Dollar Worries

The wild fluctuations in the value of the rupee vis-à-vis the US dollar has in turn impacted the Indian aviation industry essentially on account of its effect on the price of aircraft turbine fuel.

On account of its international exposure, the financial paradigms of the aviation industry in India are inherently dynamic in nature as evidenced in the volatility of the Indian Rupee especially in the recent past. Over the past two years, the Indian rupee has depreciated against the US dollar by 42.71 per cent from 46.61 in 2011 to 61.52 in 2013, touching a lifetime high of 68.85 in August 2013. But India is not the only emerging market facing the brunt of US Federal Reserve’s policy of Quantitative Easing, i.e. injecting money into the economy through buying back of government bonds. Currency depreciation against the US dollar has also been witnessed in South Africa, Brazil, China and Bangladesh. But in India, the rate of depreciation was higher due to dual deficit in the form of current account deficit (CAD) and fiscal deficit caused due to falling demand for exports to the US and the European Union, as also on account of increasing imports of gold and crude by India.

The wild fluctuations in the value of the Indian rupee vis-à-vis the US dollar has in turn had an impact on the aviation industry in India essentially on account of its effect on aircraft turbine fuel (ATF), a derivative of Brent crude that comprises nearly 50 per cent of the operating cost of the Indian carriers. The Indian aviation industry has grown at a CAGR (compound annual growth rate) of 16 per cent in the last decade that in turn has enhanced the consumption of ATF. Over the last two years, the price of ATF has gone up by 35 per cent and currently, it is 65 per cent higher in India than in other global destinations.

Now, the depreciating rupee and the consequent hike in the price of ATF has had a multiplier effect in draining airlines’ operating cost. The falling rupee also offset the advantage of the decrease in import prices of Brent crude from $118.46 per barrel in April 2011 to $109.94 per barrel in October 2013. In its Annual Monetary and Credit Policy of 2007-08, the Reserve Bank of India had permitted authorised banks to allow domestic carriers to hedge their exposure against the fluctuating international commodity rates. But just a few Indian carriers use this mechanism and only around 30 to 40 per cent in comparison to global practice by Southwest and JetBlue up to 80 per cent of the fuel consumption is hedged.

The demand for the Indian rupee is driven by two aspects, namely the current accounts and the capital account. A depreciating rupee not only affects the import bill but also the cost of borrowing from foreign sources. The capital account consists of three divisions, namely foreign institutional investors (FII) equity which is the money invested in Indian stocks by foreign institutions, foreign direct investment (FDI) – the money invested directly into companies and foreign debt including external commercial borrowings (ECB) – money borrowed by Indian entities.

CAD leads to demand for more US dollars whereas capital account surplus leads to demand for more rupees. India’s external debt through ECB rose from $345 billion to an alarming $390 billion between March 2012 and June 2013, primarily on account of short-term debts and NRI deposits. The reason behind this is availing loans from FIIs at a cheaper rate than in India. But, the fall in rupee adversely affected this strategy of Indian corporates. This fall was triggered by a sudden withdrawal of FII debt money since the middle of May 2013. Almost $10 billion of debt and $2.9 billion of FII equity were pulled out that increased the demand for Dollars and the rupee collapsed.

In 2011-12, the total foreign debt of Indian carriers stood at $20 billion. The Indian carriers are exposed to this dimension in two ways. Firstly, the acquisition of aircraft, whether through outright sale or sale and lease back from foreign manufacturers such as Boeing, Airbus and Embraer or any other carrier to expand their fleet is paid in dollars. The Indian low-cost carriers (LCC) are worst affected as they have limited international flights. So their dollar expenses are much higher than their dollar revenue since they still require at least five years of domestic operations and 20 aircraft to be licensed to operate on international routes.

Currently, IndiGo is licensed to operate on five international routes which is meager. The full service carriers (FSC) are relatively in a better position due to their access to international routes, but even then their profits are being drained to meet maintenance costs comprising 12 per cent of their operating cost that they mainly owe to the foreign maintenance repair and overhaul (MRO) companies. This factor constitutes the second dimension of foreign exposure. As per Ravi Menon, Executive Director of Mumbai-based MRO provider Air Works, only five per cent of MRO work of Indian carriers are carried out within India. This practice is one of the factors which have outweighed the competitive advantage of availability of low-cost labour in the country. Even the international market is majorly capacitated by foreign carriers such as Emirates exploiting the six freedom rights, which further multiply the non-competitiveness of the Indian international carriers like Air India and Jet Airways.

In the context of this exposure to foreign debt, last year the Indian Government enhanced the limit of FDI to 49 per cent in Indian carriers by foreign airlines in order to transform foreign funds into investment on the basis of partnership along with foreign expertise. This decision is bearing fruit as foreign carriers such as AirAsia and Etihad Airways with quality expertise and deep pockets buying stake in Indian carriers.

The global recession in 2008-09 had also affected the Indian aviation industry. At this time, the value of the rupee against the US dollar had appreciated from 48.32 in 2009 to 45.65 in 2010. But, on account of the sharp rise in oil prices and unfavorable foreign exchange situationthe Indian aviation industry witnessed a decline in passenger traffic. Increase in interest rates on external debts owing to global economic uncertainty rendered the environment unfavorable.

The proverb “Every coin has two sides” plays a role even in the relationship between depreciating rupee and the Indian aviation sector. Itis true that international travel has become expensive due to the fall in the value of the Indian rupee as the cost per person went up by around eight to 12 per cent. But, coincidentally the Indian vacationers seem to take their jaunts seriously as there have not been too many cancellations. The outbound travellers appear to have revised their plans for vacation from longhaul destinations such as the US, UK and Europe to short-haul destinations such as South Africa, Australia, South Eastern and Middle Eastern countries where the rupee depreciation has been comparatively lower. The long-haul business has dropped by over 40 per cent in comparison to the short-haul which dropped by only 10 to 15 per cent. However, there has been an increase in domestic traffic by 12 per cent but the inbound international traffic between June 2012 and June 2013 depicted a marginal growth of 0.01 million only.

The Author is a student of MBA-Aviation Management (2012-14), UPES.