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Last updated: 05 Jul, 2021  

Entrepreneur.9.Thmb.jpg Saving the small contractor

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Vikash Khandelwal, CEO, Eqaro Surety Private Limited | 02 Jul, 2021

The COVID-19 pandemic has had a debilitating impact on the Indian economy. The 2nd wave which was far more lethal and ravaging in its impact than the first one, has pushed us into the midst of heightened levels of economic uncertainty. The viciousness of the wave necessitated the re-imposing of curbs on movement of goods, interstate travel, attendance at offices, functioning of malls, market places etc. Travellers from India were also barred from most countries. The focus shifted to survival at any cost and making it to the other side of the pandemic, ALIVE.

Most of these measures while being necessary to contain the pandemic, had a telling impact on the economy. The infrastructure sector is not an exception either. The curbs stalled construction activity at the sites. Even the sites that were functional were operating at 50% of capacity. The entire sector faced a plethora of setbacks in the form of labour migration, limited supply of raw materials, reduced/stalled construction activity, stuck payments, choked banking lines, locked up collaterals etc.

While the larger contractors were better equipped with management and financial resources to navigate through the crisis, survival became difficult for the smaller ones. Despite the pandemic having now subsided and the economy gradually opening up, revival may be extremely difficult for the small contractors who may not be able to participate in any new project opportunities.

What can be done?

All infrastructure contracts require guarantees to be put up by the contractor. These include bid security, performance guarantees, advance payment guarantees & retention guarantees. These guarantees cumulatively add up to over 15% to 20% of the project costs. Bank guarantees are currently catering to 100% of the guarantee requirements in the country today. Most banks in the post pandemic world have serious reservations in supporting a contractor’s need for guarantees and require him to lock up incremental amounts of collaterals (if still available) & margin money thus pushing his already ailing business closer to the brink. Now if guaranteeing facilities were made available to contractors without the need for collaterals, these small contractors would also be able to participate in and take advantage of new project opportunities. Since the small contractors operate largely in the semi urban and the rural areas, such projects will play a crucial role in promoting entrepreneurship, generating local employment & rural demand thus aiding economic revival within the more fragile segments of the economy.

This is where the Government can step in to support by way of policy action -

Guarantees are probably the first need for the contractor and starts with the submission of the bid and continues even after the handover of the project till the end of the defect liability period. As such, guarantees have a cumulative effect of locking up of productive collaterals thus escalating the costs of execution for the contractor.

For all small projects either at the state, municipal or the panchayat level, the GOI should extend counter guarantee support to the bank against the bank guarantees issued by it on behalf of these small contractors. This is similar to a reinsurance transaction and will have the effect of taking the risk off the bank with respect to these guarantees. For eligibility, the contractors can be screened and only the ones that possess the knowledge and skills necessary for success and a proven track record of on time execution be made eligible for such kind of guaranteeing facilities. This single step can result in multiple benefits

· It will result in enhanced participation in the bids for projects thus resulting in a more efficient price discovery

· Since banks will no longer carry the risk, it will release collaterals to support working capital requirements thus improving efficiency of execution

· With this support, the balance of the bank line of credit can be used towards meeting working capital requirements.

· It will promote entrepreneurship and generate employment at the local level thus reducing the strain on the other welfare programs run by the government.

· It will also help generate rural demand thus assisting in the overall revival of the economy. This revival will be for real!

Sub-contractor payment guarantees can make a huge impact as well if made mandatory for all government projects. It’s usually the smaller contractors that operate as sub-contractors whether it be for supply of materials, labour or even construction of a part of the project. The construction of large infrastructure projects is completed over a number of years. The sub-contractors being small are usually vulnerable and at the mercy of the main contractor for their payments. Further, if the sub-contractor walks away due to non-receipt of his dues, it could stall the entire project.

Sub-contractor payment guarantees ensures that the sub-contractors, suppliers are paid in full through the construction of the project. Sub-contractor payment bonds are mandated by law in many of the developed countries around the world.

Sub-Contractor payment bonds will impart certainty to the receipt of payment by the sub-contractor and will encourage their participation in the projects. With the resultant certainty around the receipt of payments, the banks will be more willing to extend working capital limits for such sub-contractors thus infusing liquidity in to a segment that is currently starved of the same.

In the stimulus package during the first wave, Finance Minister, Ms Nirmala Sitharaman had used guarantees effectively to help infuse liquidity in the MSME sector. She had also announced the reduction in the need for performance guarantees from 10% to 3%, replaced the need for bid security with a bid declaration and released bank guarantees in proportion to the quantum of work completed at the project in an effort to extend a helping hand to the contracting community. She has used guarantees very effectively in ECLGS 1.0, 2.0, 3.0 which has resulted in credit disbursals of Rs 2.69 lac crores to over 1.10 crore businesses by the banks. The recent announcements will help the deeply impacted sectors get access to an additional Rs 1.50 lacs crores of credit. Guarantees have clearly emerged as an efficient way of easing the access to credit for businesses.

While a considerable amount has been done to ease the availability of credit to businesses, the situation today merits going a step further by way of policy action in support of what is clearly the back bone of the Indian Infrastructure Industry.

 
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