Introduction

Indian Railways stood at an important junction in its 167 year history when the Government of India decided to permit the entry of the private sector in passenger train operations on more than 100 routes. Acuité Ratings believes that the introduction of the public private partnership model (PPP) is a significant step towards reforms in the domestic infrastructure sector which needs significant investments for enhancing competitiveness in the key sectors of our economy.

The Indian economy has witnessed a distinct growth slowdown over the last two years which have been further aggravated by the protracted crisis brought about by Covid-19. While providing for a fiscal stimulus package for the daily wage earners and the small businesses that have been severely impacted by the Covid lockdown, the government has also initiated reforms in some key sectors namely agriculture and mining that is expected to bolster foreign and private sector investments necessary to strengthen the economy over the longer term. The introduction of PPP model in passenger train services is a further step which reinforces the government’s intent to pursue reforms that can unshackle the economy.

This momentous step can go a long way in transforming the operations of Indian Railways which has been a complete monopoly since its inception in the pre-independence era. In the opinion of Acuité Ratings, there are three fundamental benefits that will accrue from the PPP in railway passenger services. Clearly, it will address the age old demand for better quality customer services and also bridge the gap between demand and supply in the passenger segment. Secondly, it is expected to improve the overall efficiency of operations of Indian Railways over the longer run as reflected in its Operating Ratio with the cash flows from the private operators more than offsetting any possible losses of higher value customers. This will further reduce the pressure on the government to provide large budgetary support to the railways to sustain its operations and also help them to allocate more funds for the much needed upgradation of the core railway infrastructure. Thirdly, the roll out of the PPP programme will also stimulate private sector investments in India and give a significant push to the government’s ‘Make in India’ as the required locomotives and coaches are likely to be manufactured in the country.

In a global context, private participation in train services has worked well for western countries like the USA and EU, the two regions with the largest railway networks. In countries like Canada and Brazil, railway operations remain largely with the private sector. The rail network in South America would be a lot smaller than it is today, if several governments had not taken the bold step to invite private participation in the 1990s.

Initiation of reforms in the Railway Sector

On June 1, 2020, the Ministry of Railways invited Request for Qualifications (RFQ) for private participation to operate passenger train services in over 109 routes through the introduction of 151 modern trains carrying a minimum of 16 coaches. This project, which will entail a private sector investment of Rs 30,000 Cr in the first phase, is expected to attract significant interest both from the domestic private sector and foreign players in railroad sector, given the long term demand prospects in the premium passenger segment.

In the PPP model, the private operators will have the freedom to decide fares and stoppages, and also the basket of services on offer in these trains, as well. With a long term concession period of 35 years, they are expected to earn a reasonable return on their investments. The successful bidders will have to pay fixed haulage charges, energy charges as per actual consumption and a share in gross revenue to the Railways determined through a transparent bidding process.

The PPP model, however is not new to the infrastructure sector and has been successfully deployed over the last two decades to attract private enterprise in the construction, operation and maintenance of highways, ports and airports in the country. The experience in the road sector has largely been favourable except for a portfolio of delayed projects which had been impacted by land acquisition problems.

The initial steps for such reforms in the railway sector, however was taken in last financial year, when in an attempt to formulate a basic template to engage private players, Indian Railways handed over the operations of two trains – Delhi-Lucknow Express and the Ahmedabad-Mumbai Central Express (Tejas) to its subsidiary, Indian Railway Catering & Tourism Corporation (IRCTC). The pact, valid for three years, gave IRCTC advertising rights on the coaches and pricing flexibility and in return, it will pay IR a monthly fee (or haulage charges).

The dire need for private participation in the rail sector was highlighted by the Finance Minister in her 2019 Union Budget speech where she had strongly advocated the use of private public partnership model to develop rail infrastructure. The IR requires an amount to the tune of Rs 50 Lakh Cr as investment till 2030 to plug the gap in infrastructure funding and highlighting this need to boost rail infrastructure was seen at that time as an indication to open up IR for private bidders.

In fact, the modernization drive in the IR has gained momentum in the recent past with an Rs 50,000 Cr scheme to build underpasses and road bridges and eliminate manned crossings, deploy wifi facilities in 3,767 railway stations, redevelop railway stations, rehaul its signalling systems and convert railway factories to PSUs. PPP had been already proposed for transportation of perishable goods in refrigerated coaches in the 2020 railway budget.

Address pent up demand in the premium passenger segment

In its most recent reformative measure to invite PPPs to run passenger trains, the Ministry of Railways has laid down a few criteria. In line with the ‘Make in India’ philosophy, the private parties who shall be responsible for financing, procuring, operation and maintenance of the trains, have to manufacture a majority of the trains in India. Moreover, the trains should be designed for a maximum speed of 160 kmph, facilitating the introduction of high speed locomotives.

The PPP model is expected to introduce advanced and clean technology which will not only reduce transit time and provide "world class experience” to the passengers but will also enhance safety levels and lower maintenance costs. The new trains will be fitted with the latest passenger safety gadgets and GPS-enabled passenger announcement systems apart from new design coaches.

Beyond these advantages, the launch of private train operations would also reduce the demand supply deficit in the passenger transportation sector. Clearly, IR has been unable to meet the demands of the passenger segment which is reflected in an average supply deficit of 8% and a peak summer deficit of over 13% in FY20. Also, between 2013 and 2018, reserved passenger traffic in railways grew at less than 5%, on average. This compares to a 13% growth in air traffic during the same period.

In the opinion of Acuité Ratings, the entry of private operators will address the pent up demand for high end rail passenger services. We believe that there is a latent demand for premium and rapid rail transport services for distances less than 1000 kms which will be of short duration and convenient. This segment is likely to develop and grow in India and also compete with domestic air travel. Such pent-up demand for premium passenger transport has been partly met over the last decade through a steady growth in air traffic volume.

Improve overall operating efficiency in railway operations, reduce fiscal burden

IR’s estimated surpluses are very modest in the range of Rs 3,800 Cr for FY20, as compared to its gross revenues of Rs 2.06 Lakh Cr. Its operating ratio or the proportion of operating expenses to revenues has been chronically high at 97%-98%. Given the meagre operating surpluses, it has to necessarily depend on government budgetary support and grants to fund its capital expenditure programme, which is pegged at Rs. 1.61 Lakh Cr in FY21. While the government support is budgeted at Rs 70,000 Cr, the balance is funded from bodies like Indian Railway Finance Corporation through lease arrangements.

Further, IR has been raising its freight fares regularly to offset the losses or very weak margins in passenger operations. This has increased the logistics costs for many manufactured commodities and has also led to a structural shift from rail freight to road freight over the last decade. The element of cross subsidisation of passenger travel with freight fares has therefore, impacted the cost competitiveness of indigenously produced goods and has indirectly contributed to higher imports or lower exports. With a gradual transfer of passenger services to private operators, IR will be in a better position to compete in freight services with road transport and also contribute to better competitiveness in domestic manufacturing.

Acuité believes that PPP mechanism, if implemented well will lead to a structural improvement in the operating ratio of Indian Railways and will increase the availability of funds for the much needed overhaul of the core railway infrastructure such as tracks, signal systems and bridges. Given the demand-supply deficit in the upper class passenger segment, the loss of revenues is likely to be limited and any such risks of loss of higher value customers should be more than offset by the steady income from the PPP model in the form of haulage charges and a share in gross revenues. Over the longer run, this will help to reduce the dependence of IR on the government budgetary support for the sustainability of operations, thereby leading to fiscal savings. This will also enable higher outlay and better focus on infrastructure upgradation and capital investment which has not been adequate for many decades due to shortage of resources.

According to a World Bank report, efficient rail transport can be an important catalyst for economic growth and development. PPPs in railways can bring opportunities for investment, operating efficiency and modern and clean technology.

Spur private investments, boost ‘Make in India’ initiative

In the PPP model, the onus will be on the private operator to procure the train, raise finances for funding the project and also undertake O&M. The investment envisaged in the first phase is around Rs. 30,000 Cr. This is likely to spur new private sector and even foreign investments in the railroad segment where many domestic and global players will be keen to establish a foothold. Since the required funds will be raised through both debt and equity, it will also present an opportunity to banks, financial institutions and bond investors to finance such long term PPP projects.

In the current climate, any public-private initiative is set to strongly endorse the ‘Make in India’ component. The Ministry of Railways document includes the rider that the majority of the trains have to be made in India. This will result in a surge in the order books of railway coach manufacturers over the next 1-3 years. There are several government and private (foreign) companies manufacturing coaches, locomotives, signalling systems etc. in the country such as the state owned large-scale locomotive manufacturers like Diesel Locomotive Works at Varanasi, Chittaranjan Locomotives in Asansol, the Integral Coach Factory in Chennai and international players like Alstom, General Electric, Bombardier, Siemens and Macquarie, to name a few. It is a significant possibility that some these firms can team up to form joint-ventures to bid for this project which will also facilitate the transfer of foreign technology.

The entry of private operators will not just unlock more opportunities for businesses engaged in railway equipment segment but clearly it will also facilitate the development of ancillary units to support this ecosystem and foster an environment for a sustainable ‘Make in India’ initiative.

Effective implementation of the PPP initiative, however critical for its success

Without a comprehensive plan, challenges may emerge in the implementation of the PPP mechanism. The government should leverage on its learnings from the past experiences in PPP projects in roads, ports and the urban infrastructure sector. Well drafted contractual agreements and adequate clarity in the sharing of risks, will be a key in sustaining the initiative. Indian Railways will also need to work out the details of how to accommodate the new high speed private trains in the overburdened rail network and ensure that they are able to operate seamlessly. Going forward, the government should also explore the formation of an independent regulator to oversee the management of disputes between the private operator and the Indian Railways. However, private participation is only limited to the introduction of 150 new trains, which is a small number compared to the 13,500 passenger trains that the railway runs daily and therefore, these are unlikely to pose any major challenges in the initial stage.

Effective implementation of the PPP initiative, however critical for its success

The launch of PPP in Indian Railways is a small step in the right track of reform. It is clearly an integral part of the Indian government’s efforts to deploy Public Private Partnership (PPP) frameworks to scale and enhance infrastructure in the country. Acuité believes that proper implementation of the proposed scheme will not only lead to a significant improvement in passenger service quality but also strengthen the railway’s core operations, boost private investment and indigenous manufacturing in the railway sector. This is also set to lead to the introduction of new age, innovative technology in rolling stock that will lower transit times and maintenance costs while also creating jobs in the private sector. Importantly, it will no longer be necessary for the railways to tap into limited fiscal resources at the disposal of the government to fund this transformation. While there are significant positives that can accrue from this development, the government needs to draw from its past experiences in PPP projects and ensure that it does not run into early hurdles.

Table 1: Indian Railways: Key Budget Nos: FY 2020-21 [Rs Cr.]

	FY19 (A)	FY20 (RE)	FY21 (P)
Traffic- Upper Passenger	18125	19383	21151
Traffic- Second Class	32942	36617	39849
Total- Passenger Revenue	51067	56000	61000
Freight Revenue	127433	134733	147000
Gross Traffic Receipts	189907	205833	225613
Gross Revenue Receipts	190507	206269	225913
Total Operating Expenditure	186734	202458	219413
Net Surplus	3773	3811	6500
Operating Ratio	97.3%	97.5%	96.30%

Source: Railway Budget, Feb 2020