Racking up Debt for ML-1

Main Line 1 (ML-1) is the most important railway line operated by Pakistan Railways, stretching from Karachi to Peshawar, stretching across the length of the country, handling more than 75 percent of the country’s freight and passenger traffic. ML-1 is slated to be dualized and revamped with an estimated cost of $6.8 billion with 90 percent of the funding to be provided by China as debt, under CPEC.

This money will be used for dualization of tracks, and overall renovation. As per media reports, the amount also does not include any provision for rolling stock, and only pertains to tracks, and their upgradation. Given the precarious financial position of Pakistan Railways, the debt will essentially be sovereign in nature, and may potentially be paid through the federal budget, rather than cash flow of Pakistan Railways.

A review of financial position of Pakistan Railways exhibits that operating expenses (excluding pensions) are generally higher than its revenues which is largely passenger-centric, resulting in a consistently and heavily negative free cash flow. Subsidies provided to Pakistan Railways have run in excess of Rs150 billion, over the past five years. These were largely funded by the sovereign through the Federal Budget. The sovereign continues to subsidize operations of Pakistan Railways, supporting its operations, and pensions.

An extensive and freight-friendly railway network is an essential infrastructure requirement. However, funding infrastructure through project cash flows, rather than an already stretched budget would have been a more prudent approach. Before any such debt is assumed, it is essential that governance and operations of Pakistan Railways are reformed. An annual deficit of more than Rs40 billion is not only an obscene use of previously received taxpayer funds, but is also unsustainable, and takes away focus from other more productive ventures.

Although financial details are still not clear, but assuming a 15-year tenure of the loan an interest rate of LIBOR+2 percent, and annual rupee depreciation of 5 percent, the cumulative payments made over the tenure would be in excess of Rs1.6 trillion, at an average of Rs110 billion per annum, solely funded through the federal budget. To give perspective, this is more than double of the amount that may be required for universal health coverage, which has already been initiated in KPK. This also does not factor in any increase in interest rates, sinosure premium, interest during construction, or any project delays. Adding pension liabilities, growing at a modest rate of 5 percent per annum (lower than historic average), total payments just to meet liabilities of Pakistan Railways would be in excess of Rs2.5 trillion. As debt would be denominated in US dollars, it would also affect the country’s foreign exchange reserves adversely.

Racking up project debt, repayment of which is not linked with project performance, but extracted from an already stretched budget creates a plethora of adverse incentives, and unintended consequences. Before Pakistan Railways is burdened with additional debt with a significant foreign currency component, it needs to be restructured to generate a positive free cash flow. Without clear ownership of debt, without clear cash flows which can service that debt, and without a business plan, the debt burden will not only be a drag on finances of the sovereign, it will also make it harder for Pakistan Railways stay on track.