The Case for Privatising Indian Railways

 Ever since the pre-elections period, Prime Minister Narendra Modi has been betting big on focusing on infrastructure, particularly the railways, to fuel growth and employment. This fact has been reflected in the recent months’ rally in several railway stocks such as Kalindee Rail, Kernex Micro, Texrail, Texmaco, and others that have seen consistently increasing prices ever since February and March.

Given the fact that the stock market prices reveal the expectations of the investors about the future prospects of the companies they choose to invest in, it goes without saying that Indian Railways is set to witness major transformation in the coming years.

Mr. Modi has plans for bringing in high-speed trains and building dedicated freight corridors for transporting coal, steel and agricultural products from surplus areas to deficient areas in considerably faster time. Given his track record for action-oriented and decisive leadership, there is little doubt that railways could be transformed and its slumbering potential leveraged for country’s benefit in the coming decade, if only the right method is followed.

The question, then, boils down to the path that his government would have to take to bring these goals to fruition. The task of modernizing Indian Railways would be a particularly cumbersome undertaking given its monstrous size and reach. A thorough modernization process would not only require huge investments, but also entail tailoring down the gargantuan bureaucracy so as to ease decision-making and increase overall efficiency.

In other words, it would require bringing about structural changes.

By “structural” changes, I mean a comprehensive overhaul in the economic model under which it currently operates. For instance, Indian Railways has been known for keeping the prices of passenger fares artificially low under the pretext of enabling inclusive growth.

I use the word “artificially” because the State fixes fares manually (instead of allowing the market forces of demand and supply to determine the price), and resets them periodically to align with the constantly changing input costs. And since there is usually a lag between the period when the input costs change and the period when the fares are manually reset, it usually results in a significant loss. Indian Railways has attempted to raise passenger fares to keep up with higher input costs of coal, but to no avail.

Owing to this business model that is fundamentally uneconomic in nature, Indian Railways has not only sacrificed revenues, but also quality and innovation. As a result, it is now best known for its rickety wagons, filthy stations, an unrelentingly sluggish website and a dreadful booking process.

Furthermore, the cost of subsidizing passenger fares comes from maintaining artificially high prices on freight rail, a phenomenon that, thanks to an improving road infrastructure, has compelled a bulk of the freight traffic to choose road transport instead.

One more reason why our businesses are forced to use the more expensive truck transport is that the Indian Railways currently runs shockingly low on wagons. And since businesses often require timely delivery of goods as inputs in the production process, they are left choice-bound. This raises their costs and ultimately hurts their profits. Increased truck transport also results in a spike in consumption, and therefore also a spike in imports, of oil.

Given that the domestic oil industry is characterized by anything but a free-market, the oil imports are made at comparatively higher prices (than what the prices would have been had we sourced oil domestically under a free-market production model), and this at least partly contributes to inflation.

So as to meet the funding requirements of railways, which according to the 12th Five Year Plan were estimated to be approximately Rs. 8.4 lakh crore, allowing substantial foreign direct investments is critical.

A 2012 report on Indian Railways by an expert group constituted by the Ministry of Railways and chaired by Sam Pitroda also proposed a modernization plan, which estimated a funding requirement of Rs. 560,000 crores. To fulfill this need it suggested four main sources of funds, namely budgetary support, internal generation by Railways, monetization of blocked assets coupled with resort to PPP and fund raising from financial institutions and markets, domestic as well as international.

In my view, there is also a fifth source of funding: Privatization. This approach can potentially overshadow most other sources of financing, and can catapult our railways to a truly enviable position in the world.

It is important to remember that the fundamental role of subsidies is to provide to the poor equal opportunities as opposed to an equal outcome. In that sense, subsidies should best be used to provide only for basic needs such as food, water, education, and sanitation. These too, however, are of secondary importance.

The primary role of the State is to ensure law and order and protect our borders. When the government unnecessarily expands its role beyond what it was originally created for, it fails miserably even in fulfilling its basic duties. The numerous crimes against women in our nation can be seen as this dissipation of the attention of the State from its primary duties.

Given that railways do not even remotely fall into the category of basic needs, there is no need to spend taxpayers’ money on subsidizing them. Privatization would ensure that the demands for both passenger tickets and freights matches their respective supplies through allowing fares to change automatically as per the dynamics of the market.

While considering privatization, India has the advantage of learning from two global precedents, Japan and Britain, the former being quite successful while the latter not so much. Beginning in the late 80s, Japan privatized Japanese National Railways (JNR) – which earlier suffered from high debt, poor management, and virtually non-existent operating profits – by spinning it off into seven different companies through a process called ‘vertical integration’.

In simple words, it involved separating tracks, trains, and other rolling stock vertically among different companies. This process led to significant cost efficiencies resulting in low transaction costs, ease in creating performance schedules, and increased incentives for the track authorities to undertake improvement and safety measures.

Britain, on the other hand, adopted horizontal integration, a process that compromised the potential for maximizing competition by creating greater dependency between different operators in terms of providing and attracting passengers. As a result, it suffered from administrative inefficiencies and subsequent rise in fares.

India can also learn from Argentina, which privatized its railways back in the 1990s. Currently, around 10% of the capital of Indian Railways is locked into non-core segments such as running hospitals and schools for its employees. Handing over of these institutions to private players through a transparent bidding process could significantly cut costs. Splitting up of railways into smaller companies could improve decision-making and enhance efficiency.

India has already reaped the benefits of privatization in airlines — an industry that become conspicuous for its brutal cost cutting and fierce price wars. Competition in this industry has ensured lower, competitive fares coupled with better quality of services and infrastructure.

Then why not consider this model in railways?

India must study the best privatization models employed across the world, improve upon from their mistakes, and execute the reforms boldly so as realize the slumbering potential of Indian Railways.