Indian Railways: Can the elephant dance?

Indian Railways has been fighting intense competition, and losing. The organization that carried 89% of India’s freight traffic in financial year (FY) 1951 was left with only a 32% share in FY12. Its passenger kilometers was flattish in FY15-FY17 highlighting that Indian Railways is coming off second-best versus the airline industry, that has been growing in late-teen percentages in the last four years, as well as against the fast-improving road network.

In the last 10 years, Indian Railways has witnessed perceptible deterioration in operational and financial metrics. This has been caused largely by a combination of distorted top line growth, a huge jump in wage costs, and years of underinvestment. Profit margin and return on equity are targeted at a paltry 3% and 2%, respectively, in FY18, bringing Indian Railways’s vastly reduced fund-generation capability into focus. Revised budget for net receipts (effectively, profit) in FY18 at Rs6,425 crore reflects a decline of 50% from FY13.

Indian Railways’s gross receipts (revenue) in the last 20 years have been artificially aided by an aggressive escalation in freight rates even though service standards remain patchy. Its upper-class passenger fares too have witnessed regular inflation while airlines have dropped their fares substantially in the last three-four years. For example, air-conditioned, 3-tier fares have risen at a compound annual growth rate (CAGR) of 5% in the last five years—to about Rs2,500 for a Mumbai-Delhi trip, which is not too different from the airfare. On the other hand, lower-class passenger fares have been static. This system of cross-subsidization has been a key reason for the loss of market share.

A railway regulator, if put in place, can lead the way in drawing up and implementing a fare-rationalization road map. Improvement in facilities, higher frequency and punctuality of trains, ease of travel and transportation, and enhanced safety are essential for Indian Railways to claw back volumes. Interestingly, during FY03-FY18, India’s per-capita gross domestic product (GDP) on a purchasing-power-parity basis has grown by 200%, but the per-km passenger ticket price for second-class express trains has risen by just 20%. In contrast, in FY91-FY03, the comparable ticket price increase has been a healthy 88%, in line with the increase in per capita GDP—suggesting that the undercurrent of pragmatic commerce was trumping politics in that period. Not surprisingly, Indian Railways bears sizeable losses (of about Rs34,000 crore in FY17) on account of social service obligations, mainly on lower-class passenger fare discount.

Wages that constituted 35% of gross receipts in FY08 have swelled to 62% in Indian Railways’s revised budget for FY18. With such high fixed costs, the only way to improve financial sustainability is to augment capacities without inflating the manpower base, thus tapping the operating leverage to the maximum. The total running rail track—the key capacity bottleneck—has grown at a disappointing 0.9% CAGR since FY01. This is despite the fact that more than 40% of Indian Railways’s sections suffer from capacity utilization of more than 100%, as a result of which too many trains run on the same stretch of lines. Congestion causes train delays and leads to overcrowding in lower-class categories. This, of course, curbs the speed—to a sluggish 50 kmph and 30 kmph for passenger and freight trains, respectively—diluting Indian Railways’s competitiveness further. In addition, it leaves very little time for repair and maintenance. To broaden capacities, an aggressive plan to double, triple or quadruple rail lines must be drawn up and carried out.

The roll-out of dedicated freight corridors (DFC) can go a long way in easing traffic congestion, improving speeds, and reducing accidents by segregating freight and passenger trains. By providing customized and efficient logistics services with faster and predictable transit times at low costs, DFCs can help Indian Railways in regaining lost market share. In addition, as freight traffic shifts to these freight-only lines, passenger trains too can see service quality improvement. Accordingly, work on the two corridors, Dadri-Nhava Sheva and Dankuni-Ludhiana, must be expedited to make them fully operational by FY21. Equally importantly, work on the four other DFC projects should be commenced soon.

During FY05-FY15, Indian Railways’s capital investments averaged about Rs39,000 crore per annum, i.e. 4% of gross receipts, falling woefully short of the requirement. Since then, investments have shot up quite commendably. The government is now targeting figures of Rs121,000 crore in FY18 and Rs148,500 crore, i.e 7.5% of gross revenue, in FY19. Indian Railways seems to be progressing well on its multi-pronged medium-term overhaul plan with a capital investment target of Rs850,000 crore over the next five years. However, this may not be enough for its metamorphosis, especially for capacity augmentation, given decades of underinvestment. A more potent plan to bolster revenue and efficiencies will need to be chalked out—perhaps with active private-sector participation on funding—and aggressively implemented.

Vipul Prasad is founder and CEO of Magadh Capital, a long-only Indian equity fund based in Mumbai.