Privatization of trains: Indian Railways chasing its own tail?

Assuming that the entire exercise by Indian Railways (IR) is not about, first boiling the ocean and then blamestorming, but hopefully more like doing nothing by halves, certain sine qua non must be spelt out. This is the aim of this blog.

 

The RFQs (Requests for Qualification) were received on October 7th, 2020 and the shortlists should be announced sometime this month. Since financials are the main eligibility criterion with prequalification broadly predicated on financial capacity of the net worth of 50% of the indicative project cost of a cluster. A majority of the bids should be found to be eligible in the ongoing evaluation exercise, the successful ones will be issued with an RFP (Request for Proposal) and concessions for 35 years would be awarded based on the share of gross revenue offered. So far so good.

I was intrigued to go through the following news item in Indian Express:

 

https://indianexpress.com/article/india/private-train-operators-must-deposit-security-with-railways-6910705/.

 

The successful concessionaire, the Private Train Operators (PTOs), to operate passenger trains would need to deposit a security amount equal to 3 per cent of the project cost with Indian Railways (IR). The news item further said that to ensure safe operations of private trains, IR officials will carry out the same pre-departure inspections as the ones for IR’s own run trains. Both the decisions were reportedly taken at a meeting of the government’s Public Private Partnership Appraisal Committee (PPPAC) with NITI Aayog and IR officials to sort out the multiple imponderables and roadblocks to facilitate smooth operation of the hundred odd private trains.

 

The second issue first. IR would need to carry out safety inspections and certification of PTO’s trains is absolutely logical and the issue was not flagged as a point of contention by any of the prospective bidders. Why was it even contended that the clause could be done away and let PTOs certify a train as safe on their own? It is unthinkable that safety-certification can be assigned to the PTOs themselves as that would be like playing with fire. I am not saying that this certification process is so esoteric that it cannot be done by others. It simply involves safety of thousands of travellers and no PTO would take the risk of self-certification as the risk of damages in an accident, particularly those with casualties, would be too big to take.

 

The issue that is mystifying is the first one about furnishing a security deposit. With the projected investments at a level of Rs 30,000 crore for all the 12 clusters in which private trains would be operated, we are talking of an estimated security deposit of around Rs 1,000 crore. For IR it is neither here nor there as they are already assured of a model in which they save on interest burden on investment and depreciation of rolling stock whereas a certain level of revenue, most likely higher than what they earn today, is assured. It is understood that NITI Aayog officials felt that the PTOs would anyway be bringing in huge investment at some risk and this security deposit would be an impediment to the ease of doing business with Indian Railways. What, however, prevailed in the meeting was that in the event of a PTO not being able to meet its financial obligations or provide the services, the government should have some financial leverage to fall back upon and therefore retention of the security deposit rider was favoured.

 

Guarding against such a contingency would logically involve making business as easy as feasible for a win-win situation and not make it harder for the first-time investors in railways. It is obvious that the PTOs would be taking the main and many allied risks and a security deposit may be just another comfort for IR but a major dampener for the prospective investors. Why do I keep getting the feeling that the whole exercise of privatization of train operation is being handled in a manner of an auction of a goldmine, presupposing that it would be windfall for the PTOs? There has been weak regard, at least so far, for the red flags raised by the bidders whereas new provisions are invented to safeguard the make-believe interests of IR. While the greatest interest of IR should be that this novel initiative should succeed, the actions, or inactions, suggest that IR believes that the exercise is already a big success with a long list of bidders queuing up and so they must ensure that the bidders do not land a bonanza. Glimpses of the magical Water of India but only if the chimeral golden goose actually existed without the disaster that followed.

 

There may be fifteen entities in the fray but many appear to be there just to have their hat in the ring; purchase of RFQ documents and submission was not an expensive proposition. No one with interests in the field wants to be left out as this indeed is a novel project with significant ramifications for the future of passenger transport in India. The proof of the pudding would, however, be in the level of participation at RFP stage and that too with a competent binding bid.

 

It doesn’t require multiple reiterations that as Indians, and indeed as rail-lovers, we all want this concept of private trains to succeed and enhanced passenger experience in efficient and competitive manner be achieved. So, let me be the devil’s advocate today.

 

A lot of water has flown down the Ganges since extensive discussions started on the issue of privatization of trains. There are many imponderables or impediments, which have been talked about, in pre-bid conferences or otherwise, but did not get a favourable response from IR. Many of these need to be buried, going forward, as it is time to focus on what would yield the best bang for the buck, and some of these, inter alia, are:

 

·    Can the operators use a standard rake in a cluster? The pattern of distances, type of train, i.e., overnight/day with a killer in case a round trip has both, demography of clientele etc. determine the optimum configuration of a rake. A big complication for a PTO.

·     Washing and cleaning of trains, along with inspection and scheduled maintenance facilitated after 7,000 kilometers and 31 days of the previous schedule or a travel of 40,000 kilometers respectively. This norm is not cleared by IR’s own LHB coaches and therefore it effectively makes employment of locomotive-hauled trains with LHB type coaches untenable. So, it is mainly about train sets, or somewhat far-fetched, Talgo type imported coaches for a locomotive-hauled train. Train 18? The signals are confusing as IR has tinkered with unnecessary and insipid modifications to the specification, thereby killing its own much-touted poster baby, a success story. If train sets are imported, or at least foreign-designed, the investment level goes up significantly. The world majors of manufacturing are looking only for derived demands and would hardly like to invest themselves and at best may only provide incentivized offers. A possibility of modern rolling stock finally arriving in India through this route, therefore, is not very high. 

·   The rolling stock has to be fit for operation at 160 km/h whereas there are clusters which do not hold the promise of such an infrastructure for a decade or more.

·      Significant reduction in journey time would remain on paper as long as the infrastructure does not see a matching upgrade, which seems to be the case.

·    The haulage charge of Rs 512 per km payable to the IR by the PTOs is much higher than the actual pro rata expenditure by IR. It may be lower than the benchmark haulage charge IRCTC pays for its Tejas trains. The Tejas rakes were invested into by IR, not IRCTC.

·    No flexibility for changes in services like frequency and timings, composition of the train, changes the train services themselves, including introduction of new services.

·   Although dynamic pricing of fares is permitted, waitlisting of tickets is not permitted, which can be a hindrance to good occupancy.

·    Harsh Key Performance Indicators, with the one on Punctuality (95% to be guaranteed or a penalty would be levied on PTO) being a major dampener. Like it or not, those familiar with punctuality would agree that rolling stock is hardly a reason for loss of punctuality on IR and that is the only variable in control of a PTO, the rest like infrastructure and access to it, are totally within the realm of IR. The damages that a PTO can claim from IR, on the other hand, is loaded in favour of the latter. This would be a breeding ground for innumerable disputes, regulator or no regulator.

 

But as I said, let these be buried as fait accompli, at least for now, because IR refuses to look at them and so be it. Let me flag only those issues which, unless resolved, make it inconceivable that meaningful concession agreements would emerge:

 

Independent regulator: With so many imponderables and potential areas of dispute, it would be implausible to have IR as a competitor operator, the policymaker, an adjudicator and the regulator, all rolled into one. This lack of separation will surely lead to unresolved issues, and frightfully for PTOs, daunting conflicts of interests. Clause 23 of the draft agreement, however, provides that IR would appoint a consulting engineering entity, substantially in accordance with the selection criteria set forth in the document, to be the Independent Engineer. Given the system-caused diffidence among rail authorities to even to look at genuine concerns of private players, this type of half-hearted solution cannot and will not work. Privatization of trains will not take off, let alone succeed unless a genuinely independent regulator is put in place before the operation starts. Consider the experience in Electricity sector which had independent sectoral regulators with adjudicatory roles similar to that of a civil court. In close to two decades of reforms and independent state and central regulators and multiplicity of players, across central PSUs like NTPC, NHPC, NPCIL, state GENCOs of each state and a number of Independent Private Power Producers, all litigations reached the Supreme Court and high decibel of noise emanated on every issue thereto. 

 

Revenue share: Commercial viability has been contested by all the serious bidders, in various ways. A key to success is, indubitably, in a sound financial model, for the PTOs. So where do the main grouches and grinches lie?

 

First, lack of clarity about the demand and capacity with attendant impact on occupancy and revenues. The information made available to prospective bidder are Project Information Memorandum (PIM), Draft Concession Agreement (prepared along with Niti Aayog) and Draft Feasibility Report (DFR) of RITES with M/s Deloitte, which includes passenger data for the year 2018-19. The DFR brings out the station to station confirmed and waitlisted passengers and respective earnings but is hardly comprehensive; the DFR seems to have cherry-picked to make a strong commercial case. In some sectors the ratio of waitlisted to confirmed passengers is well below 5%. Moreover, the capacity is likely to undergo a major transformation in some sectors with the commissioning of Dedicated Freight Corridors (DFCs) but the possibilities in other sectors are not clear.

 

Second, the headroom available to PTOs to charge extra fare is not very wide what with airline tariffs not too much above the AC II fare; a business case for AC I with increased fares is even more difficult to envision. Will the passengers really pay a large premium merely for better amenities and cleanliness in the train and improved on-board catering, particularly as the travel time would hardly see a significant reduction? A case for non-AC segment in any case does not exist as non-AC coaches are not permitted at 160 km/h speed, and even if they were with actual operation at lower speeds, there is no environment in the country for this segment to pay higher fares.

 

Third, it would appear that this gross revenue share model is a bit of a killer, and that too, over an extended period of 35 years, with all the uncertainties in revenue and expenses persisting for the PTOs whereas the haulage charges do not see any correction. Energy charges and operating costs are somewhat in control of the PTOs but haulage charge is not. Let us revisit the drivers for the project: IR does not make profit today and the service itself is poor whereas a PTO would provide better customer experience that IR is constrained to do, employ cost-effective management, be free of political compulsions to hold down fares while delivering to IR a revenue higher than what the latter earns today.  So, IR, in any case would sit pretty, providing enhanced passenger experience and gather added revenues for itself, without any investments and the attendant interest and depreciation burdens. The least the PTOs would need are reasonable returns on their massive investments and workable mitigation of risks.

 

Lastly, The PPP structure itself invites serious questions. With capital intensity, security deposit stipulation, 10% gross revenue share and such clauses, a lack of understanding or empathy of the higher cost of debt and equity for the PTOs, even for potential consortium of large international manufacturers, operators and funds stand out. The low cost of funds, around 8%, by IRFC as well as IR cannot be matched by any of the PTOs and therefore the PPPs would be burdened by higher asset amortization costs. Further with services not in isolated routes but in direct competition with IR, operational cost efficiencies would remain doubtful. Theis PPP model can hardly rely on a miracle in making wherein all of these high capital and operating costs would be more than offset by a very high fare realization and a Utopian near 100% capacity utilization to meet revenue share and still yield profits for the PTOs. 

 

A gross revenue share of 10% has been assumed in the DFR projections and it has the making of a futile long walk. Going by my own back of the envelope calculations and concerns raised by the bidders about financial viability and given that IR is averse to the concept of profit-sharing due to apprehensions of manipulations, we have to tweak the revenue model itself suitably.

 

One way could be to consider negative bids such that while IR is relieved of any investments in unpopular sectors, it shells out some subsidy to the PTO. Another way could be to reconstruct the revenue component to be shared by reducing the haulage charges from the gross revenue. Or some other way to make investments more attractive.

 

Some of these concepts have been handled in Infrastructure, Highway and Telecom sectors and IR should not shy away from the learnings made thereto. Inexplicable denial by IR appears to be standing in the way of the project succeeding and IR cannot be blind to these harsh realities.

 

Penalty for good performance: The agreement would provide that while IR would not have a competing train an hour before and after a PTO’s train, they are free to do so once 80% occupancy is reached for three successive months or otherwise after three years. Added to that is the ambiguity that IR is not disabled to introduce a train from other origins and destinations in the same city. These are the clauses which the bidders have looked askance at as they sound like an inverse reward for success. IR cannot hope to eat the cake and have it too. These clauses need a relook to encourage occupancy in PTOs’ trains and once they succeed, they should be given further incentives to free them from the restrictions of train length and stoppages etc. to exploit the segment better. In any case, these clauses reinforce the avoidable perils of concessionaire and competitor being the same.

 

Leasing option: The culture of leasing rolling stock should be encouraged. The easiest way, at present, is to work out a sound leasing regime by IR such that it can lease its own train sets or locomotives. This has been dealt with cursorily, leaving it to initiatives by PTOs and their financiers. A good look at this will open up many possibilities for IR to improve passenger services with either a higher return on investment of reduced investments. Learning from past experience of DMRC and Container trains will help. IR, moreover, as the largest aggregator and operator with ownership of underlying infrastructure would be the ideal counter-party to leverage economies of scale

 

Adequate time to work out a competent bid: Bidders would hardly use the DFR data as the bedrock of their investment decisions. They must institute their own research into commercials, passenger occupancy and revenue data, sourcing of rolling stock and so on. I learn from prospective consultants, rolling stock majors and the bidders themselves that they had not done this so far at any length as all this while they had been sitting on the fence, waiting for things to unfold. The date for submission of bids against the RFP is now in January and it gives them only 2 months to do their study and prepare a bid. That is unworkable, particularly for those bidders who would submit bids for multiple sectors; submission of bids in multiple sectors is a sound strategy from the standpoint of spreading out the risk and also for bringing down the price of rolling stock with higher volumes. Instead of waiting for the bidders to start whining about this strongly, IR should revise this to a reasonable time frame for comfort of the bidders.

 

In summary, it appears that there is no risk for IR, except losing face in case of failure of the project whereas a PTO has to contend with high risks and perhaps even perpetual losses. At stake is not merely this project but long-term credibility and allure of IR, both from ease of doing business and long-term PPPs into the future. IR cannot afford the smug luxury of a premise that it was dispensing favours, not looking for a partner in success. This privatization project is a very welcome move of IR to liberate itself from its proverbial stick in the mud and it should not be allowed to fail due to cocksure rigidity and a fundamentally flawed PPP architecture. It’s time for IR to open the kimono and meet the prospective bidders halfway.