Construction sector underpins Sri Lanka’s growth formula

Thursday, 14 November 2013 00:33 - - {{hitsCtrl.values.hits}}

By Damith Wasantha and Samudrika Jayasinghe – LOLC Securities Ltd. In Sri Lanka the construction sector (sub segment of the industry sector) accounts for the majority of the total investment as country is marching towards a rapid economic expansion after the end of the 30-year war. Construction sector GDP stood at Rs. 247 b (US$ 1.9 b) in 2012 while the sector recorded a growth of 21.6% in 2012 (Graph1) compared to the GDP growth of 6.4% and industry sector growth of 10.3%. The growth rates started to pick after 2009 as major buildings and other infrastructure projects are taking place in the transition period of the country (Graph 2). The Institute of Construction Training & Development (ICTAD) and the Chamber of Construction Industry Sri Lanka (CCI) are the apex bodies and accredited representative of the domestic construction industry, while many State-owned entities and private construction companies are registered under ICTAD. In addition, international contractors and unregistered informal contractors carry out construction work in the

country. The main State-owned construction companies are State Engineering Corporation of Sri Lanka (SEC), Central Engineering Consultancy Bureau (CECB) and State Development and Construction Corporation (SD&CC). Main private sector companies are ICC, Sanken, Maga, Nawaloka, Tudawe and Access Engineering, etc. The Sri Lankan construction industry can be categorised under the following main segments: i. Building construction ii. Highway construction iii. Bridge construction iv. Water supply and drainage v. Irrigation and land drainage vi. Dredging and reclamation vii. Other constructions Building construction includes housing and commercial buildings while other sectors can be categorised under infrastructure. Out of the subsectors, generally, building construction accounts for 50% of the total investments. Private sector participation remains significant in building, water supply and drainage and other construction sectors while other constructions mainly include telecommunication, power and energy, etc (Graph 3). 77% of the 2010 construction projects were above Rs. 50 m investment value (Graph 4). Building construction The building construction sub sector witnessed a drop in 2009 due to the economic downturn and high lending rates while issues faced by private sector entities (e.g. Ceylinco Group) also weighed on the growth of the sector. Sale of apartments slowed down considerably over the last two years with the global concerns over the property market, while very few new projects were developed. Even the projects that were under implementation progressed slowly while some projects were abandoned due to numerous reasons (Dawson Grand Twin Towers, Mayfair City). The recently completed and presently under construction large-scale, luxury condominium projects are Trillium Residencies, Emperor Tower, Fairmount, Monarch, Iceland, Ceylinco Celestial Residencies, Altair, On-Three Twenty, Fairway and Havelock City. The Greater Colombo Housing Approval Index has started to move up slowly (since 2009) while the Government has initiated many housing projects, especially in rural areas through the National Housing Development Authority. (Graph 5) Roads and bridges Road density of the country (roads per square kilometre) which stands at 1.6Km (2009) in Sri Lanka is higher compared to other countries in the region. The network’s density is among the highest in Asia, as the number of road kilometres per population exceeds the related indicators of both Pakistan and of densely-populated Bangladesh. Despite the extensive and dense road network, mobility is a major constraint in Sri Lanka’s contemporary freight and passenger transportation. The Government policy depicted by National Road Master Plan (NRMP) on road development is focused mainly on building a national highway system, supported by an integral road network, improving the management of the roads and increasing private sector participation in investing on new roads (Graph 7). The Southern Expressway (with an investment value of Rs. 59.5 b), Colombo-Katunayake Expressway and Colombo Outer Circular Highway Project (with an investment value of Rs. 82.6 b) are among the major road development projects. Water supply and drainage During 2012, approximately 40% of the population was covered in terms of water supply (source: National Water Supply and Drainage Board – NWSDB) (Graph 9). Water supply and drainage projects are expected to increase in future with the GoSL’s plans to further expand the access to pipe borne water throughout the country. Raw material and labour Prices of raw materials used in the construction industry are rising which increases the total construction cost. The main reason for the price increase is lack of availability of raw material. Availability of natural resources such as sand and bricks (made out of soil) is coming down drastically, which has increased the prices rapidly of such resources. The price of illicit river sand used for construction has risen up with the tightening of restrictions on river bed mining in an effort to minimise the environmental damage. Transportation of sand and oil requires licenses, which would also increase the price of the resources. Also due to the insufficient local production of cement, most probably half the portion of total cement requirement is imported. According to the growth in the construction industry, demand for labour has risen while the supply seems to be insufficient. Migration of skilled labour (especially to Middle East countries) has been one of the main reasons behind this. Due to this insufficiency of labour, supply prices of labour tend to be increasing over time, which ultimately increases the cost of construction since it captures almost 12% of total construction cost.

Lending rates and funding The construction industry is heavily depending on debt where long-term loans are one of the keys of funding large-scale construction projects. Volatility of lending rates therefore has a negative effect on confidence of investors, considering the long lifecycles of project completion. As a result most projects tend to get completed with varied cost structures than budgets. However, as a measure to increase the money supply, the CBSL cut down the policy rates twice during the year. Accordingly AWPR (Average Weighted Prime Lending Rate) responded by shedding 200 basis points from 13.5% to 11.5% from May to October 2013. CBSL’s recent policy rates would further reduce AWPR and we expect this phenomenon to entice credit expansion with the low inflation position of the country. Therefore we expect more construction projects to materialise in the future. Project issues for foreign investors Given the large number of projects proposed, it is necessary to have system of acquisition of land for development projects in a manner that takes care of the interests of various stakeholders. Frequent changes in regulations, even after providing the necessary approvals, have caused a lot of hardships to developers. Further, overlapping controls by multiple authorities have also impacted project progress. Foreign investors face a few difficulties at the initial stages of large-scale projects where Sri Lanka is lagging behind other developed Asian countries such as Singapore, Malaysia and Thailand. In terms of duration taken and the process cost, the country is not that efficient compared to some regional countries. (Graph 12) The GoSL has introduced many legal reforms in order to reduce many obstacles like length of project approval process and obtaining approvals. Despite the efficiency lagging compared to East Asian developed countries, Sri Lanka has improved a lot after the war as the country leads South Asian countries in terms of the ‘Doing Business’ rank (Doing Business rank in 2014 was 85). Sri Lanka has developed its rank in terms of dealing with construction and registering property sectors over the past couple of years.

Continuous stimulus from the Government The GOSL has taken commendable measures to entice local private construction projects while it has been actively engaged in infrastructure development collaborating with foreign constructors in China and India. Here are some highlights of the budget pertaining to the construction sector:

Reduce the cost of imported machinery and equipment by reducing prevailing taxes at the point of Customs on such imports.
Expand guarantees provided by Construction Guaranty Fund to improve access to finance for small construction companies.
The grace period given to apply default status prescribed by CRIB will be extended to three months with regard to construction contracts with Government agencies.
Issue permits to all well-established local road construction companies import bitumen to improve competition in the supply.
Earmark a section of the Northern Expressway for local construction companies in order to further develop this industry
Maintain adequate tariff differentials at the point of Customs between finished products and associated raw materials.
Impose conditions at the time of approval by the Government, requiring direct involvement of local contractors with regard to foreign investment in the local construction industry.

Summary

Construction sector GDP stood at Rs. 247 b (US$ 1.9 b) in 2012 while the sector recorded a growth of 21.6% in 2012 compared to the GDP growth of 6.4% and industry sector growth of 10.3%.
Building construction accounts for 50% of the total investments. Private sector participation remains significant in building, water supply and drainage and other construction sectors while other constructions mainly include telecommunication, power and energy, etc. (Graph 3). 77% of the 2010 construction projects were above Rs. 50 m investment value.
Construction of expressways and highways of the ‘National Road Master Plan’ involves six major projects with a length of 594 km and an estimated cost of Rs. 238.3 billion spread over the entire program of 10 years.
Approximately 40% of the population was covered in terms of water supply.
Prices of raw materials used in the construction industry are rising and migration of skilled labour (especially to Middle East countries) has been one of the main reasons behind the insufficient labour. Construction industry is heavily depending on debt where loans are one of the key sources of funding large-scale construction projects. However, CBSL’s recent policy rates cost would further reduce AWPR and we expect this phenomenon to entice the credit expansion.

GOSL has taken commendable measures to entice local private construction projects and to eliminate hassles that foreign investors have to go through while it has been actively engaged in infrastructure development collaborating with foreign constructors in China and India.