GAME THEORETIC ANALYSIS OF PRIVATE PARTICIPATION IN

INDIAN RAILWAYS
KARTIKEY BHARGAV
1. INTRODUCTION
Indian Railways is an engine of economic growth of the country that requires
continuous flow of funds and technology for its infrastructure and modernization.
The resource challenge facing the Railways has led to greater focus on alternative
financing mechanisms. Ministry of Railways wishes to attract private capital for
accelerated construction of fixed rail infrastructure. Globally, rail sector has found
limited success with Public Private Partnership (PPP). However, the successful
experimentation on Indian Railways has facilitated preparation of investor friendly
PPP models which balances the interest of Government and private sector.
2. ADVANTAGES OF PRIVATE PARTICIPATION:
1. Ensure timely development of & returns from rail infrastructure.
2. Develop more sustainable & environment-friendly mode of transport.
3. Boost up business activities in & around ports, industries & other remote
areas.
3. PRIVATE PARTICIPATIVE MODELS
Although there are several frameworks for implementation of rail infrastructure
projects, we will analyse two of the models through the lens of Game Theory:
1. Joint Venture (JV) Model
2. Build-Operate-Transfer(BOT) Model
Throughout the whole study, the terms government & Ministry of Railways ca be
used interchangeably.
1

Key Terms : Joint Venture, Bayesian Games, Build-Operate-Transfer, Concession

Period, Bargaining Game Theory

4. JOINT VENTURE MODEL

When should the government prefer private over public development?
In private development, the possibility of the project getting defaulted (fail to pay
back) limits the amount of investments required for the project. Also, the motive of
the private developer is to maximize its own profits, without bothering about the
total social surplus.
In public development, the consumers can directly observe actions & form beliefs
about the quality of the government. This may force the government to take up
decisions in favour of the public (increasing the total surplus), but such decisions
could be economically inefficient. This also implies why government continues with
the projects which should be terminated on economic grounds.
So, there is a trade-off involved between private & public development, & we will
try to analyse this trade-off using game theoretic model.
4.1. PROBLEM STATEMENT:
We want to make a model for joint venture between private & public sector to
determine the optimal points at which public sector (government) goes forward
with the JV. We will model this strategy using Perfect Bayesian Game, wherein the
amount of investment (as a measure of seriousness) by private firm is used as signal.
4.2. GAME THEORETIC MODEL:
PLAYERS:
1. Private developer (P) of two types-Benevolent(B) & Corrupt(C)
2. Government (G)

ASSUMPTIONS:
1. The profit of government lies in increasing the consumer surplus.
2. The venture with corrupt developer generates low profits, & takes up all the
profits with her.
3. Successful JV with a private developer gives more payoff to the government
than continuing the development with public sector.
4. Small amount of investments by the private developer gives more profit to her
than large amount of investments.
5. Termination of venture implies public development.
ACTIONS OF THE PLAYERS:
P:

LB-Low Investment by Benevolent developer

LC-Low Investment by Corrupt developer
HB-High Investment by Benevolent developer
HP-High Investment by Corrupt developer

G:

FH- Go forward with the venture when developer invests high

FL- Go forward with the venture when developer invests low
TH- Terminate the venture when developer invests high
TL- Terminate the venture when developer invests low

BELIEFS:
G believes that

Pr( |B)
(Pr( |B) + Pr( |B))

Pr( |B)
=
(Pr( |B) + Pr( |B))

Nature choses the kind of developer with

Pr(B) = n
PAYOFFS:
G:
Goes forward with B = S (Consumer surplus gained by successful venture)
Goes forward with C = 0 (Nothing gained by the consumers)
Terminates the venture = s (Consumer surplus gained by public development )
S > s (Assumption 4)
P :
If G goes forward with the venture (F) Profit gained by LB & LC = (More profit with low investment)
Profit gained by HB & HC = (Lower profit with high investment)
>
If G terminates the venture (T) - Profit gained by HB, HC, LB, LC = 0

EQUILIBRIUM ANALYSIS :
Perfect Bayesian equilibria
Pooling equilibria:
Strategy : HBHC
Using Bayes Rule, q = n
Payoffs of G:
F : qS G : qs + (1-q)s = s

If q , best response of G is T

Thus, when n there is pooling equilibrium in which q = n &

((HBHC),(THTL)) is played.

If q , best response of G is F. But since > , P will not play H in first

place.
Strategy : LBLC
Using Bayes Rule, p = n
Payoffs of G:
F : pS G : ps + (1-p)s = s

If p , best response of G is T

Thus, when n there is pooling equilibrium in which p = n &

((LBLC),(THTL)) is played.

If p , best response of G is F. In this case, P will prefer to play L in first

place. Thus, when n there is pooling equilibrium in which p = n &

((LBLC),(FHFL)) is played.

Separating equilibria :
Strategy : LBHC
This implies p = 1 & q = 0
Best response for G is FLTH
But action HC is not rational for P
Strategy : HBLC
This implies p = 0 & q = 1
Best response for G is FLTH
But action LC is not rational for P

Hence, there are no separating equilibria in this game.

There are three pooling equilibria in this game((HBHC),(THTL))
((LBLC),(THTL))
((LBLC),(FHFL))

5. Build-Operate-Transfer (BOT) Model

Build-Operate-Transfer (BOT) is a type of public-private partnership in which
the private sector builds an infrastructure project, operates it and eventually
transfers ownership of the project to the government. The private investor receives a
concession from the private/public sector to finance, design, construct, and operate
a facility stated in the concession contract. This enables the private investor to
recover its investments in the project.
5.1. WHAT IS CONCESSION PERIOD?
Concession period starts from the signing of the concession agreement between the
government and the private sector indicating the span of time within which the
private investor is responsible for the construction and operation phase of the BOT
project. Concession period ends at the point of time when the project is transferred
from private investor to the government.
5.2. WHY CONCESSION PERIOD?
During the concession period, the private party is responsible for construction,
operation, maintenance & collect fees/toll (within the boundaries of concession
agreement) to overcome debts involved during the project & make profits. As soon
as the concession period ends, the project is transferred to govt. for free or at an
agreed price. Therefore, it is crucial to determine optimal length of concession
period that will attract private capital & keep the interests of both the parties as
well. Hence, it is a key to determine the success of the BOT project.
5.3. VIABILITY GAP FUNDING
A government grants to a private partner a certain level of revenues during the
concession period, as a part of the total investment, to make the project viable. This
is called Viability Gap Funding (VGF). In this way the government increases the
7

surplus generated by the project, making the project less risky and more attractive
to private partners.
5.4. PROBLEM STATEMENT
We want to model the concession period negotiation for a project as complete
information cooperative bargaining game between the private sector and the
government. In the process of bargaining, private investor, at the price of harming
the interests of the government and the public, will try to lengthen the concession
period which will lead to better quality of infrastructure & better returns. On the
contrary, the government, in order to protect the interests of public & maximize the
returns (after the concession period), will try to shorten the concession period. But
this will deteriorate the quality of the infrastructure and increase the maintenance
costs after the project has been transferred. We will find out a unique Subgame
Perfect Nash Equilibrium for optimal concession period.
5.5. GAME THEORETIC MODEL:
PLAYERS
Government-G
Private Investor-P
ASSUMPTIONS
1. The two players, Government (G) & the private party (P) behave rationally

during the negotiation, i.e., both the players take account of all the possible
best responses available in order to minimize the risks & maximize their own
profits.
2. Both the players share common knowledge about the project being

undertaken.
8

3. No kind of unfair practices leading to unfair competition can be adopted by

any of the players.

4. The project life (once completed) is assumed to be (long-run project).

DECISION VARIABLES
: Revenue generated by the project from time n to time m
R0 : Initial revenue generated by the project
Cp : Concession period
I : Total investment required by the project
I : Viability gap funding from the government
: Growth rate parameter index
: Growth rate parameter base
: Discount Factor
ACTION OF THE PLAYERS
G : Accept (A) the offer made by P , Reject (R) the offer made by P
P: Accept (A) the offer made by G, Reject (R) the offer made by G
REVENUE MODEL
Marginal revenue generated by the project at time t = Rtt =

This implies- Rt(, ,t,a,b) = t

PAYOFFS

0 ( )

UG(R0, , , , Cp) = t I =

UP(R0, , , , Cp) = 0 t (1-)I =

I-------------------------------(1)

0 (1 )

(1-)I------------------(2)

EQUILIBRIUM : ( ( ), ( ))
ANALYSIS OF THE GAME
CASE 1 : FINITE HORIZON BARGAINING
The two players, G & P, bargain to determine optimal concession period. Adding
the payoffs of G & P, we get total utility to be split between G & P.

UT =

10

Thus, equilibrium value of & are determined by the split of UT, which is
implicitly related to the corresponding equilibrium value for concession period .
In the first round, G makes an offer to P, which P can accept or reject. If P accepts
the offer, The game ends, with the proposed split ( ) & ( ).
If P rejects the offer, the game continues to round 2.
In round 2, P makes an offer to G, & G decides whether to accept it or reject it.
A discount factor is a number used to deflate a payoff received in the next round
so that it can be compared with a payoff received in the present round.
Now consider the subgame starting at round S-1. P makes an offer to G in this
round. In any Subgame Perfect Nash Equilibrium (SPNE) G will accept an offer in
round S-1 iff it provides G a payoff of at least S-1UT, since otherwise G will do be
better rejecting it & waiting to make an offer in the next round. So P must make an
offer in round T-1 that gives G a payoff of exactly S-1UT, & G accepts this offer (
otherwise the rejected offer will result in receiving zero payoff for P). Thus, the
payoffs arising if the game reaches round S-1 must be (S-1UT, S-2UT - S-1UT).
Going on the same line, we can determine that the unique SPNE when S is odd
results in an agreement being reached in round 1, with payoffs () = T(1 + 2 - + S-1)
() = ()
CASE 2: INFINITE HORIZON BARGAINING
This case can be seen as a finite horizon bargaining game in which S. In this
game, we have a unique SPNE in which both the players reach an immediate
agreement in round 1, with G earning

1+

& P earning

1+

NOTE: The bargaining game can also be initiated by P but it wont change the
equilibrium value of .

11

EQUILIBRIUM VALUE FOR CONCESSION PERIOD

UG= =
UP= =

1+

1+

Thus, employing equations (1) & (2)0 ( )

0 (1 )

I =(

(1-)I =(

I )(
0

1+

I )(

1+

It can be seen that the above two equations are equivalent.

Solving the above equation, we get =

0 (1+)

log((

0 )+(1+)

APPLICATION: KONKAN RAILWAY CORPORATION LIMITED

Konkan Railway Corporation Limited was set up as a Public Sector Undertaking
under the Ministry of Railways in July 1990 to bridge the 738 km Konkan Gap by
providing railway connection between South Mumbai & Mangalore. KRC was
structured as a build - operate - transfer (BOT) project, with a concession period of
10 years.
Here, we implement the model developed in previous sections to find out the
optimal concession period.
PLAYERS:
G : Ministry Of Railways
P : Private Construction & Operation Firms (L&T, Gammons & AFCONS)

12

DECISION VARIABLES:
R0 = 320 Crores ( initial income )
I = 3375 Crores ( total investment )
= 0.51 ( investment from the Ministry of Railways)
= 0.072 ( based on inflation parameters)
= 2.16 ( based on market volatality)
= 0.83 ( assumed )
CALCULATION:
Using the above data, we get = 12.174 years
which is comparable with the actual value of concession period, i.e., 10 years.

CONCLUSION & FUTURE WORK

We have attempted to cast two models of private participation in rail infrastructure
using Game Theoretic models .These models can prove to be a good estimate in
framing appropriate & economically efficient policies. But the environment under
consideration is not always the same. The models developed above to analyse
various decision parameters are nave in the sense that they do not incorporate
many important parameters governing the policies & decisions.
This encourages us to step forward & improvise the techniques used to calibrate the
parameters, & develop more robust frameworks that will lead to more realistic
outcomes.

13