Time for Reckoning

The heads of India’s airlines are smiling at last. Thanks to a dramatic slide in the price of oil since June 2014, the prospects of the commercial aviation industry are brighter than at any time in the past five or six years. Hordes of eager travellers, lured by low fares, are flocking to the turnstiles and the country is likely to record double-digit air traffic growth this year.

However, according to the CAPA - Centre for Aviation (CAPA), the industry suffered an estimated loss of Rs. 10,660 crore in 2013- 14, its worst performance since 2007-08, and the financial health of some carriers is still precarious. While Air India’s losses of Rs. 5,390 crore were just over half the industry’s total, the Jet Airways Group and SpiceJet posted their highest ever yearly loss of Rs. 4,100 crore and Rs. 1,003 crore respectively. They will need several good quarters to emerge from the gloom.

The industry’s woes are mainly due to high operating costs – especially the irrational pricing of aviation turbine fuel (ATF) and usurious airport charges – coupled with ferocious competition for market share. While low-cost carriers (LCC) slash fares to ridiculous levels, full service carriers (FSC) try to match LCC ticket prices although their operating costs may be up to 70 per cent higher. Most airlines have adopted a low-fare strategy to woo customers, neglecting financial prudence. While passengers are not complaining it hardly contributes to the long-term viability of the industry.

A Gathering Crowd.

This is a quick snapshot of how the country’s carriers performed in 2014 and their plans for the future.

• LCC IndiGo, the lowest cost domestic operator and the country’s only continuously profitable airline, was market leader with 31.8 per cent share. It has a fleet of 84 Airbus A320-200s with 430 Airbus A320neo aircraft on order. This is an astounding number considering that the country’s total commercial fleet is below 400 aircraft currently.

• Jet Airways was a distant second with 21.7 per cent share. It has a fleet of 116 aircraft, mainly Boeing B737 jets and ATR 72 turboprops plus about 90 aircraft on order, mainly Boeing B737 MAX and Boeing B787 Dreamliners. In December 2014, Jet Airways finally reverted to its full-service roots.

• State-owned Air India, one-time monarch of India’s skies, had just 18.4 per cent share. This FSC has been unprofitable since its ill-starred merger with Indian Airlines in 2007. At present, it deploys only 27 per cent of its capacity towards domestic operations, but plans to increase the figure to 40 per cent this year. It has 108 aircraft of different types and about 29 more on order, mainly Airbus A320-200s and Boeing B787s.

• LCC SpiceJet, mastermind of many flash sales, had 17.4 per cent market share, mainly through sold-for-a-song seats. In July 2014 it had 50 aircraft but severe financial problems have reduced its operational fleet to 35 (20 Boeing B737 jets and 15 Bombardier Q400 turboprops). It has 42 Boeing B737 MAX jets on order.

• LCC GoAir’s 9.2 per cent share and modest profitability is creditable considering that it has only 19 Airbus A320s. It has 72 Airbus A320neo aircraft on order.

• Air Costa, a regional airline, was launched in October 2013. Its 0.9 per cent market share with four Embraer regional jets gives no hint of its big plans for the future, including going pan-India. Its orders total 50 Embraer E-Jets E2 aircraft.

• LCC AirAsia India garnered just 0.5 per cent market share since it was launched in June 2014. Currently operating a fleet of four Airbus A320s, it plans to induct one aircraft every month.

• FSC Vistara began commercial operations on January 9. It has a fleet of six Airbus A320 aircraft and plans to reach 20 in four years.

• Pegasus Airways, the youngest of the lot, launched operations on April 12 with a fleet of two ATR 72-500 aircraft. This Bengaluru-based low-fare regional airline plans to scale up to six aircraft by December and touch various cities in South India.

Sick yet Surviving.

Surely the well-known perils of the industry and numerous regulatory hurdles should deter new aspirants? Not so. Coming up possibly are Premier Airways, Air One, Turbo Megha, Air Carnival, FlyEasy, Zexus Air Services and Zav Airways (India’s first scheduled helicopter service) that plan to launch operations this year. If all the planned new entrants materialise, significant overcapacity is likely to be created in 12-18 months.

The stark truth about the industry is that nine airlines have ceased to exist since the mid-1990s. Late last year, SpiceJet was in dire financial straits. It appealed for help and the government gave it time to clear its dues. Then Ajay Singh, its former partowner, announced an investment of Rs. 1,500 crore in the floundering airline and assumed control. Although Singh hopes to increase SpiceJet’s fleet, he is also urgently cutting operational costs by rationalising its network and trimming the workforce. Eventually the carrier may have to return to a single-aircraft fleet, the eminently sensible practice of some of the world’s most successful LCCs like AirAsia, Southwest and Ryanair.

The government may have missed a golden opportunity to privatise Air India soon after assuming office in May 2014

Air India, whose debts have ballooned to Rs. 40,000 crore, remains afloat thanks only to huge sums of taxpayers’ money, notably a bailout package of Rs. 30,000 crore spread over 10 years. The unexpected improvement in the aviation environment has boosted its finances and given it some breathing space. However, its recovery may not last once the price of oil begins to climb. Jet Airways has also seen much financial stress but is fairly stable thanks to its stakeholder Etihad Airways which values Jet as an assured source of passengers for its large airliners bound for the Middle East and beyond.

International Flights and Regional Connectivity.

Currently 62 per cent of the industry’s capacity is domestic and 38 per cent international. The government is seized of two urgent issues – whether to ease restrictions on overseas operations by domestic airlines and how to increase flights to the remote and underserved areas of the country.

India’s airlines are permitted to go international only if they have operated for at least five years domestically and have at least 20 aircraft, a restriction that no other country imposes on its carriers. Since it was introduced, this ‘5/20 Rule’ has worked as a needless curb on the industry. It is also highly discriminatory since it does not apply to foreign carriers. When it comes to regional connectivity, the route dispersal guidelines (RDGs) formulated in 1994 force scheduled domestic airlines to deploy a certain percentage of their capacity on poorly connected and unprofitable routes. The RDGs too do not affect foreign airlines.

Strangely enough, these two unrelated issues may soon be artificially brought together by the government, ignoring the fact that while international operations need long-range fueleconomising jets, regional flights are mainly short-haul and thrive on turboprops. According to CAPA, “Linking capacity on international routes to capacity on domestic routes is not logical and may force carriers into making poor commercial decisions in order to meet an arbitrary regulatory requirement.” CAPA also observes that the country’s airlines may need to add around 30 aircraft just to fulfil the revised RDGs

A far better option to promote regional connectivity would be for the government to set up an Essential Air Services Fund (EASF) or employ a viability gap funding model to provide financial support to airlines for operations on unviable routes, at least to begin with. This would cost far less than the amount being spent to prevent Air India from folding up.

Hope for the Future.

For years, India’s aviation industry has been plagued by high input costs and low fares in a highly price-sensitive market, completely blurring the difference between LCCs and FSCs. However, with the entry of Vistara, the re-emergence of Jet Airways as a high-quality FSC, and Air India’s renewed enthusiasm for upgrading its product, the country’s FSCs are again becoming distinct from the LCCs. This is all to the good.

With the economy poised to grow at a handsome rate over the next few years there’s hope in the air. India is currently the world’s ninth largest aviation market and is expected to become the third largest in less than a decade. That’s why so many new airlines are seeking entry. But the need of the hour is strong players with deep pockets that increase capacity in moderation and price their tickets sensibly. And some analysts believe there’s room only for four or five strong pan-India airlines, besides a few purely regional outfits.

It is true that handholding a tottering SpiceJet avoided unemployment, preserved value for its shareholders and benefitted consumers. But will this be repeated for the next airline in trouble? Survival of the fittest carriers is preferable to survival of all with some on permanent life support. When will the authorities recognise that regulation should simply foster ease of doing business and ensure that the aviation industry is viable and competitive, subject to meeting safety standards and achieving reasonable regional connectivity targets? A regrettable tendency to micromanage the sector, even attempting to control fares, needs to be curbed.

The steep decline in crude oil prices by over 50 per cent in under a year has brought the industry welcome savings. Yet just 28 per cent of the benefit of reduced oil prices has been passed on to the airlines and the cost of ATF in India is still 60 per cent more than in competing hubs like the Middle East and South East Asia. Why should this be so? Analysts believe that the key issue is a reduction in tax on ATF at Delhi, Mumbai and Chennai that are among the country’s busiest airports and also levy some of its highest taxes. Besides, bringing down domestic fuel prices will make regional flights more viable and automatically reduce the appeal of operations to foreign countries where ATF is much cheaper.

The next few months are critical. The government may have missed a golden opportunity to privatise Air India soon after assuming office in May 2014. But due to a combination of factors like low ATF prices, growing traffic and fresh thinking, 2015 seems set to be a decisive year for civil aviation. A comprehensive new aviation policy is expected to be announced in May and it has the potential to change the face of Indian commercial aviation.

Once oil prices rebound, as seems practically inevitable, the worry lines on the faces of airline CEOs may return. According to CAPA, “The government should take this opportunity to push through with bold decisions such as classifying ATF as a ‘declared good’ that would result in a uniform sales tax of 4 per cent across the country. Combined with the fall in base prices this could reduce airlines operating costs by a game-changing 30 per cent that would stimulate growth and set the industry on a more viable long-term trajectory.” Is anyone listening? The window of opportunity won’t remain open forever.