Construction sector appears resilient as projects pick up pace

• ICRA Lanka says firms largely operate with secured funding, which alleviates serious 
• liquidity issues 
• Says muted order book  on new projects and pressure on profits could undermine industry’s medium-term outlook
• Points out construction firms largely insulated from adverse effects of raw material price volatility, due to currency depreciation

Sri Lanka’s construction sector appears largely resilient to the shocks reverberating from the coronavirus-related economic malaise compared to other sectors, as the projects are gradually gaining pace after the easing of curfew while the companies largely operate with secured funding, alleviating any serious liquidity issues, said ICRA Lanka Research. 

It was only recently the construction major, Access Engineering PLC, said secured project funding had eased pressure on its liquidity and hence, did not expect major hurdles financially and operationally in the medium term. 
Despite the factors favouring the sector’s relatively quick revival, the rating agency, which is part of Moody’s Investors Service, however cautioned on the muted order book on new projects and the pressure on profitability to undermine the sector’s outlook through the medium term. 

According to ICRA Lanka, what will further aid the construction companies to resume work is the local manufacturing of certain raw material types and the available inventories of imported raw materials although there could be some hiccups from the import controls imposed by the government.

Meanwhile, the rating agency also said the construction companies are largely insulated from adverse effects of raw material price volatility, due to currency depreciation. 

Global commodities are trading at multi-year lows, due to subdued demand stemming from the coronavirus-related lockdowns, as economic activities, including that of construction work, had to be suspended to stem the spread of 
the virus.

However, the benefit of lower metal and oil prices is largely expected to offset by the depreciation of the rupee, ICRA Lanka added. 

“Prices of metals that are critical to the construction industry have experienced over 10 percent decline from year open to end-May (e.g. copper -14 percent, aluminium -16 percent, lead -16 percent). 

Steel, a key input for the construction sector, has also plummeted amidst the weaker global demand. Oil, which is used for producing construction raw material like tar, has fallen almost by 50 percent,” the rating agency said. 

While some foreign currency-funded projects provide a natural hedge against the foreign currency risk, most construction projects in Sri Lanka are local currency denominated. Given the current circumstances, the availability of funding support is the biggest consolation some of the large construction companies have, because their projects are funded by funding arrangements from multinational agencies and international financial institutions, such as ADB, JICA, World Bank, IDA or bilateral arrangements with countries like China. 

However, as most of these foreign-funded projects generally require the initial financial commitment from the government, with up to 20 to 30 percent of the project value invested before the utilisation of the foreign funding lines, the projects which are at this stage could face certain challenges, ICRA Lanka noted. 

Further, the projects that are directly funded by the Treasury could also face come challenges, given the current fiscal position of the government. But the projects that have funding arranged from local banking sources may not face such challenges,” the rating agency added.

However, ICRA Lanka expects the muted order book from both local projects and foreign-funded national infrastructure projects, due to the global economic downturn, could undermine the overall industry outlook in the medium term. 

Further, a moderation in profitability and some impact on liquidity of the sector are also expected, due to a considerable level of fixed cost associated with the nature of the industry. 

“The companies, which are into high capital-intensive segments like piling, would be greatly affected,” the rating agency noted. 

To ease the liquidity pressure, ICRA Lanka proposed the provision of working capital support payments, such as mobilisation advances or interim payments between milestones, especially for small to 
mid-sized contractors. 

The proposed debt moratorium and concessions for corporate entities are also expected to cushion some pressure on liquidity, in the second half of the year.