The path to railway liberalization

  • 2005-02-23
  • By Vladimir Solomatin, partner at Bridge Capital
The legal basis for railway privatization was laid out when Latvia joined the EU in May 2004. Under Directive 91/440/EC "On EU Railway Development," Latvia is obliged to alter its rail system in order to make it more suitable to the requirements of a market economy. This stipulates that the system has to be based on free competition, better efficiency, as well improved technology and safety.

Latvia initiated its railway restructuring program in 2000. As a result, Latvijas Dzelzcels (Latvian Railway) spun off some functions not connected with its core business of railway carriage and infrastructure management. Now such companies as Passenger Lines, International Passenger Carriages, Zasulauks, and Railway Security operate as separate legal entities within a concern, having their own budgets, personnel and accounting. The next step in the restructuring process is to define the status of cargo carriages that remain a part of Latvian Railway, the implications for financing railway infrastructure and sources of funding passenger carriages. What are the cornerstones of further restructuring process?

The most acute issue that was, and still is, on the agenda is financing railway infrastructure. Currently the major source of funds is revenues from cargo carriages, or approximately 55 percent. Budget participation in investment programs remains insignificant 's around 3 percent. But according to the transportation development program, this share might increase to 28 percent in 2006. If cargo business is separated from infrastructure, then the only source of revenues for the infrastructure management company will be fees charged from cargo carriage companies. This may be insufficient to meet the terms of credits taken on by Latvian Railway and to provide adequate investment level. For this reason EU funds are imperative.

Another implication of restructuring is open access to the Latvian railway system to any foreign railway operator. Legally, the Latvian railway system provides open access. Three private cargo carriage companies, Baltic Express (Ventspils), Baltic Transit Services (Riga), and ITC Liepaja (Liepaja), operate in Latvia. Practically, in order to enter the Latvian system, a company must have access to local ports, own locomotives and be able to meet strict operational and safety standards. That creates high entry barriers. So far, no foreign company has expressed its intention to enter the market.

The primary aim of restructuring is to turn the structural divisions of Latvia's railway system into independent profit centers. However, passenger carriages remain unprofitable, mainly because of the old wagons and low quality of services, while renovation and acquisition of new locomotives and cars is quite costly (around 5 million euros per train). Currently, passenger carriages' loses are cross-subsidized from Latvian Railway's profitable cargo business division. In order to resolve the issue, government subsidies and investments are critically needed. The government began subsidizing railway carriages only recently 's in this year's budget around 10 million euros are allocated for the purpose. Again, significant investments are expected to come from EU funds.

Overall, the restructuring of Latvian Railway may bring improved efficiency and financial performance. With separated business functions, the industry will become more transparent, and the destination of credits and EU funds will be rather clear. At the same time, looking at the path that other countries followed worldwide in their railway system reforms, the improved performance may be attained only with severe staff lay-offs and abolishing unprofitable (though socially important) routes. In Latvia, the major threat in this process may come from the unclear separation of social and financial responsibility in regards to railway infrastructure among the government and the future infrastructure management company.