When Minister for Railways Suresh Prabhu presents his second Rail Budget on February 25, he will attempt to pull off an unusual stunt that he managed last year as well. Prabhu has set himself the uneasy task of doing just the opposite of what railway ministers before him have done routinely – he will attempt to cut freebies and may once again refrain from introducing new trains and increasing passenger fares.

It is easy to criticise Prabhu or rest of the rail ministry and its decades of history for the Railways’ legacy of inefficiency and underperformance but it’s tough to explain why these have persisted over the years despite growing traffic at exponential levels.

At the beginning of this year, the Railways was spending as much as Rs 97.8 to earn Rs 100 – a sign of worsening financial health and an operating ratio level not seen in more than a decade. The target set for this year was of an operating ratio of 88.5.

While the final results will be known only on the morning of Budget presentation, Railways’ performance has been largely underwhelming over the past few years – a worrying sign for the economy as well as the Rail Minister who vowed to “transform” railways in the last year’s budget.

He took the first step right by not moving on any of the dozens of the requests for new trains, stations and stoppages that his ministry received before the budget and kept the situation as is. While he didn’t increase passenger fares during the budget, rates were hiked by introducing levies on First Class and all AC fares by 4.35% in November while general and sleeper class rates remained unchanged.

Flashing red

However, much seems to have remained unachieved as one looks forward to the Rail Budget of 2016-'17 when the situation, experts say, is only set to worsen for the Railways.

“This is going to be the first year in the last three decades or so that railways' passenger kilometres carried are going to be less than previous years,” said former Railway Board Chairman Vivek Sahai. “The financial distress is more a function of slowdown in Railways’ growth than anything else. They are simply not running enough trains to increase revenue from passengers.”

Sahai pointed out that over the years, cancellations of trains have increased and this has led to idle rolling stock which not only increases costs but fails to bring in any revenue which a running train would have – even if it is running late.

In the current financial year, while Railways has so far overtaken last year’s earning figures, it has fallen short of targets. For instance, earnings from freight till December 2015 were 6.2% more than what it achieved in the same period last year, the earnings are short by Rs 2,150 crore of its own target of raking in Rs 82, 676 crore. The situation is even grimmer when it comes to volumes. The railways reportedly carried only 8 million tonnes of freight more than last year by December 2015 while its target is to ferry 85 million tonnes extra by March 2016 which looks almost impossible to achieve.

Similar is the case with passenger earnings which did not grow as much as expected, falling short of the target of Rs 35,042 crore by Rs 1,937 crore.

This is not where the Railways’ financial troubles end – it’s where they begin. The Railways is about to incur an additional Rs 33,000 crore on salaries each year due to the Seventh Pay Commission which has bumped up salaries and pensions of its employees by more than 20%.

The Railways expects another 5 lakh personnel to retire in the coming decade, which means even more amount will have to be shelled out of its kitty in paying its former and current staff. Moreover, there is no clarity on the kind of expenditure the railway might actually end up incurring due to the seventh pay commission because there are many other allowances which haven't been taken into account, explained Bibek Debroy, member of NITI Aayog.

"There's no way to know exactly how badly will the railways be hit by the pay commission because a lot of pay elements have been left out of estimates," Debroy said. "We have accounted for salaries but a large part of compensation is travel allowances etc which could add another Rs 8,000 crore or so to the final bill."

It is with in this backdrop that one must note that the freight revenue is not growing as fast as the railways expected because of slowing economy and lukewarm demand which has resulted in wagons, line capacity, engines going unused and only accumulating further losses on upkeep and depreciation.

“When there is no demand from the ports to ferry coal or iron ore from the mines, the rail industry is bound to suffer,” said NP Srivastav, former Finance Commissioner with the Indian Railways. “There are specific wagons and infrastructure for different commodities," he explained. "You can’t carry passengers or even other goods in wagons specifically made for carrying coal or iron ore.”

Cash strapped

Anticipating the situation, the railway minister approached the finance ministry for additional funds but received a stern no for grant, followed by a 30% cut in the gross budgetary support from the central government. The finance ministry categorically rejected the Railways’ demand for grant in its communication and asked it to raise its own funds.

And this is where the problem lies.

Over the past years, railways has increasingly been dependent on central government grants and gross budgetary allocation to carry out its capital expenditure and network expansion activities, in addition to meeting overhead expenses.

As seen in the chart above, the share of the Railways' own revenue in financing this capital expenditure has been coming down becoming a cause of concern for the government which expects it to run like a company and report profit each financial year.

Infinite loop

It’s not just the rising expenditure that ails the railways, the public sector entity is also required to pay back dividend to the government each year which is determined by a parliamentary convention committee. In December, the committee denied the railways’ request for a waiver this year due to rising costs and pegged it at 4% for the current fiscal.

This means that the Railways will have to shell out some Rs 8,000 crore to the Centre as dividend this year.

“The Committee believes that Railways should pay dividend. It may be less or more. However, dividend has to be paid every year. There is no case for granting waiver,” said Bhartruhari Mahtab, who heads the Railway Convention Committee, adding that rate was pegged one percentage point lower, providing the railways a relief of some Rs 2,100 crore.

While this sounds as a considerate move, experts point out that the problem is that the dividend is being paid for the last seven decades on capital-at-charge which was pegged at Rs 800 crore in 1951 and yet not a penny from that loan has been repaid.

“Whatever loans are received from the government are added to the capital-at-charge which is more than Rs 1.5 lakh crore as of now and there is no repayment period,” said Vivek Sahai. “It’s perpetuity based so even if we have paid three times the amount in dividend, the principal amount still remains a liability.”

This also came up in April last year when a committee headed by former railway minister Dinesh Trivedi recommended that the policy of paying dividends be scrapped. Calling it “contradictory and counterproductive”, the committee said that the government should adopt a two pronged approach to improve finances of the railways, involving cutting expenditure and raising revenues, but should keep away from charging dividend on general revenues.

Not much left to save

While the Railways finds itself buried under its own finances, the problem of low-demand being unable to boost freight revenues further exacerbates the situation. Estimates suggest that up to Rs 28,000 crore of losses on passenger fares are subsidised by freight income which is not going to benefit any longer from oil prices which provided a windfall last year.

That, experts feel, brings us back to the issue of raising passenger fares at least to an extent so that at least cost can be recovered.

“When you don’t have any viable option to earn, you save,” explained Srivastav. “The railways can’t save much from oil prices anymore, the government support has been slashed and it has to give interest payments as well as bumped up salaries. I don’t see where these funds will come from if not from a hike in passenger fares which is long due.”

In this context, it is worth repeating what Suresh Prabhu told domestic and international investors as well as the government about the Indian Railways’ need for funds.

“You have successfully invested in the telecom and power and roads sector, but never in the railways. The government also didn’t invest during the past two decades and so we’ve chalked out a five-year plan under which we are looking at an investment of Rs. 1 trillion this financial year and Rs. 8.5 trillion over the next five years,” Prabhu said. “For improving rail infrastructure we need to invest 10 per cent of the total infrastructure GDP of $2 trillion over next five years.”

It remains to be seen how much transformation his ministry can achieve in the remaining financial year. Sahai cautioned against being too optimistic.

"This is is an absolute majority government which should not shy away from making tough choices and doing what their predecessors," he said. "But that hasn't happened much. The railways has focused on being more customer centric but only for passengers, not the industry. We need to make businesses happy otherwise they will switch to road. We can't neglect them just because they don't tweet as much as general passengers do."

This is the second article in a three-part series on the railway budget. The first part can be read here.