Subir Gokarn: The business of the railways

Not touching lower-class fares has come as a disappointment.

As much as we would like to cast the railways in rosy metaphors, we must remember that, at the end of the day, they are a business. As with any business, they must continually deal with a predictable set of issues.

How much does it cost to produce each of the services that it offers? Are potential consumers of one or more services willing to pay a reasonable premium over the bare cost of production? If not, should they continue to offer them?

What is the minimum amount of money needed each year to maintain acceptable levels of service quality (which, in the case of the railways, would definitely include safety)? How much money should be spent on increasing productivity and expanding capacity?

None of these considerations minimises the role of the railways in providing critical public services that cannot be subject to commercial considerations. To the extent that these services are being provided by an essentially commercial organisation, the provider can be subsidised by the government, which asks for these services to be provided.

It is in the overall interests of the country to have these services at minimum cost, which can only be accomplished when they are provided by an efficient organisation, which can accurately measure the costs of its individual services.

In short, financial separation between the commercial operations and social functions of the railway system is required to make it viable, self-sustaining, and capable of attracting investments from the outside, while relying as little as possible on government resources, which may well have greater impact elsewhere.

If this is not recognised and the railways continue to function as a government department, with all that it entails for objectives, priorities, and emphasis, the system is caught in a vicious circle of tiny surpluses, inadequate investments, and deteriorating efficiency and safety.

These were the arguments underlying the recommendations of the Expert Group on the Railways, which submitted its report over four years ago.

A corporate (not private) structure, a massive change in the tariff structure, which involves lowering the average freight rate and upper class passenger fares, while raising lower class fares and the setting up of an independent regulator to analyse costs, set tariffs, and thereby provide a benchmark for subsidies, were the key suggestions it made with a view towards achieving the business orientation and separation between the commercial and social aspects, which it considered so critical to reforming the system.

Clearly, the recommendations on the corporate structure and the regulatory framework are nowhere in consideration. The very presentation of a separate railway budget is testimony to the predominance of the "government department" view.

Tariff reforms have been made, with a small upward revision of passenger fares in 2002, followed by a reduction in freight rates and upper-class fares in 2003.

In that year, a flexi-fare scheme was also introduced, providing for discounts during off-season, a logical counterpart to the tatkal scheme, which garnered premia for seats on crowded trains. Along with this, internal programmes on system improvement, safety measures, and so on continue within the existing framework.

Over the last couple of years, the sustained recovery in industrial activity has also provided a boost to the railways' top line. The recovery has been spearheaded by sectors like steel and automobiles, which use steel.

It has been a relatively material and fuel-intensive recovery, which is always good for the railways. As a result, freight movement and revenues, which account for about two-thirds of the total, have been buoyant. They have grown slightly faster than costs, allowing for an increase in surpluses.

However, in any absolute sense, the surplus, though increasing, is so small that it offers no hope of self-reliance as far as financing even the minimum level of investments required every year.

One important drain on the surplus is the amount of money that needs to be provided for pension payments. For 2005-06, it is Rs 6,940 crore, increasing by about Rs 300"�400 crore every year. This constitutes almost 14 per cent of gross revenues of about Rs 50,000 crore and points to a fundamental constraint that will continue to dog the system for years to come.

Even if operating costs are reduced by speeding up attrition through voluntary retirement and so on, the savings will be diluted by the increase in pension claims. The pension overhang is a problem that plagues the government as a whole.

Although it has moved to a provident fund system for employees entering in 2004 and after, the benefits will not be visible for many years. Any organisational and financial restructuring of the railways that may be visualised will have to come with the government absorbing the pension liability. The legacy of past excesses is extremely difficult to live down.

The core issue, however, remains the imbalance in fares and freight rates. What are the relative costs of lower-class and upper-class services? If a second-class sleeper bogey carries 76 passengers and a first-class one 18, 1:4 is a reasonable estimate.

Premiums can be added for comfort and special services and, for different categories of trains, for speed and so on, but on any given train, the difference cannot far exceed the ratio of seats per bogey. And, this ratio cannot be achieved without either significantly increasing the share of upper-class passengers or the lower-class fares.

It must be emphasised that subsidies should only be considered when the social returns to a specific line or service warrant them. It is inconceivable that it is necessary to subsidise billions of passenger kilometres in lower-class bogeys.

The government or the railway system certainly cannot afford it. Most importantly, by charging more per tonne kilometre than is warranted by relative costs, the system is contributing to a distortion of choice of transportation modes and weakening the competitiveness of producers.

Under the circumstances, the decision by the railway minister not to touch lower-class fares at all should come as a disappointment to those concerned about the future of the system.

Accepting the political difficulty of doing this, the best opportunity is always going to be in the early part of the government's term. Having passed up this chance, it is only going to get more and more difficult as the general election looms on the horizon.

Overall economic buoyancy will give the system enough to keep its head above water, but not much more than that. From a business perspective, this is simply not doing justice to the resources and capabilities of the system.

The writer is chief economist, Crisil. He was associated with the Expert Group on Railways during 1999-2001. The views expressed are personal