Financial Cost of High Speed Rail

Introduction

In the past 20 years, China’s High-Speed Rail (HSR) construction has overcome countless engineering difficulties, conquered mountains, rivers, and ultra-low temperature. Lines were completed ahead of schedule with little overrun, while the services operated smoothly and orderly. From zero to 40,000km in less than 20 years, HSR has become a trophy for the Chinese manufacturing and engineering.

However, there is another word that is often associated with infrastructure construction, Expensive. Many foreign experts refer to large-scale infrastructure projects as “White Elephants.” The referred animal eats a huge amount and is expensive to raise. It looks beautiful but is suitable for neither agricultural nor war activities because it is easily frightened. Story goes that the kings of Southeast Asian countries gave white elephants to annoying ministers to get them bankrupted. Therefore, today, the term “white elephants” highlights that large-scale infrastructure projects often ruins stakeholders as they demand high inputs but yield low outputs.

Are China’s HSR white elephants? To answer this question, costs of the projects should be closely examined. Most people are familiar with construction costs, which are transparent in general through project investment data. For China’s HSR, construction costs average a little more than RMB 100mn per kilometer. This is very expensive but is already one of the lowest globally according to World Bank’s research.¹ 

Another category of costs, which is less transparent to the public, is financial costs, which consist of high interest payment associated with advances borrowed to finance project construction. For many HSR projects in China, construction costs are too high to be funded fully through equity investment. Assuming a unit costs of RMB 125mn per kilometer, 40,000km operating mileage requires RMB 5tn, which translates into an annual investment of RMB 25mn per year in the past 20 years. This is an amount that is too overwhelming to be shouldered by public finance alone.

Loans for infrastructure projects usually have a longer maturity. While smoothing/delaying principal payments, long maturities bring high interest repayments. For instance, suppose one borrows RMB 100mn for 30 years at 3.3%. If the principal is repaid in one lump sum at the end of the tenor, interest payments total 100% the amount of principal. Even if it is repaid in fixed installment, the interest is still as high as about RMB 60mn.

Therefore, when evaluating HSR projects in China, it helps to compare operating profits with financial costs. This is not easy since data are seldom available. Fortunately, for four of the six of HSR projects supported by the World Bank, traces of information are available in the Implementation Completion and Results Reports (ICRs).²

Analysis of the documented information shows that China’s HSR projects are able to cover operating costs with operating incomes. However, with the existing passenger density, it is not easy to cover the interest payments and principal costs, especially after considering the life-time average maintenance costs which escalates as years of operations grow.

Analysis also shows that the high financial pressure stems from two aspects: first, the large amount of borrowing as a result of large project investments; second, the lower-than expected growth of passenger density. 

While HSR expansion in the future are to be continued given its broader political, security, and social-welfare impact, measures should be taken to reduce the financial burden, such as matching the annual construction spending with fiscal capacities and expand the sources of operating income such as trading carbon trading credits.

Evaluating the financial burden of HSR projects in China

China’s HSR projects are usually with a debt-to-equity ratio of 100%, ³ that is, 50% of the project investments are the from equity injection by the Ministry of Railroad (or the China Railway Group Limited) and local governments, and the remaining 50% is borrowed from financial institutions, such as China Development Bank, commercial banks, and multilateral development banks. The interest and principal payment of these debts forms the financial burden discussed in this research.⁴ 

Four the four HSR projects sponsored by the World Bank, the average cost of debts ranges from 5.4%-6%. The annual interest expenses range from RMB 950mn to RMB 2.2 bn. Basic information for projects and debts are summarized in the table below.

Table 1 Project Information for Four Chinese HSR Projects Sponsored by the World Bank

Source: Author compiled from World Bank Implementation Compeltion and Results Report of the respective project.

Interest payments need to be compared with incomes to evaluate the associated financial pressure. Estimates by the World Bank in ICRs show that the operating costs of China’s 250 km/h HSR is RMB 0.20 per seat-kilometer, and the average operating income is RMB 0.31 per passenger- kilometer; for the 350 km/h HSR, the operating costs and incomes are RMB 0.22 per seat-kilometer and RMB 0.50 per passenger-kilometer, respectively. Combined with passenger load factors, which represents the average percentage of seats occupied in each ride, unit operating profits (profits for transporting each passenger for 1 kilometer) can be calculated. Multiplied by passenger turnover, the annual operating profits can be obtained.⁶

According to the World Bank estimation, in 2015, the Guiguang HSR had a load factor of 86% and a passenger turnover density⁷ of 0.1 billion, resulting in an operating profit of RMB 0.56 billion.⁸ This indicates that Guiguang was able to cover its operating costs, but paying for the RMB 2.2bn interests would be hard. For Nanguang HSR and Changhun HSR, the operating profits was RMB 0.52bn and RMB 0.21bn, respectively, also less than the respective annual interest payments.

The Shizheng HSR, on the contrary, faced less financial pressure. As a 350 km/h HSR, its was able to charge higher fares and attract more passengers (the passenger turnover density was 0.2 billion, doubling that of Guiguang HSR). Its operating profits reached RMB 1.6bn, enough for its RMB 1.2bn interest pymensts.

The above-mentioned financial burden would weigh more on some HSR projects after considering maintenance costs. According to World Bank estimates, China’s 250 km/h HSR requires, in life-time-average terms, RMB 1mn annually for maintenance. ⁹ For 350 km/h HSR, the maintenance costs are estimated at RMB 2mn per annum. **To ensure service quality, the operating profits will usually pay for maintenance costs before covering interest expenditures, aggravating financial pressures.

Factors behind the Financial Burden

The relatively high financial burden of China’s HSR projects are a result of two factors. On the one hand, project investments are very high. On the other hand, the growth of passenger density for some lines is below expectation.

Table 1 summarized the costs of the four HSR projects sponsored by the World Bank, but billions of Renminbi are too far away from daily life. After all, compared with the Beijing-Shanghai HSR, which costs RMB 220.9bn, their investments, under RMB 100bn, seems relatively low. To bring those numbers to reality, costs of HSR projects are first compared with historical railway projects in China, and then with other manufacturing projects in China that are perceived to be costly.

China’s total Fixed Asset Investment (FAI) in the railway sector from 2002 to 2004 was 96.3 billion, 86 billion and 90.1 billion, respectively. ¹⁰ In other words, spending on Guiguang HSR, started in 2008, was equivalent to the total investment in railway in 2004.** Even considering the 6-year construction cycle, the annual investment of the this single project, without considering inflation, was equivalent to one-sixth of the annual total investment in railway around 2004.

A look at some other megaprojects completed before mid-2000s also confirms that HSR are, in general, much more costly than traditional railway projects. The Daqin Line, put into operation in 1988, completed 653km of tracks with a total investment of RMB 7bn. The Shuohuang Line, started operation in 2002, completed 585km of tracks with a total investment of RMB 18.9bn. The 1142km Gela Section of the Qinghai-Tibet Line, facing enormous engineering difficulties such as frozen land, finally completed in 2006 with a total investment of RMB 33.1bn. The Qinshen Line, built in 2003 as a Passenger Dedicated Line of 200 km/h, which by some criteria is already a HSR, completed the 405km of tracks with RMB 16bn. Compared with the above-mentioned projects, investments in Guiguang, Nanguang, Changhun and Shizheng are huge.

**Investments in China’s HSR projects are also comparable to those required by large-scale manufacturing factories. **For example, the Tesla Gigafactory in Shanghai envisaged a total investment of RMB 50bn, of which the Phase 1 project already completed accounts for about RMB 16bn. For another example, the SMIC factor in Shanghai, producing 28mn and above electronic chips, will cost about RMB 57bn (USD 8.9bn). Auto factories and semiconductor factories are known for large scale investments. With similar magnitude of construction costs, it is understandable that Chinese HSR projects require large amount of borrowings, resulting in high interest payments.

Nonetheless, HSR projects will not feel “pressured” financially if they produce high operating profits. As a special infrastructure with high social impact, fares of China’s HSR are regulated. Therefore, operating profits is mainly driven by the amount of passenger services. If the number of passengers grow less than expected, high amount of interest payments becomes a serious problem. **However, aggregated data shows that the growth rate of high-speed rail passenger traffic have been slowing in recent years, even before the COVID-19 pandemic. Looking at China’s HSR as a whole, **the annualized growth rate of passenger turnover per kilometer of HSR dropped to 3.0% in 2015-2019 from 5.0% in 2011-2015. ¹¹

Project-level passenger turnover are hard to be evaluated because of data availability, but the following calculation based on news reports on Changhun HSR can provide some insights. During project appraisal, the World Bank estimated that its passenger turnover would increase by 57% in the first five years of operation. One piece of news showed that it sent 18.7mn passengers in the first year of operation, while another piece showed that it sent a total of 54.46mn passengers in the five years since its opening (till September 2020).¹² The five-year annual-average was much lower than the first year. To take out the impact of the COVID-19 pandemic, suppose in 2020 there were zero passengers, then the four-year annual-average, 13.6bn, was still well below the first year This rough calculation showed that the passenger traffic of Changhun HSR was less than expected in the initial years of operation.

Future HSR Projects Call for Reforms in the Financial Model

HSR networks, in general, benefits China, a country with vast lands and a large population.** **HSR projects in remote and less developed areas in China, considering the social, political, and welfare impacts, are worthwhile from a multi-decade perspective. **This is confirmed by evaluations in the ICRs by the World Bank for all the six HSR projects it sponsored, with Economic Rate of Return no less than 8%. **

However, the financial model with “50% equity + 50% loans” should be reformed as it brings high financial pressures to HSR projects. There has been news that debts on some existing HSR projects have been restructured to give time for passenger densities to grow, but restructure should not become an often-adopted tool as it introduces risks to the financial system in case of coordination failure.

The experience of the American railway development serves valuable lessons in this regards. Railways expanded in strong momentums in the United States in the 19th century, relying on on bonds and bank loans. Many economic historians believe that railroads completely transformed the American economy. It gave birth to the Second Industrial Revolution in the United States, as the steel revolution was derived from the demand for railroad tracks.

However, many railroad companies eventually became insolvent due to high financial burden with less-than-expected traffic. Jonathon Levy, during the decade of the 1890s, more than one-third of railroad companies in the US went bankrupt, and the creditors involved were, on average, took loss of one-third of their principals, resulting in financial crisis. ¹³ For instance, the Crisis of 1873 (known as the Great Depression before the Great Depression in 1929), was triggered by the North Pacific Railway debt problem, which dragged down Jay Cooke & Company.

Two proposals are listed below to better enhance the sustainability of China’s HSR projects.

First, refine the financing structure of HSR investments. Project-level leverages needs to be lowered to cut the financial pressure. This may result in less projects under constructure annually, but mitigates the risk of defaults. For HSR projects that are expected with high profits, introduce social capital in forms of Public Private Partnership is a good practice. The Hangtai HSR made a good attempt in this regard. For HSR projects in less developed areas (thus with less expected operating profits), more fiscal contribution are to be devoted for its role in social welfare and their planning and construction should match with fiscal capacities.

Second, expand the revenue sources of HSR projects. HSR brings considerable positive social externalities. Good mechanism design may help capture some of these benefits to pay for interests and principals. For example, ICRs of the World Bank mentions that HSR contributes to Green House Gas reduction as its unit carbon emissions are lower than those of automobiles and airplanes. With higher portion of electricity from renewables, HSR contribution to carbon neutrality may further increase. To this end, perhaps it is possible to issue carbon credits to high-speed rail projects based on their carbon reduction contributions for sale on the carbon trading markets for income.

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