restructuring egypt's railways - august 05

Policy Note 4

Restructuring egypt’s Railways

Egypt Public Expenditure ReviewAugust 2005

Social and Economic Development GroupMiddle East and North Africa RegionThe World Bank

Copyright © 2005by the International Bank for Reconstruction and Development/THE WORLD BANK

Designed, edited, and produced by Communications Development Incorporated, Washington, D.C.

About this Policy NoteThis Policy Note is part of the analytical work supporting the Public Expenditure Review (PER) in Egypt, a collaborative effort between the Government of Egypt and the World Bank. The PER is led by Richard Allen, Lead Public Sector Specialist, MNSED.

This Note is the fourth in a series being prepared during 2005 and 2006. Itprovides an analy-sis of the fiscal and public expenditure implications of the current operation of the railways sector in Egypt. It serves as input for the ongoing Public Expenditure Review (PER). In addition to the diagnostic analysis of the situation, this Note provides a summary of future reform options for the railways sector, with a particular emphasis on the impact of potential reforms on Egypt’s public finances. A companion background note describes in greater detail the specifics of restructuring proposals and options; see the World Bank working paper “Egyptian Railways—Diagnosis of Pres-ent Situation and Restructuring Strategy,” July 18, 2005.

This Note was prepared by Axel Baeumler, Senior Private Sector Development Specialist, INFVP, under the supervision of Michel Bellier, Lead Transport Specialist, MNSIF, and Rich-ard Allen. Valuable comments on a draft of the Note were received from Paul Amos and Karim Budin.

For a list of other Policy Notes in this series, see http://web.worldbank.org/WBSITE/ EXTERNAL/COUNTRIES/MENAEXT/EGYPTEXTN/0,,contentMDK: 20601542~pagePK:141137~ piPK:141127~theSitePK:256307,00.html.

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contents

Abbreviations and acronyms iii

Executive summary 1

1 Overview of the railways sector 4

Public expenditure and fiscal impact 5

ENR financial operations 6

ENR fiscal impact 7

2 Key drivers of ENR financial performance 9

ENR analysis of revenue and tariffs 9

Performance analysis by business unit 9

ENR staffing 11

3 Fiscal implications of railway sector restructuring options 13

4 Conclusions 16

Annex 1 Asset base and potential renewal program 17

Annex 2 Tariff evolution 18

Notes 20

Figures

1 ENR productivity: an international comparison 5

2 Overview of institutional arrangements 8

3 Staff productivity 11

tables

1 ENR revenues and expenditures, 2000–04 6

2 Capital expenditures and investment costs 6

3 Railways sector impact on public finances 8

4 Unit revenues 9

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5 Passenger traffic, 1995–2004 10

6 Freight traffic, 1995–2004 11

7 ENR staffing 11

Box

1 Railways sector restructuring proposals 15

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Abbreviations and acronyms

eRF Egypt Rail FreighteNR Egyptian National RailwaysGDP gross domestic productle Egyptian poundNiB National Investment BankPSo Public Services Obligations

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The railways sector in the Arab Republic of Egypt is operated by the Egyptian Na-tional Railways (ENR), a public Economic Authority subordinated to the Minister of Transport. ENR plays a significant role in the Egyptian economy: it is a big railway, with a strong focus on passenger services and generally high technical productivity. Because ENR is part of the public sector, its operation significantly affects Egypt’s public sector finances—the state, as the owner of ENR, carries the ultimate respon-sibility for any financial shortfalls (as well as the benefit from any surpluses).

Key findings

ENR has been operating with significant finan-cial losses over the past decade, placing a contin-uous and substantial burden on Egypt’s public sector finances:• ENR has typically not covered its operat-

ing costs. Between 2000 and 2004, oper-ating losses ran about 30 percent and 60 percent of revenues before interest pay-ments to about 100 percent (after inter-est payments). The annual operating loss in 2004 was LE 1,404 million (US$240 million). Over the past five years ENR has incurred cumulative operating losses of LE 4,560 million (US$780 million). ENR simply does not generate enough cash flow from operations to be profitable: cash flow has been negative over the past five years, except in 2002. In 2004, negative cash flow from operations was LE 106 million (US$18 million).

• Annual investment expenditures in the rail-ways sector have averaged about LE 1 bil-lion (US$170 million) since 2000, with some variability: the lowest level of in-vestment was in 2003 at LE 705 million (US$120 million), the highest level in 2004 at LE 1,467 million (US$251 million). On a cumulative basis, between 2000 and 2004

investment expenditures reached a total of LE 5,636 million (US$965 million).

• Operating losses and investment expendi-tures constitute a major burden on Egypt’s public finances: in 2004 they added up to about 0.85 percent of total annual public ex-penditures and 0.63 percent of gross domes-tic product (GDP). Operating losses alone constitute a burden of 0.42 percent of pub-lic expenditures and 0.30 percent of GDP. These ratios have varied over recent years, though they have always demonstrated a significant impact by the railways sector on Egypt’s overall public finances.

• ENR’s operating deficit (and negative cash flow) has been driven mainly by very low traffic unit revenues and to a lesser extent by some operating inefficiencies. The key driver of the impact on the public purse, therefore, is that the Government has kept tariffs ar-tificially low: in 2004 average revenue for passenger traffic amounted to LE 0.011 (US$0.0018) per passenger-kilometer and average revenue for freight traffic to LE 0.048 (US$0.008) per ton-kilometer. The resulting deficits have been caused by express services, local services, and (to a lesser extent) suburban and special services on the passenger side—with intercity ser-vices almost covering their direct operating

executive summary

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costs. Freight services are also likely to be close to covering their direct operating cots. Overstaffing is not a significant issue compared with other railways in the region, though some overstaffing exists in adminis-trative functions and support services.Given its traditionally weak financial per-

formance (resulting particularly from artifi-cially low tariffs and somewhat less from op-erating inefficiencies), ENR has been placed under very close supervision by the Ministry of Finance. This is in addition to its supervision by the Ministry of Transport. The Minister of Finance, after discussions with the Ministry of Transport, signs off on the current budget (re-lating to overall operating expenditures) each year. Since 1999 the Ministry of Finance has also covered all operating deficits by authorizing a current overdraft, financed through an over-draft facility from the Central Bank. The capi-tal budget (relating to investment projects and repayment of loans) is approved by the Ministry of Finance, Ministry of Transport, and Minis-try of Planning. All investment expenditures are financed through loans provided by the National Investment Bank (NIB) and repaid by the Ministry of Finance. The implication of these arrangements is clear:• Although ENR does not receive official

subsidies, the Ministry of Finance de facto covers all explicit and implicit (through con-tingent liabilities) financial shortfalls in the railways sector (as evidenced, for example, through the repayment of NIB debt). Al-though public financial support for railways is common in many countries, the provision of financial transfers to the railways sector in Egypt is very ad hoc and not strategic. It lacks the transparency and strategic ratio-nale necessary for making the right policy decisions about the optimal allocation of public funds in the railways sector.

Priorities for action

The overall fiscal impact of the organization of the railways sector is significant. Without fun-damental reform, the public burden of operating ENR is estimated to remain at least at the level

of recent historical averages—between 0.10 and 0.50 percent of public expenditures (and 0.10 and 0.30 percent of GDP), if only operating deficits are considered. If investment expendi-tures are included, the ratios are between 0.40 and 0.80 percent of public expenditures (and 0.30 and 0.60 percent of GDP). These are min-imum estimates. With an increasingly aging physical asset base (both rolling stock and fixed infrastructure), either maintenance expendi-tures (affecting operating losses) or investment (renewal) expenditures may need to increase to retain current technical service standards. This situation clearly points to a continued sig-nificant burden on Egypt’s public finances from the railways sector. Therefore, any railway sector reform scenario needs two strategic pillars:• Restructuring the sector fundamentally—

to reduce the impact of the railways sector on Egypt’s public sector finances.

• Increasing the transparency of allocating any (remaining) public financial support—to clearly identify which public services are subsidized (and for what reason).A fundamental principle in restructuring

the sector will be to distinguish between services that are commercially viable (such as freight and intercity passenger), and services that are not commercially viable, for which the use of public funds is justified. These funds are pro-vided under PSO (Public Services Obligations) schemes (such as local, suburban, and possibly express services). Although it is not possible to financially quantify the potential impact of rail-way sector reform options, it is clear that reduc-ing public financial support critically depends on some of the following strategic decisions:• First, a decision on the extent to which the

most heavily loss-making services (local passengers and possibly express) should be reduced, given that they could be provided at lower economic costs by alternative road transport.

• Second, a decision on increasing tariffs for regulated services for which there is a PSO agreement.

• Third, a decision on reducing discounts pro-vided to certain groups of customers (such as students and the military).


The Government will also have to finance the initial transition cost of any restructuring program associated with cleaning up ENR’s balance sheet by repaying NIB debts and the Central Bank overdraft, resolving potential redundancies, and making some continued in-vestment in physical infrastructure and rolling stock. Therefore, the public financial contribu-tion to the railways sector is not likely to decline significantly in the short term, even in a restruc-turing scenario. However, if a restructuring pro-gram is implemented successfully, the Govern-ment could expect to see a reduction over the medium term in the burden ENR places on Egypt’s budget.


1 overview of the railways sector

The railways sector in Egypt is managed and operated by Egyptian National Rail-ways (ENR). ENR is an integrated railways company, subordinated to the Minister of Transport. It is responsible for managing the railway infrastructure and operates railway transport services on the entire network.1 The network, 5,085 kilometers long, serves the main activity and population centers in Egypt: about 60 percent is in the Nile Delta (Alexandria, Cairo, Port Saïd, Ismaïlia, and Suez) and along the Nile Valley (up to El Sad Ali, beyond Aswan). In the north-south direction it spans from the Mediterranean Sea to Sadd el Ali, where it connects with the river steamers of Sudan Railways. In the east-west direction it runs from Salûm, at the Libyan border, to Beer Al-Abd on the Sinai peninsula. There is another east-west link from the Red Sea port of Safaga to Abu Tartour. Other lines in the desert provide connections to iron ore and phosphate mines.

Overall, the network adequately serves the Egyptian economy: main cities are linked by rail, as are ports and industrial and mining cen-ters.2 No major development of the railway net-work seems necessary over the medium term. A few short-distance new lines may be required to connect the railway network to the “new subur-ban towns” (for suburban passenger transport) or to new industrial or port areas (for freight traffic). The 225 kilometer-long new line under construction between El Ferdan and Rafa (at the Gaza strip border) is essentially strategic and likely to generate only limited traffic.

ENR operations are significant, with a strong focus on passenger services. Total com-bined passenger and freight traffic in FY 2004 reached 57 billion traffic units; this exceeds the combined traffic of the railways in Turkey, Iran, Morocco, Algeria, and Tunisia; it amounts to 46 percent of the traffic of French railways and almost equals the traffic of British railways. ENR is predominantly a passenger railway,

with passenger traffic constituting more than 90 percent of the traffic volume (against 30 to 42 percent in the above-mentioned countries, 68 percent in Britain, and 59 percent in France); the remaining 10 percent is freight traffic. Such high dependence on passenger traffic is seen elsewhere only in Japan.

ENR’s physical productivity is excellent and its technical efficiency good. ENR scores very well in terms of physical productivity (fig-ure 1): infrastructure is very densely used, and locomotive and passenger coach productivity is high. The only exception is the low productiv-ity of freight wagons, a symptom of the ineffi-cient management of freight activity. Techni-cal functions are adequately handled. Track on main lines is generally in good condition, and telecommunication and signaling systems work properly. The situation is more mixed for rolling stock. Passenger coaches are generally in good condition. Freight wagons are also in good con-dition, with a favorable availability factor (90 to


96 percent). Availability of locomotives, though, is below standard (about 70–73 percent against a target of 85 percent).

Some of ENR’s assets need to be modernized over the medium term. Although assets are generally in good condition, some need to be renewed or modernized in years to come. The motive power and rolling stock fleet is aging. In a fleet of 688 locomotives, only 146 are less than 20 years old. Similarly, part of the passenger coach fleet has reached the end of its economic life. Some rolling stock maintenance facilities are old and lack adequate equipment. Only 180–200 kilometers of track is renewed annu-ally, an amount that might be insufficient on a heavily used network. About 4,500 kilometers of lines are still equipped with old mechanical

signaling systems, which should be replaced by color-light Central Traffic Control on busy lines and radio-based Direct Train Control on less busy single-track lines. The entire network is covered by a modern, fully digital microwave system that is satisfactory for operational pur-poses but not suited to the data transmission used in modern management (for more details on the asset base, see annex 1).

Public expenditure and fiscal impact

As the key indicators above show, the Egyp-tian railway is operated very productively and assets are generally used efficiently. However, operating the Egyptian railways under the cur-rent rules of the game imposes high financial costs—and thereby direct and indirect fiscal


cost—on the Government. The overarching rea-son is that railway services are sold at a very low price (below operating cost coverage rates for all but intercity services and freight transport) and that some services are provided by rail where it would be more economical to provide them by road (for example, local passenger and possibly express services). This section provides an over-view of ENR’s financial situation, with an anal-ysis of the impact its operations have on Egypt’s public expenditures and fiscal situation. It also describes how ENR has been able to finance its ongoing operating deficit and overall invest-ment expenditure program. The key message is

that ENR imposes significant financial and fis-cal costs on the Government and this situation is unlikely to change unless the railways sector is significantly restructured.

ENR financial operations

ENR generates significant operating deficits. In 2004, the operating deficit (before interest on investment loans and on current overdraft) was LE 537 million (US$92 million) (table 1). The cumulative operational deficit (before interest on investment loans and on current overdraft) over the past five years has amounted to LE 1.87 billion (US$320 million). The ratio of operat-ing loss to revenue has been between 30 and 60 percent, again calculated before interest. There is one principal reason for this weak financial performance: The cash flow generated from operations (revenue less current expenses, before depreciation and interest) has been almost con-sistently negative since 2000 (except in 2002). In 2004 negative cash flow generated from operations reached LE 106 million (US$18 million), or 12 percent of gross revenue. This situation derives mainly from the very low level of revenue per traffic unit (as shown in greater detail later), and some operating inefficiencies.

Investment and maintenance costs. ENR’s capital expenditures and investments have aver-aged about LE 1 billion (US$170 million) over recent years, with significant fluctuations, as when in 2002 it reached a low of LE 705 mil-lion (US$120 million) and in 2004 a peak of LE 1.45 billion (US$251 million) (table 2). Investment expenditures are decided on as fol-lows: ENR prepares its five-year investment plan, which is approved by the Board of Directors and then by the Minister of Transport. The plan is then discussed with, and potentially modi-fied by, the Ministry of Planning. Investment costs (see table 2) do not include maintenance expenditures, though they include asset renewal expenditures. Maintenance costs are likely to be covered under the line items of spare parts/goods and services as part of operating costs (see table 1), and are estimated to amount to a maximum of LE 350 million (US$59 million)

LE millions2000 2001 2002 2003 2004

Investment expenditures 1,082 1,249 705 1,131 1,467

Source: ENR.

Table 2 Capital expenditures and investment costs

2000 2001 2002 2003 2004

Revenue (LE millions)

Passenger traffic 437 468 483 510 568

Freight traffic 164 180 212 193 209

Others 175 142 217 222 78

Total 776 789 912 926 856

Operating cost (LE millions)

Labor costs 455 508 505 534 568

Spare parts/goods 275 231 250 289 252

Services 82 76 86 103 112

Others 14 5 3 18 30

Total 826 820 844 1 034 962

Cash flow from operations (LE millions)

Cash flow from operations (50) (31) 68 (108) (106)

Other charges (LE millions)

Depreciation 335 317 322 336 432

Interest 771 514 85 445 867

Operating profit (loss) (LE millions)

Before interest (385) (348) (254) (354) (537)

After interest (1,156) (862) (339) (799) (1,404)

Operating loss/revenue (%)

Before interest 50 44 28 38 63

After interest 149 109 37 86 164

Source: ENR.

Table 1 ENR revenues and expenditures, 2000–04


in 2004.4 Although it is difficult to estimate whether maintenance is adequate, some initial evidence suggests that ENR is not spending enough on maintenance (also suggested in light of its negative operating cash flow). This under-spending, together with a depreciating physical asset base (especially on the locomotive side), implies that investment and renewal expendi-tures may need to increase from historical levels over the medium term, to allow ENR to main-tain current levels of service quality.

Interest payment and debt service. Because ENR generates negative operational cash flow, interest payment and debt service are important in two respects: first, ENR requires an overdraft facility to finance operating expenditures; and second, it cannot finance any capital expen-ditures or pay the interest on loans to finance capital expenditures. ENR meets its operating cash flow deficit and investment needs in the following way:• Since 1999, operating cash shortfalls have

been financed by overdraft facilities pro-vided by the Central Bank.

• Capital expenditure and investment in infrastructure and rolling stock are fi-nanced by loans provided by the National Investment Bank (NIB).5

ENR is not in a position to repay its over-drafts or loans, or the interest associated with either. For full accounting purposes, however, it is important to show the effect of interest on ENR’s financial operation. In 2004 interest payments (LE 867 million, or US$148 million) alone exceeded ENR’s gross revenue (LE 856 mil-lion, or US$146 million) (see table 1). This is because the effective interest costs increase from year to year as debts and loans remain unrepaid, leading to a snowball effect. On a cumulative basis, during the 2000–04 period, ENR gen-erated a deficit after interest of LE 4.56 billion (US$780 million), again almost equivalent to its cumulative gross revenue (LE 4.26 billion or US$730 million). Interest rates vary over the years because while, on the one side, unpaid interest accumulates on ENR’s books, on the other side, the Ministry of Finance provides

financial transfers to clean up ENR’s balance sheet from time to time. In relative terms, the ratio of after-interest operating loss to revenue has been on average about 100 percent over the past five years (in 2004 the ratio was as high as 162 percent). Clearly, the full financial deficits (including interest payments on debt) generated by ENR are substantial.

ENR fiscal impact

The financial deficit of ENR has a significant impact on the situation of public finances in Egypt. Under the present financial rules of the game, the railways sector is formally not sub-sidized by the Government. But this situation is fictitious. ENR cannot finance its opera-tional deficit and cannot pay off its investment loans, as described above. Overdrafts provided by the Central Bank as well as loans provided by the NIB have no serious prospect of being reimbursed. The Government, the Ministry of Finance specifically, therefore takes over ENR’s accumulated debt from time to time and repays the Central Bank and NIB. In the ENR bal-ance sheet, this appears as a conversion of ENR debt into Government equity. All ENR’s oper-ational deficits and investment are implicitly financed by the Government budget, even if they do not appear clearly in the budget (table 3). Overall, financial transfers from the Gov-ernment to the railways sector to cover operat-ing deficits are significant—estimated at 0.10 to 0.50 percent of total public spending during the past five years (or between 0.10 and 0.30 percent of GDP).6 If investment expenditures are included with operating deficits, then the range rises to between 0.40 and 0.80 percent of total public expenditures, and 0.30 and 0.60 percent of GDP.

Given its weak financial performance, ENR has been placed under very close supervision by the Ministry of Finance, as well as by the Ministry of Transport. According to law 152 of 1980, ENR is under the supervision of the Min-ister of Transport, who designates or approves the designation of Board members and must endorse decisions made by the ENR Board

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before they take effect (figure 2). The deficient financial situation of ENR has led the Ministry of Finance to impose its own strong supervi-sion in addition to the relatively softer super-vision exercised by the Ministry of Transport. Supervision by the Ministry of Finance is imple-mented by constraining budgeting and financial management procedures.

The ENR’s current budget allocations (re-lated to key operating expenditures) are dis-cussed by ENR, the Ministry of Transport, and the Ministry of Finance and approved by the Minister of Finance. All ENR revenues are in a single account in the Central Bank; each month ENR is authorized to withdraw a total of one-twelfth of the expenses approved for the year. An overdraft is authorized up to LE 900 million; it bears interest (at about 7–8 percent). ENR’s capital budget (related to investment projects and repayment of loans) must be ap-proved by the Ministry of Transport, the Min-istry of Finance, and the Ministry of Planning. All investments are financed through loans to ENR by the NIB. Because ENR does not gener-ate sufficient cash, the Ministry of Finance is de facto financing loan repayment, considered as a subscription to ENR capital.7 In addition to the control exercised by the Ministry of Transport and the Ministry of Finance, hiring of supple-mentary staff must be authorized by the Min-istry of State for Administrative Reform. As a result, ENR has little management discretion, responsibility, or accountability, making it dif-ficult for ENR to manage its operations on a commercial basis.

2000 2001 2002 2003 2004

Base information (LE millions)

Operating loss (after interest) 1,156 862 339 799 1,404

Investment expenditures 1,082 1,249 705 1,131 1,467

Operating loss + investment expenditures 2,238 2,111 1,044 1,930 2,871

Total public spendinga 237,642 259,541 285,819 286,479 337,804

Nominal GDP at market prices 340,100 358,700 378,500 417,500 474,440

Operating losses

% of public spending 0.49 0.33 0.12 0.28 0.42

% of GDP 0.34 0.24 0.09 0.19 0.30

Investment expenditures


% of GDP 0.32 0.35 0.19 0.27 0.32

Operating losses and investment expenditures


% of GDP 0.66 0.59 0.28 0.47 0.63

a. Includes Economic Authorities.Source: ENR data and World Bank calculations.

Table 3 Railways sector impact on public finances

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Key drivers of eNR financial performance

This section analyses the causes underlying the poor financial performance of ENR. It sheds light on the drivers of operating losses through an analysis of the pricing and tariff structure, looking at the specific operating performance of the business units (for example, passenger versus freight), as well as taking stock of the staffing structure.

ENR analysis of revenue and tariffs

Revenue per rail traffic unit is very low, and tariff increases have been rare. The majority of ENR revenue is generated by passenger revenue (about 70 percent) with the remainder gener-ated by freight traffic (see table 2). In some years other revenues are also important, with a con-tribution of more than 20 percent in both 2002 and 2003.8 But revenue per rail traffic unit is generally low, for both passenger and freight transport. In FY 2004 average revenue for pas-senger traffic (table 4) amounted to LE 0.011 (US$0.0018) per passenger-kilometer and average revenue for freight traffic to LE 0.047 (US$0.0080) per ton-kilometer. In compari-son (2002 data), average revenue in Morocco is about US$0.02 per passenger-kilometer and US$0.024 per ton-kilometer (US$0.10 per passenger-kilometer and US$0.034 per ton-kilometer in France). The very low level derives principally from the low level of official tariffs approved by the Government and from substan-tial discounts imposed on official tariffs by the Government for various categories of travelers (such as students and military staff). Although tariff increases were fairly regular until about the mid-1990s (about 5 to 10 percent per year) they have not increased regularly in recent years. Unit revenues have been fairly constant since the mid-1990s (table 4) (see annex 2 for more details).

Performance analysis by business unit

Passenger transport is the predominant activity of the railway.9 Passenger transport accounts for 92 percent of the physical activ-ity of ENR and 73 percent of traffic revenue in 2004 (table 5). Passenger traffic steadily devel-oped from the early 1990s until 2001 (when it reached a record 66 billion passenger-kilome-ters), then dropped very sharply in 2002 (to 39 billion passenger-kilometers). Since 2003 traffic has recovered and reached 53 billion pas-senger-kilometers in 2004 (similar to the 1997 level). The present market share of the railway is reportedly about 40 percent of the total public transport market. ENR operates five categories of passenger services: intercity services, express

LE

Average revenue by passenger-kilometer

Average revenue by ton-kilometer

2000 0.013 0.040

2001 0.012 0.044

2002 0.012 0.049

2003 0.011 0.049

2004 0.011 0.047

2004 (US$) 0.0018 0.0080

Source: ENR.

Table 4 Unit revenues

2


services, local services, suburban services, and special services.

Intercity passenger services. Long-distance, high-quality services (in terms of comfort and speed) serving only big cities operate on the Cairo–Alexandria route (18 pairs of trains per day, some continuing to Marsa–Matrouh) and the Cairo–Luxor–Aswan route (12 pairs of trains).10 The main competitors to inter-city passenger services are private cars, bus ser-vices, and air transport.11 Intercity passenger services account for about 20 percent of total seat-kilometers but generate about 55 percent of passenger traffic revenue. Revenue per seat-kilo-meter is LE 0.053 (US$0.009). Services are likely to cover their direct costs (except for the “turbo-train” operated on the Cairo–Alexandria route, because of its very high maintenance cost).12

Express services. Long-distance, lower-qual-ity services (not air-conditioned coaches, lower speed) serve big and medium cities on routes also served by intercity services, as well as other routes in the Nile Delta (Cairo–Damietta, Cairo–Port Saïd, Cairo–Suez, Alexandria–Damietta, and Alexandria–Port Saïd). Custom-ers are mainly low-income people, who cannot afford more expensive intercity services. Com-petitors are mainly buses, mini-buses (14 seats), and taxis (seven seats). Intercity services account for about 45 percent of total seat-kilometers but

generate only 28 percent of passenger traffic rev-enue. Revenue per seat-kilometer is LE 0.012 (US$0.002). Express services run a substantial deficit, estimated by ENR at LE 182 million (US$31 million).

Local services. Short-distance, low-quality ser-vices mainly connect rural communities to cit-ies and markets, for low-revenue people. These services have an important social dimension. Ten routes operate (nine in the Nile Delta, one in Upper Egypt). Local services account for 29 percent of total seat-kilometers and gener-ate a mere 11 percent of passenger traffic rev-enue. They generate a deficit estimated by ENR at LE 250 million (US$43 million). This very important deficit derives from the high pro-duction costs of small capacity, short-distance trains combined with the low revenue per seat-kilometer (LE 0.007, or US$0.001) owing to the low fares set by the Government for social purposes, as well as the poor occupancy ratio of trains.13 Mini-buses and taxis operated by the private sector are fierce competitors. They often offer better quality—and more frequent—service, a factor that explains the low occupancy ratio of trains.

Suburban and special services. Suburban ser-vices are operated by ENR in the Cairo and Alexandria areas; they account for about 3 per-cent of total seat-kilometers and 3 percent of total passenger revenue. They reportedly gener-ated a deficit of LE 29 million (US$5 million) in FY 2004. ENR also operates special pas-senger services for the military (almost 90 per-cent of the services), police, and some factories. This activity is quite marginal (about 4 per-cent of total seat-kilometers and total passen-ger revenue). It reportedly generates a deficit of LE 29 million (US$5 million).

Rail freight transport plays a limited role. Freight provides 8 percent of total traffic vol-ume but accounts for about 27 percent of traffic revenue (table 6). Although it does not cover the fully allocated cost, freight traffic is quite likely to cover its direct costs. Freight tariffs are rela-tively low: US$0.008 per ton-kilometer, well

Passengers(millions)

Passenger-kilometers(millions)

Average travel distance(km)

Average passengers per train

1995 718 48,242 67 1,110

1996 735 50,465 69 1,154

1997 771 52,926 69 1,228

1998 810 55,000 68 1,225

1999 831 59,638 72 1,776

2000 863 63,060 73 1,863

2001 892 66,008 74 1,874

2002 450 39,083 87 975

2003 367 48,185 126 856

2004 418 52,682 126 1,003

Source: ENR.

Table 5 Passenger traffic, 1995–2004


below average U.S. tariffs (US$0.01–0.015) gen-erally considered the lowest economically based tariffs in the world. The main traffic is related to minerals (iron ore, phosphate, clay), coal and coke for the steel industry, petroleum products, imported wheat, and containers (the “land-bridge” operation between the Red Sea and the Mediterranean Sea). Average transport distance is 366 kilometers. Over the past decade, global rail freight traffic has stagnated at about 12 mil-lion tons and about 4.2 billion ton-kilometers. During this period, substantial competition from the trucking industry has developed and rail market share in national freight transport has declined. The current share of all freight transported by ENR is estimated at about 12 percent. The aggressive private trucking indus-try generally provides good and flexible service, enjoys total freedom in setting prices (as ENR does not), and reduces its costs by overloading trucks. The railway has not been able to adjust its commercial and operating practices to keep a competitive edge in highly competitive seg-ments of the market, which have therefore been lost to the trucking industry.

ENR staffing

ENR has reduced its staffing in recent years and is not significantly overstaffed. ENR has gradually reduced its staff by from 84,977 in 1999 to 70,333 in 2004, through attrition and hiring freeze (table 7). The single largest category is staff employed in workshops (42 percent), explained in part by the fact that ENR main-tains its rolling stock in-house. The second largest category is mid-level technical staff (28 percent), followed by support services (17 percent). Over-all, staff productivity is reasonably high (figure 3). In 2004, it was 809, surpassed in the bench-marking panel only by Japan (1,747) and Iran (1,600), a heavy haul freight railway. That said, staff productivity can be improved. Some over-staffing may exist in administrative functions, principally in the headquarters (and possibly in regional offices) and in the support service cat-egory.14 With potential reform of ENR, these two categories are most at risk, as modern man-agement techniques and computerization require

Management staff

Technical staff

Administrative staff

Support staff Total

Highlyqualified Qualified Other

1999 72 2,818 25,010 34,165 7,162 15,750 84,977

2000 70 2,821 24,916 34,178 7,042 15,520 84,547

2001 50 2,812 24,865 34,440 7,019 15,489 84,675

2002 51 2,690 23,141 30,625 5,250 13,259 75,016

2003 59 2,670 21,451 30,471 5,245 13,259 73,155

2004 (Actual) 71 2,626 20,675 29,362 4,940 12,659 70,333

2004 (Authorized) 101 2,988 27,126 38,440 6,498 16,058 91,455

Source: ENR.

Table 7 ENR staffing

Tonnage(thousands)

Ton-kilometers(millions)

Average transport distance

(km)

Average net tonnage per train

(tons)

1995 12,240 4,073 333 610

1996 12,795 4,117 322 618

1997 12,000 3,969 331 657

1998 12,533 4,265 340 554

1999 10,830 3,464 320 617

2000 12,120 4,000 330 618

2001 12,026 4,217 351 581

2002 11,903 4,188 352 635

2003 11,237 4,104 365 633

2004 11,814 4,321 326 669

Source: ENR.

Table 6 Freight traffic, 1995–2004


fewer (but better qualified) staff to fulfill admin-istrative functions and support services may be contracted out. However, in view of the very low cost of labor, increases in staff productivity will not have a significant effect on overall staff costs. Hiring new staff is possible, within limits, but requires approval from the Ministry of State for Development Reform and the Central Agency for Organization and Administration.

Staffing costs. The cost of wages amounts to about 30 percent of ENR’s overall expenditures. The ratio of staff costs to operating revenue (66 percent in FY 2004) largely exceeds the thresh-old (about 35 percent) generally considered nec-essary to ensure financial viability of the railway company. However, this ratio might be consid-ered somewhat misleading given the very low level of revenue per traffic unit.


3 Fiscal implications of railway sector restructuring options

The financial contribution of the Government to the railways sector is likely to remain significant. It may even increase. Any reductions would come from restruc-turing the way the sector operates. Although it is difficult to estimate the continued fiscal implications of the unreformed sector with any precision, they are likely to re-main, at a minimum, in the range of the recent past: between 0.10 and 0.50 percent of public expenditures (and 0.10 and 0.30 percent of GDP) over the next few years, if only operating deficits are considered. If investment expenditures are included, these estimates reach between 0.40 and 0.80 percent of public expenditures (and 0.30 and 0.60 percent of GDP).

Note that these are minimum estimates: with an increasingly aging physical asset base (both rolling stock and fixed infrastructure), either maintenance expenditures (affecting operating losses) or investment (renewal) expenditures must increase to maintain the current technical service standards. The most obvious place where higher costs may arise is on the locomotive asset base: up to 80 percent of all locomotives may need to be replaced or refurbished over the next 10 years (see annex 1). Some locomotives to be acquired or refurbished should be financed through loans contracted by ENR or the Egypt Rail Freight (ERF) company that is to be cre-ated to manage freight operations.

Also, as mentioned earlier, there is some ini-tial indication that ENR has been underinvest-ing in maintenance more broadly, which points to a likely increase in future investment (and renewal) expenditures. Finally, note that the current five-year plan (which runs until 2007) indicates a total investment of more than LE 8 billion (US$1.37 billon). That is about LE 1.6 billion (US$274 million) per year, higher than the average annual investment over the recent past. If the railways sector remains unreformed, its ongoing (or potentially higher) financial

deficits will have to be met either through con-tinued fiscal transfers—implying potentially higher taxes or public debt—or through higher tariffs for railways passenger and freight cus-tomers (or both).

Restructuring the relationship between the Government and ENR is a main element of any reform. Restructuring financial relations between the Government and the railways sector is a key element in any restructuring sce-nario. This is not just because of the current, high level of financial transfers to the sector, but also because of the way these transfers are granted and organized. The sector is not offi-cially subsidized by the Government. Operat-ing deficits are financed through an overdraft facility provided by the Central Bank, and railway investment is financed through loans provided by the NIB. But this situation is ficti-tious: since ENR is (and will remain) unable to pay back loans, all loans made by the Central Bank and NIB are in fact Government subsidies to the sector. Given the complicated structure of explicit and implicit transfers (and contin-gent liabilities), the current system is not at all transparent. This prevents policy makers from


understanding exactly which railways services they are paying for, preventing the optimal allo-cation of public funds.

Financial transfers and subsidies to the rail-ways sector must be made more transparent. A key reform objective, therefore, must be to make the financial transfers between the Gov-ernment and the railways sector much more transparent. One useful organizing principle would be to classify railways services into two broad categories: commercial services and PSO services—fully in line with international best practice:• Commercial services are services operated

for profit, in a competitive and deregulated environment, with no direct or indirect financial support from the Government. The railway operator enjoys full freedom to determine the configuration and tariffs of commercial services, without any Govern-ment intervention.15 Freight and intercity services fall into this category.

• PSO services are those services that the Gov-ernment considers essential to offer to the public for social or political reasons and for which it wants to set service configuration and tariffs and those services that a railway operator is generally not willing to operate as commercial services, because they are not profitable. PSO services (almost exclusively passenger) include local and suburban ser-vices, as well as any discounted services (for students, military staff, and so forth).

While increased transparency will not reduce the fiscal burden in itself, it will provide a basis for making better fiscal decisions. By making the allocation of fiscal resources more trans-parent, according to the distinction between PSO and commercial services, the Government would move away from providing “blind” con-tributions to the railway sector (that is, sim-ply covering operational deficits and financ-ing investments). Its financial contribution to the railway sector would be explicit and would compensate for PSOs formally and explicitly. No financial contribution would be provided for commercial services, for which the railway

would enjoy full freedom to set service configu-ration and tariffs. The Government could then make better decisions about which services to pay for, based on an assessment of overall eco-nomic and financial costs. In the transition period financial transfers will remain at the current level. Increased transparency will not directly reduce transfers, but it will provide the basis for improved decision making. The finan-cial reductions will come from more fundamen-tally restructuring the sector (box 1), which can be successfully achieved only by making fiscal transfers more transparent.

Potential impact of the railway restructur-ing program on public finances. Currently available information is insufficient for prepar-ing a comprehensive estimate of the impact of the railway restructuring program on public finances. However, it is likely that the Govern-ment’s current budget must permanently bear two contributions to railway operations: com-pensation for passenger services operated by ENR at the request of the Government under a PSO scheme, and compensation for discounts imposed on tariffs of commercial passenger ser-vices by the Government for some categories of customers (such as students, military staff, police, and veterans). The level of compensa-tion will be highly dependant on Government decisions on three issues: reducing or canceling local passenger services (and, possibly, express services) for which alternate road services can be provided with adequate quality of service and tariff, at a lower economic cost; increasing tar-iffs of PSO services (which would remain mod-erate anyway); and reducing discounts on tar-iffs of commercial passenger services (intercity services) imposed by Government for some cat-egories of customers.

In addition to its recurrent contribution to the railway sector for PSO compensation, the Government budget will also finance the first years of implementing any restructuring pro-gram. That will include the cost of financially restructuring ENR—namely, reimbursing the overdraft facility provided by the Central Bank and repaying part of the investment loans pro-vided by NIB (as well as potential redundancy


programs)—and possibly, investing in infra-structure and rolling stock related to com-mercial services, as an initial contribution to financially “re-railing” the railway. Detailed medium-term financial projections of ENR activity will determine the detailed contents

and amounts of budgetary financial support for these items. The overall budgetary contribution to the railways sector will probably not substan-tially decrease in the first years of restructuring. However, a significant reduction could occur over the medium term.

Restructuring the railways sector is a far-reaching exercise that im-

plies a new perception of the role of the railway by decision makers

and by the public, as well as a profound change in the mentality of

railway managers and workers. In addition to restructuring financial

relations between the Government and the sector, the proposed

program would deal with various closely interrelated components:

reform of the legal framework of railway activity; internal reorgani-

zation of the sector; relaxation of Government control of the sec-

tor; introduction of modern management techniques and operating

practices; implementation of a modernization investment program;

and promotion of private sector participation in railway activities.

As mentioned earlier, a key organizing principle is to distinguish

Public Services Obligations (PSO) schemes and commercial ser-

vices, to identify the areas to be supported by public funds:

PSO Commercial

• Local services • Freight

• Suburban services • Intercity passenger

• (Express services) • (Special services)

In addition, the following areas need to be addressed:

Legal framework: Although reforms are possible under law 152 of

1980, an improved law would be preferable. It should set out key

principles on ownership of assets (public for infrastructure, private

for operators); infrastructure and railways operation (including con-

cession laws), the distinction between PSO and commercial ser-

vices, and transparent financial relationships between the Govern-

ment and the railways sector.

Internal reorganization and modern management techniques: Internal

reorganizations should be introduced to enable more efficient man-

agement and more commercial operation of the sector. The railways

companies must be transformed from a public service to a business

culture. Examples include creating the Egypt Rail Freight Company

(ERF) with possible private participation, and contracting out ancillary

services currently performed in-house, such as cleaning.

Relaxation of Government control: ERF should be managed as a pri-

vate undertaking without Government control from the outset (so it is

free to determine tariff and service configuration). Government con-

trol of ENR (possibly incorporated as a joint stock company) should

gradually be relaxed as the financial relationship with the Government

is restructured. The Government will change its role to one of ex-post

evaluation (key performance targets, etc.) from one of control.

Modernized investment program: As part of the overall restruc-

turing program, investments should be financed that upgrade the

fixed infrastructure, as well as rolling stock—but under the new

principles of the railways sector: a clear distinction between PSO

and commercial operations, and a clearer view of what the public

sector should finance.

Private sector participation: Passenger transport services, the core

of ENR, should remain a public entity, but the private sector could

participate in outsourcing of services (such as maintenance and

support), assumption of specific management contracts (such as

the creation of ERF and some aspects of passenger services), and

public-private partnerships (such as a telecommunications joint

venture).

Box 1 Railways sector restructuring proposals


conclusions

The fiscal costs of the railways sector are high and fiscal transfers are not allocated transparently. The Note has also made clear that unless the railways sector is re-formed fundamentally, fiscal transfers are going to remain at the current level or even increase over the medium term, given the depreciating physical asset base. Al-though reform will not immediately decrease the financial burden on Egypt’s bud-get, greater transparency in the allocation of public funds, as well as improved com-mercialization and operation of the railways in the right authorizing environment (in terms of laws, tariffs, private sector participation, and so on), should provide the basis for an eventual reduction of fiscal transfers to the sector.

4


ANNex 1

Asset Base and Potential Renewal Program

Generally, speaking technical depreciation life on the main lines is as follows: passenger wagons, 35 years; freight wagons, 40 years; locomotives, 25 years; and track, 20 years. Stock is then moved to local lines for 20 years, then to shunting areas and warehouses for 20 years—a total of 60 years. The current age distribution of the stock is as follows:

Freight wagons, age distributionAge 1–5 yrs 5–10 yrs 10–15 yrs 15–20 yrs 20-30 yrs 30-40 yrs > 40 yrs

No. 264 906 1,780 1,913 4,373 2,324 400

Source: ENR, December 2004.

Locomotives, age distributionAge 5–10 yrs 10–15 yrs 10–20 yrs 20–25 yrs 25–30 > 30 yrs Total

No. 98 33 71 366 114 6 688

Source: ENR, December 2004.

Passenger wagons, age distributionAge > 5 yrs 5–10 yrs 10–15 yrs 15–20 yrs 20–25 yrs 25–30 yrs 30–35 yrs > 35 yrs Total

No. 985 98 335 193 794 930 48 23 3,641

Source: ENR.

The figures in the tables suggest that for freight wagons and locomotives—over the medium term—an increased renewal program may be necessary. That in turn implies increased maintenance and investment costs. For passenger rolling stock, this appears to be less the case.

1� REstRuctuRing EgyP t ’s RA ilwAys

ANNex 2

tariff evolution

Passenger tariffsThe general trend was an increase of 10–15 percent every year or every two years during the period 1989–95; tariffs then held steady until the late 1990s. In 1999, tariffs started to increase again but not on a regular basis (for example, air-conditioned trains in one year, regular trains the next year). In all cases, students’ subscriptions remained unchanged. Revenue per passenger-kilometer has remained very stable.

Passenger transport, excluding the Cairo Metro

YearPassengers (millions)

Passenger-kilometers (millions)

Revenue (LE millions)

Revenue (LE/passenger)

Revenue (LE/passenger-

kilometer)

1993/94 303.8 26,127 293.7 0.967 0.011

1994/95 338.5 29,110 332.1 0.981 0.011

1995/96 329.6 29,669 352.7 1.070 0.012

1996/97 377.7 32,480 370.1 0.980 0.011

1997/98 385.1 33,121 377.4 0.980 0.011

1998/99 395.0 33,969 393.8 0.997 0.012

1999/2000 416.2 34,960 437.1 1.050 0.013

2000/01 424.0 38,160 467.5 1.103 0.012

2001/02 450.7 39,083 483.5 1.073 0.012

2002/03 367.3 46,185 490.5 1.335 0.011

2003/04 418.1 52,681 567.84 1.358 0.011

Source: ENR.

Freight tariffsFreight tariffs increased by about 15 percent every year until 1994; thereafter, tariffs increased for some commodities but in a very unsystematic way (for example, in September 2004, the cement transport tariff increased by 50 percent).

Rail freight transport

YearsTons

(thousands)Ton-kilometers

(millions)Revenue

(LE millions)Revenue (LE/ton)

Revenue (LE/ton-kilometer)

1994/95 12,784 4,257 173.31 0.014 0.041

1995/96 13,385 4,352 179.40 0.013 0.041

1996/97 12,487 4,144 179.99 0.014 0.043

1997/98 12,584 4,159 173.48 0.014 0.042

1998/99 11,081 3,562 137.14 0.012 0.039

REstRuctuRing EgyP t ’s RA ilwAys 1�

YearsTons

(thousands)Ton-kilometers

(millions)Revenue

(LE millions)Revenue (LE/ton)

Revenue (LE/ton-kilometer)

1999/2000 12,229 3,980 157.66 0.013 0.040

2000/01 12,256 4,299 187.53 0.015 0.044

2001/02 12,333 4,254 209.96 0.017 0.049

2002/03 11,472 4,188 206.25 0.018 0.049

2003/04 12,235 4,740 224.41 0.018 0.047

Source: ENR.

Fare reductions

User groups with reduced tickets % reduction

Holders of honor certificates and Sinai Star 75

Police and armed forces 50

War veterans 75

Members of the Journalism Syndicate 50

University and higher institute students 50

Visually impaired 50

Hearing and vocally impaired 50

Visitors to industrial and agricultural exhibitions 25, 33

Visitors to the Book Fair, Cairo Stationery Exhibition, and Cairo Hospitals’ Exhibition 50

University faculty members 25

Egyptian teachers in Sudanese and Arab schools and their families 50

Authorized orphanages 30

Youth care authorities 50, 66.6

Students 30, 50, 60

International matches and races 20, 30

Members of syndicates and bankers 50

Workers syndicate 50, 65

Workers 30

Authorized religious authorities 25

Red Cross and Red Crescent 50

Martyrs’ families 50

College of Aviation 82

Charitable organizations 25

Circus members coming from abroad 30, 50

Visitors of exhibitions held by governorates 25

Source: ENR.

Rail freight transport, continued


Notes

1. The analysis in this Note excludes the Cairo Metro (the subway), which is also managed by ENR, through a special branch. Cairo metro will be ana-lyzed in the Urban Transport Note for the PER.

2. This does not imply that the transport ser-vices are provided cost-effectively through the rail-ways, it only indicates that the major population and economic centers are connected by the railways (in a technically efficient way).

3. Assuming LE 1.00 = US$0.17132.4. There is some overlap between investment

and maintenance expenditures: in general only track renewal (and possibly some track component re-newal) and rolling stock rehabilitation (and possibly heavy periodic overhaul) are considered investments. There is also a tradeoff: lower maintenance expendi-tures in the short run imply higher investment and renewal costs in the medium and long run.

5. Loans from NIB are normally repaid over 10 years with a 2 year grace period. The interest on these loans is 13 percent per annum (if not paid on schedule, interest increases to 16 percent). ENR has about LE 8 billion of debt to NIB.

6. The public expenditure ratios are calculated using public spending data that include Economic Authorities. This is necessary because most pub-lic expenditures in the transport sector (including railways) are included in Economic Authorities. Ex-cluding them would lead to an overestimation of the expenditure ratios.

7. The authors attempted to triangulate the budgetary transfers to the railways sector from a Ministry of Finance perspective. We have received information only on 2002, when the transfer from the Ministry of Finance to the railways sector was LE 1,335 million—higher than the combined oper-ating losses and investment costs (probably because the Ministry is also paying itself back).

8. It is not entirely clear what the category “other revenue” includes, but it is likely to include land holding disposals and the like.

9. The following information is based on ENR’s internal costing system (called the Business Evaluation and Management System, or BEAMS). The system has some shortcomings and one can-not easily assess profitability of the various business units. Hence the analysis needs to be treated with some caution.

10. Intercity services offer first and second class services, all air-conditioned; sleeping services are offered on routes to Aswan.

11. Bus services are operated by five public en-terprises (four regional companies and one “Super-jet” company).

12. This estimate, like all subsequent profit-ability calculations, should be considered as an order of magnitude only, because ENR costing methodol-ogy can be questioned on some aspects.

13. According to ENR, the fully allocated cost per seat-kilometer is 35 percent higher for local services than for express services.

14. There is anecdotal evidence of ineffi-cient operations; for example, accounting and payroll management is mainly done by hand. The organization and management practices are labor-intensive, with about 5,000 administrative staff in 2004.

15. Commercial services should cover their incremental track costs and make a further positive contribution to costs recovered jointly with PSO services.

16. Preliminary recommendations for restruc-turing the sector have been submitted to the Min-ister of Transport; see “World Bank Policy Note: Egyptian Railways, Diagnosis of Present Situation and Restructuring Strategy,” May 2005.

restructuring egypt's railways - august 05

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