown up by the computerized system can be overridden only by a high-powered committee and that too only under certain exceptional circumstances. Andhra Pradesh i s one o f the states which has completely adopted this and seems to be reaping considerable benefits. A post-qualification process for procuring contractors and concessionaires for road works will perhaps prevent collusion and forming cartels while bidding. 16. Setting up web-based contractor databases updated at periodic intervals will enable the procuring agencies to confirm and verify: (i)the detailed credentials and qualifying criteria directly and/or through a consolidated grading o f the firm; and (ii) a contractors' performance database, which could include qualitative comments o fprevious clients as well as tangible information on performance like time delays, disputes engaged in versus the disputes lost, and defects noticed during the defects liability period. This database could be expanded to include a list o f specialists and experts in the field with their biodata and experience details. This web site, which should be accessible to anyone, could be owned, updated and managedby some industryassociation (like the Construction IndustryDevelopment Council-CIDC) for a fee that it could charge from the Government and the contractors. 68 17. To prevent misrepresentation o f contractors' and consultants' qualifications, they could be certified by the respective industry associations, like CIDC or the Consultancy Development Council (CDC). These umbrella organizations could also set up state-level centers to encourage the industry at state level. This could also be done through collaborationwith existing similar organizations at the state level. 7.2.2.2Easing Barriers For New and Foreign Firms to Enter the Road Construction Sector 18. Measures worth considering include: Inthe case ofnew Indian subsidiaries of foreign firms, allowing the experience ofthe parent firms with some sort o f undertakingguarantee by the parent firm might help, provided that the capabilities and skills o f the parent firm meet the work requirements. Easing visa and other travel documentation procedures for international staff working on road construction projects, especially for those on short assignments. Visa extensions also seem to be tahng an inordinatelylong time, far longer than inmany other countries. Bringing the construction specifications o f our country on a par with international standards for survey, design and construction o f roads through improved R&D, which can be partly industrysponsored. Easing qualifying criteria requirements to enable contractors from other sectors to slowly enter the road sector, at least for some minor and/or maintenance works and then slowly buildup their capacity. This could be done by the firms showing some similar experience or their capability in managing and financing contracts of similar size, and they could then participate in a joint venture or as an associate with a road construction firm. Facilitating the access o f road construction firms to working capital finance, especially for small and unorganized players. These contractors can fill inthe essential areas o f maintenance and rural road works and free up the capacity o f stronger contractors for taking up larger works. Here the industry associations should take upon themselves to upgrade the standards o f accounting and make all transactions more transparent. Lenders and other registration agencies could use "proxies" for assessing small players. With the Reserve Bank o f India extending the lending norms for small and medium enterprises (SME), it i s prudent for the industry associations to get the very small, small and medium contractors to obtain an SME rating, to allow them easier access to finance. 7.2.2.3Improving Dispute Resolution and Contract Management 19. This section is extremely important from the point o fview o fprofitability. Profitability inthe road sector among all sectors i s possibly the lowest due to non-transparency and poor governance, which often leads to compromise inquality. Informal sources indicate that this i s one o f the prime reasons for entering into litigation by contractors to make up for the losses or scant profits. This i s also probably discouraging some o f the better Indian and foreign contractors from taking up itemrate road contracts. 20. Timely resolutiono f disputes duringcontract execution will go a long way inreducing delays intime and increases in cost. One option could be to institutionalize the arbitration process by setting up Road Appellate Tribunals at central and state levels. These should be independent from the implementing agencies as well as any form o f regulator which the government might later decide to bring into the sector. Any disputes not resolved by the Dispute Resolution Board/Adjudicator (DRB) system provided inthe contract couldbe referred to these Tribunals (having a fixed constitutionof arbitrators specialized in contract law) and their decisions should be considered final. The existing provision of referral to an arbitration panel (made up o f persons named by the contractor and client) i s more time consuming and possibly results in dissatisfaction and consequent appeal in higher courts o f law. Another strong suggestion i s that in a sequential process o f dispute resolution the decision o f the previous process inthe sequence should be implemented till the next higher process either reverses or changes the award and 69 recommended awards should be made suitably backed by a guarantee / security deposit. This should be applicable to both contractors/consultants and road agencies. 21. Another suggestion i s for the employer, engineer and contractor to sit together when works begin, to clearly interpret the contract and come up with a set o f bulleted guidelines clarifying their respective roles, responsibilities and approval powers. Here, it i s strongly recommended that all road agencies should have some expert in contractual law to advise them to ensure correct interpretation o f the contract, as well as issue notices and approvals as per the contract's provisions. This will help gwe the field level project officer some confidence in taking ownership o f DFU3 awards and complying with them without pushingthe decision-malung upwards. 7.2.2.4Subsidies, Fiscal Concessions and TaxationRelated Issues 22. Recommendations which came out o f the interviews with contractors and their associations were: 9 Abolishing works contracts tax in states wherever it i s still levied. The central sales tax i s already beingphased out, but all states should also fall inline. 9 Extending Section 44BBB benefits to road sector projects to provide incentive to foreign contractors to enter the road sector. This benefit allows the foreign companies to assume that their profits will be 10% o f their contract value, minimizing confusion and delay during taxation. Domestic contractors enjoy a similar tax benefit under Section 44AD. 9 Providing duty exemptions to all contractors working on contracts above a certain threshold value instead o f being provided for only certain projects funded by multi-lateral agencies or NHAIprojects. Similarly, the GO1could look at the possibility o f reducing customs duty on importing o f capital goods and machinery used inroad construction from the current level o f 37%. Duty exemptions which sometimes are extended to only a part o f the equipment, should be rationalized. 9 Deemed export benefits should possibly be given for large road and expressway projects on the lines o f the Ministry o f Power's Mega Power policy. Another way to achieve a comparable fiscal incentive could be by providing faster depreciationrates on equipment. 9 Central Value Added Tax benefits are not being extended to certain road construction equipment like crushing plants on the grounds that they produce input materials for road construction which cannot be termed as "goods". This could also be reviewedby the Government. 9 Certain road contractors doing a highlevel o f cash contracts are requesting extension o f Section 80- 1Abenefits, which according to the current year budget clarifications were deemed applicable only to developers. Similarly there i s a request from certain potential developers to reinstate the Section 10(23)G, at least for a certain period longer to enable easy access to long-term funds (refer to para. 40 inChapter 4). 9 Reviewing taxation of joint-venture firms as an association of persons. This has been preventingthem from offsetting an individual member's share o f profit against its individual losses and vice versa. Similarly, allow existing import benefits on equipment to be passed on to the JV members rather than the JV as an entity. It will help the members by giving them more freedom in their balance sheet assets. 7.2.2.5Administrative/Procedural Issues -Licenses, Clearances, TaxAdministration and Customs 23. Some important procedures needto be streamlined, including: 9 Streamlining procedures for customs and excise exemptions for import o f equipment/purchase o f materials, especially for duty-free import o f equipment on specified projects. The requirement o f producing excise/customs exemption certificates at multiple points leads to delays and procedural hassles and couldbe done away with. 70 P Easing restrictions governing reexport and re-sale of imported equipment. Equipment users face issues with respect to refund o f import duty on re-export o f imported equipment. Easing time and other restrictions currently imposed on re-sale o f imported equipment eligible for duty and other exemptions will also help increase the equipment pool available within India. 9 Facilitating access to aggregates. Several cases o f mining quarries being taken over by mafia gangs have been reported and this reduces the supply o f key materials such as aggregates. The Government should attempt to ensure that the Mafia is not allowed to interfere with the workmgs o f the mining quarries. It would also be useful if each state prepared maps showing material sources and made them available on the web. Conditions and procedures for obtaining licenses for mining and quarrying should be spelt out on this web page, which could also be downloaded as a booklet. 7.2.2.6Institutional Structure and Regulation 24. Since there i s already a move inIndia to bringin a Construction Law, it may now be a good idea to speed it formulation and then further enactment. This would essentially form the legal basis for the entire construction sector and would be essentially a compendium o f all laws which have direct impact on construction business with necessary revisions to reflect latest developments and international best practices. This would further pave the way for declaring the construction activities as an industry. 25. Another important aspect o f investment climate i s the need for safeguarding the interests o f all stakeholders --users, government and the private sector players. Since a substantial part o f the financing for roads comes from fuel levies and other budgetary support, there i s a strong need for an independent road board, comprising members from the key stakeholders in private and government sectors. The board couldbe set up at the central and state levels with functions to: a. periodically assess the needs for investment and maintenance o f all the roads; b. identify the sources o f financing from government and fuel levies; c. identify the gaps in funding after a prioritization exercise and advise how the private sector and other funding agencies can recoup their investments through appropriate levels o f tolling or other means; d. periodically review and advise the G O M o S R T H on the various aspects o f road concession agreements, especially on the risk allocation and sharing and the need for refining them as the sector evolves; e. manage a dedicatedroad fund, ifone exists; and f. set up a medium-term monitoring framework for the performance o f different categories o f roads, irrespective o f ownership or operating and maintenance rights, and ensure its adherence for a level playing field. 7.2.2.7Timely Completion of Contracts 26. It has been noticedthat bonus or early completion incentives are workmg well inworks contracts let out by private concessionaires. However, this could also be an important incentive for cash contractors to complete works on time and prevent delays on the contractors' part in government-financed contracts. However, this needs good contract management by the client and timely decision mahng. Delegation o f powers to the appropriate implementing agencies will help them take decisions and not resort to a legal/dispute resolutionmechanism at the drop o fthe hat. 7.2.3 Improvingthe Availability of Inputs 27. Road agencies and the contractor/consultant key persons need to be better trained to tackle contracts with newer forms o f financing and risk sharing options. Thorough laowledge o f the forms o f contracting and concessions and the liabilities and accountabilities o f all parties i s very important for all signatories. 71 Moreover, conventional input-based contracts are being slowly and steadily replaced by performance- based contracts, and new materials are being used which perform better over the long run but are marginally costlier at an initial level. Specialized training needs for these different aspects o f contracting and construction engineering need to be imparted to the road agencies as well as to contractors and consultants. 7.2.3.1Human Resources 28. India i s a young country: about 50% o f its population i s below the age of 25 years. As such it seems anomalous that it should be faced with a human resources crunch. During the past decade, civil engineering is slowly regaining its lost glory but the demand for civil and road engineers i s far more than the supply. Many o f the graduates move to other attractive options o f working with IT, financial and other sectors which pay better and probably are much less physically demanding. Options o f working in developed countries which offer a better quality o f life i s an added benefit in worlung in these sectors. Some important recommendations for improving the quantity and quality o f manpower are: 9 Empowering construction industry associations: Many o f the large and medium contractors o f the country are closely held family-managed firms with very little professionalism. Many slulled and capable employees know that rising above certain limits i s not possible in such companies. Public ownership with professional management will be an ideal solution for large construction firms. This will enable the private sector to bring in the incentives like employee stock options (ESOPs), which are absent in the present form o f family-based organizations. Construction industryassociations can go a long way inprofessionalizing management within construction firms bybringinginregistratiodrating/grading andperformance management for employees. 9 Providing for merit-based rewards and promotions in the private and public sector agencies and disseminate the concept o f incentives for employees who perform well (including ESOPs in private firms), to improve the attractiveness o f the road sector firms. 9 Active marketing by contractors, consultants, implementing agencies and the respective industry associations; and sponsor students in their final year for practical projects based on real-life problems. This may go a long way in attracting more graduate and post-graduate students into the road sector. 9 Looking at options for hiving off parts o f public works departments and other government agencies into autonomous constructioddesign firms which may increase the availability o f highly skilled staff in the fields o f construction and designing. If implemented, this would reallocate presently sub-optimally utilized engmeering and other technical human resources to more active and needy parts o f the industry. 9 The Government and one o f the industry associations could take up andprepare a training policy and strategy for the entire road sector o f the country. This could talk about institutionalizing training as an integral part o f the jobs, finding the funding needed, and mapping out the key slull gaps. This report has done a preliminary study but this needs far more detailing. 9 Setting up more regional centers for training road construction engineers, skilled workers and unskilled laborers. One example i s the training center called National Academy o f Construction in Hyderabad set up as a PPP effort. There is an urgent need for replicating such structures in at least the major regions o f the country. The National Institute o f Construction Management and Research i s another agency which provides training on construction management for contractor personnel. 9 Fresh graduates and post-graduates joining the road sector agencies, especially with the contractors and consultants, are put right away on the job - either at construction sites or other design and planning offices. Tlus tends to infect them with some o f the incorrect practices. Instead, it may be good idea to make them undergo a 6-month freshman's training at a reputed institute with some certification--which will needperiodic validation. 9 On-the-job training at construction sites with best practices (like Delhi Metro) may also encourage the students to take upthe challenges o fmega-construction projects. 72 9 Introducing new courses to strengthen the project and contract management aspects, PPP roles andneeds and basic aspects o fprojecthon-recourse financing (see Annex 111for details). 9 Gradually introducing a system of independent accrediting and certification and giving incentives to contractors and consultant to post such accredited people for key and important positions inprojects. 9 Ensure proper working conditions for labor - since they are one o f the most important resources for road construction it should be ensured that their living conditions, health, child care and wages are based on certain minimum standards. All existing laws pertaining to this should be adhered to as well as any pending Bills would need to be enacted soon. 7.2.3.2 Equipment 29. Key ways to overcome constraints in the supply o f equipment and spares (in addition to incentives mentioned above under exemptions for duties and taxes) are: 9 A dedicated construction equipment manufacturing association could be set up. It could be affiliated to some international organization o f a similar lund. This i s important from the view point o f carrying out fiequent assessments o f the market potential, supply gaps and methods for filling them. 9 Scarcity o f spare parts for equipment already in use i s a big problem for contractors when implementing key time-bound projects. The long lead times to supply spare parts when needed in a timely manner delay projects. Appropriate vendor bases ineach region to be set up by bothnational and international manufacturers aiming to achieve timely delivery should be one o f the objectives o f manufacturing firms. 9 Small and medium-size contractors complain o f obstacles to buying equipment, especially for shorter duration contracts. At the same time larger Indian and international contractors are able to import some listed equipment through incentives provided for certain types o f projects. However, there are delays inpaper processing and delivery at site. Equipment leasing and rental seem to be viable options but they are not well established in India. There seem to a very few players in the market like QUIP0and NACEIL. It may be worthwhile to explore what actions it would be appropriate for governments (central or state) to take to facilitate the setting up by the private sector o f equipment leasing companies. 7.2.3.3Material Resources 30. Scarcity o f materials is not seen as a big issue in general. But naturally occurring stone metal and aggregates will indeed be a problem. Even at the present level o f construction under way inthe country, it has been observed that crushed aggregates production i s always behind schedule and causes delays. Access to mines and quarries i s sometimes difficult due to strict regulations in environmentally sensitive areas, and this i s further aggravated by poor crushing capacities planned by contractors. Implementing some o f the recommendations mentioned above under B (v) and (vi) might improve the situation. Recently localized scarcity o f cement has been observed due to the prevailing monopolistic situation o f the Indian cement manufacturers. This is probably because o f the Cement Quality Control Order of 2003, which requires Bureau o f India certification for foreign cement manufacturing units, and the difficulties associated with t h s process. This could be reviewed and actions taken based on the practices followed in other countries. Locally available alternative materials and industrial wastes may prove acceptable substitutes without compromising on quality. 7.2.4 MarketingIndianRoadSector andExperienceSharingwithinIndia 31. During our discussions with international firms and associations, one point raised was the lack o f information available about the investment and business potential in the road sector in India and about 73 recent regulatory/fiscal/procedural changes happening in the country. Prime road sector agencies like the MoSRTH and the Indian Roads Congress (IRC) and industry associations like CIDC can help in marketing the opportunities that exist in India for foreign road contractors, consultants and concessionaires. This could be done by collaborating with the commercial attach6 in Indian embassies/ high commissions abroad. Annual road shows on each continent (probably in a different country each year) could highlightthe opportunities inIndian markets and the steps the Indian Government i s t a l n g to welcome international f m s and expertise. The successes and failures should be candidly presented. This will also provide a forum for the Indian government to take note o f any remaining concerns the international community has and ways to help solve them. This marketing exercise will help in attracting to India not only foreigners but also persons o f Indian origin worlung abroad. 32. Similarly, many innovative and good practices are being followed in different states, but they exist in silos. International organizations when they work across different states find this amazing and it i s therefore recommended that, apart from the annual IRC sessions, there could be many more opportunities for the engineering and other road sector communities to visit other states and learn more about the best practices inconstruction, institutional structure, governance and transparency, and fiduciary provisions. 33. At the end o fthis chapter a table o frecommendations ispresentedinthe form o f an actionplanmatrix. It also includes suggested time fiames and the responsible agencies. The critical areas are: - 9 Sector-wide policy and planning; 9 Institutional structure and regulation; 9 Marketing, raising international awareness o fthe Indianroad sector and knowledge management; 9 Contract structuring, management, enforcement and dispute resolution; 9 Easingrestrictions and administrative procedures to improve the business environment; 9 Easingentry barriers to foreign contractors andcontractors from other sectors; 9 Improving cash flow and accessto finance and credit; 9 Providing incentives like subsidies and fiscal concessions for attracting more and larger contractors; 9 Improving access andavailability o fthe critical inputmaterials; 9 Capacity buildingfor humanresources inboth quantity and quality - attracting and retaining high quality professionals to this field -from boththe contractors' and employers' side; 9 Improving the availability o fkey plant and equipment; P Strengthening R&Dto integrate and support the industry; 9 Ensuringthat the employer/client gets value for money from the contractors and consultants through improved contractual conditions and structuring the contracts differently; and 9 Improvingprofitability for the industry to create win-win situations for the client and contractors. 7.3 ExpectedOutcomes 34. The ultimate aim o f the above exercise i s to provide good quality road infrastructure at the best prices to the roadusers. Some o fthe key outcomes which we expect from implementing the recommendations are: 9 Increase inthe number o f contractors capable o f executing different sizes o f contracts; 9 Increase inthe number o f international road contractors working alone or inassociations; 9 Increase inthe number o fprojects completed on time and within costs; 9 Decrease inthe number and amounts lockedup indisputes - quicker resolution o f disputes; 9 Increase inaverage number o f contractors biddingfor every projectlcontract; 9 Bidprices and contract values inreal terms coming down -this will probably happen only after an initial increase and later stabilization; 9 Increased use o f modem equipment, technology and specifications to meet international standards for high-end roads; P Time frame for setting up a businessinthe sector reduced and doing business made easier; 9 Reduction inconstraints on humanresources, equipment, raw materials and finance; and 9 Increasedreturns and better profitability to the key players inthe road construction industry. 74 7.4 ConcludingRemarks 35. Some o f the recommendations listed here have been voiced by the construction industry stakeholders already where actions have been initiated by the concerned agencies. Unless actions are taken immediately on the remainingrecommendations and the process accelerated for actions already launched, the improvement o f the road network will be delayed, dragging down the performance o f the whole Indian economy. 36. The policy and institutionalreforms which have been suggested here have emerged as major issues fiom the feedback o f the different stakeholders in the road sector or from the case studies o f the three comparator countries prepared as part o f this study. The various players are concerned about the need for transparency and effective governance structures, as well as sound planning through master plans, rolling three-year plans and annual plans, all o f which need to be properly marketed. It i s also to be understood that while India i s viewed as a place with very high business potential, the same time there i s a lot o f scope for improving the business environment through changes in policies and regulations. The human resources problem, for example, really needs to be tackled on a war footing by all parties. Attracting younger people to the profession and retaining them in the road sector i s something to be considered through further brainstorming. The Government and private sector have to encourage continuous s h l l upgrading and to ensure quality. The latest techniques, brought inthrough active R&D efforts need to be internalized through appropriate incentives. 37. It is now suggested that the Planning CommissiodDepartment o f Economic Affairs could set up a steering committee or task force to look into the detailed recommendations o f this and other studies, workshops and conferences. This will help to secure high-level stakeholder commitment and to ensure ownership o f the final action plan. The terms o f reference would be to look into the detailed recommendation matrix at the end o f this chapter, and then to take up actions which could result in quick wins inthe short term, and then some o f the more difficult ones with a view to the mediumto long term. The time duration for this review could be about 2 months. After the action plan i s finalized a series o f virtual workshops could be held using the Bank's Global Development Learning Network with access to the National Informatics Centre Network, in some o f the state capitals like Andhra Pradesh, Gujarat, Karnataka and Uttar Pradesh. 38. The Bank could assist and advise the Government and the industryand work together with them intaking forward the findings o fthe study through the following possible interventions - Incorporating some o f the recommendations mentioned above in the design o f future Bank-funded projects, such as: long-term contracts, creating autonomous road corporations, independent road boards, and supporting PPP. Helping the central and state governments in improving governance through advice and help inthe implementation o f e-governance/procurement, disclosure to comply with the Right To Information Act, and setting up databaseso f vendor qualificationsand performance. Continuing to pursue some o f the study recommendations and reform initiatives through the proposed study / note on `investment climate in the construction industry' requested by Ministry o f Commerce and Industries, Government o f India Facilitating international knowledge transfer and help --especially in key institutional areas like management and financing o f road network assets- through knowledge sharing trips international1y. Helping, if required, in piloting the transition from fully government road departments like public works departments to autonomous organizations by creating public sector undertakings which can compete in the domestic market -an experience which has been successfully tried out in such countries as China and the UK. 75 (vi) Training and sharing experience in good practices and the latest in the field of engineering and research. Key areas could be new materials, survey techniques like aerial photogrammetry, new geodetic systems, latest construction techniques, value engineering methods, and road safety audits. (vii) Assisting,throughtechnical and advisory services, to study some ofthe recommendations ingreater depth and then help in implementing the suggested actions -for example, management of human resources, equipment andnatural aggregates. Recommendations& SuggestedActions Plan . Envisaged Timeframe* Widening the ambit of reform. 9 Widening reform: . Pass a construction law to enable Ongoing and dealing with aspects like legal continuousprocess framework for establishing and 1 PlanningCommission Pass construction law: operating construction firms, their MoSRTH procurement, legal liabilities, dispute 9 Give construction resolutions mechanisms, safety, quality, . State implementing Medium term agencies sector the full fledged market regulations etc. Give Ministryof Law status of an industry: construction the full fledged status of an Long term industry. Selecting the right model for PPP MoSRTH projects including appropriate types of State implementing Short to mediumterm biddina. aaencies Undertake a Master Planning exercise, Master planning: Short multi-yr rolling and annual planning term based on actual road needs and Multi-yr and annual budgetingbasedon them. planning: Short to mediumterm Sector policy and policy Enact the pending LA (amendment) and implementation; the new national R&R Bills as smn as possible. IKey issues addressed: Ensure at least 50% of land free of encumbrances is handed over to 1. Improving investment climate contractors/concessionaires with at Strengthening pre- least 10km in continuous stretches at investment planning . the time of award. Remaining stretches Enhancingproject be handed over in not more than 6 readiness months. Take decision Decision to go in for greenfield projects immediatelyand on new alignments wherever Planningcommission implementin short term economically,financially and technically .. MoSRTH/NHAI feasible. Encourage bypasses and State implementing expressways. Construction is much agencies faster after the land acquisition. Create an environment for forming trade associations with opportunities for free and open dialogue with the governments. Encourage self regulation by the industry(refer S No 7) Training policy and strategy prepared for the entire road sector to cover . private and government workers at all 1 Initiate training policy levels in centre and states. Requisite preparation:Short term training would need to be imparted to Approve and start vigilance, audit and accounts personnel implementing: Medium to help them appreciate the modern term contracting procedures and risk sharing asoects. 76 Setting up a Road Board (with government and non-government members) at central and state levels as a quasi-regulator/advisor to take care of (i) assessing the gaps between road sector needs and available funding and Planningcornmission Take policy decision: strategies to make up the gaps: (ii) MoSRTH Shortterm advise the governments on the model State Finance and *Establish functioning concession agreements and tolling Roaddepartments Road Boards: Medium term 'nstitutional structure and levels; (iii) managing the dedicated road *egulation fund, if one exists; and (iv) set up a monitoring framework and ensure its adherence for the performance of the !. . sedAction Plan lrR&Din the RoadSector ActionPlan Actionby Time Horizon OutcomeIndicator Formulate R&Dvision and policy MOSRTH in [mediate Policy document approved by the covering, inter alia consultation with government by December 2007 and Institutional framework MORD, DGBR, widely disseminated (put o n website o f Identification o f thrust areas NHAI, State the government) Financing strategies Governments, Strengthen research centers and DST, CRRI, IRC academic institutions Monitoring o f research work Knowledge pool through national and international collaboration Dissemination Utilization on the ground Enhancedrole and strengthening MOSRTH and :mediate Workshop o f stakeholders held to o f the Highway Research Board IRC to Short review HRB's mandate by Dec 2007 ofthe IndianRoads Congress term HRB's functions reviewed and revised mandate issued in2008-09. Strengthening o fCRRI MOS&T and Short term Business Plan for next 10 years CRRI in prepared by CRRI and published in consultation with 2008-09 MOSRTH and MORD Creation o f Data and Knowledge IRCwith the Short term Data Center inoperation in2008-09 Management Center inthe IRC approval o f Links established with international MOSRTH collaborators Accreditation o f innovative IRC withthe :mediate A core group formed byDec 2007, materials (under the aegis of the approval o f the and on- which scrutinizes the proposals and HRB) MOSRTH, going issue its findings as per guidelines MORD Guidelines for accreditation formulated and Dublishedbv IRC bvDec 2007 Identification o fpriority schemes HRBin :mediate Listo f schemes publishedinIRC for research consultation with journal by December 2007 MOSRTW MORD ANNEX V The Value EngineeringProcess What i s Value Engineering(VE)? 1. VE is a management tool which involves carrying out a reassessment o f a design, proposal or process to seek out optimum value for both initial and long-term investment. VE has been widely practiced in the manufacturing industrybut lately the construction industry in some developed countries has also adopted this tool, realizingits potentialinoptimizingproject costs. 2. The VE process can be defined as a systematic application o f recognized techniques by a multi- disciplinary team o f industry experts to: (i) identify the function o f each design feature or proposal; (ii) establish a worth or need for that proposal; (iii) generate alternatives; and (iv) recommendthe best proposal to accomplish the project's objective, reliably and at the lowest life cycle cost (LCC), without compromising on the project objectives, safety, quality and socio-environmental aspects. 3. Ithas been often arguedby designers that the process of VE is very similar to the basic design principle. However it i s hghly unlikely that we use this principle at all times duringthe normal design process. VE has many elements, such as functional analysis, creativity, innovation, estimation o f lowest LCC and team work. Unless all o fthese elements are used, the process i s not called VE. 4. The overarching goal o f a VE study i s to achieve the `best value for money' and its objectives are to improve the quality, performance, efficiency, constructability, safety and environmental benefits within the least LCC. The process ofVE 5. VE is carried out mainly through a workshop, inwhich a selected multi-disciplinary team o f industry experts, including contractors, consultants and employers, as well as active public interest groups, are invited to take part. The workshop i s facilitated by a VE expert or leader o f the VE team. Duringthe workshop, the following agenda i s followed: 0 InformationPhase 0 Speculation Phase 0 EvaluationPhase 0 Development Phase 0 PresentationPhase Information Phase 6. Inthis phase, the design team presents the background, objective, design solutions with their intended function, cost estimates, risks, implementation schedule, and impacts o f the proposed project to the audience. The prime objective o f this phase i s to give the participants an understanding o f each design feature and its function. SpeculationPhase 7. This phase i s also called the creative phase. The team applies brainstorming techniques to develop good alternatives to the way the project i s currently designed and the facilitator invites ideas from the participants on any aspects o f the project or proposed design solutions. Each idea i s noted down and a number i s assigned to it. It i s prohibited to judge or reject any idea in this phase. The list may include ideas that can be further developed, evaluated and used inthe design. 51 Evaluation Phase 8. This phase o f the workshop can also be called the analysis phase. The participants define the criteria and establish a weighted evaluation system to be used for evaluating ideadalternatives prepared inthe speculation phase. Ideas which are found to be impractical or not worthy o f further study are discarded. Those ideas that represent the greatest potential for cost savings and value improvement are developed firther in the next phase o fthe workshop. DevelopmentPhase 9. Duringthe development phase of the VE study, ideas listed andretained under the evaluation phase are further developed and expanded into workable solutions. Depending on the complexities o f the project, this phase can either be taken up during the workshop or in a separate smaller group, which can include key members o f the design team as well. Each idea and proposed alternative i s developed by describing the recommended design change, advantages and disadvantages o f the proposed recommendation, cost comparison and L C C calculations. 10. Each recommendation is presented with a brief narrative to compare the original design method to the proposed change. Sketches and design calculations, where appropriate, are also included in this part o f the study. Presentation Phase 11. This is the last phase o fthe VE Study, where the VE team presents its recommendations inthe form o f a written report. The report i s presented to the Client and stakeholders, as well as the Design Team. The presentation includes the final recommendations, the justification and rationale o f each proposed alternative and cost impacts. The report and the presentation should also include an implementation plan, which describes the process that the implementing agency must follow to implement any recommendations. Inthis phase a decision is made as to which VE proposals will be accepted for implementation and incorporation into the design documents. Benefits of Value Engineering 12. VE can be applied at various stages ina project including construction. However, the earlier it i s applied, the higher are the returns. It has been established that the savings realizedby undertahng VE exercises can be inthe order of 10-15%ofthe originally designedproject. VEprocessresults inbetter informed decisions and encourages competitiveness by facilitating creativity and innovative design solutions. The Indian construction industry suffers from a lack o f attention to design review and optimization, frequent design changes during construction, and a lack o f client's capacity to review the design. In these circumstances, VE can be a brilliant tool to deal with this issue and can greatly improve the quality o f our designs. Furthermore, the participation o f selected public groups in the VE process gives comfort to the public in the project area, that their needs have been taken care o f inthe project design, and minimizes the risk o f design changes resulting from public demands duringproject implementation. 13. At the planning stage o f development, VE can help to review the program's goals and objectives, consider alternative approaches to the program, define performance indicators to monitor the program's success, and ascertain that the budgets are sufficient to carry out the proposed program. VE at the planning stage has very little impact on the schedule and redesign costs, and it increases the likelihood that project development will proceedwith few changes. 14. At the design stage, VE has the maximum advantage. An independent review by industryexperts during the VE workshop gives the assurance that all reasonable alternatives have been explored. The design gets confirmed and documented, and the possibility o f surprises during construction reduces. The client also gets confidence that the `best value for money' i s being implementedinthe project. 52 15. At the end o f this annex are sample worksheets, which may be used during a VE workshop at the planning and design stage to record and evaluate ideas. 16. During the construction phase, VE is still possible through the use o f a Value Engineering Change Proposals (VECP) clause inthe contract. Such a clause i s a contractual mechanism provided by Federal, state, and private businesses in the US. It gives a financial incentive to get contractors and subcontractors to reduce the cost of works, systems, supplies, and services for contracts inprogress. To qualify as a VECP, a proposal must, at a minimum, require a change to a contract to be implemented and save money. It must lower the overall LCC, without degrading performance, reliability, maintenance, or safety. No obligation to accept a VECP i s present and the risk for the contractor's development costs resides withthe contractor. 17. After contract award, there i s little reason for the contractor to reduce acquisitionor life-cycle cost. Since profits are derived from the contract cost, reducing that cost should reduce the expected profit. However, the introduction o f a VECP clause inthe contract dramatically changes this situation. Contractors can be provided with monetary incentives to propose solutions that offer enhanced value to the owner, and share in the financial benefits realized. Clearly the owner must consider contractor-generated proposals very carefully, from a life-cycle perspective and a liability perspective. The evaluation o f a VECP is treated similarly to any Variation Order duringconstruction. Success Stories 18. While VE concept has been around for decades, its use by the road industry has greatly increased in recent years. VE became popular after a 1995 Congressional regulationinUS, mandatingthe use of VE on all Federal-aid highway projects o f $25 million or more. Three states California, Florida, and Washington were recognized by the Federal Highway Administration (FHWA) in 1999 for their "exceptional accomplishments inapplyingand promotingVE." California was the first state highway agency to demonstrate the benefits of VE, having started its program in 1969. From 1994to 1999, California conductedmore than 200 VE studies, resulting inover $400 million insavings 19. A FHWA survey o f 380 projects nationwide in 2001 showed that during the VE process, 1,058 alternatives were considered and approved, which resulted in a saving of about $932 million. Similarly, the Oregon State Highway Department carried out VE on 40 highway projects, which yielded savings o f $2.5 million infour projects. 20. The Ontario Ministry of Transportation (MTO) completed its first VE study in 1995. Early successes on highway projects helped to expand the program. MTO now does VE studies on road standards and business processes as well as highway projects. Since 1998, accepted savings from the Ministry's VE program have exceeded $150 million. 21. Since 1996, the UK Highways Agency has also adopted VE at key stages o f schemelproject development. In the A 2 M 2 Cobham to J4 scheme, value engineering at works commitment stage achieved savings o f 6%. Furtherreferences for Value Engineering The SAVE International -A Value Society http:llwww.value-eng.org/ The Institute o f Value Managemen?, UK http:llwww.ivm.org.uW httv:llwww.fhwa.dot.aovlve1 The U S Department o f Transportation, The Federal Highway Administration American Association of State Highway and Transportation Officials httv:llwww.wsdot.wa.govleescldesidaashtovel Canadian Society o fValue Analysis http:/lwww.scav-csva.org/ 53 3 2 ?: e d 3 - I go 5.5I u a 4- 9a2 3 B O 2z ANNEX VI Case Study: RoadAgency Privatization -Actual Experience 1.0 Context 1. Attached below i s a presentation made by Mr Keith Madelin of the actual experience of the process o f corporatizing/privatizing the construction wing of the Shropshire County road agency. This is also available inthe web site - http://worldbank.org;/transport/training;/arms0l/madelin.pdf Privatization inPractice: The perspective of Direct Labor Organizations inthe UK KeithMadelin School o f Civil Engineering THE UNlVEKSlTY OF RlR#lKCHAM BackgroundConditions 0 Legal duty to maintain highways 0 Post 1950s -Emphasis on new construction 0 No consistency of standards 0 Maintenance taken for granted 1970-MarshallReport First study of highway maintenance inUK 0 Proposed Standards 0 Advocated maintenance management 0 Concerned about productivity ofDLOs 0 Recommended Training 55 PoliticalPressures 0 1970s-Oil Crisis -costs increase 0 Maintenance budgets reduced 0 1977-National RoadMaintenance Condition Survey I 1981-Legislationfor Competition 0 No work byDLO without an estimate 0 >&100,000 open competition 0 >5% profit to beachieved No Work without anEstimate EachDLOhadto set up a separate account 0 Expenditure-labor costs, materials, plant, overheads. 0 Income- from work estimates or from tenders, income has to be certifiedby client. 0 Profit - 5% based on value o f capital employed. 56 MinimumProfitLevel Profit - 5% based on value o f capital employed. 0 Minimumprofitability mustbe achieved over 3 year period 0 Accounts audited by government auditors Failure to achieve profit resulted inclosure o f DLOby government unless explanation accepted I The PressureIncreases More work has to be won incompetition 0 1982 -reduced to work >&50,000 0 1983 -reduced to work >E50,000 + 30% o f <&50,000 0 1983 -National Code of Practice for maintenance 0 1986-Audit Commissionreports on maintenance I Action Taken-1980s 0 Creationof DLO as business unit 0 ClientKontractor roles established 0 Aimto improveproductivity 0 Rationalise depots 57 Action Taken- 1980s 0 Review conditions o f employment 0 Revise bonus payments 0 Assess size o f workforce 0 Review plant and equipment needs Action Taken -1980s 0 Estimating unit established 0 Improve financial information 0 Discussions with Trade Unions 0 Training and preparation Organization of Shropshire -1982 Administration and Traffic Division 58 Organization of Maintenance Division 1982 Responsibilities of Division -1982 Identify maintenanceneed Advocate budget to politicians Allocate budget to areas Planwork programofDLO Supervise work Arrange for private contractors to assist Keep DLO employed Action Taken Organizational change 0 Focused on MaintenanceDivision 0 Separationof client and contractor roles Procedural change 0 Adoption ofMaintenance Code of GoodPractice 0 Introductiono fneedsbased budgeting Both changesare needed to be effective 59 Organizational Change Contractor Division Phase 1 Client Division AssisIaflt -COUIlty --: sutvf3yor -1 " _. - __ , I - _- - - Maintevdnca , -7 I Oesyn a~ct ,- Coritiacts - ! ~ - -- - - ~ c r- Area Afed I Area Area Surveyor t , ' 2 . . , 3 , 60 Role of Contractor Division Employ and manage workforce Purchase and manage plant and equipment Provide estimates for client Undertake agreed maintenancetasks Improve slulls and productivity Purchase materials Training and safety Keep accounts o f income and expenditure Role of Client Division 0 Develop a needs based maintenance management system 0 Advise politicians o frequiredbudget 0 Prepare specifications and contracts 0 Procure the work usingeither public or private contractors 0 Act as the focus for public contact Results - Phase 1 0 Shropshire County Contractingcreated 0 Turnover increased 0 Work planning improved 0 More use of sub-contractors 0 15-20% improvedproductivity 0 Minimumprofit levels exceeded I 61 The PressureIncreases 0 1987-reduced to >&25,000 + 30% o f<25,000 0 1988-reduced to >&25,000 -+ 60% o f <;E25,000 1996- 100%o f ALL WORK 1990s -Other Changes 0 Citizen's Charter concept 0 Public attitude surveys 0 Customer expectations 0 Enablinglprocurement role for public sector 0 Service provider role for private sector ActionTaken-1990s 0 Move towards fiee standing business unit 0 Strengthen clienthontractor roles 0 Critical review o foverheads 0 Continual improvements inproductivity 62 ActionTaken- 1990s 0 Re-define role o fpoliticians 0 Managers given power to manage 0 Delegationo f authority 0 Performance targets set 0 Payment linked to performance ShropshireCounty Contracting 0 Preparation o f Business Plan 0 Understanding the competition 0 Independent financial advice 0 Emphasis on marketing 0 Slulls and flexibility of workforce AnnualBenefitofDLO Tenders won by DLO f4,2 16,000 Next lowest private contractor &4,820,000 Saving f 604,000 DLOprofit & 100,000 Estimated effect o f competition Createdby DLO (5% lower cost) & 300,000 Total estimated saving &1,004,000 (Worth 10%o fbudget) 63 SCC-Resources 1992 0 Employees -375 0 Plant andequipment -600 items 0 Depots- 8 No-value E3.2m 0 Turnover-&17mpa SCC-Predictions for 1996 0 Employees-downto 250 0 Turnover-down to 28.2mpa SWOT Analysis STRENGTHS WEAKNESSES Quality Too dependenton County Reputation Marketlimitedby law Localknowledge Public sector pay & conditions Profitable THREATS OPPORTUNITIES ReducedCountybudget Alliances Extensionof competition Other public services Withdrawal of Gov agency 64 The ChangingClient 1981- 1982- 1983- 1984- 1985 1986 1987- 1988 1989- ?BO- 1991- 1992- 1993- 1994. 1995 82 83 84 85 88 87 88 E3 90 91 92 93 94 95 96 ReducingManpower Manuals t3 Staff 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 65 Options for Change 0 Carry on and compete in a limitedmarket Manpower losses andproJitability at risk,failure could result in forced takeover 0 Merge with other local DLOs No local DLOwouldrecognize thepotential, nopolitical will, manpower losses. 0 Explore privatization ina controlledway Ability to influence choice of apartner Exploring Privatization 0 The results o f the review shared with workforce and Trade Unions consulted 0 Workforce agreed to explore privatization 0 Representativetask-force set up and given the freedom to meet with whom they wished 0 Timescale established, client to proceed with draft contract documents Packaging the Contract 0 All options hadan impact on the client, therefore client also explores options 0Keyissues were the scope, lengthandnumber o fcontracts 0 Large all-purpose contract would keep DLO intact for a merger and facilitated better emergency cover 0 Small contracts may give lower prices but are more difficult to supervise 66 ProcurementProcess 0 5 year general contract for maintenance and minor construction work, extendable to 7 yrs on good performance 0 Advertised and a long list o f contractors chosen on basis o f quality and financial standing Taskforce allowed to visit and appraise all contractors and privatized DLOs DLOcontinues to reduce manpower Selecting a Short List 0 Politiciansagreed that employee taskforce can inputinto process, and that privatizationwill only occur with employee approval 0 Long listed contractors invitedto seminar to discuss tender procedure 0 Longlisted contractors make presentations to client andtaskforce 0 Client and taskforce consult and identify preferredshort list o f 6, politicians approve TenderingProcedure Documents include typical quantities but are not guaranteed 0 Depots, plant and equipment listedand made available for purchase or rent 0 Labor details supplied and contractor must over the DLO employees 0 DLOalso tenders on same documents, bothto benchmark the bids and also to keep option for DLO to win and continue 67 Financial Evaluation Three elements: 0 Tender for works 0 Payment for plant and equipment 0 Any specified cost for tahng over employees, includingpension provision and conditions o f service Results 0 The lowest privatebidwas 10% above the DLObenchmark bid 0 The politicians decided that 10%was within the riskthey would carry for redundancy payments ifthe DLO continued inbusiness 0 Employees were strongly infavor o fprivatizing 0 The best bidcame from the contractor who was first choice for the employees FinalDecision 0 The contractor offered to takeover all of the workforce and managers, withminimal change 0 Employees voted 95% infavour o fprivatizing with their preferred contractor 0 Politiciansagreed and transfer took place inApril 1995 0 The client was not so happy since the cost of maintenance increased by 10%. No extra budget was allocated. THE UNlVEKSlTY OF BIRMlNGH.4M 68