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.