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FDI in aviation sector: A Bon Voyage or Just a Mirage?

FDI in aviation sector: A Bon Voyage or Just a Mirage?

By Chaahat Khattar

Edited by Madhavi Roy, Senior Editor, The Indian Economist

In the aviation industry, there is this famous quote- “If you want to make millions in the airline business, then start with billions.” The quote holds true not only for developing nations, but also across the globe. Despite the soaring demand due to an inclusive rise in per capita income of the world population, the airline business is still far from being the most lucrative one. No matter how developed the United States of America is, all its international airliners are bankrupt and are flying due to  the government’s grace. The situation is similar in a majority of the other nations too, but there are also success stories, such as China Airlines, Singapore Airlines, Virgin Atlantic, and a couple of Gulf carriers, to name a few. Interestingly, domestically-focused no-frill airlines such as Southwest and Jet Blue in the USA, IndiGo Airlines in India and RyanAir of UK are in better positions than their larger international competitors.

In September 2012, the government relaxed Foreign Direct Investment (“FDI”) limits for a host of industries such as single brand retailing, media, power distribution and more importantly,in the much awaited airline sector. The government came up with the magic figure of 49% FDI allowance in the civil aviation sector that clearly aimed at helping the airlines raise capital without losing the actual effective control over them.

India is the world’s 9th largest civil aviation market in the world, and the 4th largest in domestic passenger volumes with over 45 million fliers annually. There are 5 major scheduled passenger airlines in India, namely, Jet Airways and its subsidiaries, IndiGo, Air India, Spice Jet and Go Air. IndiGo leads the pack with a 30% market share and it is the online airline with a green bottom-line with a positive figure of over USD 130 million. Kingfisher Airlines, which once dominated the market share, is now out of the business for almost a year with no sign of a revival. As per ICRA, the Indian aviation sector shrunk by 3.2% in the FY 2012-13, and has had a Compounded Annual Growth Rate (“CAGR”) of 9.2% for the past 5 years. This poor show is largely because of the sudden exit of Kingfisher Airlines, which led to the underutilization of resources in the sector, coupled with non-catered routes that once used to be the primary sectors for Kingfisher Airlines. On a positive front, ICRA has stated that the industry might come back to 11% CAGR due to the expansion of Low Cost Carriers (“LCC”) and cost rationalization by the existing carriers.

The enhancement of the FDI limit in the aviation sector permits FDI up to  49%  and  investment  by Non-Resident   Indians   (NRI)  up to  100%  on  the automatic  route, subject to regulations notified by Ministry  of  Civil  Aviation. Like a coin, the move comes with two sides with its own set of Pros and Cons.

Discussing about the Pros:

Tackling the ever growing Debt: Indian airlines are flying with an accumulated debt of close to INR 20,000 crores that is probably more than the market capitalization of a majority of Indian companies. With a debt of this size, the airline business in India does not look healthy. With the introduction of FDI, airlines can well get away with a good chunk of this debt and probably raise fresh capital for expansion or revival purposes.

Improvement in Infrastructure: Foreign investors while going for FDI in the aviation sector will not sit back infusing capital in the airlines. They will definitely look forward to safeguarding their investments by ensuring that there is an efficient technology transfer alongside the capital. This will help the Indian carriers to offload some of their unproductive modes of operations and get introduced to international methods of saving costs and thus gaining customer loyalty.

Synergies: As the Indian carriers will get a chance to breathe fresh air with FDI, they will also have access to the infrastructure and customer base of the capital infusing company. For example, if an airline from UK invests in an Indian carrier, definitely to improve the state of the airline, the UK carrier will not only give access to the Indian carrier to its international hubs, but it will also look forward to bringing in synergy amongst its customer loyalty programs with that of the Indian carrier. Similarly, the international carrier will look forward to managing the utilization of resources by enabling the Indian carrier to offload the unproductive resources while making use of the ones owned and managed by its international counterpart.

Economic Development: When our import bill is inflating and we have an increasing fiscal deficit apart from a ballooning Current Account Deficit, any kind of FDI will anyway help the economy positively. Also, the domestic banks that are hiding and wallowing in their misery for the loansthat they have granted to the Indian carriers,which are now under the umbrella of Non-Performing Assets, will get a push in terms of both repayment of loan by these carriers post capital infusions, as well as market capitalization due to the positivity amongst their shareholders.

Moving on to the Cons of FDI in aviation,

Predatory Pricing: Many analysts believe that as a result of the support given by the profitable international airlines to the domestic ones, airfare might be undercut, which will harm the hopes of other domestic carriers. This will further lead to an increased competition amongst LCCs, motivating price wars that will negatively impact the bottom lines of non-FDI backed airlines.

Infrastructural and Political Issues: On paper the regulations say that up to 49% FDI will be allowed through the automatic route, but in reality, each proposal will be scrutinized by the apex aviation regulatory body of India apart from the standard evaluation done by authorities like the Department of Industrial Policy and Promotion, Foreign Investment Promotion Board and Cabinet Committee on Economic Affairs that will anyway lengthen the procedure of actual realizable investment. Another issue is that even if we get larger domestic airlines in the near future, the infrastructure (except metros and sub-metros)does not have not too much to talk about. So instead of promoting direct FDI in airlines, there is a dire need of promotion of FDI in infrastructure.

Domination of the investors: FDI can also lead to foreign investors forcing the Indian carrier they might invest in to fly by their terms, if not officially, then unofficially. They will definitely command the Indian carriers to implement the principles as per their requirements as the investors will always be aiming towards turning the airline into a profitable one, at leastuntil they can gain from the share they have bought in the airline.

The Mayaram Committee has recommended a 100% FDI in aviation sector but the government has clearly indicated not to go ahead with it, as it has already observed that it is in itself a Herculean task to even approve 49% FDI. Also, many believe that as airlines are a large capital based business, it might not be good for the economy to hand over the reign to international players, who might exploit the entire industry. On the flip side, every industry gains from perfect competition. Even if there are no economic profits, but at least the industry is not doomed with limitless losses. Increased competition always leads to better offerings, greater efficiency, cheaper airfares and more choice to the passengers, apart from access to capital, global connectivity, technology, management and operational best practices.

Chaahat Khattar is an ardent economist and is working with an international consultancy firm. He is an MBA and pursuing Masters in Business Laws. He is also a Harvard University alumnus and a certified financial modeller. He has keen interest and experience in authoring research papers and case studies and have contributed to various renowned journals. Chaahat can be reached at [email protected]

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