India is to open up its dilapidated railway network to foreign investors in a government move that will hopefully boost economic growth and strengthen infrastructure across the country.

Recently elected Prime Minister Narendra Modi is working hard to fulfil his promises of an improved Indian economy, and key to this is an upgrade of the country’s vast railway network to the tune of $93bn over the next five years. Whether the government will be able to improve existing tracks, strengthen bridges, and modernise signalling and communications to meet the demands of the modern Indian economy is questionable: the upgrade will be largely dependent on foreign direct investment. What’s more, a century-old monopoly threatens to make the upgrade a drawn-out affair.

Indian Railways, the world’s third-largest train system, carries about 23 million passengers and 2.65 million tonnes of freight on 19,000 daily trains. It is a popular and much-needed means of transportation for the millions of Indians travelling to the country’s urban hubs. According to PwC, more than a quarter of India’s railways are being used over capacity and 50 percent of the network is nearing the same height of overload. The state-run network, which employs 1.3 million people, has struggled to keep pace with rising passenger numbers, freight demands and economic aspirations.

About 94 percent of the system’s revenues are spent on operating costs and social obligations, leaving little to modernise its creaking infrastructure. Out of India’s 130,000 railway bridges, about 25 percent are more than a century old. This alone presents massive security issues and causes severe delays regularly, yet is only a small part of the problem. There is a desperate need for better railway technology, such as signalling and an expansion of the network itself through more tracks and trains.

This is why Modi’s government wants to create a number of bullet-train rail links between large cities, starting with the long-discussed line between Mumbai and Ahmedabad, 500km away. Each of these links would cost about $10bn, but would greatly boost the 161-year old network. In early July, the country’s first high-speed train was sent on a test run to Agra, the home of the Taj Mahal, on which it reached a top speed of 160 km/h – a serious improvement from current travel times. Already the link is being called the ‘Bullet Raja’ or Bullet King. Nevertheless, the new high-speed train, set to launch officially in November on the New Delhi-Agra route, travels at just half the speed of the superfast trains Modi wants to build (in addition to planned new freight corridors and coaches).

Large-scale problems
This a crucial project to focus on, says PwC, as India’s ailing railways have hurt the economy greatly: itsfaltering logistics could otherwise service its manufacturing industry. What’s more, high freight rates – about twice the rates in China – have prompted many companies to ship cargo by truck instead. Today, trains carry just 30 percent of India’s freight, down from nearly 80 percent 30 years ago.

“The railways have been losing freight for years,” says Manish Agarwal, PwC India’s Leader on Capital Projects and Infrastructure. “This mostly comes down to the inability to ensure a time frame for freight travel, because of the lack of sufficient technology and the size of the network. Passenger and freight lines are shared, and, when there is a delay, passenger trains are always prioritised. This makes it impossible to ensure deliveries within a set time.”

The delays on the railway system are largely caused by a lack of new and efficient technology, such as proper signalling, track changes and trains with more comfortable capacity. In a country where temperatures easily run to 40 degrees celsius, the lack of air-conditioning on a rammed commuter train is no laughing matter. This adds to the growing security issues related to the railways.

Decrepit tracks and bridges aside, the trains are grossly overloaded on a daily basis. People can often be killed falling off overcrowded trains or crossing the tracks. Others are charred to death by high-voltage electrical wires while perched on coach roofs. The network has a dreadful safety record, with a government report in 2012 putting the number of deaths each year at nearly 15,000.

The urgent need to upgrade the system is not just one of economics; it comes down to life or death. But the upgrade is largely dependent on a grossly monolithic and bureaucratic government system that so far has impeded modern railway maintenance for the past 10 to 20 years. And that is no easy hurdle to overcome, says Agarwal.

“The Indian railways have lacked investment. There’s been an inability to raise passenger fares because it’s a political ideology that public transport in India needs to be accessible for everyone. It also has to do with execution. The railway is a monopoly behemoth and as is often the case when policymaking is bundled with execution, efficiency has gone down. A lot of previously announced projects have not been completed. But I think it’s a good sign that the new government has promised to finish these projects in addition to taking on new ones.”

Foreign investment
The majority of the new projects related to the railway will have to be funded by public-private partnerships, according to DV Sadananda Gowda, the Indian Railway Minister. He said the government is relying on foreign investment to fund station upgrades and new bullet trains. The cabinet will approve FDI in railway infrastructure, which has previously not been allowed.

The move comes in acknowledgement of the fact that India’s current fiscal issues present a significant problem to major investments such as this. As Gowda remarked: “Internal resources are insufficient to meet the requirement”.

Given the magnitude of the railway upgrade, it is no question that the investment needed will be of the long-term type, with realistic estimates suggesting it will take a minimum of 10 years for the network to reach modern standards. In order to not be overwhelmed and repeat the mistakes of past governments, Gowda has taken a pragmatic approach that divides the upgrade into several smaller projects that will be tackled one at a time. These will include the establishment of the high-speed rail network and increasing speed on the current structure – the two projects considered top priorities so far.

The PPP models need to be spelt out to attract FDI, so investors can see which projects are aligned to their risk appetite

This division of projects is crucial, says Agarwal, pointing to how previous PPPs have failed to attract sufficient investment.

“The PPP models need to be spelt out to attract FDI, so investors can see which projects are aligned to their risk appetite,” says Agarwal. “That said, we need to get the PPP model closer to what the world understands as a PPP model, ensuring that it has the right clearances and approvals before it’s put out to bid. Also, performance-based revenue models are more aligned to foreign investor appetite than traffic and real-estate-based models”.

Concerns about risk are a particular hurdle for India in its attempts to attract FDI, but Agarwal maintains investors must keep their eye on the risk-return equation instead. Another issue pertains to the lack of long-term financing in India for projects such as these, as well as the governments tradition of bundling infrastructure projects in with real estate. It is crucial that the upgrade doesn’t depend on such multi-projects, as the risk appetite of infrastructure investors does not match up to that of real estate and could prevent the inflow of FDI. The government and the Reserve Bank of India will also have to work hard at reforming banks lending practices – and this, again, could prove a long-term affair.

Control system
While infrastructure experts have welcomed the overall drive for private and foreign participation, they have also said institutional reforms, such as creating an independent rail regulator, will be required to de-politicise the railway sector. In 2013 alone, India spent 10 percent of GDP on its logistics sector. Considering the state of the railway system and that other countries average an investment of seven to eight percent, it is clear the network could be a lot more efficient.

“An independent railway regulator is necessary to deal with economic side of the railways and de-politicise issues such as tariffs and prioritisation of projects,” says Agarwal. “It’s taken 10 years for the government to do a 14 percent rate increase, so government involvement needs to be reduced. The regulator should be able to gauge investments and tariffs based on demand and costs, and then the government could subsidise projects or passenger classes in a more targeted manner.”

To this end, the Indian Transport Minister has proposed establishing automatic revisions to the subsidised passenger fares in order to reduce political skirmishing over increases needed to cover rising costs. For decades, successive Indian governments have held passenger fares far below their costs to keep trains universally affordable, while charging steep freight rates in order to cover the losses. This has hurt commercial train freight in India, but is not by any means the only issue keeping companies on the roads and away from the tracks.

The Indian Transport Minister has proposed establishing automatic revisions to the subsidised passenger fares in order to reduce political skirmishing

“Reducing rates alone will not impact logistics in the country,” says Agarwal. “Committed service levels are equally important to attract more freight movement to railways. For example, a level playing field amongst private container freight licensees could bring competition in service levels, while in the monopoly segments service levels could be locked in through long-term PPP contracts. Breaking the monopoly and letting others operate container freight on the railway would be a significant advantage to cost and time.”

It’s clear that the biggest hurdle to overcome for India’s railway dreams is institutional. Major changes are needed in order to bypass the century-old monopolies and separate policymaking from the actual running of the railways. The unbundling of the sector and creation of benchmark competition will undoubtedly be a challenging one. But Modi and his government must focus on it in order to realise the upgrade within the necessary timeframe.

Unfortunately, India’s railways cannot wait if the country’s economy is to sustain growth and create the 100 million jobs that its population needs. This project demands efficiency and innovative technology, which can only be achieved through a serious inflow of cash – one that will be stunted by a bureaucratic railway system. Modi’s government is seemingly taking the necessary steps to open up the sector. The question is just how far they will actually go, and whether this will be enough to lure in those much-needed foreign investors.