Subir Gokarn: One-track reform

There is little question that the performance of the Indian Railways this year represents a significant turnaround from a rather dismal direction. The announcements to this effect in the railway budget had been anticipated by the spate of advance publicity about the many fronts on which efficiency and capacity utilisation had increased.

The broadest measure of efficiency of the system is the operating ratio, which is the ratio of "ordinary working expenses", or operating costs, to revenues. For the last several years, this ratio has been in excess of 90 per cent, indicating that the system had less than 10 per cent of its earnings left over for important things like investment and transfers to the government in the form or repayments, or dividends.

For the current year, Mr Lalu Prasad estimates an operating ratio of 83.7 per cent, a phenomenal one-year improvement, which provides a huge increase in the availability of internal resources to make long overdue commitments to upgrading infrastructure, rolling stock and communication equipment. He expects this improvement in efficiency to sustain over the next year, with a marginal increase in the ratio to 84.3 per cent.

When faced with a situation as comfortable as this, a politician's first instinct is to play Santa Claus. Ministers in India are not reputed for taking hard decisions that may inflict at least short-term political damage when times are good. Genuine reform is almost exclusively a response to deep crisis. For observers from the sidelines such as myself, this is always frustrating to watch, enamoured as we are of the idea that good times usually provide opportunities for relatively painless change. From this perspective, the appropriate judgment of the railway budget is that much of what it did was the right thing to do, but it simply did not take full advantage of the good times to push through some radical change, which might have substantially reinforced the positive financial outcomes seen this year.

For years now, there has been a broad consensus amongst us, sideline observers, that raising lower-class passenger fares was the single-most important reform measure that the railways needed to implement. The losses on this business segment are perceived to be so large that they would overwhelm the potential benefits from all other attempts at reform. In recent years, the compulsions of a high operating ratio have tied the hands of railway ministers into at least leaving this category of fares unchanged. Given the improvement in financial health this year, many people would have expected Mr Prasad to give in to political temptation and do what his predecessors couldn't, particularly in this year of five elections (four states and one UT).

To his credit, he didn't and we must be thankful for that. However, the opportunity lies in the impact of one of the key drivers of the huge jump in freight revenues, which is the primary reason for the improvement in the operating ratio. Yes, increasing wagon loads and improving turnaround times have contributed, but the overall buoyancy in the economy, particularly in the manufacturing sector, which is the biggest user of freight services, has also helped. Economic buoyancy presumably means that employment opportunities have increased and more and more people are on the move searching for those opportunities. Given that the railways will end up carrying the vast majority of these people and given their opportunity costs of not making the journey, one would imagine that most of them wouldn't grudge the railways a small increase in fares.

In other words, it would have been perfectly reasonable for the railways to exert some of the indisputable monopoly power they have in this particular market segment, in exactly the same way in which the budget played the competitive game in other segments. Rationality certainly prevailed in the decision to lower upper-class passenger fares, continuing a trend that was initiated a few years ago. The logic of consumer demand says that lowering prices will increase total revenues from products or services that have a price elasticity of demand greater than 1. This is certainly true of upper-class passenger services, more so, in the face of aggressive competition from low-cost airlines. If a price war broke out between the airlines and the railways, there is no question about who would lose.

Even if the minister was averse to going the distance and raising lower-class fares this year, this was perhaps the appropriate occasion to establish a rail tariff authority, which is an essential step in de-politicising the setting of fares. With one stroke he would have cemented his reputation as a reformer and constrained his successors, particularly if they happen to be from an opposing party, from undermining railway finances for political ends. Here again, there is a sense of not having taken a perfectly logical and feasible step, particularly when the railways are apparently quite eager to increase the degree of private participation in the system.

Private sector entry into the operation of container trains was announced a few weeks ago. Apparently buoyed by the rather enthusiastic response to this from a number of big players in the freight and logistics business, the budget speech assured us that the concessions would be finalised by the end of the fiscal. There were other references to public-private partnerships as well. If the desire to broaden legitimate business opportunities for the private sector is genuine, a regulatory mechanism that oversees compliance with various contracts is necessary.

Such a body would, in any case, have to understand the cost structures of various activities to determine the viability of contractual terms. There is no reason why it cannot also look at the passenger fare structure and, at the very least, inform the public about what it really costs the railways to provide various services. This is an essential first step in reasonable cost recovery from and the depoliticisation of lower-class passenger fares.

Overall, this budget has utilised the opportunity provided by the revenue buoyancy to both sharpen its competitive position (fare reductions, freight category rationalisations and dynamic pricing) and find the resources for investment. However, in the absence of more fundamental reforms on lower-class fares, these initiatives run the risk of reversal, if a revenue shortfall were to suddenly hit the system. The circumstances did provide an opportunity to initiate more enduring changes that would have been difficult for anybody to reverse, which may not recur for a long time. This is what differentiates between a good budget and a great one.

The author is chief economist, Crisil. The views here are personal.