FDI in aviation must be backed with reforms in the sector

Thanks to the government's decision to allow foreign airlines to acquire up to 49% stake in domestic airliners, the possibility of Indian passengers flying in a Lufthansa or Etihad on Mumbai-Delhi route has become realistic. Yet it may not materialise on the ground due to structural issues that have marred Indian civil aviation sector for long. Unless that’s sorted out, systemic issues may continue to plague the sector in the short-to-medium term.

The government’s move is expected to bring strategic investors into the sector (earlier restricted to non-airline investors) at a time when most domestic carriers are in dire need of capital to reduce accumulated losses and mounting debt levels. Isn’t it a bit naive to think that foreign airlines will buy stakes in loss-making domestic carriers at a premium, factoring in high fuel and operational costs?

That the feeling is palpable among top policy circles, has been confirmed by none other than Aviation Minister Ajit Singh. While taking a long-term view on the growth prospect in the sector, Singh accepted that merely allowing foreign carriers to invest in India may not solve the problem.

No one wants to jump on board a sinking ship. At present, Indian carriers with losses running into thousands of crores are akin to a sinking ship with an uncertain future on returns. Take for instance, in the last reported financial year (2011-12), Jet Airways, India’s largest carrier by market value, reported a loss of Rs1,236 crores. The Kingfisher’s losses stood at Rs2,328 crores while Spicejet posted a loss of Rs605 crores. On top of it, Jet, Kingfisher and Spicejet’s balance sheets are highly leveraged with debt of Rs13,500 crore, Rs7,057 crore and Rs860 crore respectively.

To compound the matter, the financial situation of international carriers doesn’t inspire faith. In the last reported financial year, major international airlines posted losses – Qantas ($253 million), Lufthansa (13 million euros), Air France-KLM (809 million euros). However, airlines like Singapore, Air China, Emirates saw decline in their profits by 69%, 43%, 72% respectively to 269 million dollars, 1121 million dollars, 409 million dollars respectively on yearly basis.

If merely finances of aviation companies were in bad shape, one could have suggested fire-fighting as an option. But what renders grim look to the whole sector is the restrictive and retarding environment in which airlines have to operate. Even International Air Transport Association (IATA) has expressed its reservation stating that unless issues of high taxes and infrastructure costs are addressed, sector may struggle to take-off despite allowing FDI.

In India, aviation turbine fuel (ATF) constitutes around 45-50% of the total operating cost of an airline as compared to the global benchmark of 20-25%. To expect Indian domestic carriers to remain profitable even after paying 50% more on ATF than their global counterparts is unfair. Even international airlines have to pay nearly 15% more for refilling in India. The ATF prices in Delhi were reportedly at Rs73,711 per kilo litre – an almost eight year high figure.

The high cost of ATF is attributed to the country’s severe taxation policy. ATF is a decontrolled petroleum product and the price of ATF is reviewed and fixed by oil marketing companies on a fortnightly basis at par with the international crude prices movement. But what make ATF dearer in India is the variable sales tax rates ranging from 4 to 30% across states. The increase in ATF price raises the component of tax in that ratio, making the fuel even costlier. Such irrational tax structure eats into the profits of domestic carriers, making airlines in India unattractive for equity capital.

The silver lining, however, is that the idea of rationalising duty structure on ATF is gaining currency. The aviation minister has written to the oil ministry to bring ATF in the notified category. If that happens, the sales tax would drop to 4%. In addition, the Directorate General of Foreign Trade (DGFT) has also allowed import of ATF by airlines. But lack of infrastructure impedes substantial progress in this regard.

To further compound the matters, high airport fees haven’t helped the cause of domestic carriers. In April 2012, Delhi International Airport Limited (DIAL) hiked airport fees by almost 344% drawing flak from various quarters including international airlines. It has increased the burden on air travellers. The cascading effect of the move in recent months is net decline in passenger traffic. In August, the passenger traffic has declined by three% on month-on-month basis. Earlier, it had declined by 11.8% and 5.6% in July and June respectively.

While FDI is welcome, Indian aviation sector will remain underutilised unless accompanying policy and infrastructure reforms are undertaken. The time for procrastination and squandering opportunities is over.