The government has taken several measures for the highways sector over the last decade and several projects have been awarded to private developers through the build-operate-transfer (BOT) model on a tolling or annuity basis. As the sector has progressed towards maturity, financiers? and private sector stakeholders? increasingly favourable perceptions of the sector?s attractiveness and risk have been reflected in finer pricing and greater availability of capital (barring, of course, the obvious effects of rising interest rates and reducing liquidity in general in the recent past).

Key projects such as the Delhi-Gurgaon expressway have seen the sector move towards a regime where developers are willing to pay significant upfront premia to acquire concessions. At the same time, the financing trends?which saw lower levels of equity being supported by higher senior debt and a proportion of sub-debt?indicate increased banker confidence in road sector projects. The maturity of the sector is seen from the fact that road sector projects account for almost half the infrastructure projects achieving financial closure.

Although the concept of private investment in India?s national highways is now over a decade old, active participation in project bids by leading international players is a fairly recent phenomenon. This may be due in part to the fact that toll-road markets in developed/other developing countries appeared more attractive for international deve-lopers in the earlier part of the decade; moreover, individual project sizes in the Indian market were relatively small and better suited to local developers.

Apart from these factors, we believe that the country also needed more projects successfully implemented and in operation before international developers would consider investing in the Indian market.

The new model concession agreement also tends to reduce the variability of returns on a project, with changes in factors such as traffic growth and inflation. And the current system of ranking bidders on the basis of their credentials and qualifying a limited number of players for each project makes participation in these bids more meaningful for large international developers.

However, 2008 has seen a dramatic turnaround in the global financial scenario, with obvious implications for all sectors, including highways. The global financial meltdown is likely to have far-reaching implications for international and domestic developers alike, in particular those who have not taken advantage of the general optimism of the previous few years to raise funding for investment in BOT assets. Fluctuating crude prices, high inflation rates and interest rates of 13-15% have increased capital costs exponentially for projects currently under implementation.

We believe that the expected returns of such projects, tendered during much more favourable economic circumstances, would be detrimentally affected. This, coupled with a change in banks? lending strategy, may lead to a delay or even failure in the financial closure of specific projects, including larger projects tendered under the new model concession agreement.

This year has also seen the auction process for more than 50 projects commencing through a PQ process, which shortlists for each project the top six bidders with the highest technical score. Thus far, these projects have witnessed a highly enthusiastic response from reputed developers from around the world.

According to an international developer, this participation can be attributed to, among other things, the process facilitating competition between experienced and stable developers. The shortlist for these projects has been delayed by a few months as the evaluation criteria were under debate on several points. Subsequently, the shortlist for around 20 projects was announced, with an additional restriction of each bidder being allowed to submit bids for only eight of the projects.

So what does the future hold? Given current market trends and regulatory regime, we believe that the sector will witness a number of interesting trends in the near and mid term. Given the general level of market volatility and instability, project costs are likely be high, and we do not expect highly aggressive project pricing from more organised players.

It is difficult to assess whether most large international developers will show sustained interest in the Indian market beyond the project auctions in the immediate future; we believe the results of the current auctions and the eventual decision on whether or not to retain the current PQ norms for projects in future will be key to retaining international interest in the sector in India.

Developers will need to invest significantly greater effort in planning the commercial, technical and regulatory risks of each project before bidding as project sizes increase, and greater flexibility is given to developers to come up with their own project designs. Accordingly, we expect the market to seek higher returns on these project in the near to mid term. At the same time, bidders that have deep pockets and have managed to address the equity challenge for future projects would be better placed to win projects.

It is interesting to note that a majority of Indian infrastructure firms active in the highways BOT space are listed entities. In the current market, it may be difficult for them to raise further equity through the public markets without dilution levels that reduce promoter holdings to dangerous levels, or at valuations that are simply not meaningful.

We expect that developers will need to address the deficit of options in the equity market through more innovative deal stru-cturing. Listed developers in particular will need to arrange equity funding in structures that are not hindered by the current stock market valuations, which tend to substantially discount subsidiary BOT portfolios vis-?-vis their intrinsic worth.

With banks changing their lending strategies in the wake of the current financial turmoil, we believe that failed financial closure by unrealistically priced/marginally viable road projects may become a reality. We also believe that developer exits from operating highway concessions will take centre stage in the highways M&A space.

In summary, we believe the Indian highway sector today stands poised at an interesting crossroads, and the events of the coming months may well shape the future of the sector over the mid to long term.

?The writer is associate director, Ernst & Young