Will FDI Provide a Safe Landing to the Indian Aviation Sector?
Posted in Finance Articles, Total Reads: 3799
, Published on 01 January 2013
On September 14, 2012, Indian government opened its skies for Foreign Direct Investment (FDI) in the Aviation sector. Among other policy initiatives, the measure was announced by the government as it went into overdrive mode as far as reforms are considered. While FDI was already allowed in the sector, the current regulation was directed at the foreign airlines who are interested in buying stakes in the Indian Airlines, a measure which was previously prohibited.
The listed companies in the aviation sector had already factored in the reform in their stock prices as they saw a significant increase in anticipation of the reform. The reforms look good, especially when players in the industry are deep in the red and there are hardly any players that have posted profits in the near past. They would help these beleaguered firms to raise capital by selling equity to foreign airlines. But is this the complete story that is hurting the Indian aviation sector? It remains to be seen as the companies battle countless issues, both in the short term and the long term.
While the government in its capacity has allowed the entry of FDI into the sector, there is still a lot more that needs to be done to uplift the sentiment. To have a better view,let’s look at some of the problems that the industry is battling with. While no one can deny the immense potential growth in the sector, a close look suggests a mismatch between capacity addition and growth in the sector. In the period from January 2011 to January 2012, while the passenger traffic witnessed a growth of 12%, the capacity addition lagged behind at 3%. In recent times,the situation has been aggravated further from the cut down in operations by Kingfisher airlines. Another problem with the capacity addition is that, while certain trunk routes have capacity shortage, some other off beat routes have idle capacity. Due diligence in the allotment of route and fleet operation would go a long way in optimizing the operations. Along with the capacity load factor, many airlines struggle to meet the tight flight schedules and thus have a poor on time performance record.
Capacity addition is something that takes time to build up and is fixed in nature, but the operating aspect that is hurting the industry the most, is the high Aviation Turbine Fuel (ATF) charges. ATF forms close to 40% of the operating costs of the carriers and is thus hurting them the most.
The above data highlights the issue of domestic carriers at loss as they are being charged the highest for ATF. The Indian ATF prices are generally among the highest in the world, making operation of aircrafts all the more costly. The taxes and duties further imposed by state governments compound the problem. The price of ATF for International airlines is cheaper as the fuel supplied is deemed export and thus escape the myriad of taxes imposed on fuel for domestic consumption. Though the Indian government has given a go ahead to the airlines for direct fuel import, the issues related to the handling and storage of fuel have done little good as the airlines will have to rely on the existing oil companies. A reduction in duties will certainly provide some breathing space to the players.
High airport fees is another area where the Indian players are at the receiving end as they pay some of the highest airport fees in the world. The recent steep increase in airport fees at Delhi and the one proposed in Mumbai will exacerbate the problem. According to the GM of an eminent global airline, Airlines should be liable to pay for the usage of the airport as they use it, but asking the airlines to pay for the development of an airport and other allied facilities is unreasonable. Also the image of major airports (Mumbai and Delhi) promoted as hubs for international airlines is dented when they increase their airport charges. So in the end, not just the domestic players but the International Carriers also monitor the changes in airport charges closely.
When talking about the domestic aviation sector no one can ignore the white elephant of the industry, Air India. In spite of the numerous bailout packages and restructuring of the beleaguered player, it has failed to post any profits. The state carrier has failed on most of the fronts such as load factor, on time performance, efficient employment and others. While the performance of the airlines has been poor it has been trying hard to compete with others in terms of pricing. Their existsan intense competition in the industry and the pricing strategies of the players in the domestic Indian Aviation industry reflects this. Air India has off late been reducing its fares considerably and as a result the other players are following the suite, as they are left with few choices. This has not only inflated the debt of Air India, but also had a profound effect on the other players as the industry is witnessing a deadly combination of high costs and price based competition which can be lethal in the long term. Air India is also suffering from over employment when compared to major International and domestic players.
Coupled with these issues, the companies are facing acute shortage of funds and are not even able to meet their daily operational expenses. Most of them have already exhausted their credit limits and banks are now wary of extending more credit. So on paper, most of the players are not even worth Re. 1 as mentioned in a newspaper headline. According to a report the entire sector has loans worth Rs. 1,10,000crores, but the net worth of the sector is just 25 percent of the total loans and thus the sector is worth nothing when looked purely from the accounting perspective.
While problems are plenty for the sector, the FDI regulation will certainly provide some relief to the cash crunch players in the industry. The immense growth potential that the sector offers is one of the many attractive facts that would bring in foreign investments. Another major advantage for the Indian players is the operational expertise that the foreign players bring along with them. This will certainly help in optimizing the operations of the national players. The Indian Aviation industry is still in the development phase and will thus gain immensely from the experience of the other foreign airlines. Globally there have been many successful models of low cost airlines such as Air Asia, Ryanair, Southwest Airlines and others. These will certainly help their Indian counterparts in improving their operational efficiency and thus improve their bottom lines.
Also FDI will give a boost to the Maintenance Repair and Overhaul (MRO) industry that serves as the backbone for the industry. The current size of the MRO industry in India is US$800 million and is expected to grow to US$ 1.5 billion by 2020. The Indian players must now justify their positions so as to seem attractive for foreign airlines to infuse capital in them. For the Foreign Airline, this is a valuable opportunity to enter one of the fastest growing aviation markets globally and gain a substantial share in the market that is still developing. At present most of the foreign airlines are skeptical of entering the Indian market and watching every movement in the sector closely. As stated by Aviation think-tank Centre for Asia Pacific Aviation, "The floodgates of investment are unlikely to open in the short term but from the perspective of improving sentiment and demonstrating that the government is committed to supporting the development of a viable airline industry, this is a positive milestone". It thus becomes clear that FDI alone would not be able to rescue the Indian aviation sector as it faces a humongous task ahead. It has to be coupled with many other allied reforms in the sector to make the sector come out of the red.
This article has been authored by Varun Sanghi from MDI Gurgaon.
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