By Amitabh Kumar, Vishnu P. Sudarshan and Gautam Shahi.There is a lot of buzz in the market about opening up of the rail sector in India to private investment. Recently, GATX Corporation entered India after signing a Concession Agreement with the Ministry of Railways for permission to lease rail wagons to Indian Railways and private players in India. This is the second big push in this direction by the Indian Railways after it opened the container transport sector for private players in 2006. There is no denying the fact that the rail sector in India is in need of funds. Further, the inefficient supply chain system is costing India dearly..According to certain industry reports, Indian loses approximately USD 65 billion every year due to inefficient supply chain systems. If corrective measures are not taken, this figure may touch USD 145 billion by the year 2020. The supply chain costs in India are about 12% to 13% of the gross domestic product compared with 7% to 8% in developed countries. Indian Railways should form the backbone of the supply systems in India but is struggling to fulfil its role. Since independence, Indian Railways has added only 20%, i.e., about 10,000 kms, to the rail network whereas traffic has increased tenfold or 1000%. Compare this with China, which, in the same period, has added about 69,200 kms to its rail network..In order to rectify this situation the Ministry of Railway came out with the Vision 2020 Plan which envisages that Indian Railways will, (i) add 25000 km of railway line; (ii) double the freight carried; and (iii) set-up six dedicated freight corridors. The Vision 2020 plan entails an investment of Rs. 13,87,842 crores. The Ministry of Railways has also accepted the recommendations of the Kakodkar Committee Report on Rail Safety and, inter alia, intends to adopt an advance signalling system at an estimated cost of Rs. 20,000 crores. It also seeks to eliminate all level crossings at an estimated cost of Rs. 50,000 crores..It is difficult for the Indian Railways to generate these funds by itself. Its operational costs consume 95% of its revenues leaving little for any development programme. This is in spite of the fact that average freight revenue per tonne kilometre of Indian Railways at USD 395 is almost 4 times the average freight revenue per tonne kilometre of railway companies in the United States. The Union Government has also been of limited assistance vis-a-vis the fund requirement. The Ministry of Railways requested budgetary support of Rs. 50,000 crores for FY 12-13 based on an estimated budgetary outlay of Rs 60,000 crores. This request, however, has been responded with a budgetary grant of Rs. 25,000 crores..In this kind of scenario, PPP seems to be the most obvious way forward. Sectors like airports, ports and road have benefitted from the PPP initiatives. In fact, as per a Ministry of Finance website, the total value of PPP contracts in the road sector amounts to Rs. 1,76,724 cores. Indian Railways itself has benefitted from private investment in container transport sector. Railways opened container transport sector in 2006 and gave licenses to private players for operating container trains on the rail network. Private players paid Rs. 640 crores as license fee and invested over Rs. 4000 crores in creating infrastructure including terminals, rakes and handling equipment. It is anticipated that in the next five years, private players will give INR 3000 cores to the Indian Railways as haulage charges. Prior to the budget, the Railway Minister had indicated that almost a third of the investment requirement (Rs 7.5 Lakh Cr.) for the next five-year plan might come through private investments..However, is the rail sector ready for private investment? It is pertinent to note that prior to 2006, two initiatives in the year 1994 and 2004 to invite private investments in the container transport sector failed. Even the experience of the private players in the container transport sector post-2006 has not been good. The Indian Railways has failed to create a business friendly environment and has shown intense resistance to competition from private players. Instead of collaborating with the private players, it has ended up creating obstacles to the growth of the sector..For instance, immediately after accepting the license fee from the private players and even before signing the concession agreements, the Indian Railways imposed a blanket restriction on transport of coal, coke, iron ore and minerals in container trains. It may be worthwhile mentioning that these four commodities constitute almost 60% of the total goods transported by rail. Similarly, the Indian Railways has imposed higher haulage charges on commodities that are perceived by the Indian Railways as bulk goods, which restricts the market for the private players by another 30 per cent. Further, frequent changes in the haulage charges and other terms and conditions making it difficult for private players to enter in to long-term commitments. In fact, there are instances where the private players have had to transport goods at a loss because of commitments given to the client before the change in the haulage charges..Further, the duration of the concession agreement at 20 years is not long enough to induce large investments. Similarly, absence of provision to deal with investment in rolling stock and terminals at the end of the concession period also creates a doubt in the minds of private players. Moreover, there is an inherent conflict of interest with the Indian Railways being the grantor of the concession as also being the minister, regulator and operator. This multiplicity of functions creates an environment of uncertainty..This environment is not conducive for private investment. If the Indian Railways is keen on private investment, it will have to put in genuine efforts to improve the business environment by creating a robust and balanced contractual framework, which would make the private investors comfortable about their investments. It may also be appropriate to create an independent regulator to establish and promote competition and growth of the sector. Most importantly, the Indian Railways needs to bring about a change in its attitude and accept private investors as partners in reinventing railways as the backbone of the supply chains in India. Failure to do so would lead to further marginalisation of railways in the Indian growth story..To conclude, to attract private sector participation, the Indian Railways should ensure that:.(a) The framework should not be prescriptive or rigid but be flexible to accommodate diverse formats of PPP-as per the needs of the sector as also peculiarities/specifics of a project;.(b) The framework must provide for striking a sustainable balance between universal service or lifeline supply, and commercial viability of the sector..(c) The choice of the format for PPP should be decided by the concerned governmental authority after evaluating factors such as: (i) need for a particular infrastructure facility which determines the output/performance parameters; (ii) need for private participation in the development and operation of that facility including the value for money proposition; (iii) most efficient way of developing and operating that facility, and (iv) balance between viability, welfare objectives and public policy needs..(d) Suitability of a project for private sector participation should be predicated on ‘value for money’ analysis (such that the private sector brings in efficiency in operations, finance and technology commensurate to the rewards assured for risk taken) and welfare consideration..(e) The Concession Agreement should provide a clear definition of the role, responsibility and rights of various parties in the governing instruments including the scope of public service, service standards, pricing, and scope of governmental intervention or assistance;.(f) The scope of bankability and securitisation of the concession, project assets and revenue (including assignability) so that the concessionaire is in a position to avail affordable debt finance by securing lenders..(g) The risk allocation is fair and well balanced as improper risk allocation enhances risk profile of the project and will (i) deter credible players who wish to deliver quality infrastructure facilities; and (ii) attract those players who work on ‘concession capture* and short term profiteering business model..Lastly, when designing a commercial structure for undertaking any infrastructure project in a PPP format, it is essential to consider the interplay between the regulatory framework and the variety of options available to parties. For PPPs to be effective in terms of attracting private sector investment and providing for the needs of citizens/users, the Partnership must take into consideration the needs of all key stakeholders including the citizen/user, the developer and the State. In doing so, the Indian Railways should build on the precedents and continue to develop a dynamic PPP model, which is responsive to the needs and realities of the Indian market..Vishnu P Sudarshan (left) and Amitabh Kumar (centre) are Partners at JSA. Gautam Shahi is an Associate.
By Amitabh Kumar, Vishnu P. Sudarshan and Gautam Shahi.There is a lot of buzz in the market about opening up of the rail sector in India to private investment. Recently, GATX Corporation entered India after signing a Concession Agreement with the Ministry of Railways for permission to lease rail wagons to Indian Railways and private players in India. This is the second big push in this direction by the Indian Railways after it opened the container transport sector for private players in 2006. There is no denying the fact that the rail sector in India is in need of funds. Further, the inefficient supply chain system is costing India dearly..According to certain industry reports, Indian loses approximately USD 65 billion every year due to inefficient supply chain systems. If corrective measures are not taken, this figure may touch USD 145 billion by the year 2020. The supply chain costs in India are about 12% to 13% of the gross domestic product compared with 7% to 8% in developed countries. Indian Railways should form the backbone of the supply systems in India but is struggling to fulfil its role. Since independence, Indian Railways has added only 20%, i.e., about 10,000 kms, to the rail network whereas traffic has increased tenfold or 1000%. Compare this with China, which, in the same period, has added about 69,200 kms to its rail network..In order to rectify this situation the Ministry of Railway came out with the Vision 2020 Plan which envisages that Indian Railways will, (i) add 25000 km of railway line; (ii) double the freight carried; and (iii) set-up six dedicated freight corridors. The Vision 2020 plan entails an investment of Rs. 13,87,842 crores. The Ministry of Railways has also accepted the recommendations of the Kakodkar Committee Report on Rail Safety and, inter alia, intends to adopt an advance signalling system at an estimated cost of Rs. 20,000 crores. It also seeks to eliminate all level crossings at an estimated cost of Rs. 50,000 crores..It is difficult for the Indian Railways to generate these funds by itself. Its operational costs consume 95% of its revenues leaving little for any development programme. This is in spite of the fact that average freight revenue per tonne kilometre of Indian Railways at USD 395 is almost 4 times the average freight revenue per tonne kilometre of railway companies in the United States. The Union Government has also been of limited assistance vis-a-vis the fund requirement. The Ministry of Railways requested budgetary support of Rs. 50,000 crores for FY 12-13 based on an estimated budgetary outlay of Rs 60,000 crores. This request, however, has been responded with a budgetary grant of Rs. 25,000 crores..In this kind of scenario, PPP seems to be the most obvious way forward. Sectors like airports, ports and road have benefitted from the PPP initiatives. In fact, as per a Ministry of Finance website, the total value of PPP contracts in the road sector amounts to Rs. 1,76,724 cores. Indian Railways itself has benefitted from private investment in container transport sector. Railways opened container transport sector in 2006 and gave licenses to private players for operating container trains on the rail network. Private players paid Rs. 640 crores as license fee and invested over Rs. 4000 crores in creating infrastructure including terminals, rakes and handling equipment. It is anticipated that in the next five years, private players will give INR 3000 cores to the Indian Railways as haulage charges. Prior to the budget, the Railway Minister had indicated that almost a third of the investment requirement (Rs 7.5 Lakh Cr.) for the next five-year plan might come through private investments..However, is the rail sector ready for private investment? It is pertinent to note that prior to 2006, two initiatives in the year 1994 and 2004 to invite private investments in the container transport sector failed. Even the experience of the private players in the container transport sector post-2006 has not been good. The Indian Railways has failed to create a business friendly environment and has shown intense resistance to competition from private players. Instead of collaborating with the private players, it has ended up creating obstacles to the growth of the sector..For instance, immediately after accepting the license fee from the private players and even before signing the concession agreements, the Indian Railways imposed a blanket restriction on transport of coal, coke, iron ore and minerals in container trains. It may be worthwhile mentioning that these four commodities constitute almost 60% of the total goods transported by rail. Similarly, the Indian Railways has imposed higher haulage charges on commodities that are perceived by the Indian Railways as bulk goods, which restricts the market for the private players by another 30 per cent. Further, frequent changes in the haulage charges and other terms and conditions making it difficult for private players to enter in to long-term commitments. In fact, there are instances where the private players have had to transport goods at a loss because of commitments given to the client before the change in the haulage charges..Further, the duration of the concession agreement at 20 years is not long enough to induce large investments. Similarly, absence of provision to deal with investment in rolling stock and terminals at the end of the concession period also creates a doubt in the minds of private players. Moreover, there is an inherent conflict of interest with the Indian Railways being the grantor of the concession as also being the minister, regulator and operator. This multiplicity of functions creates an environment of uncertainty..This environment is not conducive for private investment. If the Indian Railways is keen on private investment, it will have to put in genuine efforts to improve the business environment by creating a robust and balanced contractual framework, which would make the private investors comfortable about their investments. It may also be appropriate to create an independent regulator to establish and promote competition and growth of the sector. Most importantly, the Indian Railways needs to bring about a change in its attitude and accept private investors as partners in reinventing railways as the backbone of the supply chains in India. Failure to do so would lead to further marginalisation of railways in the Indian growth story..To conclude, to attract private sector participation, the Indian Railways should ensure that:.(a) The framework should not be prescriptive or rigid but be flexible to accommodate diverse formats of PPP-as per the needs of the sector as also peculiarities/specifics of a project;.(b) The framework must provide for striking a sustainable balance between universal service or lifeline supply, and commercial viability of the sector..(c) The choice of the format for PPP should be decided by the concerned governmental authority after evaluating factors such as: (i) need for a particular infrastructure facility which determines the output/performance parameters; (ii) need for private participation in the development and operation of that facility including the value for money proposition; (iii) most efficient way of developing and operating that facility, and (iv) balance between viability, welfare objectives and public policy needs..(d) Suitability of a project for private sector participation should be predicated on ‘value for money’ analysis (such that the private sector brings in efficiency in operations, finance and technology commensurate to the rewards assured for risk taken) and welfare consideration..(e) The Concession Agreement should provide a clear definition of the role, responsibility and rights of various parties in the governing instruments including the scope of public service, service standards, pricing, and scope of governmental intervention or assistance;.(f) The scope of bankability and securitisation of the concession, project assets and revenue (including assignability) so that the concessionaire is in a position to avail affordable debt finance by securing lenders..(g) The risk allocation is fair and well balanced as improper risk allocation enhances risk profile of the project and will (i) deter credible players who wish to deliver quality infrastructure facilities; and (ii) attract those players who work on ‘concession capture* and short term profiteering business model..Lastly, when designing a commercial structure for undertaking any infrastructure project in a PPP format, it is essential to consider the interplay between the regulatory framework and the variety of options available to parties. For PPPs to be effective in terms of attracting private sector investment and providing for the needs of citizens/users, the Partnership must take into consideration the needs of all key stakeholders including the citizen/user, the developer and the State. In doing so, the Indian Railways should build on the precedents and continue to develop a dynamic PPP model, which is responsive to the needs and realities of the Indian market..Vishnu P Sudarshan (left) and Amitabh Kumar (centre) are Partners at JSA. Gautam Shahi is an Associate.