Construction Industry plays a major role in the economic growth of a nation and occupies a pivotal position in the nation’s development plans.
India’s construction industry employs a work force of nearly 32 million and its market size is worth about Rs. 2,48,000 crores. It is the second largest contributor to the GDP after the agricultural sectorI.
Construction sector is viewed as a service industry. It generates substantial employment and provides growth impetus to other manufacturing sectors like cement, bitumen, iron and steel, chemicals, bricks, paints, tiles etc. whose combined value is Rs.1, 92,000 crores annually. The construction equipment market is valued at Rs.1, 05,000 crores.
Risk in Construction needless to mention, with huge money, comes the company of big risks. Construction is a high-risk business. Or is it? This is a classic dilemma, which haunts every participant in the business. The Project owner, construction companies, consultants, bankers and financial institutions, vendors & suppliers and even the service providers, each has his own fears of facing risks in the conduct of business. The magnitude of the risks is indeterminate at times. What needs to be determined is:
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The proportion of real versus perceived risks.
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The monetary quantification of risks.
- The real import and the impact of a type of risk.
Risks, when indeterminate, are worse than assessed risks. The obvious outcome of the situation is that the Banks and Financial Institutions hesitate in lending to the operators of Construction Industry or alternatively lend in absence of authentic and reliable inputs. Either of the situations is detrimental to the overall growth of the industry and thus, the economy.
It is therefore of paramount importance that the present operating systems be substantially strengthened to provide comfort to the financial systems.
Mitigation of risks is the all en-compassing requirement. Broadly speaking, Construction Projects face the following type of risks :
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Business Risks
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Financial Risks
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Technology Risk
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Project Risk
- Political Risk
The risks in a standalone project are big. They include:
Completion risk This is the risk that the project may not be completed on time, or at all, due to various reasons such as cost overruns, technology failure, force majeure etc.
Price risk This is the risk that the price of the project's output might be volatile due to supply-demand factors. If new capacities are coming up or if there is likelihood of fall in demand of the project output, the price risk is high.
Resource risk This risk includes the non-availability of raw materials for the project operation. It also includes the risk that the raw material prices might move adversely
Technology risk This is the risk that the technology used in the project is not sufficiently proven.
Operating risk This is a risk that the project operational and maintenance costs would escalate. It also includes the risk that the project will have operational problems.
Political risk This risk relates to matters such as increased taxes and royalties, revocations or changes to the concession, exchange controls on proceeds, forced government participation in shares and refusal of import licenses for essential equipment.
Casualty risk This is the risk of physical damage to the project equipment. It also includes liabilities to third parties on account of accidents at the project site.
Environmental risk This risk refers to increased project costs for complying with new environmental standards. There could also be environmental protests from the local populace against the project.
Permission risk This is the risk that official clearances for the project may not be forthcoming or subject to expensive conditions.
Exchange rate risk This is the risk that the currency of sale of the project produce would depreciate with reference to the currency of the project loans. Even though the debt being rated might be Rupee denominated, the presence of foreign currency liabilities can decrease the debt service coverage ratio of the bonds in case there is adverse exchange rate movement.
Interest rate risk This is the risk that the floating interest rate of the project loans would increase beyond the levels assumed for preparing projected cash flows.
Insolvency risk This is the risk of insolvency of contractors, project sponsors, suppliers, purchasers of project output, insurers or a syndicate bank.
Project development risk This is the risk that the project development might not take place in an orderly manner.
Site risk This is the risk that the project site might have legal encumbrances. It also includes the risk that the site has technical problems.
Financial closure risk This is the risk that the project that the project might not reach financial closure.
POSSIBLE WAYS OF MITIGATION OF RISKS Where as the basic premises remain unaltered and the broader classification is still valid, the exigencies and the systems adopted, reduce or enhance the intensity of encounter, even in the present day.
An effort, therefore, has to be made, to make an assessment of such risks, quantify them and also to work out solutions, products, or the practices, to mitigate them. If not mitigated, following could be the possible repercussions (behavioural) outcome:-
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Dilemma of the Project Owner to invest in the project.
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Dilemma of the construction company to complete the project in time and within the scheduled costs.
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Dilemma of the consultants to provide effective support services.
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Dilemma of the Banker to provide the required financial support to the venture.
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Dilemma of the vendor to meet his supply obligations in time.
Regarding mitigation of such risks, the elements continue to remain unchanged, with varying degree of sophistication arising out of the type and the nature of mitigant used. While defining the elements, one can again classify them in the following broad categories.
By evolving a risk spread system, to reduce the impact.
By following better work practices and enacting regulations to allow only the acknowledged masters of the trade to practice independently.
By creating systems and subsystems to facilitate and operationalize the practices in consonance with above two premises. (e.g. initiation of formal training and HRD)
Having thus articulated the premises, and cutting out the charter of activities, one vital question yet confronts all concerned, and that is to devise the mechanisms of Profiling and Quantifying the risks. The answer is found in creation of a database (Some call it colloquial wisdom, or experience) and applying the principles of mathematics.
An attempt, therefore, is to be made to develop following:
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Risk identification Instruments.
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Risk management Instruments.
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Risk mitigation Instruments, & eventually.
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Damage control, containment and resolutions Instruments.
Experts, who work on evaluating the possibility and the quantum of risks as numbers, are named as Actuaries. Actuaries document the details of the events, which lead to failures, analyse the causes as mathematical expressions, determining the frequencies, and the extent of damage/ losses.
Construction, as a large economic activity, has now started drawing attention from several quarters, and work in right earnest has begun on such aspects, which, though vital, remained neglected all this while.
Evolution of techno-commercial grading systems, Institutional Systems for performance surveillance, designing of Insurance/ non-insurance backed products, and several other such services and support systems are being designed and practiced to continuously improve the performance of the Industry as a whole.
Conclusion
In absence of the above mentioned systems and procedures, the obvious result is impeded and stinted progress of work, employment of obsolete technology, impeded supply of resources and therefore rampant time & cost over runs in the execution of projects.
This could be achieved by collecting data regarding functioning of the Industry, analyzing the same and evolving systems, which could be offered as service to the stakeholders.
Thus, there is a definite need of developing the following,
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An effort to collect and sample datas, conduct research, analyze causes and develop models to profile, and quantify various types of business risks.
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A network of several Service Organizations, who may adopt the models and systems developed thus and offer professional services to the stakeholders. Needless to mention, such networks would emerge as an obvious reaction of market forces, and may for the time being be kept out of the purview of present paper, however, working models and procedures would have to be created, and this is where the Apex Organizations would have to play the role of a Catalyst / facilitator.
CIDC and some other professional bodies have done some work in the area of risk alleviation in Construction Engineering, however a conscious thrust is needed. The work, which is being done so far by CIDC, in order to have better risk identification, assessment and profiling of various risks involved with this important sector of Economy, is
Evolution of a novel concept of Construction Equipment Bank.
Introducing the services of Lenders Engineer.
Grading of various Construction agencies in association with ICRA.
Evolution of new construction sector specific Insurance Products, soon to be launched by the Insurance Companies in India.
Evolving jointly with IBA, more flexible lending norms to be adopted by different Financial Institutions.
This is just a beginning. Many more such efforts are required for development of the Construction Sector of India.
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