Financial Sustainability for Railways



Economic Analysis

Economic analysis 45 of railways expands on financial analysis by incorporating non-financial externalities and impacts on a broader range of affected entities. Financial analysis is fundamental as it determines the financial revenue and cost streams to the railway entity. Economic analysis considers financial and also non-financial benefits and costs accruing to all stakeholders, including as the government, railway customers and other citizens. Economic analysis seeks to establish whether a project or a policy intervention is worthwhile from an overall social perspective. The analysis is a comparison between alternative states of the world—between “with project” and “without project”. The latter scenario should be a realistic base case against which the project/policy options are tested. Both the base case and project need to be clearly defined in terms of project scope, period and impacts.

Project scope and stakeholders
The first step in economic analysis is to describe the project, define its geographical and economic area of influence, and determine the period of analysis. Stakeholders, i.e. agents affected by the project, also need to be identified and typically include some of the following: railway operator, infrastructure owner, the government, freight customers, passengers, other transport modes and society as a whole. Project impacts need to be identified for each stakeholder. Ideally, all impacts should be included, no matter how small they are, but in practice data collection is made less cumbersome by excluding minor impacts. Impacts may include investment costs, maintenance and system operating costs, vehicle operating costs, journey time savings, safety benefits, environmental impacts (pollution, noise), and wider effects on the economy and government.

Traffic forecast
A traffic forecast should be prepared for “with project” and “without” scenarios to quantify generated traffic in the project area of influence and diverted traffic from other transport modes for both freight customers and passengers. Adequate data collection for the period of analysis is crucial to preparing a reliable traffic forecast. Traffic forecast is essential to determining any time savings or other benefits that may accrue to users from speed or reliability improvements.

Project benefits
Railway customers experience project benefits through travel time savings, greater reliability and improved comfort. In economic terms, there is a positive change in consumer surplus, i.e. willingness to pay more than the cost of a trip, when the project improves railway service. The value of time can be quantified through savings in foregone income per hour during working time and willingness to pay for greater comfort when traveling by rail vs. road. The value of reliability can be quantified as the cost of extra inventory held to guard against unreliable shipment time. Railway operators and infrastructure managers derive direct benefits through higher revenue and/or lower operating or maintenance costs 46. Indirect benefits can result from creation of productive economic activities and increased mobility, if, for example, transportation delays and costs are reduced for businesses within the project area of influence. Avoided infrastructure costs for alternative transport modes and avoided higher fuel costs also count as benefits. External benefits can refer to safety (lower accident costs) and environmental benefits which increase social welfare.

Project costs
Identification of project costs is typically more straight-forward than defining benefits. Normally financial costs for investment, maintenance and operation are converted into economic costs by eliminating physical and price contingencies, VAT, and other taxes and duties. External and non-financial costs arise from pollution, global warming, noise, involuntary settlement of people and safety risks. Quantification of such costs is challenging due to measurement difficulties and the need for context-specific assumptions. It is noteworthy that the “without project” scenario may include investment costs in other transport modes, such as road rehabilitation or expansion, if the railway project is not undertaken.

Results and sensitivity analysis
When all costs and benefits have been identified and quantified, net economic benefit can determined by calculating the project’s net present value, internal rate of return and benefit-cost ratio. The discount rate should be determined specifically for each project. The World Bank uses 12 percent as a standard discount rate in economic analysis over a 20-30 year forecast period. As project costs and benefits are typically uncertain, sensitivity analysis should be performed on the results by testing the relative impact of project variables. For example, “switching analysis” determines the changes in variables which yield a net present value of zero. Monte Carlo simulation can determine the probability distribution of project results given changes in key variables.

Additional resources
The World Bank has produced with the UK Department for International Development 22 economic evaluation notes which detail the different stages in transport project evaluation. The series of Transport Notes (TRN-5 to TRN-26) is available on worldbank.org/transport > Research and Analysis > Transport Notes Series 47. A good example of the World Bank’s railway economic analysis can be found in the Project Appraisal Document for Egypt National Railways Restructuring Project (P101103) 48.

    


45 There are different interpretations of economic analysis but here it refers to cost-benefit analysis.
46  If the reduction in operating and maintenance costs entails staff reductions, the economic price of labor should be used in benefit calculation instead of money wages and benefits (financial price of labor). Economic price of labor, or labor supply price, can be estimated using the shadow wage rate which depends on skills, location, economic sector, and even season.
47  http://web.worldbank.org/WBSITE/EXTERNAL/TOPICS/EXTTRANSPORT/0,,contentMDK:20457194~menuPK:1323557~pagePK:210058
~piPK:210062~theSitePK:337116,00.html
48  See Annex 9 of Project Appraisal Document on http://www-wds.worldbank.org/external/default/main?pagePK=64193027&piPK=64187937&
theSitePK=523679&menuPK=64187510&searchMenuPK=51351213&theSitePK=40941&entityID=000334955_20090224045050
&searchMenuPK=51351213&theSitePK=40941

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