alternate means of financing railways -...

Alternate Means of Financing Railways

G Raghuram and M Ravi Babu

This paper by Raghuram and Ravi Babu focuses on the financial requirements of Indian Railways and the means of pro-viding for them. Drawing lessons from the existing modes of finance, the pros and cons of the potential modes includ-ing budgetary support, internal resource generation, market borrowings, BOLT (Build, Operate, Lease, Transfer), and BOT (Build, Operate, Transfer) are discussed. With declining budgetary support and expensive market borrowings, the paper seeks to focus attention on internal re-source generation and BOLT/BOT schemes which involve stakeholders. Increased internal resource generation is possible by increasing revenues through value added service and innovative pric-ing, and reducing cost through improved asset utilization. G Raghuram is a member of the faculty in the Public Systems Group and M Ravi Babu is a doctoral student at the Indian Institute of Management, Ahmedabad.

Transportation in India is a critical infrastructure for economic growth. With an expected real economic growth rate of 4.5-6.0 per cent per annum, the demand for transport is expected to increase at a faster rate. The freight transport is expected to grow at a rate of about 6-7 per cent, doubling in 10 to 13 years. Passenger transport is expected to grow at a rate of about 7-8 per cent, doubling in 7 to 10 years (World Bank, 1995). While the economy grew at over 5 per cent per annum over the past decade, as far as the Indian Railways (IR) is concerned, the physical growth in freight traffic was 2.6 per cent per annum and passenger traffic was 3.3 per cent per annum. While the national income grew at 14 per cent per annum at current prices between the middle of the seventh and the eighth plan (1985-90 to 1992-97) periods, the IR revenue grew at 13 per cent per annum. Thus, the growth in IR traffic has not kept pace with the study expectations.

The primary modes of transport in India are road and railways. For freight, coastal shipping and pipe-line are alternate modes with growth potential. For passengers, air is an alternate mode with growth potential. However, these alternate modes currently account for an insignificant share of traffic. Given the geographical spread of population and industries, an appropriate modal mix of transport is necessary for development. Over the years, the share of rail trans-port in the total transport market has come down very steeply (Table 1).

Table 1: Market Share of Rail Transport

Freight Traffic Passenger Traffic Year

Road BTKm

Rail BTKm

S l u m o f Rail %

Road BPKm

Rail BPKm

Share of Rail %

1969-70 57 127 69.0 210 118 36.0

1979-80 98 159 61.9 543 209 27.8 1984-85 193 206 51.6 850 241 22.1 1989-90 295 230 43.8 1282 280 17.9 1994-95 413 250 37.7 1953 318 14.0

Source Indian Railway Year Book (different years).

Note: BTKm: Billion Tonne Kilometre, BPKm: Billion Pas-senger Kilometre.

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The market share shift towards road has occurred in spite of the direct transport cost advantage enjoyed by the railways due to its inherent technological advantage. In fact, during 1993-94 and 1994-95, the actual IR traffic in BTKm dropped compared to the previous years, reflecting a negative growth rate. This performance of IR is due to reasons such as : (a) insufficient infrastructural investment reflected in capacity shortages and (b) organizational inefficiencies reflected in poor customer orientation.

During the period (1986-87 to 1993-94) when the GDP at current prices grew at 14 per cent per annum, the plan investments in the transport sector grew at 12 per cent per annum. For railways, the investment grew at a lesser rate of 7 per cent per annum, with its share of total transport plan investment dropping from 56 per cent to 48 per cent.

In a study conducted by the Indian Institute of Management, Ahmedabad (1998) and Giridhar (1996), shippers (customers) gave the following reasons for preferring road to railways for freight movement:

• Irregular supply of wagons: Shippers are not sure of availability of wagon stock on demand. The variability in supply of wagons complicates the planning process for shippers and also increases inventory costs.

• Irregular delivery at destination: Shippers are not assured of the arrival of their consignments in a specified time frame. The arrival pattern also has a high degree of variability

• Inflexibility of service: While road transport pro vides door to door service, a similar service is not provided to the shipper by IR. All shipments by rail which necessarily have a component of road transport at the despatch/destination ends have to be arranged by the shippers. Further, shippers also perceive that railways do not provide access to certain markets where there is no railway line.

In the passenger market, lack of supply and appropriate amenities are perceived as problems. This is more acute in the case of suburban traffic and during peak demand seasons.

Given that the above problems exist at current levels of traffic, an assessment of the likely future would bring to light the gravity of the issue. We consider annual growth rates of 3, 3.5, and 4 per cent for freight traffic and 4, 4.5, and 5 per cent for passenger traffic and project for fifteen years until the year 2011-12 (Table 2). The freight traffic demand would go up by 55-80 per cent and the passenger traffic by 75-105 per cent.

Table 2: Projections of Rail Traffic

Freight Traffic BTKm

Passenger Traffic BPKm Year

R a t e 3 3.5 4 4 4.5 5

1996-97 278 278 278 357 357 357 2001-02 322 330 338 434 445 456 2006-07 374 392 412 528 554 582 2011-12 433 466 501 643 691 742

This would call for appropriate investments in infrastructure to service the projected traffic. Apart from this, more investments would be required both in infrastructure and organizational effectiveness to increase the market share and attract financially rewarding traffic. It should also be mentioned that IR has consistently been making financial surplus, enough to pay an interest like dividend on capital invested, but not sufficient to keep up with required invest-ments.

Estimates of Future Requirements

We first examine the past investment patterns. The actual investments made during the years 1985-86 to 1997-98 and proposed for 1998-99 are given in Table 3, the total of which is Rs 76,933 crore. When corrected for price increases of inputs, this figure works out to Rs 34,076 crore at 1984-85 prices.

The plan investments for various heads during the years 1993-94 to 1998-99 are given in Table 4. Track renewals and rolling stock have generally been the top two investment heads, accounting for about 40 per cent between them. Gauge conversion has also been a significant head, with investments as high as 21 per cent of the annual investment in 1994-95. Since then, the share has dropped to 8.5 per cent in 1998-99, both due to the fact that some of the significant routes have been converted and changing political priorities.

The corporate plan of 1985-2000 had estimated that at 1984-85 prices, a total of Rs 46,150 crore would be required to fund new investments and for replace-ment of aged assets from the years 1985-86 to 1999-2000 (Table 5) (Corporate Plan, 1987). Comparing this with the investments made until 1997-98 and proposed for 1998-99 at 1984-85 prices (Rs 34,076 from Table 3), only 74 per cent of the expected investment had been achieved over 14 of the 15 year corporate plan period. Viewing it another way, to achieve the cor-porate plan objectives, the total investments needed for the year 1999-2000 (the last year of the current corporate plan) would be Rs 12,074 crore at 1984-85

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Table 3: Actual Investments by IR

Year Nominal Investment (Rs Crore)

Cost Index*

Adjusted Index

Real Investment (Rs Crore)

1985-86 1942 490 1.1 1756

1986-87 2697 560 1.3 2134 1987-88 3419 640 1.4 2367 1988-89 3929 710 1.6 2452 1989-90 4562 775 1.7 2608 1990-91 4815 837 1.9 2549 1991-92 5393 927 2.1 2578 1992-93 6162 1057 2.4 2583 1993-94 5861 1193 2.7 2177 1994-95 5472 1312 3.0 1848 1995-96 6468 1312 2.7 2396 1996-97 8310 1391 2.9 2904 1997-98 (RE) 8403 1474 3.0 2770 1998-99 (BE) 9500 1563 3.2 2954 Total 76933 34076

Source: Indian Railway Year Book (different years), and Rai lway Fare and Fre igh t Commi t tee Repor t (1993).

Note: *Cost Index developed by the Rail Tariff Enquiry Committee Report (1987) up to the year 1995-96. For the years 1996-97 to 1998-99, a fixed Cost Index growth rate of 1.06 has been used. RE: revised estimates, BE: budget estimates.

The investment estimates in Table 5 assume a 5 per cent growth rate of GDP and 65 per cent market share of the total freight traffic to be carried by IR. Assumptions regarding the traffic have gone wrong, with rail share in freight traffic coming down to under 40 per cent (Table 1) by 1995. In terms of physical units, the corporate plan had estimated 370-400 BTkm of freight traffic and 415-440 BPkm of passenger traffic by the year 1999-2000. However, as of 1997-98, the actual freight traffic had been 284 BTkm and passenger traffic 370 BPkm (as per figures released by the railway board in June 1998). By the end of the corporate plan period, these figures are likely to be 300 BTkm and 400 BPkm respectively. It is a matter of debate as to whether the less than anticipated traffic called for reduced investments or the reduced investments have resulted in the fall of traffic growth and market share.

Comparing the investment profile proposed in the corporate plan (Table 5) and the actual break up of the plan investments since 1993-94 (Table 4), we see that the track renewals have been as per expectations at around 20 per cent of investments. Rolling stock investments (17-25%) have been less than what was intended (32%). Gauge conversion and doubling (14 -25 %) have been higher than what was intended (5%). New lines and electrification have been as proposed. Investments in computerized operating information system and signalling have been less than what was proposed.

prices, i.e., Rs 38,637 crore at 1998-99 prices. Obviously, The Committee on Expansion of Railway Network the total actual investments have not kept up with (CERN, 1988) had recommended that an investment the corporate plan expectations. of Rs 5,000 crore would be required to finance (a)

Table 4: Break -up of Plan Investment

7993-94 Rs Crore %

1994-95 Rs Crore %

1995-96 Rs Crore %

2996-97 Rs Crore %

1997-98 Rs Crore %

1998-99 Rs Crore %

Track Renewals 970 16.6 1177 21.5 1546 23.9 1597 19.2 1680 20.0 I960 20.6

Rolling Stock 1464 25.0 1024 18.7 1704 26.3 1949 23.5 1522 18.1 1590 16.7

Gauge Conversion 931 15.9 1150 21.0 1251 19.3 1143 13.8 1185 14.1 803 8.5 Doubling 232 4.0 206 3.8 220 3.4 245 2.9 272 3.2 513 5.4 New Lines 225 3.8 234 4.3 213 3.3 296 3.6 369 4.4 496 5.2 Signalling 156 2.7 169 3.1 208 3.2 230 2.8 222 2.6 361 3.8 Electrification 278 4.7 291 5.3 348 5.4 281 3.4 320 3.8 341 3.6 Traffic Facility 120 2.0 72 1.3 98 1.5 122 1.5 149 1.8 224 2.4 Metro Transport 224 3.8 255 4.7 196 3.0 145 1.7 152 1.8 251 2.6 Total of Above 4600 78.5 4578 83.7 5651 89.4 6008 72.3 5871 69.9 6539 68.8 Others 1261 21.5 894 16.3 684 10.6 2302 27.7 2532 30.1 2961 31.2 Total Plan 5861 100 5472 100 6468 100 8310 100 8403 100 9500 100

Source: Indian Railway Year Book (different years).

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Table 5: Investment Requirements of IR (Based on Corporate Plan)

Plan Head New Investment (Rs Crore) %

Funds for Replacement (Rs Crore) %

Total (Rs Crore) %

Rolling Stock • Locos 2000 8.7 2150 9.3 4150 9.0 • Coaches 1500 6.5 2200 9.5 3700 8.0 • EMUs 700 3.0 300 1.3 1000 2.2 • Wagons 1700 7.4 4300 18.7 6000 13.0

Capital Spares and Cranes 300 1.3 200 0.9 500 1.1 Workshops and Sheds 800 3.5 800 3.5 1600 3.5 Machinery and Plant 600 2.6 1400 6.1 2000 4.3 Track Renewals 0 0.0 9000 39.0 9000 19.5 Bridges 100 0.4 500 2.2 600 1.3

New Lines 1500 6.5 0 0.0 1500 3.3 Traffic Facility Works 2100 9.1 100 0.4 2200 4.8

Conversion, Doubling, etc. 2300 10.0 100 0.4 2400 5.2 Signalling and Telecommunication 1300 5.6 1100 4.8 2400 5.2 Electrification 2250 9.7 0 0.0 2250 4.9 Other Electrical Works 400 1.7 400 1.7 800 1.7 Staff Quarters 500 2.2 500 2.2 1000 2.2 Operating Information System 950 4.1 0 0.0 950 2.1 Staff Amenities 400 1.7 0 0.0 400 0.9 Passenger Amenities 500 2.2 0 0.0 500 1.1

High Speed Track 1200 5.2 0 0.0 1200 2.6 Miscellaneous 2000 8.7 0 0.0 2000 4.3 Total 23100 100 23050 100 46150 100

Source: Corporate Plan (1987).

building of new lines of 2,902 km and (b) gauge conversion of 1,836 km from metre gauge to broad gauge and 470 km from narrow gauge to broad gauge to meet the traffic needs by the year 2000. (Actual investments have been higher than suggested by CERN, with greater emphasis on gauge conversion. The "unigauge policy" gave a major fillip to gauge conversion and a total of over 6,500 km was converted during 1990-97. However, during the years 1987-97, track length had increased from 61,813 km to 62,725 km showing a net increase of only 912 km).

As per figures released by the railway board in June 1998, the total investment requirements for network expansion to provide rail "connectivity" throughout the country were Rs 90,000 crore. For gauge conversion, the requirement was Rs 10,000 crore. Out of this, Rs 34,000 crore would be required for 180 projects currently in the pipeline. As against this, the plan investment proposed for the year 1998-99 was Rs 9,500 crore.

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A direction for decreasing investment require-ments is improvement of asset utilization, especially rolling stock and track. In 1996-97, a broad gauge wagon moved 158 km in a day. With the average goods train speed being 23 kmph, a wagon is effectively running for seven hours in a day. Similarly, broad gauge electric and diesel locomotives moved an average of just over 400 km in a day, giving an average utilization of 16 hours in a day. Passenger coaches for broad gauge mail/express services achieved an uti-lization of over 500 km per day, giving an average of 10 hours in a day. at an average speed of 50 kmph. Even if one accounts for time spent at yards and terminals and for maintenance, the scope for improv-ing rolling stock utilization is very high. In terms of track utilization, the need is in the golden quadrilateral connecting the metropolitan cities, which account for over 60 per cent of the traffic on 20 per cent of the route km. Even though these are high density tracks, often carrying over 70 trains each way on double track

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sections, the potential to carry over at least 100 trains each way can be exploited through improved signal-ling and information systems.

Apart from network expansion and gauge con-version, investments would be required in capacity augmentation of the congested routes. Improving service quality and meeting the peak demand would require additional investment in coaches, section capacity, and terminals. Another area of concern would be the high density suburban traffic which needs both upgradation and expansion of the existing suburban network. Investments in information tech-nology and safety would be crucial, both for service quality improvements and operational flexibility.

We next examine how IR has financed its invest-ment requirements. Existing Modes of Finance

Traditionally, the main sources of financing invest-

ments in IR have been budgetary support and internal resource generation. Since 1988-89, a new source of financing was attempted, namely, market borrowings through a subsidiary organization set up for this purpose. This organization was called the Indian Railways Finance Corporation (IRFC). Two other project-oriented financing modes were attempted in the 90s. These were the Build Operate Lease Transfer (BOLT) and Build Operate Transfer (BOT) schemes. These schemes were structured to attract financing from stakeholders with interests other than just finan-cial returns. The BOLT scheme and a variant called the Own Your Wagon (OYW) scheme were first started in 1994-95. Since the BOT scheme was applied in the specific context of the Konkan Railway Corporation (KRC), it does not show up in the overall IR finances. We discuss the KRC later. The amounts under different sources of plan expenditure since the first five year plan are given in Table 6.

Table 6: Sources of Plan Expenditure

Plan/year Investment Rs Crore

Budgetary Support Rs Crore %

Internal Resources Rs Crore %

Market Borrowings Rs Crore %

BOLT/OYW Rs Crore %

I 422 143 34 279 66 0 0 0 0

II 1043 574 55 469 45 0 0 0 0 III 1685 1146 68 539 32 0 0 0 0 1966-69 762 442 58 320 42 0 0 0 0 IV 1428 1028 72 400 28 0 0 0 0 V 1525 1144 75 381 25 0 0 0 0 1978-80 1251 938 75 313 25 0 0 0 0 VI 6585 3819 58 2766 42 0 0 0 0 • 1985-86 1942 874 45 1068 55 0 0 0 0 • 1986-87 2697 1483 55 1214 45 0 0 0 0 • 1987-88 3419 2086 61 1333 39 0 0 0 0 • 1988-89 3929 1532 39 1611 41 786 20 0 0 • 1989-90 4562 1779 39 1779 39 1004 22 0 0 Total VII 16549 6951 42 7116 43 2482 15 0 0 1990-91 4815 1637 34 2070 43 1107 23 0 0 1991-92 5393 1780 33 2157 40 1456 27 0 0 • 1992-93 6162 2589 42 2548 41 1025 17 0 0 • 1993-94 5861 974 17 4031 69 856 15 0 0 • 1994-95 5472 1145 21 3548 65 745 14 34 1 • 1995-96 6468 1138 18 4212 65 985 15 133 2 • 1996-97 8310 1465 18 4462 54 1954 24 429 5 Total VIII 32273 7311 23 18801 58 5565 17 596 2 1997-98(RE) 8403 2001 24 3419 41 2520 30 463 6 1998-99(BE) 9500 2200 23 4400 46 2665 28 235 2

Source Indian Railway Year Book (different years), and Railway Fare and Freight Committee Report (1993).


Budgetary Support As can be seen, the budgetary support has been declining over the years. The budgetary support came down from 75 per cent of total plan outlay in the fifth plan to 17 per cent in 1993-94 and 18 per cent in 1995-96 and 1996-97. Budgetary support has been given to IR with the expectation of an interest like dividend payment on the total paid up capital. (The rate of dividend to be paid on the capital is fixed by the Railway Convention Committee appointed by the parliament. It is payable even if IR does not generate surplus. It varies with the age of the investments and is presently 6.5 % on fresh investments). The dividend outflow on the total budgetary support to the gov-ernment has increased to an extent that it results in a next cash outflow from IR, as shown in Table 7. Table 7: Budgetary Support, Dividend Payments, and Cash Outflows

Rs Crore

Year Budgetary Support

Dividend Payment

Net Govt Support

1985-90 6951 3367 3584

1990-91 1637 938 699

1991-92 1780 1106 674

1992-93 2589 1514 1075 1993-94 974 1296 -322 1994-95 1145 1362 -217

1995-96 1138 1264 -126

1996-97 1465 1507 -42

1997-98 (RE) 2001 1546 455

1998-99 (BE) 2200 1777 423


Internal Resources

The internal resources as a share of the plan expendi-ture have varied from 66 per cent to 25 per cent prior to the 80s. During the eighth plan period, the share was 58 per cent. For 1998-99, this is proposed to be 46 per cent, with a contribution of Rs 4,400 crore. The availability of internal resources is a function of the total revenues and the operating ratio (defined as the ratio of expenses to revenues). The operating ratio had been around 83 per cent in the mid-90s, and then increased to nearly 90 per cent by 1997-98. The corporate plan target of 80.2 per cent has been illusory. Thus, neither reduction in proportion of expenditure has taken place nor has revenue increased at an expected rate to provide the required investible sur-

plus in the context of decreasing budgetary support.

A closer look at the revenues between 1993-94 to 1997-98 and the budgeted revenues for 1998-99 is possible from the commodity-wise revenue data given in Table 8. The share of passenger and freight revenues has been steady at 28 per cent and 72 per cent respectively. Similarly, the share of the top few com-modities in freight revenues has also remained steady. It should be noted that the bulk commodities consti-tute a large share of the revenues. This has implications on potential growth of revenues which could come as a result of (a) increased traffic in these commodities, (b) increased traffic in other commodities, especially the high rated ones and (c) price increases. Recent indications are quite clear that price increases would no longer be tenable and only better market and service orientations could woo additional traffic.

Market Borrowings

IR floated a fully owned subsidiary called IRFC in 1986 to access debt markets. A separate corporation was started by IR for ease and flexibility of operation and to overcome the legal problems in leasing. Resources raised by IRFC were used to purchase wagons and locomotives which were leased to the railways. IRFC has an equity capital of Rs 232 crore and is wholly owned by IR. In 1994-95, IRFC made a profit of Rs 204 crore.

IRFC floated two types of bonds, namely, tax and non tax. Though the coupon rate on the bonds depended on the market rates, for non-tax bonds it was around 9 per cent and for tax bonds it varied around 15 per cent. IR in turn paid lease rentals at 14.5 per cent of asset value till 1992-93, which was later raised to 17.5 per cent. Thus, compared to the 6.5 per cent dividend that is paid on budgetary support, IR has to incur around 17-18 per cent as interest costs. While market borrowings can be used to tide over immediate problems, the same mechanism would be a costly option to overcome long-term investment needs. IR, with its return on capital being much lower, cannot afford to continue with this mode of financing for long.

The share of market borrowings began at 20 per cent in 1988-89 and varied between 14 per cent (1994-95) and a high of 30 per cent (1997-98). There is a debate as to whether the market borrowings have led IR into a debt trap, i.e., more borrowings are required just to keep up with the interest payments. Table 9, which gives the amount of borrowings and interest payments to IRFC over the current decade, reflects that the net additionality for investments has not been significant.

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Table 8: Commodity-wise Revenue Data

1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 Rs Crore % Rs Crore % Rs Crore % Rs Crore % Rs Crore % Rs Crore %

Passenger 4895 28.5 5464 28.6 6124 Freight 12275 71.5 13670 71.4 15290 • Coal 5193 30.2 5630 29.4 6406 • Foodgrains 972 5.7 855 4.5 1064 • POL* 1460 8.5 1801 9.4 1999 • Cement 1048 6.1 1120 5.9 1162 • Fertilizers 575 3.3 672 3.5 706 • Iron and Steel 1073 6.2 1100 5.7 1129 • Others 1956 11.4 2492 13.0 2824 Total 17170 100.0 19134 100.0 21414

28.6 6633 28.5 7534 27.5 8368 27.8 71.4 16668 71.5 19886 72.5 21686 72.2 29.9 7322 31.4 8779 32.0 9489 31.6

5.0 1273 5.5 1512 5.5 1623 5.4 9.3 2031 8.7 2397 8.7 2633 8.8 5.4 1312 5.6 1562 5.7 1750 5.8 3.3 638 2.7 757 2.8 811 2.7 5.3 1159 5.0 1391 5.1 1597 5.3

13.2 2932 12.6 3489 12.7 3783 12.6 100.0 23301 100 27420 100.0 30054 100.0

Source: Indian Railway "Year Book (different years). * POL: Petroleum, oil, and lubricants. Table 9: IR's Borrowings from and Payments to IRFC Rs Crore

Jear Borrowings Payments

1991-92 1456 626 1992-93 1025 855 1993-94 856 960 1994-95 745 1125 1995-96 985 1395 1996-97 1954 1443 1997-98 2520 1815


BOLT/OYW BOLT is a financing scheme in which the asset is owned by the asset provider /creator and is then leased to railways, during which period the owner receives lease rentals. Assets could either be fixed like tracks, overhead electrification equipment, or rolling stock, in which case it is termed as Own Your Wagon (OYW) scheme. In the year 1996-97, Rs 500 crore were to be raised from BOLT schemes (other tha n for wagons) and Rs 400 crore for OYW.

viability of such schemes, the attributes necessary for the private party, and the extent of "homework" and flexibility on the part of IR.

In the OYW, the owning companies could be paid lease rentals or given rebate in freight and in some cases guarantees of transit in transporting the goods. Actually, the practice of companies owning wagon stock for captive movements was prevalent before OYW was formally introduced. This was restricted to either specialized wagons like alumina tank wagons for National Aluminium Company or short distance movement in closed circuit for companies such as National Thermal Power Corporation.

The OYW scheme was first introduced in 1992 but did not make much progress. This was both due to the high capital cost not being properly offset by the freight rebate and procedural complexities in implementing the scheme. The scheme was further modified in 1994 and 1996 to make it more attractive to the users.

Inflows in these schemes began in 1994-95 and reached a peak of five per cent of investment share in 1997-98 at Rs 463 crore. However, in the budget

estimates for 1998-99, only two per cent share is expected at Rs 235 crore. The modalities of the BOLT and OYW schemes, along with an assessment of risks/ benefits are given in Annexure 1.

BOT

refers to a case where the project is built and operated by a third party (usually a private party) for a pre-specified period, after which it is transferred to a public body (usually the licensing party). Such


Though IR sought private participation under the BOLT scheme in 1996 in a variety of projects, including gauge conversion, doubling, electrification, etc., par-ties could be selected in only two projects. These were the Viramgam-Mehsana and Adilabad-Mudkhed gauge conversion projects. Unfortunately, the projects never took off due to financial difficulties faced by the selected parties and inability of IR to provide appro-priate guarantees. This raises issues regarding the

a scheme is operational in one project, namely, the Konkan Railway, which was actually executed by a public body, the KRC, set up as a subsidiary of IR in July 1990. Some details of the BOT scheme are given h Annexure 2. Private participation, especially in building new railway lines through BOT, has not yet taken off due to problems of network interconnectivity and enforcement of contractual obligations by the BOT organization on a monopoly like IR.

For completing the Konkan Railway project, BOT was preferred due to non-availability of sufficient finances with IR and willingness of the beneficiary states (Maharashtra, Goa, Karnataka, and Kerala) to put in equity capital as they could see potential benefits from the project to their states. (In addition, the role of the incumbent Minister of Railways, Mr George Fernandes was crucial in bringing all the states together for financing the project.)

The KRC became operational in early 1998 with a total project cost of Rs 3,375 crore including an equity participation of Rs 800 crore (by the four state governments and IR) and market borrowings of Rs 2,575 crore. The KRC is expected to meet its market rate based interest commitments and pay back all loans as per schedule by the end of the tenth year of operation or earlier, at which time IR will have the option of merging the KRC within its larger system. The key issue in this mode of project execution was the freedom given to the KRC in sourcing funds, managing the project and related expenditures, and operational flexibility including pricing as long as it does not exceed a cap.

Potential Modes of Resource Generation

Budgetary Support

While the message from the government is clear in the direction of reduced budgetary support, IR should renegotiate this as an annual contribution towards social obligations imposed on it by the government. The extent of social service obligation during 1996-97 was assessed at Rs 1,826 crore on account of:

i. Transport of essential commodities carried at very low rates.

ii. Concessional passenger fares to season ticket holders and a variety of social welfare constituents, including "forced" operation of certain unremu-nerative passenger trains.

iii. Investment in uneconomic railway lines on na-tional considerations and "forced" operation of uneconomic branc h lines.

To make a strong case for such contributions, the present costing system of IR is inadequate and needs to be redesigned. Regarding item (iii) above, there have been situations in which other ministries like Defence, or state governments have contributed part of the costs. The government has also declared the Rs 2,100 crore Udhampur-Srinagar-Baramula line in Jammu & Kashmir as a national project and agreed to fund the project fully.

While renegotiating government support, finan-cial restructuring of the capital at charge (which was nearly Rs 31,000 crore by the end of 1996-97 and is likely to be about Rs 35,000 crore by the end of 1998-99) as equity should be considered. This would enable IR to hold back the obligatory dividend payment which has been in the order of Rs 1,500 crore per annum in recent years.

Increasing Revenues

Revenue increase as an option has certain limitations owing to the current strategies being followed by the railways. Presently, the emphasis is on increasing freight rates to generate additional revenues. This has, however, boomeranged, leading to a decrease of market share even in bulk commodities. To improve traffic revenues, railways should concentrate on at-tracting more traffic through service quality improve-ment and possibly even reduction in freight prices. Multimodal transport efforts should also be taken up seriously to divert freight traffic from road to rail.

Focus on value added services (both in passenger and freight) at premium prices could also generate additiona l revenues. Recent studies have shown that increased capacity in upper class passenger services would be viable. Reservation for journeys from sta-tions other than from where booking is being made, reservation related enquiries, tourist train circuits, etc. are services for which customers would be willing to pay premium charges. Similarly, on freight, time guarantees both for wagon allotment and transit time, transit and handling insurance, etc. are services for which customers would be willing to pay, especially since there would be savings for them on inventories and losses.

Apart from the passenger and the freight shippers as customers, IR should expand its vision of a customer base to advertisers, telecom operators, and real estate developers. For these parties, the IR infrastructure and service operations offer valuable inputs to leverage their own businesses. The potential in these areas is under-exploited and needs to be carefully nurtured as a significant business proposition.

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Reducing Costs

Railways have made some effort to cut down costs. The main element in railway costs is the manpower costs which now account for over half of the total working expenses. Some of the steps taken to reduce the manpower costs are reduction of manpower by abolishing posts on retirement, privatization of main-tenance activities, and increasing use of contractors for execution of works. However, most of these efforts have been half-hearted. It should be noted that an earlier minister of railways committed to create six additional railway zones to develop backward regions and provide employment. Another minister set the clock back on privatization of maintenance services, by going back to increased inhouse employment. Overall, there is scope for reducing costs, provided it is done with a strategic perspective and in a disciplined manner.

Market Borrowings

Domestic market borrowings are expensive, with interest rates being over 15 per cent. The average return (revenues less expenses, but before dividend payment) on equity (budgetary support) has been 14.9 per cent and 11.7 per cent during 1995-96 and 1996-97 respectively. The average return on total investment has been 10.4 per cent and 8.1 per cent respectively. With these kinds of average returns, what would be feasible are borrowings from foreign capital markets, where interest rates are lower. The study in 1997 by Mckinsey Consultants on behalf of the Asian Devel-opment Bank aptly called IR as a "sunrise sector" for investments. However, the customer and commercial orientation and the internal organizational structure would have to undergo a drastic change to attract such investments.

Specific projects with high returns could consider domestic market borrowings and would also be in a position to attract foreign investments. However, the project would have to be structured in a manner that the investments and the returns are clearly accounted and protected for the investors. Conceptually, this would amount to moving in the direction of creating an SPV (special purpose vehicle) under a BOT frame-work.

BOLT/OYW

The BOLT scheme has not been successful since projects under the scheme are being treated as con-ventional projects in awarding and finalizing con-tracts. The potential of the scheme is difficult to assess since sufficient experience has not yet been built up.

To make BOLT schemes successful, IR needs to appreciate the fact that the risks faced by the BOLT operator are quite high and different from small contracts. The BOLT operator should also be capable of absorbing any downswing in the financial or operational climate. The operator should have a long-term interest in the project. IR should attempt to build long-term relationships with potential BOLT operators based on mutual interest and not go for a case by case approach. To offer economies of scale to the operator, especially for his supply contracts, equip-ment purchase, and deployment, etc., either large projects or bundling of smaller projects may be essential.

The present procedures of obtaining cle arances and clarifications from ministries like finance and environment, cost estimation, etc, do not in all cases explicitly recognize that the BOLT operator is a body different from- IR. Matters that could be taken for granted or even dealt with during the project execution stage between ministries would have to be consciously considered prior to the project award stage. Similarly, hidden costs such as use of rolling stock, transport of material and men, use of captive communication facilities, etc., need to be explicitly considered. These could significantly affect the project viability.

BOT The only experience to date under this scheme is the KRC. While the SPV set up for this could benefit from the reduced project financing and completion risks, it is not adequately protected from the market risk. With no direct access to major traffic originating/ terminating points, the KRC is dependent on the neighbouring railway zones for traffic. This is com-pounded by the fact that the existing railway zones would like to hold on to their traffic to post better financial results at a time when the overall freight market growth for rail traffic is uncertain. This raises questions of appropriate project structuring. For ex-ample, would the KRC have been better off with a direct access into the Mumbai industrial area?

In fact, if the BOT concept is to be used for infrastructure hardware development, the confound-ing aspect of the market risk will always remain, as long as one has to interconnect with the larger network controlled by IR. The BOT concept seems to have more potential for value added services (like tourist circuits, catering services, terminal operations, multimodal operations, freight forwarding and consolidation serv-ices, etc.) where the market is better accessed by the BOT operator, but due costs being paid to IR. In such cases, the scheme could be viewed as a BOO (Build,


Own, Operate) where the "transfer" issue is irrelevant.

Conclusions

While IR may be viewed as a "sunrise" sector for investments by consultants, the important issue is how to ensure the same perception among potential inves-tors. This is partially dependent on some of the questions raised in the recent status paper brought out by IR [Status Paper, 1998].

• Should the railways be both a commercial enter prise and a public utility?

• What should be the relative proportion of funding

for socially relevant but financially unviable projects from out of railways' own resources and the criteria for prioritization of such projects for execution?

• Should fixation of tariffs for freight and passenger business be done by a machinery (other than parliament)?

The answers to these questions have a bearing on how risks and ensuring appropriate returns on the investment will be taken care of. Amidst all this, there is a lot that IR can do on its own to increase the resources required for investments. A key step is to bring about a transformation from a production-oriented organization to a customer-led organization.

Annexure 1: BOLT/OYW Schemes

Project Financing through BOLT

Attractiveness of the BOLT scheme, for project finance, lies in its innovativeness. It helps in lowering the administrative costs for IR as the main construction work is taken over by the private contractor. It is assumed that this privatization would bring in efficiency through better project manage-ment and reduced time and cost overruns.

Project Selection (common to both the conventional method and the BOLT scheme)

• Reconnaissance Survey : This survey comprises a prelimi nary project feasibility study.

• Detailed Engineering Survey : As the name indicates, it is a detailed study for finalizing the alignment and in cludes final location of stations, bridges, tunnels, and any other important landmark. At this stage, detailed cost estimates for the project are also prepared.

• Traffic Survey : This survey is made to estimate the traffic, both goods and passenger, expected and the additional revenues generated to make an assessment of cash inflows.

• Project Sanction and Financing : Project sanction is a part of the Annual Railway Budget process. The allocation is done as per priority of the project and the projects under execution. All the projects which have high importance due to strategic or other reasons are accorded priority. The process includes sanction by the Railway Board and finally by the parliament.

After this stage, the projects follow a different path for conventional method and for the BOLT scheme.

Project Execution (conventional method)

Under this method, the main project is split into small sub-projects of around Rs 10 crore each so that they are manageable and easy to execute. The sub-components are usually:

• earthwork • laying of ballast and sleepers • laying and linking of rails • major bridges • signalling and telecommunication works • electrical works • PWD and minor work.

Tenders are invited for each of these sub-components separately. The contracts are awarded to the successful bidders. Payments are made to the contractors on receipt of progress reports from railway engineers. An interesting and important part of the conventional method is that IR has to do all the material procurement such as rails, sleepers, ballast, cement, etc. Project Execution (BOLT scheme) Under the BOLT scheme, bids are invited from private parties for the whole project. The bids follow a two-stage process. As separate documents are provided for each stage, it is called a two -packet process. Packet 1 contains the following details: • Details of the plant and machinery with the contractor. • Track record of projects handled by the contractor

previously. He should have handled the previous projects in a satisfactory manner. He has to provide documentary evidence about these projects and their progress. The contractor should have also handled at least one project whose project cost is more than 5 per cent of the bare construction cost of the present project bid for.

• Managerial expertise of the contractor in handling such projects has to be stated by the contractor together with supporting evidence.

• Financial plan for the project has to be spelt out in minute detail together with the cash flows over the project's life. He has to specify the sources from where he will get the funds and the way he would manage the cash payments to be made over the project's life.

22 Vikalpa

• Complete financial statements of the contractor or the company have to be provided so as to reflect their financial health. The net worth, i.e., the paid up equity capital and free reserves of the company has to be more than the 25 per cent of the bare construction costs of all the projects in hand with the company. If the foreign equity is less than 10 per cent of equity capital, then it is not taken into account for eligibility purposes.

Packet 2 contains a proposal of lease payments the company expects under different scenarios. The different scenarios are a function of: • With/without tax benefits • With/without depreciation benefits

• For a period of 8/10/12 years.

Thus, the company has to give 12 different acceptable lease amounts to IR. The company should also specify the final transfer payment to be made at the end of the lease period in each case.

Packet 1 is used to find out the eligible bidders. After that, Packet 2 is opened to find out the most cost effective bid for Indian Railways. The successful contractor is awarded the project and he has to sign various agreements with IR. It is followed by the exchange of the engineering drawings and plans of IR with the PERT chart for the project as prepared by the contractor..

The various conditions under which the BOLT scheme operates are as follows: • The contractor has to execute a performance guarantee

for 5 per cent of the project cost in favour of IR. • As a first step, the land is leased to the contractor on

a nominal payment for a specified time period. Then starts the build part of BOLT scheme.

• All structures planned by the contractor are to be approved by IR.

• There are penal clauses for delay in project implemen tation and also for block bursting (block refers to the condition where traffic is stopped to do maintenance/ construction activities on a railway line which could not be otherwise done. Block burst is a railway lingo which means that the duration of stoppage of t raffic has exceeded the time which was originally agreed).

• After the asset has been created by the contractor, he owns it.

• Construction is deemed complete if the Commissioner of Railway Safety certifies that the trains are fit to run at a pre-specified speed. (The Commissioner of Railway Safety, though a former railway man in most cases, is under the Ministry of Civil Aviation and is responsible for safety of the travelling public.)

• He then leases it to railways for a monthly lease payment.

• At the end of the lease period, the asset is transferred to the railways on a transfer payment.

Mechanism of arbitration, in conventional and BOLT schemes/ is settled under the existing general clauses of contracts which specify that: • The General Manager appoints two railway officers for

arbitration on a specific request. • The Contractor can use legal machinery after exhausting

the arbitration proceedings.

During project execution, constant monitoring and evaluation is to be done by the engineers from IR to ascertain quality and timely progress of the project. Risks under the BOLT Scheme

The risks under the BOLT scheme, as compared to the conventional projects, for IR and for the private contractors are given below: R i s k s f o r I R

• Decrease in funding risks as the project financing has been taken over by the private contractor. Thus, there are very few chances of the project suffering due to lack of funds from budgetary support or the diversion of funds for other urgent or important project.

• Increase in project selection risks as financially and technically unfeasible but politically important projects can be taken up as finances would be seen to be easily available.

• Project completion is dependent on the contractor selection as he is the crucial variable in the whole scheme. Previously, the project used to be broken up and given to many contractors. Thus, the risks were diversified among different parties but now it is dependent on a single contractor.

• Decrease in project completion risks for the railways as they have many clauses in the agreement which are able to cover virtually all probabilities of delay or hold up in the project construction.

Risks for Pr iva te Contrac tors

• Project completion risks are high as he has the sole responsibility for the whole project. There are also heavy penalties in case of time overruns and block bursting.

• Increase in raw material supply risk as he has to arrange for its regular supply and the railways will not be a party to it. In addition, most of the material like rails and sleepers are specific to the railways. Thus, he will also have to bear the increased raw material costs due to inflation or adverse demand-supply position.

• Information uncertainties faced by the contractor increase the risks as he is unaware of the exa ct details of the project as appraised by the railways. Thus, he is not aware of the difficulties he would face and the project cost that he should take in his calculations while making a competitive bid.

• Risk on cash flows is negligible as it is guaranteed under the authority of President of India. The risks on return are the same as those of a sovereign bond. Therefore,


these can be considered as return without a risk. However, problems can be on contractual issues which could effect either cash flows or the perception of investors.

• Market risk is negligible as the lease payments are decided in advance and the cash flows are assured irrespective of whether the project is able to break even or not.

Own Your Wagon Scheme

The parties eligible to enter the scheme are:

• Individuals as producers

• Corporate entities as producers

• Association or group of companies

• Thermal plants and other bulk consumers

• Leasing companies.

Under the scheme, the wagons could either be procured directly from a wagon builder or from IR. In the former case, the wagon buyer has to pay a design loan and an inspection charge of one and a half per cent and in the latter case, the buyer has to pay a service charge of 3 per cent of the price. The utilization of the wagons, which could either be under a general pool or a closed circuit, would be mutually decided. The benefits to the owners under three possible arrangements are given below:

• Pure lease: As a pure lease, the wagon is used by the ra ilways as a general wagon and it pays lease charges at the rate of 16 per cent per annum, on a quarterly basis for a period of ten years, followed by a rate of 1 per cent for the next ten years. This lease charge will be calculated on the current price of similar wagons owned by IR. After the expiry of further ten years, the lease is continued on mutually agreed terms. The owner, however, has the freedom to dispose off the wagon. Maintenance will be done by IR at its own cost.

• Lease cum guaranteed clearance with general service wagons: Under this arrangement, railways in addition to paying the lease as specified before would assure the lessor to clear a minimum volume of traffic during a specific period. The movement of traffic would, however, be subject to rules, legal and administrative provisions like the Railway Act, preferential traffic schedule, central or state government restrictions/ban on movement of goods, etc. There would be no further freight concession. Maintenance of the wagons would be done by railways at its own cost.

• Guaranteed clearance : In this category, lease charges will not be paid to the wagons moving in dedicated routes and involving empty running in one direction.However, railways would give a concession in the freight rates depending on the movement patterns of the wagons. The freight concession would vary with changes in budget provisions. Maintenance would be done by the railways and the rates would be charged to owners at rates which are mutually agreed to.

In spite of the changes in the modalities of the scheme, it has not picked up as expected. The scheme has provision for many one sided contract clauses, like the termination of guarantees in case of damage of wagons in accidents by paying the book value (which due to depreciation provisions of Income Tax law would be much lower than the market value of the asset). Similarly, in case there are any change of rules which are unacceptable to the owner, the wagons would revert to railways at the book value. [Thomas et al, 1996].

There is no specific distinction between wagon supplies to participants and non-participants. Thus, while availabil-ity of wagons to participants could increase due to supply guarantees, the non-participants could also benefit due to increased overall supply of wagons. Thus, competing firms might have different capital costs while enjoying similar benefits of increased wagon allocation.

Annexure 2: The Konkan Railway Corporation Limited

Project Structuring : Physical The KRC was formed as a separate corporation to build the 768 km Konkan Railway line from Mangalore to Roha (near Mumbai). The Konkan Railway passes through the coastal regions of the states of Maharastra, Goa, and Karnataka with the length in each state being 382, 105, and 273 km respectively. The least cost option was chosen for the alignment. This choice of alignment led to problems in the Goa sector which caused delays to the project (Raghuram, 1995). As against the original completion date of October 1994, the project was commissioned in January 1998.

It was decided that the entire 768 km length would be commissioned at a stretch. However, short stretches like the 70 km section from Mangalore to Udupi and the 50 km section from Roha to Dasgoan were opened for traffic in 1993, primarily to experiment with modern maintenance methodologies (Raghuram, 1995). The project as a whole

drew up large amounts of capital without generating any positive cash flows. In addition to the above, delay in construction increased the interest burden. (This raises a question of whether the project could have been structured differently. An alternative mechanism could have been to break the project into smaller sections and build them so that revenue could be generated from those sections and ploughed back for further investments. For example, the completion of either Roha - Goa or Goa - Managalore could have been better instead of taking up the complete route simultaneously.)

The project completion risk was borne entirely by the KRC. The KRC did not involve other stakeholders who may have been better in handling certain causes of the risk. For example, when the Goa sector of the project was being objected to by the local people and had political overtones, the situation may have been handled better if the project risk on such an account had to be borne by the Government

24 Vikalpa

of Goa. The KRC would have been protected from the cost of delays attributable to this.

The market risk is also being borne by the KRC alone. The main source of traffic, in addition to the traffic originating on the KRC's system, would be from IR. How-ever, there was no definite commitment from IR to offer this traffic. In addition, under the "project unigauge," the gauge conversion work between Miraj-Bangalore and Hubli-Goa was completed during the tenure of this project. This gave an alternate broad gauge route parallel to the Konkan Railway, which would be attractive for certain streams of traffic originally expected to use the Konkan route. If IR were committed to share the risk of market loss to the KRC, then the project valuation of the gauge conversions would have been different.

The issue in a modified project structure to better take care of the above mentioned risks is not just that financial losses would have been compensated, but the efforts in risk mitigation, for which the other stakeholders are better placed, would have been far more effective. Project Structuring: Financial

The project was originally estimated to cost Rs 1,400 crore and was to be financed by equity and debt capital. The corporation was to have an equity of Rs 400 crore, to be shared between the centre and four state governments in the ratio of 51:49. The four state governments, namely Maharashtra, Goa, Karnataka, and Kerala were to put in 22, 6, 15, and 6 per cent of the equity capital respectively. The project was originally estimated to have an internal rate of return of at least 14 per cent (Raghuram, 1995). After many revisions of the project cost, the final cost was Rs 3,375 crore including the capitalized interest burden. The equity share had been revised to Rs 800 crore.

The KRC was an SPY created by a memorandum signed by the Government of India and the state govern-ments for executing the project and operating the railway line for a spec ific period. The memorandum stated:

"after a period of fifteen years from the date of incorporation or such extended period, the properties

vested or created by the company shall be transferred to the government and the states shall transfer their respective shares in the company at the face value to the government."

Currently, the understanding for such a transfer is ten years from the date of commissioning. The KRC was given all the benefits that IR enjoyed, including lower customs duty on imports, total exemption of customs duty on sleepers and rolling stock, sales tax exemptions by Maharashtra and Karnataka governments, etc.

In addition to equity from the government, the KRC relied on debt financing (market borrowings) either from the public directly or through private placement. The KRC went to the market 13 times between June 1993 and November 1996 of which only two were from the public.

One of the private placements was managed by Infrastructure Leasing and Financial Services (ILFS). ILFS syndicated a loan for the KRC by a method where the railway track or a station is sold to a funding agency which in turn leases it back to the KRC. Details of the lease arrangement (Giridhar, 1996) made by ILFS are:

• A total of Rs 98 crore was raised for the KRC by this method.

• Completed rail track was sold to a lender and then leased back to the KRC.

• The transaction structure risk was mitigated using a moveable lease.

• Lease tenure was for 15 years.

• The KRC was to bear the project completion risk.

• An independent chartered engineer was used to value the asset on a per kilometre basis.

• Escrow account was established and all revenues were to be deposited to this account. Money received from IR to the KRC should also be routed through this account. A minimum balance of three months lease rentals should be maintained in the lease account.

References

Committee on Expansion of Railway Network (1988). Planning Commission (Government of India), New Delhi.

Corporate Plan, 1985-2000 (1987). Ministry of Railways (Gov-ernment of India), New Delhi.

Giridhar, S (1996). Role of Finance and Leasing Companies, (Lecture Notes), Baroda: Railway Staff College, unpub-lished.

Marketing Strategies for Multimodal Transport for Indian Rail-ways (1998). Ahmedabad: Indian Institute of Manage-ment, unpublished.

Indian Railway Year Book, Ministry of Railways (Government of India), New Delhi, different years.

Raghuram, G (1995). "Konkan Railway Corporation: Choice of Alignment in Goa," Vikalpa, Vol 20, No 1.

Rail Tariff Enquiry Committee Report (1987). Ministry of Railways (Government of India), New Delhi.

Railway Fare and Freight Committee Report (1993). Ministry of Railways (Government of India), New Delhi.

Status Paper on Indian Railways: Some Issues and Options (1998). Ministry of Railways (Government of India), New Delhi.

Thomas, Augustine Renny et al (1996). Infrastructure Fi-nancing for Indian Railways: The Own Your Wagon Scheme, Problems and Recommendations, Ahmedabad: In-dian Institute of anagement, unpublished.

Indian Transport Sector: Long Term Issues (1995). Washington, DC: World Bank.


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