Today, Covid-19 has put the brakes on Indian Railways, with all passenger trains cancelled till month-end. But just last month, the big talk was of India’s biggest employer adding new trains. In her Budget 2020 speech, finance minister Nirmala Sitharaman announced 150 new passenger trains. Crucially, these would be funded not by the government alone, as has been the past practice, but also by private firms. This announcement was hailed as a forward-looking step to raise the extra funding required to modernize Indian Railways.

Increased capital expenditure (capex) builds new assets and has a multiplier effect on the economy. And, at a time of economic slowdown, nothing could be more welcome. But there are reasons for concern, shows a study of the railways’ financial statements over the past decade. The railways has been deploying more capital than ever before, mostly by borrowing, but the new assets are either struggling for completion or are not sweating enough, pushing it to the brink.

The railways needs to modernize, and it’s spending for that. In FY21, its capex is estimated at a record high of 1.6 trillion. This is about 2.7 times the amount in FY15, the first year of this political dispensation. By comparison, revenue expenditure has increased only 1.4 times. As a result of this relative growth, the share of capex in the railways’ total expenditure has increased from 28% in FY15 to an estimated 42% in FY21.

How the railways is funding this additional capex is the issue. Broadly speaking, there are three sources: The Centre (which owns the railways), the railways’ own funds, and other sources. Over the past decade, the Centre’s share in capital receipts has stagnated. The railways’ share has plunged to next to nothing as a result of being starved for surpluses.

Meanwhile, the quantum of “extra budgetary resources" has increased eightfold, from about 11,000 crore in FY15 to about 83,000 crore in FY21. In the capital receipts pie, the share of extra budgetary resources has shot up from 19% to 52%.

Extra budgetary resources consist of two components. The first is borrowings—from institutions such as the Indian Railway Finance Corporation (IRFC), Life Insurance Corporation of India and the World Bank. The railways has to pay interest on these loans and repay them. For instance, it is projected to pay lease charges of 11,489 crore in FY20—5.6% of its revenues—to IRFC. The second component is equity capital, which does not create a future liability for the railways. This primarily comes from the public-private partnership (PPP) model, which involves private entities partnering the railways to fund and operate projects. It is looking to raise more external capital through PPPs. In spite of the increasing buzz around tapping private funds, the share of PPPs in extra budgetary resources has decreased since FY17. Meanwhile, the share of institutional sources of finance has increased steadily.

One way to gauge the effectiveness of the railways’ capex is to evaluate it alongside revenue growth. For three years till FY15, the railways registered double-digit growth in both freight and passenger revenues. Since then, growth in both segments has drifted to a lower trajectory. In fact, in FY17, the year the government announced demonetization, freight revenue, which accounts for two-thirds of total revenue, shrank 4.5%.

Tepid growth in revenue is translating into a decreasing surplus. Although fuel expenses have been falling since FY15, expenses on staff and pension have steadily risen. Net revenue surplus has fallen considerably since a decadal high of 10,506 crore in FY16. As a result, the “operating ratio"—the share of operating expenses to revenue—has risen steadily, reducing the fiscal room.

The poor revenue situation begs the question: Why hasn’t the increased capex translated into higher earnings? The answer lies in inefficient deployment of capital. The capital-output ratio is a measure of the capital deployed by the railways for every kilometre of services provided by it.

The capital-output ratio increased from 1.71 per net km in FY09 to 4.25 per net km in FY20, indicating a declining performance in capital employed relative to passenger/freight movement.

A 2019 report by the government auditor attributed this to higher cost overruns due to non-completion of projects on time and investments in financially unviable projects. Channelling more money into projects is needed, which is something the railways has been doing. But so is completing those assets and making them work at capacity, which is something the national transporter can do better.

This is the seventh of a 10-part series on Budget 2020

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