By staff reporter Zhang Na

From Caijing Magazine

The Chinese government’s economic stimulus plan may usher in a golden era for the nation’s railway sector, with the Ministry of Railways in line for about 600 billion yuan in construction funds this year.

The boost is billed as the heaviest investment ever for the rail network which, despite its more than 76,000 kilometers of track, currently fails to meet a huge nationwide demand for domestic freight and passenger services.

Meanwhile, these ambitious expansion plans have been matched by daunting questions over long-term financing, affordability, investment risk and ongoing efforts to reform the government-owned rail system. Such questions are unlikely to derail the construction plans, but they could persist long after locomotives start riding the new rails.

Some work is already under way. The railway ministry last year launched construction of several passenger lines, including a high-speed link between Beijing and Shanghai, as well as passenger-dedicated tracks between Beijing and Shijiazhuang, and between Shijiazhuang and Wuhan.

The ministry’s recently revised Medium and Long-term Railway Network Plan calls for extending intercity lines to 16,000 kilometers by 2020.

Expensive Undertaking

The quest for more intercity passenger lines is closely connected to financing hurdles facing the system. Globally, such projects typically involve high-risk investments. At the same time, expensive technology and capital requirements force rail operators to charge high prices for passenger tickets.

Bank loans are expected to finance most of the new passenger line projects slated for China. But that raises the potential for huge liabilities in the future, particularly because paying off the financing may require setting ticket prices at levels unaffordable for a large swathe of China’s low-income train passengers.

The recent start-up of a high-speed passenger line linking Beijing and Tianjin offers a glimpse at the problem. After the line was completed last August, the railways ministry halted all slow-speed trains between the two cities. The move forced train travelers aboard high-speed trains, which cost up to 69 yuan for a seat -- up from 42 yuan per high-end ticket in the past.

Ticket prices rose to offset construction costs. Building a high-speed line, which can reach speeds of 350 kph, can cost three times more than the price for a slow-speed railway of the same length. And the 120-kilometer line linking Beijing and Tianjin required a total investment of 21.5 billion yuan, or about 180 million yuan per kilometer.

Customers with deep pockets appreciate high-speed passenger service. However, this group represents only about 10 percent of Chinese rail travelers. The rest can afford only basic service, raising questions about the value of high-speed investments.

“Too much emphasis on high speed may result in serious waste and hinder development of the railway system,” said Zhao Jian, a transportation professor at Beijing Jiaotong University. “It may also fail to meet market demand, as ticket prices are too high.”

Zhao added that “railway competitiveness isn’t only determined by speed, but also scheduling arrangements, as well as the convenience and traveling comfort.”

A major problem for China’s railway system is not slow speed but inadequate coverage, Zhao said.

But beyond passenger issues, Zhao noted the current system is burdened by inadequate freight capacity. It may be wise for freight needs to take priority over high-speed travel.

China planned to spend 1 trillion yuan for high-speed construction through between 2005 and ’10. The same amount of capital could be used to build a normal line that’s 20,000 kilometers longer, according to Zhao.

Financing Hurdles

Meanwhile, construction financing resources are limited.

The ministry’s project capital currently comes from the central government budget, construction funds, railway profits, bonds and bank loans. But it’s not a bottomless wallet.

For example, the system posted profits of only 8 billion yuan on 330 billion yuan in revenues in 2007. During the same period, railway construction funds amounted to about 50 billion yuan, while bonds raised 60 billion yuan.

As a result, the upcoming high-speed railway projects are expected to rely heavily on bank loans. But borrowing may increase liability pressure.

According to Zhao, interest payments for the Beijing-Tianjin project will total 700 million yuan a year. But with annual passenger volume of 10 million and an average ticket price of 60 yuan, the line can expect only about 600 million yuan in annual revenues – an amount below operational expenses. Other passenger line projects face similar situations, said Zhao.

The ministry’s liabilities totaled 563 billion yuan at the end of 2007, creating an asset-liability ratio of 40.7 percent. Completing projects now under way is expected to increase the liability amount to 1.2 trillion yuan. Meanwhile, the ministry has proposed 570 billion yuan worth of new projects.

Zhao warned that, even though the central government will pay more than 1 trillion yuan in loans for high-speed rail construction, those lines will need huge government subsidies for years to come to cover operational costs.

Bank Lending

The banking sector is also aware of the potential risks tied to huge loans for railway projects. Thus, to hedge risks, the China Banking Regulatory Commission (CBRC) has suggested several banks combine forces to offer railway project loans through syndication deals.

However, most banks have signed separate, strategic partnership agreements with the Ministry of Railways, promising credit support for its projects. For them, risk is a minor issue.

An executive at a commercial bank told Caijing that banks usually set aside risk concerns when they get involved in projects backed by the government. Every bank “wants to clinch a loan deal first,” said the source.

Potential liability can be neglected when a construction project gets under way, since loan payments are not required during project periods. But as part of the strategy for the next round of construction projects, future liability pressures on the ministry can be expected after completed railways start operating.

Zhao warned that, in the future, the railway industry may face losses at the same that banks are forced to confront bad loans.

Reform Delay

The latest expansion plans have also turned attention to a long debate over whether the railway system, monopolized by a government ministry, should be reformed.

While some argue that large-scale construction is the answer to the system’s problems, others claim the biggest obstacle to development is government control and messy management, which blocks outside investment.

Some industry insiders have suggested that, along with new railway construction, the government should consider inviting outside investors. They say outside participation may encourage reform.

An expert at the National Development and Reform Commission told Caijing that the latest construction plans may offer an opportunity for opening to investors, since the ministry can’t afford such huge investments on its own.

However, with bank support, the ministry’s thirst for capital has been quenched for now – a situation that may even tighten railway project control and hinder the reform outlook.

“The recent construction boom will definitely ward off reform for the railway system,” said an industry expert.

1 yuan = 14 U.S. cents