The last two weeks have been dominated with news of the situation at Jet Airways. With an Rs 1,500 crore cash infusion from banks, the industry, stakeholders and customers alike have got a bit of breathing room. But this may only be temporary. For Indian aviation to truly shine structural changes are required. Failing to introduce these changes, the industry will be having similar debates in the months and years ahead. What are these changes?
High tax on Aviation Turbine Fuel (ATF)
For Indian carriers, ATF constitutes 35% - 40% of an airline cost base. It is one of the largest expense items and unfortunately the pricing of ATF in India is based on import parity rather than on the basis of actual cost (including refining and marketing). The industry has long demanded that ATF taxation be rationalized but no such move has been initiated yet.
In spite of the GST tax implemented in 2017, ATF continues to be out of the purview of GST leading to incredibly thin margins of 2% - 4% in the industry. Compare this to putting one’s money in fixed deposits which are yielding 7% - 8% and the gravity of the situation is highlighted.
Aviation Turbine Fuel (ATF) tax policy continues to impact airline margins and thereby business continuity and sustainability. This is an item that must be addressed.
From 44 million domestic passengers in 2008 to 121 million domestic passengers in 2018, Indian aviation has come a long way. This growth is forecast to continue with India becoming the 3rd largest aviation market by 2030. But to sustain this growth, airport capacity is required, but airport expansion is lagging far behind.
Airport capacity now poses an imminent threat to Indian airlines. The country has a total of 449 airports but metro airports continue to be key to aviation traffic with 61% of the domestic traffic and 73% of international traffic still originating from the 6 metro cities of Delhi, Mumbai, Bengaluru, Hyderabad, Kolkata and Chennai. With the exception of Bengaluru which will see the addition of a new runway this year, the capacity expansion at other airports lags behind or is non-existent.
For airlines, this means that they are forced to fly unviable routes. And for passengers, this means that fares in constrained airports will inevitably rise.
The near term solution around this is to address efficiency. Specifically, working collaboratively with technology and procedures that allow for more aircraft to fly in and out of existing airports.
Taxation on Maintenance and Repair of Aircraft (MRO)
Other than ATF, the other large expense item for airlines is the maintenance and repair (MRO) of aircraft. Taxation on MRO is also a cause for concern. Maintenance and repair taxation in India remains the highest globally. With an 18% GST levy, providers have to compete on the sale price with overseas players that only pay 5% - that too at cost price. This gap works out to 20% - 22% with the result that most airlines contract their maintenance overseas leading to a loss of jobs and output.
MRO setups are capital intensive and require significant investment in terms of infrastructure, material, training of manpower and technology. Sadly foreign carriers have leveraged on this while India lags behind. Indeed, if you want to see India’s best engineers – you have to travel outside the country.
The tax policy has led to airlines to outsourcing majority of the $1.4 billion MRO business to international providers. The regulatory argument is that any relief given to aviation will lead to demands by other industries for similar relief. But that is not a solution.
This situation is simply not sustainable in the long run.
Financing Options for Airlines
For expansion, businesses need capital and the cost of that capital has to be competitive. This has been the intent of the Indian government with the NPA clean-up and the introduction of the insolvency and bankruptcy code.
An unintended consequence has been that lending to aviation has become severely constrained – both due to the history of Indian airlines and the low margins of the industry. Even so, Indian airlines are sitting on tremendous fleet orders as listed in the table below. And these orders and expansion require financing.
Some airlines have gotten around this using the sale-and-leaseback mode. This is where an aircraft is sold to a lessor at a profit and leased back to the airline for a period of 6 – 8 years. Others have followed suit and as of now, this remains an attractive financing measure. Yet it is a model where the aircraft (asset) is not owned by the airline.
Consequently, the balance sheet has few assets and banks cannot secure their lending against any asset base. Additionally, this measure only helps the financing of the aircraft and not funding for expansion.
In spite of being a key growth market in Asia, private capital is reluctant to enter the aviation industry not only because of the challenges highlighted (ATF taxation, constrained airports, MRO taxation) but also due to the legal procedures where contract enforcement is challenging at best.
There are no easy fixes here. Innovative financing measures and more pro-active measures such as looking at provisioning levels seem to be the way forward.
Taxation as a luxury and regulation as a commodity is not sustainable.
“161 million people travel by rail each week compared to 121 million that traveled by air in 2018“
The term “rail-air parity” is often heard in the context of Indian aviation. That is where airfares are at similar levels as railway fares (in AC1 and AC2 categories) - in many cases airfares are lower than railway fares. This has the effect of stimulating additional traffic which otherwise would not have traveled by Air and airlines are counting on the fact that one a passenger travels by Air s/he is likely to stick to this form of travel.
However, the rail-air parity is an after-effect of intense competition and not a core element of the aviation industry. As airfares rise one has seen committees and discussions on curbing the rise in airfares. This is commendable but when viewed holistically, it follows that there should also be a curb in the rising input costs. On this front, the demands from airlines are found wanting.
Intervention in airfare pricing is a mixed signal at best. A traveler should always have the option of choosing rail, road or air and the most competitive offering should win. The explosion of app-based taxi’s and buses has led to road-travel becoming an extremely viable option on short distances such as Mumbai-Pune, Delhi-Chandigarh and even Bengaluru-Hyderabad. For longer distances, trains have become a great option with increased availability, modernization of rail stations and a focus on passenger convenience.
The best way to ensure competitive fares: focus on a level playing field, connectivity, and competition.
As India positions itself to lead Asia and play a dominant role globally, the aviation sector cannot be overlooked. With a growing middle class of 300 million+, a trend towards urbanization, increased travel demand, a rising propensity to spend, and significant capacity entering the market – all key factors for aviation growth are aligned.
But for this growth to materialize sustainably structural changes are required.
(The author led the advisory and research teams at Centre for Aviation (CAPA). Views expressed are personal.)