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India bites the BULLET

Sunny side done, here’s the other side…

I am a CA by training, and hence my first love is towards numbers. Each man is destined to play a role, and the role of the accountant is to check the figures. So let’s ask a few fundamental questions, and seek answers to them.

QUESTION 1: India is borrowing 80 per cent of the project cost at 0.1 per cent per annum. Has India then struck a brilliant bargain with the Japanese and is this on account of the charisma and negotiating skills of the prime minister? 

Wow! For sure, that borrowing rate is abysmally low if you compare it with the rates at which you can raise money in India. But the comparison should be with rates prevailing in Japan. Also, should you believe that the lower rate is on account of the personal chemistry between the two prime ministers, Modi and Abe? I have always been weak in science (why else would I have opted for CA?) and reasonably high in numbers. So while I will not be able to answer the chemistry part, I can respond to the number part.  

Japan’s interest rates are notoriously low. In fact, since 2011, the interest rate in Japan has been zero per cent  (Chart 1), and in the current year is negative. This zero percent means that investors are willing to pay money to keep their money with the Japanese banks! Any good Indian company would be able to take a JPY loan at the rates India has struck and at worst at 1 per cent per annum.  Also remember that India is offering a sovereign guarantee, which should technically push the price of money down. So there is nothing big about the offer. I do not deny they come cheap, but they come cheap for everybody.  And whatever the project, the Japs will be willing to lend at that rate. 

QUESTION 2: So we are getting a large loan almost for free.  Is that not wonderful?

No, we are not getting it free. We are paying the rate Japan wanted. In fact from our side, we are paying a lot more. Let me explain. We are borrowing in JPY and have contracted to repay in JPY. This arrangement means that the exchange rate risk is on us. The earnings from the Bullet project will be in INR. So, we will earn in INR and pay in JPY. If we were earning in JPY and paying in JPY, we would have a natural hedge. But because we receive revenue in INR and repay the loan in JPY, we will not be enjoying the hedge. How bad is this?

The historical long-term (25 years) average shows that the rupee has fallen against the yen by close to 6.8 per cent annually. This 25-years is the right time frame to look since we are borrowing for a 50-year period. With the rupee falling against the yen, for the same quantum of yen, we will be paying higher INR. While 6.8 per cent should be the right number, we believe even at conservative estimate this will be on average 

5 per cent per annum. Hence the real cost of borrowing is not 0.1 per cent but 5.1 per cent.  

It is entirely plausible that the rupee may rise against the yen! History, unfortunately, is not on our side. 

QUESTION 3:  Is this a profitable proposition? 

Now that’s a tricky question and is dependent on a variety of factors like passenger load, price, costs, advertisement income, etc.  There is a lot of opaqueness over these. So let me answer the question differently. Let me put out how many people should travel for the project to be neutral.  We make a  series of assumptions and explain each in turn.

Eighty percent of the project cost is funded at 0.1 per cent and the balance at 8 per cent, which is the going lending rate in India. The weighted average cost is 1.68 per cent. However, given the exchange rate risk, we would like to take the cost of JPY loan at 5.1 per cent, and this makes the WACC  5.68 per cent.  To service the Rs 110,000 crore project over 50 years at a WACC of 5.68 per cent you need an annual cash flow of Rs 6063 crore. In financial arithmetic, this is the equated annual installment spread across 50 years that would equal the project cost. 

Weighted Average Cost of Capital

Project Cost Rs Cr.  Wt. Cost WACC

Equity   22,000  0.20 8.00% 1.60%

JPY   88,000  0.80 5.10% 4.08%

Total   1,10,000  1 WACC 5.68%

Next, we assume the operating costs as 25 per cent of revenue. Of course, it can be different. We sourced international high-speed rail projects and arrived at this ballpark number.   Taking the train fare at Rs 1750 (equal to airfare) one way it means a contribution of Rs 1225 per person.  Divide the Rs 6669 crore by Rs 1225 per person, and you get the annual number of passengers needed to break even. At 365 days of work, the number is 139,200 per day.  Given the train capacity of 800, we are looking at 87 trips each way or a train leaving the station every 17 minutes. Is that realistic?

QUESTION 4:  So what’s the verdict?

I am all for the Bullet project if we want to live a dream. Every dream is worth chasing. But what I do not want is to sell the story that this project right now is financially attractive. I know from my various years of experience in valuation that the excel spreadsheet does not provide the vision that a visionary leader does. Had someone done a financial modeling of the ‘mobile,’ we wouldn’t have seen the light of that path-breaking instrument. The same goes for the HSR. But we must be clear: that we are buying into a dream; we are buying a Rolls Royce.  We are not buying into an excellent investment or a high on need Jazz. n


1985: The Shinkansen magic

India had just come off a traumatic assassination and the wings of change started to blow. The country’s people’s car, the Maruti had arrived and there was an explosive growth in the 100cc motorcycle segment with Suzuki and Honda signing up partnerships with Indian majors.  There was an air of positivism.

I was on a visit to Japan. Then chairman of Maruti Udyog, V Krishnamurthy, provided a reference to Suzuki Motors for a visit to their car and motorcycle plants at Hamamatsu. 

K Giridhar, son of MMTC’s General Manager K K Raman, helped me board the Shinkansen Express at the Tokyo rail station. I was worried over my ignorance of the Japanese language and the possibility of not alighting at Hamamatsu where a representative of Suzuki Motors was to receive me. The 19-year-old lad wrote four questions transliterating Japanese to English. 

1.    Is the train running on time? 

2.    Is this the station before Hamamatsu? 

3.    Are we nearing Hamamatsu? 

4.    Is this halt Hamamatsu?

Even as I poured over them, he thoughtfully reassured: “Uncle, don’t worry. Just get down at the station at which the train stops at 1000 hours!”

He was absolutely right: To the minute the train arrived into Hamamatsu! 

Shinkansen rail systems heralded safe, high-speed rail travel in Japan. It gained a reputation for punctuality: an average of less than a minute to arrival schedules. Most important, it has a safety record of zero accidents giving it a Six Sigma rating that’s a notch higher than the maximum of six!  Mark it, this record is for the period 1963-2017: 54 whole years of zero accident. Phew!


2017: The Prabhu magic 

When they departed from this country, the British left behind three legacies: the game of cricket, the English language and the Railways. It transformed India like nothing else had. But the mandarins who managed this monolith business called the Indian Railways were pigmies with tunnel vision who could not see beyond adding a train line or two to their respective constituencies. But more of that later. 

Suresh Prabhu, a chartered accountant with a trailblazing academic record, was perhaps the first railway mantri to attempt to modernise and professionalise the ageing elephant. Let me explain why.  

First, it required chutzpah of the highest order to do away with a separate budget for railways and allowing it to merge with the general budget. Two, Prabhu’s  long-term plan of rail development involving an investment of Rs. 8 lakh crore that included the Shinkansen-type high-speed train between Ahmedabad and Mumbai and an elevated duplication of the suburban rail network in Mumbai that accounts for half the total daily rail commute in India, was spectacular. And three, he embarked on an ambitious programme of gauge conversion and electrification. In fact, he resisted the populist gimmicks of political warlords like Ghani Choudhry, Lalu Prasad and Mamata Banerjee who were content with winning a rail projector two for their states. By focusing on operational efficiencies and opting for rational pricing of fares, Prabhu promised seats on demand to end painful, over-booked travels.

IE has been commending bullet trains to help India catch up on lost time. Remember the extensive rail network that the British bequeathed facilitated movement over long distances. But this was initially tailored to the logistics needs of the colonial power, expanding later to meet commercial and social needs. Post-independence, there were weak additions. George Fernandes, as Minister of Railways, once told economic editors that the average annual addition to rail network post-independence was just around 160 km. There has been no conceivable improvement after that.

In the coalition era post-1998, the railway portfolio was allotted to minor partners of the coalition like Lalu Prasad or Mamata Banerjee. Like leaders of regional parties, these heads did not have the vision to look widely across the nation and to embark on a visionary, professional course of development.  That is, until Modi’s majority government arrived and until Suresh Prabhu took charge. 


Trains to Mumbai by the hour  

The Shinkansen type high-speed train can cover the 508 km Mumbai-Ahmedabad distance in just a couple of hours if run point to point as against eight hours today. This means more efficient use of the rolling stock and less number of engines and coaches as at present! Imagine the possibility of trips to Mumbai, by the hour.

Like the optimum utilisation of expensive jet aircraft, ensuring quick turnaround at airports and keeping it afloat to the maximum, the rolling stock of the railways could be put to maximum use. This would result in higher revenues and better operational economics.  All this will call for high-quality tracks, sophisticated traction, reliable power and signaling, and management systems. The technology would be of a much higher plane.

Remember, railway systems across the globe have reached elevated levels of excellence. The TGV of France, Deutsche Bahn of Germany, Shinkansen of Japan, and more recently the Chinese Railway have excelled in installing safe, high-speed train services. In the past two decades, China has been focusing on this. India has joined the race late. The handsome credit offered by Japan will help mark a Hanuman jump that will assist India to play ‘catch up.’ 


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