Monday, January 29, 2018

HIDING THE SKELETONS IN THE CUPBOARD-THE POLITICAL ECONOMY BEHIND MERGER OF RAILWAY BUDGET WITH GENERAL BUDGET

Dear Friends,
In the last fiscal 2016-17, Cabinet decided to merge the Railway Budget with the General Budget. Hon’ble Minister of Railways (MR), Mr Prabhu spearheaded the move, giving several reasons.
Herewith, I am sharing my understanding of the “Never stated but most plausible” reasons why the Minister was keen on skipping the Budget Speech (i.e. going speechless”) by merging the Railway Budget. Following is the gist of reasons, followed by detailed analysis.
The Gist
1. Record poor performance in operational and financial aspects compared to the Budget Projections in 2015-16; worsened further by August 2016-17, by the time the decision of merger was taken.
2. Reluctance in disclosing several Lakhs of Crores of Rs worth of Liability/Accumulated Losses of in the “Balance Sheet” of Indian Railways, with inexplicable fixation for showing good looking “Operating Ratio (OR)”
3. Inability to service the debt i.e. inability to pay interest on Loan worth Lakhs of Crs. of Rs, taken from Government of India,
4. Want of will to raise the passenger fares to capture value provided
5. Inability to cut unproductive costs using Zero Base Budget (ZBB), though promised in the MR’s Budget Speech in February 2016.
Detailed Analysis
1) Extremely poor and even negative performance in operational and financial aspects in 2015-16 aggravated further by August 2016
Mr Prabhu had taken over as an MR on 9th November 2014. He presented the White Paper and his first Railway Budget on 26th February 2015 for the FY 15-16.
Performance vis-à-vis Budget projections for the Year 2015-16
As Goods Transportation contributes about 2/3rd of Traffic Revenue of the Railways, I am giving more stress on the performance in that segment.
Goods Loading in Million Tonnes (MT)
– Target 1186 MT
– Actual 1102 MT,
– Shortfall 84 MT.
– Loading in the previous year 2014-15 was 1095 MT;
– For 2015-16 incremental Target was 91 MT, achieved only 7 MT
– 2016 had 366 days; otherwise, loading would have been still lesser by 3 MT.
Gross Traffic Receipts (GTR)
(Railways sometimes use the term ‘Receipts’ instead of ‘Income’ or 'Earning’; and there would be minor difference among them)
GTR i.e. receipts from Goods, Coaching and Sundries were far lower than estimate
– Target for 2015-16 was Rs 1, 83, 578 Cr.
– Achievement was only Rs 1, 64, 334 Cr;
– Shortfall exceeded Rs 19, 000 Cr.
– Receipts of past year 2014-15 were Rs 1, 56, 711 Cr.
– Thus in 2015-16, as against incremental target of Rs 26, 867 Cr., and increase was only about Rs 7,600 Cr., that too, after extending the Advance Reservation Period (ARP) from 60 to 120 days. It meant that for reservations made by 31st March 2016, for date of travel up to 120 days later, service would be given in 2016-17, but Railways would reckon the receipt and income for 2015-16 as per the “Cash Accounting” they selectively practise! Certainly. A few hundred Crores extra were received and still the performance was so bad for 2015-16.
– Thus, huge short-fall was despite increased ARP and also leap year
Situation in 2016-17, drifting and degenerating into de-growth.
In the next year, by August 2016 itself, the position had become much worse.
– Loading Target till August 2016 was 477 MT
– Actual loading was just 445 MT;
– Shortfall was 32 MT in 5 months
– Loading was less than even the same period of last year (which was 451 MT)
Gross Traffic Receipts
– Proportionate Target till August 2016 was Rs 73, 713 Cr.
– Actual Receipts were Rs 64,387 Cr,
– Shortfall was in excess of 9, 000 Cr. in just 5 months!
– Receipts were less than the same period of last year (Rs 67, 849 Cr.)
– This was after a record Capex of Rs 93, 000 Cr. + in 2015-16 and over 100000 Crs Rs (including from LIC loan) in 2016-17!!
– Cumulative Average Growth Rate (CAGR) for loading of goods for 14 years, from 2000-01 (474 MT) to 2014-15 (1095 MT) was 6.16%,
– CAGR for 5 years from 2009-10 (888MT) to 2014-15 (1095 MT), was 4.28%.
– Growth in loading in 2015-16 was only about 0.64% and
– Till August 2016 it slipped to negative i.e. (-) 1.3% over the previous year!
It would have been very difficult to defend such lukewarm and even negative performance in the next Budget Speech due in Parliament in February 2017.
It can be surmised that for avoiding to defend such performance, media savvy Minister was keen on merging the Budget and going speechless (by skipping the Budget Speech)!
Why did the performance deteriorate?
Macro Economics tells us that other factors being the same (Ceteris Paribus), if price of a commodity / service is increased, the demand would come down. The Railways increased the freight rates in 2015-16 by about 9% and curiously enough, expected the growth in physical loading to shoot up to about 8.3%, against the CAGR of 4.28% for preceding 5 years!
The moot question is, which economist or financial wizard would expect such miracle to happen, particularly when the prices of petro-products like diesel; one of the major inputs for transport industry, had plummeted worldwide? The competition, i.e., the Road Sector benefitted by slashing the rates as their input cost of fuel had substantially come down. How is it that Railways increased the Freight Rates and expected that much more goods traffic will flock to Railways? Besides, once the goods customers are repelled, it is very difficult to wean them back from the Road to Railways. This is what happened the next year also as in 2016-17, the loading tonnage and the earnings continued to lag behind the corresponding periods of the last year, month after month. At the end of the year, earnings fell short of the Budget target by humungous Rs 20, 000 Crs, and they were even less than the Actual earnings for last year 2015-16 by over 700 Crs.
As by August 2016 itself the performance was far below the Budget projections in the second year in a row, I believe that this was one of the major reasons for merger.
2). Reluctance in disclosing the Liability and Accumulated Losses worth Lakhs of Crores of Rs. in the Balance Sheet, for showing good looking OR
Instead of emphasizing on Profit & Loss Account and Balance Sheet, Indian Railways have been prominently mentioning of only one major metric for their financial performance; the Operating Ratio; a percentage of working expenses to earnings. Railway Finance Code Vol I, Paragraph 434, r/w 308, defines OR as
Gross Working Expenses (=true expenses in an accounting period whether or not actually disbursed)
Gross Earnings  true or accrued earnings in an accounting period whether or not actually realized)
As per the glossary released by Railway Board’s Statistics and Economics Directorate, it is defined as
= Expenditure on Administration, Repairs & Maintenance, Operations, Contribution to Pension Fund and to Depreciation Reserve Fund
The true earnings in an accounting period whether actually realized or not
http://indianrailways.gov.in/…/Annualreport10-…/Glossary.pdf
Most people, including in the highest echelon of Railways’ bureaucracy, also in the media, believe that an OR of 90% means, from every Re 1 earned, the railways will spend 90 paise and retain 10 paise as surplus. Hon’ble PM had also asked the Railways to achieve the OR of 90% as against the higher figure projected in the earlier Budget. Please see the following link for reference:
https://timesofindia.indiatimes.com/…/articles…/42487978.cms
These people do not realize that it is an over-simplification to infer that “90% OR means 10% surplus“. Let us check it using an example.
Konkan Railway Corporation Ltd (KRCL) had achieved an OR of 72.71% in 2007-08. Anybody who feels that OR of less than 100% indicates surplus, would think that KRCL was in profit. Indeed, KRCL was in a loss of Rs 143.37 Crs. that year!
(For KRCL’s OR and Loss for 2007-08, please refer to page nos. and 5 and 47 respectively of their Annual Report given at the following link):
http://www.konkanrailway.com/…/pd…/annual-report-2007-08.pdf
This can be explained as OR does not take into account the interest on loans taken by KRCL (as it is ‘financing expense’ and not ‘operating expense’). For Indian Railways also, numerator of the OR does not take into account the expenses towards the interest on the debt (curiously called as Dividend), and also overhead expenses like those on Railway Board, Centralized Training Institutes (CTIs), Research, Designs and Standards Organization (RDSO), Railway Recruitment Boards (RRBs) and Statutory Audit etc. and so it is not a good indicator of profitability!
Besides, in the numerator, expense like depreciation is not scientifically arrived at by Indian Railways, instead, it is estimated in an ad hoc manner, for arriving at a desired figure of OR. Also, to show ‘lower’ expenses, some bill payments and cash outgoes are artificially postponed. On the other hand, cash received in say last 3 / 4 months of the fiscal, pertaining to the journeys to be performed in the next fiscal, is shown as the income of the previous year ending March, for increasing the denominator and thus showing lower (thus rosier) OR!
In the “Shivir” organized before the Hon’ble PM, by Railways in November 2016 at Surajkund, it was presented as follows:
“Indian Railways, being a Government entity, maintains its Accounts under Cash based Accounting in the format mandated by Controller General of Accounts and Comptroller and Auditor General of India”
This is a misleading statement because,
 As seen at the definition of Operating Ratio, both numerator and denominator need to be shown on accrual basis.
 Being a commercial organization, Railways’ own Codes like Accounts Code and Finance Code contain several paragraphs, requiring them to adopt various provisions of Commercial Accounting. For example, as per the paragraph no. 339 of Finance Code Volume I, Railways should use “Actuarial Calculations” for providing for its pension liability.
 Shivir presentation indicates that Cash based Accounting is mandated by -------Comptroller and Auditor General of India (CAG).
As is seen; the same authority i.e. CAG had pointed out in the audit report No. CA-19 of 2008-09 that Railways had not taken into account the liability of Rs 5, 41,948 Crs. as on 31.3.2005, based on actuarial calculations.
Let’s refer verbatim, to certain paragraphs of White Paper of 2009 in this regard.
“20.0 Pension Liabilities
20.1 The number of pensioners of Indian Railways is around 11.5 lakh, and the pension bill continues to rise every year. The pension liabilities of the Railways are being met through a separate Pension Fund. With the implementation of the recommendations of VI CPC, the requirement of funds for meeting the enhanced liabilities has also increased. Audit had also commented in its Report No. CA-19 of 2008-09 that "appropriation to Pension Fund was not being done on actuarial calculation and appropriation was being made depending upon the likely withdrawal and also the financial position of the Railways."
20.2 According to an actuarial study conducted in 2005, the actual requirement of funds in the Pension Fund was estimated at Rs 5, 41,948 crore to make it self-sustaining. As this is a very large sum which is not available for appropriation, Railways have not taken follow-up action on this study. However, appropriate provisioning is being done on an annual basis to meet the yearly liabilities.
20.3 All employees recruited on or after 1.1.2004, however, will be governed by the New Pension System (NPS) that is expected to gradually reduce future pension liabilities.”
As against the requirement of Rs 5, 41,948 crores in the Balace Sheet of the Railways as on 31.03.2005, Railways had a balance of only Rs 1, 609 Crores in their Pension Fund!!!
Link for White Paper of 2009 is given below:
http://www.indianrailways.gov.in/…/White%20Paper_Eng_SUBMIT…
Implications
Year after year, instead of providing for such liability based on actuarial calculations, Railways had resorted to “hand to mouth” accounting and had provided only for likely cash outgo next year; leading to
1) Huge suppression of the expenses in the numerator of the OR on accrued pension on actuarial estimation and thus depicting much lower OR,
2) Starving the Pension Fund
3) Artificially boosting the surplus
4) Not disclosing the accumulated Liability towards accrued Pension in the Balance Sheet and thus,
5) Not disclosing the Accumulated Losses, in the Balance Sheet.
Thus, by 2005, while OR was being depicted to be always less than 100%, undisclosed accumulated Pension Liability amounting to about Rs 5.42 lakh Crores and thus the Accumulated Losses of that order had been piled up. Evidently, for several years, while OR would have been much more than 100%, it was shown as far less than that; leading to humungous undisclosed liability which was the Present Value (PV) of accrued liability.
While the situation was like this in 2005, then MR Shri Lalu Prasad had, in Budget speech for 2005-06 mentioned in the Parliament as
– Accounting reforms Process is set in for greater transparency in financial reporting. It includes accrual accounting, Actuarial assessment of Pension Liability .
– Contribution to Depreciation Reserve Fund would be done on scientific basis.
There was no implementation of these pronouncements in his tenure. Indeed, in his the budget for 2008-09, a hype of surplus of over Rs 25, 000 was showcased as achievement in the Revised Estimates of 2007-08.
This was done by playing with words and saying that it was the “Cash Surplus Before Dividend”, meaning that expenses on Depreciation (which is a non-cash cost) and on Dividend (actually interest) were omitted while showing this surplus.
Actuarial calculations were not even remotely kept in the reckoning.
Later, though in the White Paper of 2009, Ms Mamata Banerjee, then MR pointed out that the actuarial estimation of about Rs 5.42 Lakh Crores was not done by 2005 itself, she also took no steps towards corrective action.
When Shri Suresh Prabhu became MR, he brought out a fresh White Paper and presented it to the Parliament in February 2015. Strangely, it was conspicuously silent on “actuarial estimation of pension liability” or “accrual accounting” done or to be done in Railways! It shows that the White Paper of 2009 was not linked and taken into account!
The link for Mr Prabhu’s White Paper of 2015 is given below:
http://www.indianrailways.gov.in/…/Budget_2015-16/White_Pap…
Indeed, though in a response to the Audit report No. CA-19 of 2008-09, it was mentioned by the Railways that “employees joining on or after 1.1.2004 will be governed by the New Pension System (NPS) leading to gradual reduction in the future pension liabilities”, situation was far different, as seen from the withdrawals (cash pay outs) from and closing balances of the Fund as follows:.
Year Withdrawal from Fund Closing Balance (Rs Crs.)
2004-05 6697 1609
2014-15 28642 1360
2015-16 33220 3088 (Revised Estimate)
2016-17 45500 559 (Budget Estimate)
Thus, it is seen that on account of VI th and VII th Central Pay Commissions (CPC), increase of Dearness Allowance (DA) over 12 years and due to several other factors, the actual cash outgo for pensionary benefits went up from Rs 6697 in 2004-05 to about Rs 45500 Crs. by 2016-17, contrary to the expectation that due to NPS for employees joining on or after 1.1.2004, it will taper off! Besides, as the number of employees covered under NPS is also increasing year after year, Railways’ contribution towards their NPS accounts is also increasing.
As the Budget is merged, further update on figures of 2016-17 is not readily available. Assuming that withdrawal from the fund is somewhat less and closing balance as somewhat more (say, for reasons like superannuation age for Medical Officers is raised to 65 years); still, compared to 2004-05, withdrawals have mounted several times and the closing balance would be less than Rs 1000 Crores by 2016-17. Another development after 2004-05 is that the number of pensioners has risen to over14 lakhs now, surpassing the number of working employees at over 13 lakhs.
In view of the foregoing, it can be gathered that Pension Liability on actuarial calculations may have increased to between Rs 22 to 25 Lakh crores by now! Accumulated Losses, which not disclosed, may have also mounted accordingly. (One can’t say for sure regarding the actual extent, as no actuarial estimation for entire Indian Railways has been done after 2005, though the actuary had, in 2005, advised to get it done every year)!
As per the Companies Act and as per ICAI’s Indian Accounting Standards (Ind AS), while all the Corporates are required to get actuarial estimation done annually, show it in the Profit & Loss Account and show the Liability in the Balance Sheet, Railways have avoided it, though they love to call themselves as “Corporate”.
Not showing the Liability and the Loss does not help Railways in wishing it away. Indeed, want of such information makes all the concerned to be complacent as it shows them a green signal when it should have been stark red.
It is not that the then MR Shri Prabhu did not know of such huge undisclosed Liability kept under carpet; in fact, he would have known the seriousness far more than his predecessors, given his professional background as a Chartered Accountant who had also headed large Scheduled Bank, but he chose not to disclose this, though the professionalism warranted the disclosure.
Hon’ble Prime Minister Shri Narendra Modi has led from the front for enhancing the transparency. He took path breaking initiatives like Demonetization and GST. These are extremely brave moves. But Railways haven’t taken the transparency mission seriously. Let us see what Mr Prabhu had said about transparency.
Press Information Bureau Report dated 25th February 2016 mentions:
“Shri Suresh Prabhakar Prabhu said that the transparency is an important tenet of this Government. Presenting the Railway Budget 2016-17 in Parliament today he said, Indian Railway’s mission is to ensure 100% transparency in all its operations”
In the same vein, he had said that “Social media is also being used as a tool to bring in transparency in its day to day working”.
The link is, http://pib.nic.in/newsite/PrintRelease.aspx?relid=136780
Thus on one hand, he advocated transparency in Government, on the other hand, he chose not to disclose the huge pensionary liability and the accumulated losses in the financial reports of the Railways!
I thought, I will use the Social media to highlight the lack of such transparency.
Perhaps, for showing good looking Operating Ratio of exactly 90% as per the wish of the PM, Mr Prabhu, Professional Chartered Accountant, who had once headed the Accounting Research Foundation of ICAI, and who had an opportunity to come clean and disclose the hidden liabilities / accumulated losses, squandered such opportunity away. Instead of taking the bull of opaqueness by the horn, he chose to dodge the bull by merging the Budget.
3. Inability to service the debt (i.e. inability to pay interest on Loan of Lakhs of Crs. of Rs), taken from Government of India, called Capital at Charge, having very low interest rates.
As has been illustrated in my blog dated 12th of June 2017, (http://hemantgodbole.blogspot.in/) , the word “dividend” as used by Railways has actually been a misnomer. In fact, it referred to the interest on the “loan”, which was technically called as the “Capital-at-Charge “ or “Loan Capital”, borrowed by the Railways from the Ministry of Finance (MoF). As per page 63 of the Explanatory Memorandum to Railway Budget 2016-17, the amount of such loan as on 31.03.2017 was expected to be Rs 2,58,620 Crores and thereafter, by 2017-18 with another Rs 55000 Crores, it would have exceeded Rs 3 Lakh Crores.
http://www.indianrailways.gov.in/…/Explanatory_Memorandum_R…
Given the inability of generating adequate income, It was perhaps found expedient by Mr Prabhu to avoid payment of such interest and even to write off of the loan by seeking the merger of the Budget.
4. Inability to raise the passenger fares to capture value provided to them
Suburban or non-suburban.
Successive Governments have refrained from increasing the fares in tandem with the increase in the input costs and the current Government is no exception.
Indian Railways (IR) print on the passenger tickets as
"IR recovers only 57% of cost of travel on an average”.
It means, they are incurring a loss of balance 43%, which they are absorbing by cross-subsidizing it through goods tariff. Indeed, as the loss which will be shown with actuarial estimation will be far more, this percentage of non-recovery will get further increased. Credibility of overall costing in IR would attract a big question mark. Relentless cross-subsidization by increasing the Goods Tariff and thus ultimately, pricing out and repelling the Goods-customers and sending them to the lap of the Road operators has extremely deleterious effect on the IR’s business. The “inexplicable paranoia” of not increasing the fares, despite strong absolute majority in the Lok Sabha would in itself be subject of research.
5. Inability to cut unproductive costs by implementing Zero Base Budget
In the budget speech of 2016, MR had announced a New Norm (Nav Manak) emphasizing as
“Each rupee that gets expensed will be re-examined to ensure optimal productivity. We will take a ‘zero based budgeting’ approach to the financials of the ensuing year”.
In fact, in Railways, there is tremendous scope of cutting the fat and flab which needed to be explored and avoided. The new Chairman Railway Board (CRB) and the new MR have recently started identifying some such avenues. For example, withdrawing the staff working in the residences of some retired or other officials irregularly at the expense of the exchequer, far too many employees going to the stations / airports to receive the higher officers to receive the VIPs, spending money on the bouquets etc., just to name a few. No such movements were evident earlier, despite the budget pronouncement of ZBB.
To sum up, more than for the reasons mentioned while seeking the merger of Railway Budget with the General Budget, there were several reasons mentioned in this write-up that had prompted the MR to get the Budget merged and shun the Budget Speech.
There has been huge adverse impact on the Government of India’s fiscal deficit due to consecutive years of excessive shortfall in income(Non Tax Revenue for the Government of India), vis-à-vis Budget Estimates; at over Rs 19000 Crs for 2015-16, over Rs 20000 Crs. for 2016-17 Indeed, even in 2017-18 the trend shows that there is likely to be deficit of about Rs 13000 Crs., if not more, compared to the Budget presented in February 2017! This is despite about Rs 3 lakh Crs. of Capex undertaken, whether through Government Sources or through Extra Budgetary Resources in the same period.
Though the then MR and the Chairman Railway Board (CRB) have resigned in the wake of accidents, financial legacy that has been left to the successor Minister and CRB has been extremely challenging.
(Views expressed herewith by me are personal, and are intended to only correct the perception of the readers, as per my understanding. I would welcome with open mind, any logical updates that would help me correct my understanding).
Thank you for reading.
Regards,
Hemant Godbole
29.01.2018
PS. Sir had served in SR for some years and earned the nickname Code Bole strict to the adherence of Code Books. Also sir had served for many years as Prof of Accounts at National Academy of Indian Railways. A scholar among IRAS officers his analysis is threadbare, objective and conducive to look for corrective action to prevent total derailing of IR. I am happy to share his analysis in his Face Book page with his permission. I am sharing with you my friends. Winners put their heart soul mind and body behind the work assigned to them how little or big it may be. Thanks