Aviation

7 vital issues in Indian aviation that are crying for the Modi government’s urgent intervention

Updated : August 26, 2019 03:36 PM IST

Tax on aviation turbine fuel is among the highest in the world, constitutes up to 40 percent of an Indian airline’s cost.

Significant investment in airports has gone towards making terminals which don’t quite suit the market demand.

As the NDA government begins its second term with a decisive mandate, Indian aviation continues its long wait for structural changes. Traffic growth has slowed on a month over month basis – the first time since June 2013. One big airline has collapsed. Add to this, a slowdown in global demand, a constrained lending environment, a strong dollar, rising crude and significant capacity induction, the picture looks bleak. These unfortunate turn of events call for urgent policy interventions. Below are seven vital areas in Indian aviation that are crying for attention:

Tax on aviation turbine fuel is among the highest in the world

Aviation Turbine Fuel (ATF) is the lifeblood of aviation. Indeed, ATF, or jet fuel, constitutes up to 40 percent of an Indian airline’s cost base and consequently, ends up as one of the largest expense items. Globally, this figure averages roughly 20 percent.

India’s airlines have pressed ahead on new technology, tankering, volume purchases and other actions that impact liquidity in order to offset the input costs. Yet, sadly, the industry has seen little respite on this front.

ATF continues to be out of the purview of the goods and services tax implemented in 2017, leading to incredibly thin margins of 2-4 percent. Compare this to putting one’s money in fixed deposits, which are yielding 7-8 percent, and one can gauge the gravity of the situation.

Constrained runway capacity poses an imminent threat

While shiny new runways have been built, there has been a net addition of only one runway in the last 50 years. The country has a total of 449 airports but metro airports continue to be key to aviation traffic with about 61 percent of the domestic traffic and about 73 percent of international traffic still originating from the six metros — Delhi, Mumbai, Bengaluru, Hyderabad, Kolkata and Chennai. With the exception of Bengaluru, which will see the addition of an additional runway this year, the capacity expansion at other airports lags or is non-existent. Significant investment in airports has gone towards making terminals which don’t quite suit the market demand. The number of runways has not increased (with the exception of Delhi airport). New runways that are to come up are years away.

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 extent of this issue is highlighted with how airlines have complicated their business models and added to costs in an extremely price sensitive market in order to gain access to slots.

The costs of new airport capacity are unrestrained

The funding mechanism of airports is such that the costs of incorrect capacity planning are borne by passengers via development fees. The numbers speak for themselves. In the case of Delhi airport, the final project cost was 3.8 times the initial estimate and in the case of Mumbai it was 1.7 times the initial estimate. The cost of these overruns was covered by the flying public.

Both airports were allowed to levy development fees to the tune of nearly Rs 3,400 crore. The contribution via fees levied on passengers being 1.2X–1.4X the equity contribution in the case of Delhi and 3.0X–3.2X in the case of Mumbai. This is neither a fair nor a sustainable proposition.

Similarly, when one looks at till structures — which determine how tariffs are set and determined by airports — there is a leaning towards hybrid-till structures that are not conducive to keeping costs low. The argument airports make is that without such structures airports will not be able to get capital commitments required to modernise airports and generate an adequate return on equity but the need of the hour is to revisit the cost of building airports first and examine new innovative methods of building low-cost and high quality infrastructure that is fit for purpose.

The Next Generation Airports for Bharat (NABH) Nirmaan policy was a step in the right direction. Yet, when closely examined and with the numbers being floated for the upcoming Jewar airport, where the initial estimate is upwards of Rs 20,000 crore, it does not make for a very strong case.

The cost of capacity if not restrained will hamper aviation growth.

MRO taxation is forcing airlines to go overseas for maintenance

Other than ATF, the other large expense item for airlines is the maintenance and repair (MRO) of aircraft. Taxation on MRO is irrational at best. Maintenance and repair taxation in India remains the highest globally. With an 18 percent GST levy, providers have to compete on sale price with overseas players that only pay 5 percent — that too at cost price. This gap: 20-22 percent. Consequently, 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. The National Civil Aviation policy (NCAP 2016) attempted in part to address this issue by limiting the royalty and additional charges and mandating that these not be levied on MRO service providers for a date of five years from the date of approval of the policy. Yet, the royalty is still being imposed under different classifications ranging from 11 percent to 30 percent.

Sadly, given this complicated structure, foreign carriers have leveraged on the MRO potential of India while India itself lags behind. The tax policy has led to airlines to outsourcing majority of the $1.4 billion MRO business to international providers.

Lending to airlines is severely constrained

Indian airlines are sitting on tremendous fleet orders. And these orders and expansion plans of airlines require financing. In the current environment, banks are extremely reluctant to lend to aviation. The reasons are many, including fluctuating EBITDAs, weak balance sheets, systemic impacts of an ongoing crisis with Jet Airways and the NPA cleanup.

Some airlines have gotten around this using the sale-and-leaseback mode. Yet, it is a model that depends on liquidity of the asset type and one that is leading to weak balance sheets in the case of Indian airlines (the exception being Indigo).

In spite of being a key growth market in Asia, private capital is reluctant to enter the aviation 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.

Restructuring of regulatory bodies

With aviation growth the demands on the regulator are ever increasing. The last five years saw a determined approach to strengthen these bodies but even simple items like digitisation of records was met with significant hurdles. The new government is likely to push through additional measures. Reinvigorating bodies such as the Directorate General of Civil Aviation, the Airport Economic Regulatory Authority and the Bureau of Civil Aviation Security towards stronger oversight would likely be very welcome by most stakeholders.

Given the consistent feedback loops that the government has employed, consultations will likely have to be a focus area. The current nature of consultations in many areas is restricted to direct stakeholders. For a truly comprehensive reform inter-ministerial and ‘inter-regulatory’ consultations including a seat on the table for representatives for the travelling public will propel the sector forward.

The sustainability of the Udan scheme

The Ude Desh Ka Aaam Nagarik (Udan) scheme has been a flagship scheme for NDA1. Focused on connecting unserved and underserved airports, Udan spurred a host of regional airlines to come up and existing operators to enter regional flying. While it can be argued that the scheme has been a success highlighting the new destinations connected, a look at the sustainability of regional airlines paints a different picture.

The Udan scheme is funded by a levy on passengers flying metro routes. The funds collected are then used to subsidise Udan routes. Recent indications are that if all Udan routes that have been bid are flown, there is likely to be a funding deficit. Addressing this deficit in an environment where passenger numbers are likely to fall further will be a challenging proposition.

While the viability of Udan is addressed policymakers may also have to look at the sustainability of the scheme and how to revitalize regional operators.

*******

As India positions itself to lead and play a dominant role globally, its aviation sector cannot be overlooked. Especially as this sector acts as a growth multiplier including economic output, jobs and trade – all enabled via better connectivity. With a growing middle of 300 million-plus, a trend towards urbanisation, 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 materialise sustainably, policy interventions are necessary. An unfinished aviation policy agenda remains.

Satyendra Pandey is the former head of Strategy at a fast growing airline. Previously, he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds.

Read Satyendra Pandey's columns here.

7 vital issues in Indian aviation that are crying for the Modi government’s urgent intervention

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