South China Morning Post
Evan Auyang
February 02, 2009
The Ministry of Railways will spend an estimated 3 trillion yuan (HK$3.4 trillion) to expand and upgrade its rail network over the next five years. While much of this funding will come from the government or through debt, China will still need up to 1 trillion yuan from private and foreign sources to ensure that projects stay on schedule. The country will increasingly need to turn to these sources to fill the gap, opening up enormous opportunities for them as well as for rail equipment and systems makers.
It is no exaggeration to say that if China's railway system shuts down, the nation shuts down. As the most cost-efficient mode of transport over long distances, the country is dependent on rail to supply coal, iron ore, and other vital commodities to keep it running. Yet this massive flow is straining its rail system. To cope, China has already spent 750 billion yuan on upgrading its railways over the past five years.
Traditionally, the government has paid for these investments by borrowing from banks, issuing bonds, and tapping its Railway Construction Fund. However, these sources will not be enough to support future expansion.
To realize its ambitious targets for the next five years, it has little choice but to increase private and foreign funding. While in the past, it drew only 7 percent of its rail investment from these sources, our analysis shows this amount could, over time, increase to 30 percent. This translates into a market of as much as 1 trillion yuan in which private and foreign firms can invest over the next five years.
In countries such as Australia, India, and Britain, companies typically invest in infrastructure projects through public-private partnerships. Because China's rail sector lacks such a framework, foreign direct investment will continue to be limited in the near term. However, the ministry has announced its intention to increase private participation, and investors will be able to capture enormous opportunities in the near future.
Regardless of how quickly these public-private partnerships will develop in China, the opportunity for railway equipment and technical systems providers will be enormous. We estimate that by next year, China's railway systems and equipment market, including locomotives, signaling systems, and components, will reach 400 billion yuan, making it the largest rail market in the world.
Participating in its railway sector is by no means easy. Foreign companies often find the lack of transparency and the heavy government regulations challenging. However, aspiring players can learn lessons from those who have succeeded in this market.
First, build the right relationships. Foreign investors are often shut out of attractive projects because they do not have the same access to information as domestic players. Successful companies invest in getting to know key stakeholders and understanding how decisions are made.
Second, team up with local partners. They can help foreign firms navigate the complex regulatory landscape and can help shape deals with local authorities.
And finally, be flexible in structuring deals. Instead of demanding the transparency and control that firms are used to in developed markets, foreign companies should be willing to craft creative deals that meet government priorities. For example, instead of insisting on full control over operational details such as train scheduling, companies can obtain decision rights over priority train paths.
By getting in early and shaping how this nascent market develops, foreign players could position themselves to capture a disproportionate share of the value.
Evan Auyang is an associate principal with McKinsey's Travel, Infrastructure, and Logistics Practice in Hong Kong.
