What’s clipping our wings?

Source : Bloomberg News

The Indian civil aviation industry, with a size of $16 billion, is among the top 10 globally. It has grown at a CAGR of 17%, which, if sustained, could make it the largest aviation market by 2030. Entry of Low Cost Carriers and thrust on development of modern airports has expanded the market from business class and corporate to the middle class, who have the potential to become the largest and most lucrative customer segment.

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Figure 1: Indian commercial aviation sector

The Make-In-India program is designed to facilitate investment, foster innovation and build manufacturing infrastructure in a number of key segments that are instrumental in India’s growth and progress. In the aviation sector, the government has announced a number of key policy initiatives, such as 100% FDI in greenfield airport projects and 49% FDI in domestic passenger airlines, along with budgetary support in terms of investment and exemptions. However, there exist a lot of regulatory and taxation hurdles for airline companies in India, and measures need to be taken to support the development of the aviation sector in India.

Essential Air Services Fund (EASF): Connectivity between Tier-2 and Tier-3 cities is low due to air carriers refusing to operate flights on those routes as they perceive them to be unprofitable, due to low volumes. A proposal exists, for airlines to contribute a percentage of each ticket sold to a common fund which can be used to cross-subsidise air travel on unprofitable routes. This is similar to a fund in the telecom sector where operators contribute 5% of their gross revenues to a universal service obligation fund, which is used to provide telephone connectivity in rural areas. A similar policy in aviation would enable increase in connectivity on less busy routes.

Modification of the 5/20 rule: Currently, Indian airlines are required to have a minimum fleet of 20 aircraft and 5 years of operational experience to start international services. This serves as a deterrent for new entrants, who want to operate flights in the more profitable international segments. Instead, the policy can be modified to allow airlines to accumulate flying credits by deploying capacity on domestic routes, with additional credits for providing connectivity on routes deemed unprofitable. Also, the minimum operational experience requirement can be revised to one year. This will help improve domestic connectivity and attract more entrants in the aviation space.

Fuel taxation: High tax rates of 3-30% on Aviation Turbine Fuel (ATF) have made ATF in India 60% costlier than that available in ASEAN countries. Along with state and central taxes on ATF, there exist service taxes on air tickets and high airport charges, which are throttling Indian airline carriers’ competitiveness and adding to their debt burden. A comprehensive look at the taxation policies is required, with reduction in extra taxes.

MRO taxation: Airlines in India spend 13-15% of their revenues on Maintenance, Repair and Overhaul (MRO), making it the second largest cost component for airlines. Myopic policies regarding indirect taxes such as VAT and Service tax, along with laborious customs procedures regarding import of spare parts and consumables, has led to most airlines flying empty aircrafts to MRO facilities in foreign countries for servicing. Merely 5-10% of MRO work for domestic carriers is carried out in India. This represents a huge lost opportunity in terms of revenue and jobs. A task force needs to be set up to review the policies and modify the taxation regime to develop the domestic MRO industry.

Infrastructure development: There has been a thrust on development of infrastructure, particularly new airports, but there needs to be focus on developing low-frill airports under Public-Private-Partnership schemes. Also, a key impediment to growth of airline capacity in India is lack of availability of hangar space at key international airports, which needs to be addressed.

While the initiatives under the Make-In-India program serve as a good starting point, a comprehensive overhaul of aviation policy is required to achieve the growth targets and make Indian aviation competitive from a global standpoint.

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Arundhati Hazra is a second year student at IIM Ahmedabad. She graduated from NITK Surathkal with a B.Tech in Electrical and Electronics Engineering, and worked for three years, in ST-Ericsson and AMD, before coming to IIM Ahmedabad. She enjoys reading, writing and quizzing. She interned with McKinsey and Company during summers.

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Indian Aviation Industry: In-Flight Turbulence

2012 may be remembered as the darkest year for the civil aviation industry in India. The difficulties being faced by Kingfisher Airlines and Air India and their consequences well represent a delicate moment for the entire sector. Analysts had started to look at 2013 as the year of the recovery.  However, one thing was clear last year: business models of the major carriers were not sustainable, structural changes were needed in the industry.

APPARENT RECOVERY

In the first week of June, the DGCA (Directorate General of Civil Aviation) released the official passenger statistics for the first 5 months on the year. The overall image was of a weak recovery in the number of passengers.

Aviation 1

Passengers carried by domestic airlines during the period Jan-May 2013 were 259.98 lakhs as against 258.08 lakhs during the corresponding period of previous year thereby registering a growth of + 0.74%.

Some sector experts described these results as the beginning of a new sustainable growth trend for the industry.

The factors taken into account to support such optimism related to the fact that the Indian market is severely under-served, with less than 3% of its population utilizing the air route. Market potential is huge, and with the increase of the income per capita, demand is expected to grow at a double-digit pace in the next 10 years. According to the IATA (International Air Transport Association), by 2020, traffic at Indian airports is expected to reach 450 million, making it the third-largest aviation market in the world. However, the present reality is very distant from these expectations.

STRUCTURAL PROBLEMS

Aviation 2

According to the DGCA, India’s air passenger traffic fell by 1.84% in June from a year ago, going from 5.10 million passengers in 2012 to 5.01 million in 2013. In order to face the declining demand, all the major airlines have decided to lower or at least not increase the airfares. In particular, full-service airlines like Jet Airways and Air India have consistently dropped their fares to match those of low-cost carriers. On the other hand, IndiGo and SpiceJet are trying to keep the fares at the same level as 2012. Even though ticket fares are on average almost 20% lower this year than in 2012, no positive effect in the demand is registered.

However, demand stagnation seems to be only one of the several structural problems affecting the industry. There are a number of other critical challenges facing airline companies:

– Taxes are everywhere in India’s aviation sector, a clear indication that the government views the sector as a revenue source rather than a revenue generator. In contravention of International Civil Aviation Organization (ICAO) policy, India’s Ministry of Finance has put a service tax on tickets as well as landing and navigation charges.

– Fuel accounts for the 45% of Indian carriers’ operating costs, compared to the global average of 33%. With the presence of 8.2% excise duty, taxes are again one of the sources of disadvantage. The recent devaluation of the Rupee, and the consequent higher cost of the dollar (oil currency), is further aggravating the situation.

– Indian airlines are starved of skilled workforce. It is estimated that Indian aviation will need about 350,000 new employees to facilitate growth in the next decade. Shortfalls in skilled labor see staff salaries rise above inflation, adding further cost pressure. Given this situation, robust training programs will be the key to a sustainable future.

WORKING TOGETHER

Looking at the structural problems listed above, it seems clear that a change plan is needed. The aviation industry supports close to 0.5 % of Indian GDP, and in an emerging economy like India the need for connectivity is critical to facilitate the growth of trade and tourism. The development process of the country is at stake.

For this reason a coordinated approach, involving the government, airline companies and infrastructure developers, is urgently required. Some points that need to be developed in order to address the central challenges of infrastructure, costs, and taxes are:

– Ensure collaboration between the Ministry of Civil Aviation, other related ministries, regulators and the industry and promote other sectors that can both support and benefit the aviation sector

– Reduce fuel sales taxes. The long-term benefits on terms of higher economic activity and employment generation would more than compensate for the notional loss of tax revenue in the short run

– Establish a world-class National Aviation University and promote private sector investments in training academies to produce highly-skilled human resources

– Implement recent policy decisions such as the 49% Foreign Direct Investment limit, and establish safeguards to prevent excessive and predatory ticket prices.

Aviation 3

This last point seems to have central role in the future dynamics of the industry. Etihad Airways, the national airline of the United Arab Emirates, can be considered the pioneer of this future trend, buying a 24% stake in Jet Airways. This acquisition represents the first foreign investment in India’s airline sector since ownership restrictions were eased on March 2012. The deal, that is expected to boost the fortune of Jet Airways, has faced political opposition in India, driven by the fear that it may hurt national carrier Air India.

Many sector experts see these initiatives as the factor that can make the difference for the future of the Indian aviation industry. Top international players such as Etihad can transfer specific knowledge and best practices, improving domestic partner’s efficiency and marketing capabilities.

However, as highlighted before, the progressive internationalization of the India’s domestic airline industry needs to be coupled with structural changes, involving the government and other firms operating in related sectors.

Only a common effort by all the parties involved, would allow India’s carriers to get out of this turbulence and start to fly high.

Laviero Satriano is a Dual Degree student at Bocconi University and IIM Ahmedabad and a member of the consult club. Before coming to IIMA, he had an internship at The American Chamber of Commerce of Texas in the USA, and he was responsible for a volunteering project in Uganda. He holds a Bachelors of Management and Business Administration at Bocconi University.

Low-Cost Carriers tranforming Indian aviation

The aviation sector is often believed to be in very close correlation with a region’s economic growth and prosperity. In parallel with rapid globalization and India’s recent growth story, the Commercial Aviation sector in India has witnessed a paradigm shift over the past two decades. It has changed from an over regulated, monopolized and ill-managed sector to a liberal and investor friendly playground. In 1953, nine existing companies were transferred to two government run entities: Indian Airlines (serving domestic routes) and Air India (serving international routes. From such a nationalized beginning the sector gradually opened up and 1992 was marked with the government deregulating India’s aviation sector. This marked the beginning of a new era in Commercial Indian Aviation where private airlines flourished and air travel came of age.
Simultaneously, on the global picture, dynamics of the aviation sector in the international market changed drastically with the introduction of Low Cost Carriers (LCCs) like Southwest Airlines (USA) and Ryanair (Europe). It was finally in 2003 that the launch of Air Deccan marked a beginning for Low Cost Carriers in India. This led to a reincarnation of air travel in India from “for the elites” to “for the people”. Ever since Air Deccan started the revolution, many such players have entered the industry and they continue to flourish with rapidly climbing revenues and air traffic figures.
Through a broad view point, the Indian LCCs have emulated their international counterparts who achieved success much earlier but there have been considerable efforts to include the Indian pulse.

Low Cost Carriers in India: Business Model

The LCC model is not just about low fares but also about more efficient operations and a constant drive to reduce operational costs. Very plainly, LCCs represent a leaner and fitter organization. The entire structure rests on the important principle of volume gain, no-frill plain travel services and an aim to commoditize air travel for the common man. Their operations are characterized by low margins and load factors are crucial for profitability.

Growth Drivers

Passenger Growth:  Airline passenger growth is generally related to the GDP of a country. It is seen that air transport grows at twice the rate of GDP growth. The international passengers have grown by around 16% and the domestic passengers have grown by over 22% over the years. Air travel has increased a lot over the years because of multiple reasons. Some the important ones being:
  • Increase in inbound and outbound tourists and medical tourism
  • Over 300 million strong middle class which can be tapped as a potential passenger and can be drawn away from railways.
  • Disposable incomes are expected to grow at an average rate of 8.5% per annum till 2015, which shows willingness on the part of passengers to shift to air travel.
Passenger Growth Data
Low Entry Barriers: Recent analysis in the sector has suggested that airline launch can be done with a capital of $10 million. Most of the components of air service ground handling; catering, training, reservation etc are outsourced by airline companies. Costs are further reduced by recruiting retired personnel from the Air force or PSU airlines in senior positions.
Economic factors:  The economy of India in the recent past has played an important role in giving a boost to many sectors in the country out of which aviation is a prominent one. The economy of India is growing steadily at about 9% per annum which has led to overall prosperity, growth and investments. More and more players want to be part of the aviation sector and offer better deals and better deals and service to the passenger.

Strategies adopted by different LCCs in India

Differentiation: The LCCs in India are mainly characterized by low fares but are positioned very differently in the market. They offer different value propositions to the customer and this is a major factor in the success of one airline over another.

Differentiation Strategies:
  1. IndiGo (http://www.goindigo.in) – On time performance guaranteed. Even at low fares.
  2. Spicejet (http://www.spicejet.com)– No Frill plain vanilla air travel at cheapest rates.
  3. Kingfisher Red (http://www.flykingfisher.com)– Value added services like snacks at LCC fares.
Market Share Distribution
Conquering the rail market: The demand potential for LCC air travel is huge. As of today, Indian railways carry about 17 million passengers every day which is more than what Indian Airlines carry in a year. Even a small percentage of it if attracted to LCCs will generate enormous revenues for the carriers. It is also observed that 20% of the railways’ revenue is generated by upper class travellers and that is exactly where LCCs wish to target their marketing campaigns.
Consolidation: Being an extremely competitive industry, the aviation sector has seen a fair amount of consolidation. In the near past we have seen lot of activity happening in this sector when it comes to consolidation. The Jet-Sahara deal and the Kingfisher-Air Deccan deal for example define the dynamics of the industry. These consolidation activities have been a direct result of the introduction of the concept of LCCs.

Impact of Low Cost Carriers on Indian Aviation

From an era of natural monopoly dominated by the state-run Air India and Indian airlines to a hypercompetitive industry that is integral to India’s vision for growth; the aviation industry has evolved and so have the business practices and industry dynamics. In addition to the liberalization by the Indian government in 1990 which allowed private players to enter the aviation sector, the introduction and establishment of Low Cost Carriers – as discussed in previous sections – has been a significant game changer. 
Impact on passenger traffic
The development of LCCs was well supported by the policy changes that happened simultaneously viz. Increase in FDI Cap, Encouragement of development of airports and infrastructure, allowing private carriers to operate overseas etc. The increase in passenger traffic was enormous and unexpected. Domestic passenger growth in the aviation sector was about 11 percent in 2003-04 but saw a massive increase to 25 percent in 2005.
A micro level representation of impact of low cost carriers in India can be seen by the effect of Air Deccan flights on the Delhi-Guwahati route. Soon after Air Deccan’s launch the average load on the Delhi-Guwahati route grew from 162 passengers a day to 215 passengers a day and average fares plummeted from INR 6000 to INR 4000. 
Impact on fleet sizes and seat capacity
The increase in passenger statistics due to evolution of LCCs has had a direct impact on capacity expansion in the aviation sector. Fleet sizes, routes and available seat capacity have grown tremendously. The increase in traffic on air routes has opened up opportunities that allow scalability in operations and thus airlines have been increasing fleet sizes. At present India accounts for more than 11% of global aircraft demand which is huge considering the low penetration of air transportation in India. 
Impact on Air Fares
As a fundamental of the LCC business model the average air fares in India have dropped considerably. Low fares are aimed at higher penetration levels and at commoditizing air travel. LCCs consistently offer 10-40% lower fares than FSCs. Low fares have been the most important factor in the success of LCCs in India. However, the LCCs face constant pressure on fares due to variability issues in demand and ATF prices. 
Impact on Full Service Carriers (FSCs)
Rise of LCCs has had strong impact on FSCs in Indian airspace. The popularity of the initial LCCs such as Air Deccan forced the FSCs to rethink their business moves and induced stiff competition between the airlines. Fares have been the main point of competition. Although the FSCs viz. Jet Airways and Kingfisher airlines are still preferred over LCCs for the quality of service, the economical flying segment demonstrates much greater growth rates for the years to come. The LCC phenomenon led to Jet Airways launching its own all economy class airline JetKonnect which is aimed at competing with the LCCs.
The LCCs have also proven to be robust and easier to sustain than FSCs during business downturns that have been more frequent than ever before. Even during the financial crisis, among volatile ATF costs and a bleeding aviation sector, LCCs fared decently well and performed much better than heavy debt laden FSCs who continue to make losses.

Airline Debt Restructuring Plan

The Indian airlines industry exhibited explosive growth in the period from 2003 to 2007. Thousands of passengers started flying for the first time, drawn by new airlines offering bargain flights around the country. However, the industry was hard hit by the economic crisis in 2007-08. Passenger growth, which was touching 40% at the onset of 2007, went into reverse. Soaring fuel prices in 2008 pushed up ticket prices, which further reduced demand.

The three major players in the aviation sector in India – Jet Airways (India) Ltd, Kingfisher Airlines Ltd and National Aviation Co. of India Ltd (NACIL)—which collectively control 65% of domestic passenger traffic, were the worst affected. The three airlines currently have a combined debt of $13.5 billion (Rs63,315 crore). State-owned NACIL runs Air India. Other than the exogenous factors, poor managerial decisions including predatory pricing by the larger players and underutilization of capacity were prime contributors to the huge debt.

Factors Leading to the Debt

Kingfisher Airlines is labouring under a debt burden of Rs 7,413-crore (as on December 2009). Out of this, Rs 2,099 crore is short-term debt; the remaining amount being long-term debt. Subsequent to its launch in 2005, the first year and a half went quite smoothly for the airline. A lot of Jet passengers shifted allegiance and joined Kingfisher and the company registered rising profits. However, it spent money like water on onboard service and brand building; neglecting costs altogether. Things began to go downhill soon after the airlines a stake in Air Deccan in June, 2007. Not having a CEO further exacerbated the airline’s problems.

2008 proved to be the final straw in its operations, and as oil prices hit new highs, so did the merged entity’s problems. By end March 2009, the airline’s debts had touched over a billion dollars. Senior executives were also at loggerheads with oil companies, vendors and the Airports Authority of India.

Jet Airways is slightly better off than its rival. Although it has a debt of Rs. 14000 crore; short term debts constitute only a small portion of that amount. In 2009, Jet’s domestic revenues were 37% higher and profitability was superior to Kingfisher due to a higher share of full-service carrier operations, while the higher proportion of low-cost operations in Kingfisher’s operations dragged it down.

Furthermore, aircraft ownership is a key difference between the two airline companies. Jet owns 39 aircraft against 21 owned by Kingfisher Airlines. Difference in fleet ownership is reflected in Jet’s higher debt levels. As per Jet’s management, 85-90% of the debt is towards purchase of aircraft at long term interest rates of 5-7%.

In an effort to minimize losses, Jet entered into sale-and-lease-back of its aircraft, or the ability to sell off the aircraft it purchased and continued using them for a rental fee.

State-run Air India, which enjoyed a monopoly in the country till the deregulation of the aviation sector in 1991, is besieged by a debt of Rs. 40000 crore. One of the major factors for this colossal figure is over employment of labour. The airline has a workforce of 31,000; which translates into 230 employees per aircraft. According to international standards, the number should be 100-150 employees for every aircraft.

Another major reason for the spiralling debt are the massive aircraft orders placed by the beleaguered firm with aircraft makers — 68 with Boeing and 43 with Airbus. The orders were placed when the country was beginning to witness an aviation boom, but the figures were overestimated even according to the heydays. The orders cannot be cancelled now; since cancellation entails a hefty penalty, which the airline is ill situated to bear. Poor capacity utilization is another major issue for the national carrier, with over 40% of seats going unoccupied in 2009.

Braving the Storm

In June this year, SBI had approached RBI with a proposal to restructure more than Rs2000 crore of Kingfisher’s debt. RBI declined to clear that proposal as it was not comfortable with the idea of giving any special concessions to any particular aviation company. In an 18 June meeting with bank executives, the central bank noted it would be a moral hazard for RBI to give any regulatory forbearance for any specific company. It was made clear that any regulatory consideration of banks’ requests regarding restructuring guidelines could only be for the aviation sector—and not for any airlines in isolation—in view of the difficulties faced; and provided the banks came together in a consortium arrangement and took a long-term and holistic view on the restructuring.

This prompted the bank to put forward the case of the entire airline industry rather than that of a particular firm, which was approved by the RBI in September. The proposal asks for conversion of the short-term loans into long-term ones and then extending the repayment schedule to nine years, with a one to two-year moratorium. SBI’s investment banking arm, SBI Capital Markets Ltd (SBICaps) is working on the debt recast plan, leading a consortium of 13 banks.

The most significant beneficiary of the recast would be Kingfisher Airlines, and will get a much needed respite from the payment demands of various lenders including oil companies and airports. With the restructuring, more time would become available for repayment of loans and its operations would not be encumbered by the cash crunch. Other options like raising money overseas or diluting equity to raise cash could also be explored. In the fiscal ended March, the airline also reduced its losses to almost half of those posted in the previous fiscal. This improved performance was achieved through better seat occupancy and cost reductions.

While the airlines are talking about cost-cuts and route rationalizations to turn things around, Jet Airways posted a profit in the current fiscal year through a number of innovative strategies. These include improving aircraft utilization efficiency, increasing flights on existing and new routes without adding new aircraft, reducing the weight of flights to scale back fuel expenses, and launching a second low-cost carrier; by converting some of its full-scale flights into a no-frills all-economy service under the brand name of Jet Konnect. Jet Airways has also sought approval from the Foreign Investment Promotion Board (FIPB to raise $400 million via qualified institutional placement (QIP) to repay debt and augment capacity.

Air India’s debt of Rs. 40000 crore is a different story altogether. More than any proposed debt restructuring, measures taken by the government in terms of equity infusion and guaranteed loans would have a larger impact on the public sector carrier. However, the government has hinted that the airline should generate more funds through better passenger yields and cost-cutting, instead of expecting further bailouts.

Is the Restructuring Justified?

In the past, the government has extended support to crisis hit sectors such as real estate and steel on previous occasions, and there is no reason not to provide the same to the domestic airlines. However, the debt recast should come with certain riders. A major cause for the heavy losses was the overcapacity inducted by the airlines and the undercutting that followed.
They should commit to keeping costs under leash and run their operations with maximum efficiency. The debt restructuring also makes sense from the banks’ point of view. Big players like SBI have an exposure of over Rs. 3500 crore to the industry. RBI’s move would help provide relief to banks as they would not have to classify airline-sector loans as non-performing assets (NPAs), giving them an opportunity to contain the growth of NPAs, while airlines would get some breathing space to repay their loans and would not be compelled to raise costly debt to continue operations.