What govt needs to do to boost low-cost carriers in India

India's domestic aviation market is predominantly a low cost carrier (LCC) market, with more than 70 percent market share controlled by the LCCs. Even Full-service carriers (FSC) like Jet Airways and Air India are at times forced to offer economy class seats at a fare comparable with LCCs despite providing additional facilities like meals, lounge access and frequent flyer benefits etc. A significant number of aircrafts of Jet Airways have a full economy class configuration. India is, now, by all means an LCC territory.

The market leader, IndiGo, followed a consistent strategy of on-time performance, new fleet, competitive fares and hassle free service. The exit of Kingfisher in December 2012 helped and Indigo today has a dominant market share of over 30 percent.  It recorded an impressive profit of Rs 787 crore in 2012-13 compared to Rs 128 crore in 2011-12.

With FDI reforms, enhancement of of bilateral quotas and the anticipated abolition of the infamous 5/20 rule, we are seeing more foreign airlines entering the Indian aviation space.  The increasing competition is likely to enhance global connectivity, improve services, bring down fares, attract more flyers in India and boost foreign tourist arrivals. 

The next phase of growth in Indian aviation is likely to come from Tier 3-4 airports. The only way to stimulate demand there is by offering good frequency and lower-than-typical LCC fares. The role of the government therefore becomes critical.

The boom years

The LCC boom in India during 2003-2007 was marked by price tags as low as Re 1, internet auctions, bulk purchases and attractive last day fares. Low barriers of entry, an increase in permitted foreign equity (non-airline), favorable demographic profile and rising income levels were the key enablers.

LCCs provided cheaper connectivity to many tourist locations like Tirupati, Dehradun, Dharamshala etc., which were hitherto accessible only by road or rail.  Air travel converted even a two-day weekend into a tourism opportunity – something not possible through road or rail travel. 

In a way, LCCs addressed the rising aspirations of the Indian middle class coupled with their high price sensitivity.  LCCs made air travel accessible to many and also boosted air cargo as well.  Domestic passenger traffic increased at a CAGR of 17.5 percent between 2004-2010. No wonder airports were the busiest places on Monday mornings and Friday evenings!

The challenges today

Not all is well in the LCC world. LCCs are struggling to stay profitable, hurt by infrastructure constraints, rising operating costs, suicidal price wars, excessive taxes on aviation Turbine Fuel (ATF) and Maintenance-Repairs-Overhaul (MRO); and the absence of a favorable regulatory framework.  Owing to these and the ongoing economic slowdown in India, air traffic in India witnessed a decline of 2% in FY12 – 13, for just the second time in ten years.  The free fall of the rupee hasn’t helped either, since nearly 70% of airline expenses (fuel, leases, MRO, expat salaries, overseas offices, foreign debt etc) are all linked to the dollar. 

(Also Read: Jet Airways sees Etihad deal closure despite record Q2 loss)

Crippling operating costs

India is perhaps the costliest place to run an airline.  Indian ATF is one of the costliest in the world – nearly 60% higher than in Middle East and SE Asia.  As regards MRO, it’s a travesty that Indian carriers find it cheaper to fly empty aircrafts abroad than to get the repairs done in India.  Airport charges have gone up since they have all undergone massive capital expenditure and need to service their debt.  Third party ground handling invites over 30% royalty charges.  The impact of the rupee depreciation has been highlighted earlier.  Thus every element of the cost structure has increased in the recent past.

The slow growth in traffic has created a vicious cycle.  The high cost structure is now distributed over a near-stagnant passenger base.

All eyes on the Government

The role of the government in a highly regulated sector like aviation is paramount.  If we could just get two out of the top five aviation states (Delhi, Maharashtra, Tamil Nadu, Karnataka and West Bengal) to free aviation from the huge taxes on ATF and MRO, we are home. 

Simple analogy – it’s more beneficial for the government to tax grape-wine than the grape seed.  In India we are happy taxing the seed (the ATF) and the fertilizer (MRO).  The wine produced is therefore a fraction of the pent-up demand. 

As the mobile telecom revolution in India amply proved, the moment the government creates pro-customer policies, the outcomes are mind-boggling.  India raced from 18 million cellphone subscribers in September 2003 to over 900 million by September 2013, a 50-fold increase in just a decade!  Indian aviation could be next.

Some of the immediate reforms that the Government may undertake are as follows:  

1. Notify ATF as a declared good with uniform 4% sales tax all over India. 
2. Declare a 10 year tax-free status for MRO.
3. Abolish the discriminatory 5/20 rule
4. Provide 40% funding support for Tier 3-4 airports to expand regional connectivity
5. Carry out a thorough review of policies and procedures regarding airport security, aviation licenses, air-cargo, general aviation and aviation education

Above all, the biggest change needs to be in the political mindset – aviation is treated more like a milch-cow than a ‘driver of economic growth and employment’. 

Sign of good times…

The Ministry of Civil Aviation (MoCA) has brought in many reforms like allowing FDI for airlines, opening of bilateral rights to private Indian carriers, direct import of ATF, customs duty relief on MRO etc.  MoCA is also planning incentives like zero airport charges, seat subsidy etc to boost regional connectivity.  The ministries of tourism, defense and civil aviation are cooperating closely. The decision to privatize operations and management of six AAI airports is another welcome step.  This will enhance quality of service and competition among Indian airports.

The long term outlook of the Indian civil aviation industry remains positive, despite near-term challenges.  The challenges are man-made and hence addressable through long-term vision and political will. 

LCCs and low cost airports will be the key drivers of growth in the near future.  We expect air traffic FY 14 to end with a annual growth of 5-7%.  Growth in FY 15 is expected to touch double digits under the assumption that the new government will bring in structural reforms. 

The choice is ours!

(Amber Dubey is Partner and Head-Aerospace and Defense, at global consultancy KPMG.  He was supported by Namrata Saigal, Consultant, KPMG.  Views are personal)

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