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Aviation consolidation looming in India: Outlook 2007 report released

(Delhi: 06 March 2007) Centre for Asia Pacific

Aviation predicts a round of airline consolidation in India in the medium term,

as a solution to widening losses and rampant capacity growth, in its new Outlook

2007 report, released today.

“Despite the bullish traffic growth projections for India, overseas experience suggests that it is extremely difficult for a market to absorb so many new entrants, particularly in such a short space of time”, said the Centre’s CEO Indian Subcontinent and Middle East, Kapil Kaul.

“This is especially the case for India, which is facing a number of external issues, such as airport infrastructure and manpower shortages, that serve to increase costs and reduce efficiency and flexibility. These are compounded by the fact that airline management in some cases is relatively inexperienced and untested”, he said.

According to the Outlook report, consolidation will occur through a process of closure or mergers/acquisitions, leaving around two to three full service carriers, three to four large national LCCs (operating fleets of 70+ aircraft), and three to four niche, regional operators (with aircraft less than 80 seats). The process will begin this year, but may take time, given the overhang of foreign investment eager to enter the market.

“The merger of the two state-owned carriers, Air India and Indian Airlines will set the ball rolling for further consolidation and mergers and acquisitions. Both Jet Airways and Kingfisher Airlines are likely to be keen to grow via acquisition to expand their market share, subject to an appropriate strategic fit. Meanwhile, SpiceJet, which now has the support of investors of the calibre of Tata Group and Istithmar, may also be considering this option”, said Mr Kaul.

Meanwhile, the long-awaited Civil Aviation Policy is expected to be announced shortly. According to the report, India is currently in the unusual situation of having potentially billions of dollars of investment preparing to enter the sector – but lacks a clear policy framework. (The domestic airline industry will aim to raise in excess of USD1billion in private equity and debt in 2007/08, with IPOs likely by Kingfisher and Air India/Indian in 2008/09. This amount excludes debt raising for aircraft purchase orders).

“One of the key policy issues is the level of investment by foreign airlines in Indian carriers, currently prohibited. Opening this up could bring in much-needed strategic investment and expertise. Similarly, increasing the overall foreign investment cap from 49% to 74% could ease the availability of capital generally. The Ministry of Civil Aviation will also need to continue to work with state and central government departments to reduce the excessive taxation on aviation turbine fuel, which is currently a significant impost on carriers - most State Governments still see aviation as a cash cow”, said Mr Kaul.

Similarly, airport user charges need to be rationalised in line with international levels, according to the Outlook report. With competitive fuel and airport fees, combined with efficient airport infrastructure as it comes on line, India has the potential to become one of the lowest cost producers of air services in the world – instead of one of the highest.

In order to meet the expected traffic growth, new and incumbent carriers are meanwhile placing significant aircraft orders. Indian carriers have approximately 480 aircraft on order for delivery through to around 2012, against a fleet size of 310 aircraft today. Over 135 aircraft have been added in the last two years alone for scheduled services, with another 50 general aviation aircraft. Over the next 12 months, Kingfisher Airlines is expected to be the most aggressive in terms of fleet expansion.

Some of the aircraft on order will be used for replacement rather than expansion, however the Centre for Asia Pacific Aviation estimates that India’s fleet will reach approximately 500-550 by the end of 2010.

In the last 18 months, the incumbent full service carriers have been losing market share to LCCs at a rate of close to 1.5% per month. LCCs currently have a market share of 35% (Nov-06), from zero in Aug-03. The Centre forecasts that LCCs will achieve a market share of 70% by 2010 - one of the highest in the world.

“But the aggressive expansion of the LCC segment comes at a cost to the whole sector. India’s airlines are expected to post a combined loss of approximately USD500 million in the current financial year ending 31-Mar-07, with the last quarter set to be particularly testing. The planned expansion of capacity in 2007/08 will continue to keep pressure on yields, despite a more rational approach to pricing – but a shakeout is inevitable”, said Mr Kaul.

The rapid growth in traffic in the last couple of years is placing significant pressure on airport infrastructure, both in terms of runway/terminal capacity and quality, particularly in Delhi, Mumbai and Bangalore, according to the Outlook report. Recognising that the process of modernising airport infrastructure will require both funding and expertise, the government has a USD9 billion investment plan by 2010, which involves private sector participation.

“In order to sustain the expected traffic growth, while maintaining safety standards; reducing flight delays and providing the customer with a pleasant travel experience, significant investment will be required to upgrade and modernise India’s airports”, said Mr Kaul.

Meanwhile, Pakistan is actively developing its aviation sector, with pro-competition policies and investment in new airport infrastructure and equipment. But, according to the Outlook report, flag carrier, Pakistan International Airlines, is dragging the chain. Growing losses are indicative of the need for a fresh strategic approach and calling for more government funding support is not a recipe for long-term competitiveness.

“Rather, PIA must attack its cost structure and meet its competition head on with a high quality product. The underlying growth rates are certainly there”, said Mr Kaul.

Elsewhere on the Subcontinent, Sri Lanka has a similar market opportunity and outlook to Macau: both are well positioned on the edge of major emerging markets in India and China, respectively. Both are expecting new entrants in 2007 to raise competition, lower fares and thereby stimulate growth. But the domestic civil situation is the unique challenge facing Sri Lanka, and could be the factor that separates its aviation growth trajectory from Macau’s.

The findings are part of the Centre’s 181-page outlook report, available now at centreforaviation.com. This year’s report covers the Big Issues facing Asia Pacific aviation in 2007, including LCCs, liberalisation, restructuring, aircraft orders/deliveries, skills, funding, security, the environment and the economy.

The overall themes of ‘Outlook 2007: Dawn of a New Era’ include an impending “full frontal attack” on flag carriers commencing in 2007, and the continued unfolding of the influential LCC story in Asia.