Indian Aviation in 2013/14 Part 2: Immense change ahead - but a policy vacuum persists

The absence of a structured policy framework undermines industry viability

A massive upheaval is occurring in Indian aviation. Yet, despite this, there has been no change in the nation's approach to policy and regulation. Successive administrations have studiedly ignored the desperate need to create a structured framework and long-term vision for the sector. The result is a disconnected and ultimately costly jumble of adjustments.

Repeated flowery commitments to comprehensive overhaul of the policy have led to nothing; a proposed new civil aviation policy has remained in draft format for some 20 years. In this vacuum jolting changes occur in an ad hoc manner. Sometime they are positive - such as the decision to allow foreign airlines to invest in Indian carriers - but there has been no thought given to the far reaching implications that will have for the aviation market structure.

India's flag carrier for example continues to languish, with no prospect of recovery other than the regular band-aid bailout - convenient for politicians, but costly for the nation. And makeshift decisions taken out of context, like the foreign ownership revision, as a result have offsetting negatives that almost invalidate the positives.

Other examples:

• Just a few months ago the government wanted to encourage the development of hub airports in India, but statements in the light of the Jet Airways-Etihad deal suggest this is no longer considered a priority;
• Airlines were advised at the beginning of the year that foreign carriers would not be granted increased access until Indian carriers had exhausted entitlements, but instead dramatic opening up is taking place on selected markets;
• The Aircraft Acquisition Committee disappeared as quickly as it arrived;
• And while charging for preferential seats was not permitted by some arbitrary regulation, priority check-in and other ancillaries seemingly posed no problem.

These stuttering inconsistencies in regulations and policy reversals, in 2013 alone, entrench instability and damage viability across the sector.

Until firm directions are introduced, few will be brave enough to invest in the sector in future. India desperately needs a long-term policy and regulatory framework which spells out the government's stance on critical issues. Without this strategic clarity any major decisions will only create more structural challenges - and make investment ever more risk-filled.

India cannot expect billions of dollars of investment without a national civil aviation policy framework

Supporting modernisation and growth of India's aviation industry requires billions of dollars of investment in aircraft, airport infrastructure and ancillary services, the majority of which is expected to come from the private sector. Yet in the more than 20 years since the domestic aviation sector was first opened up India remains without a Cabinet-approved national aviation policy. Despite numerous well-intentioned attempts, especially since 1997-98, they have not progressed beyond the draft stage. There does not appear to be a genuine interest in creating a long term policy framework.

The absence of a transparent policy has prevented the corporatisation of the sector and has kept many serious investors away from the market. This unpredictability has hurt Indian airlines and airports. Private operators have invested billions of dollars in preparing Delhi and Mumbai for hub operations only to find that the bilateral policy has been changed overnight to one that encourages these airports to be bypassed. And India's airlines had been operating on the assumption that no new bilaterals would be granted until the home carriers had developed greater scale.

CAPA India continuously engages with global investors and tracks their interest in the market. It is apparent that the frequent shifting of the goalposts means that many potential investors are reluctant to commit capital despite their confidence in the underlying growth potential of the market.

CAPA urges the government to introduce a considered long term aviation policy within the next 6 months based on extensive industry consultation. This should be the key priority of the administration as the absence of policy predictability is one of the greatest barriers to serious investment.

India's bilateral policy will be a key factor in the battle of Middle East hubs

India does not have a stated bilateral policy outlining the mission, purpose and objective for which seat entitlements will be allocated. This is also the case in some other countries; but the difference in most of those cases is that there is nonetheless a certain consistency and transparency in the way traffic rights are granted and exercised. In India that is patently not the case, with wild swings in direction characterising what passes as policy.

Prior to 2004 the government had an extremely conservative stance, reluctant to grant further access to foreign carriers given that Air India, which was then the only Indian carrier permitted to operate overseas, was in no position to expand. Starved of capital by its owner, Air India at the time had not inducted a single aircraft into its fleet for over a decade. The capacity limitation was strangling international business and tourism, with passengers needing to book months in advance to secure seats during peak season.

From 2004, as a part of the overall opening up of the sector, bilateral agreements with key markets were opened up dramatically. Although liberalisation was welcome, it took place however without consultation with the industry and no roadmap on the future direction of bilateral policy was presented.

From 2008 onwards, as the operating environment became more challenging, bilateral policy returned to a conservative setting in a knee-jerk effort to protect Air India, as well as in response to controversies surrounding the increase in access that had been granted to Middle East carriers, especially Emirates, over the preceding years. The protection of Air India also impacted private Indian carriers which struggled to obtain route rights even where seat entitlements were available under the bilateral. The government stated that the rights were reserved for Air India even though it did not have the aircraft nor any interest to operate most of the routes which private carriers wanted to launch.

A hazy "official" position that is at odds with reality

The official position remains that Air India has first right of refusal, however since 2012 there has been some relaxation and almost 80,000 seat entitlements have been granted to Indian carriers in recent months. It was also stated by the Ministry that, until Indian carriers exhaust entitlements available under existing bilaterals, no new air services agreements would be negotiated with foreign countries, especially from the Middle East. And yet in late April 2013, India and Abu Dhabi reached agreement on a new bilateral that will see an almost four-fold increase in seat entitlements, which paved the way for the Jet Airways-Etihad deal to go through less than 24 hours later.

The about-turn in policy was as a result of the support of pivotal senior figures in government. European and Asian airlines will most likely protest the liberal opening up for Middle East carriers, especially since Lufthansa and Singapore Airlines have not been able to secure approval even to up-gauge the largest permitted aircraft from a 747-800 to an A380.

According to CAPA Research estimates, foreign airlines are currently seeking an additional 150,000-175,000 seats per week (excluding the recently expanded India-Abu Dhabi bilateral) over the period through to the Winter schedule 2015/16. Most of the demand is from Middle East carriers and Turkish Airlines.

Emirates for example is understood to be seeking an additional 50,000 weekly seats of which they want to utilise 26,000 immediately. Talks between the respective governments are already under way on this request. Qatar Airways is reportedly seeking an additional 50,000 seats and Air Arabia around 20,000 additional seats over the next 2-3 years. A further 20,000-30,000 seats are understood to have been requested by other Middle East carriers. Meanwhile Turkish Airlines has been aggressively seeking to increase its entitlements for more than a year from 14 to 56 weekly frequencies to enable it to offer double daily services to Delhi and Mumbai and daily services to Bangalore, Chennai, Hyderabad and Kolkata.

Following the recently concluded India-Abu Dhabi bilateral agreement, UAE carriers now have entitlements to operate 120,000 weekly seats to India, let alone the increases they are seeking. Against this backdrop Singapore is unlikely to have been pleased with the modest 10% increase to just under 29,000 seats that was agreed last month.

Change in Weekly Seat Entitlements in Indian Bilateral Negotiations with Abu Dhabi and Singapore in Apr-2013

Source: CAPA, Press Information Bureau

A new direction in policy which will integrate wider economic and political objectives

CAPA expects that the Indian government will increasingly link bilateral air services negotiations with larger economic and geo-political considerations such as foreign direct investment, trade and access to oil and gas supplies. The structure and competitiveness of the Indian aviation industry appears to be a lower priority in the broader agenda of the government. The investment by Etihad in Jet Airways is linked to larger direct investment from Abu Dhabi. Similarly Qatar is likely to link bilateral air services access to gas supplies and inbound investment. Aviation has become a trade issue.

CAPA welcomes the opening of the market but, to be effective, the process needs to be well thought and to follow a clear plan. Many states regard bilateral entitlements as a national asset and, while this attitude is shifting, there needs to be a transparent and coherent policy for the allocation of new bilateral rights. All stakeholders need to be in the position that they have a framework for investment. If rights allocations are to be linked to broader trade and investment issues - and this may well be in the larger national interest, although it is unlikely that careful analysis has been conducted to arrive at this conclusion - this should be stated, thereby allowing operators and investors to plan accordingly.

Over the last few years India has signed several Free Trade Agreements with key partners but has since found that several were rushed and poorly thought out. In a bid to seek foreign investment to correct the current account deficit the government should take care to ensure that it does not damage an industry that is strategically important to the economy.

Liberalisation of bilaterals will certainly support the growth of traffic flows but it is also likely to shift key elements of the aviation value chain and employment offshore. A couple of landmark foreign investment transactions involving Indian carriers could permanently change the dynamics of the international market and transform domestic aviation. However, these seismic developments are taking place in a policy vacuum.

Urgent clarity is required from the government on the criteria for issuing new licences

AirAsia's plan to form an Indian JV in which it will hold a 49% share is seen as a strong vote of confidence in the potential of the market. CAPA expects further interest from other Southeast Asian and Gulf LCCs to set up greenfield operations.

However, the definition of market entry guidelines remains another grey area in India's policy framework. There is no clearly stated position from the Ministry of Civil Aviation on the criteria for issuing new airline licences, especially for pan-India operations. Several start-ups are planning to launch new national airlines but are unaware of the government's intentions.

Until recently, prospective entrants such as Air Deccan founder, Captain Gopinath and others were advised that they would initially only be able to apply for a regional airline licence - and after an undefined period of time they might have the ability to upgrade to a national licence. However, with the AirAsia application for a national licence likely to be cleared, the Ministry appears to have changed its stance.

If approved it will be difficult for the government to reject other applications from start-up airlines seeking to operate nationwide. This would be a positive if so - but instead it is simply another unknown. And again, if bilaterals are being opened up on the basis that increased capacity and competition is good for consumers then the same should apply for new airline licences.

The Government is keen to encourage regional connectivity, but viability remains a key challenge. The proposed subsidy scheme is impractical to implement.

The government of India is keen to encourage air connectivity to move beyond the large metropolitan cities to Tier 2 and Tier 3 towns across the country. At present 36% of domestic capacity is deployed on connecting just the six largest cities to each other.

Share of Weekly Seat Capacity on Metro and Non-Metro Routes, 6-May-2013

Source: CAPA, OAG

India's Route Dispersal Guideline (RDG) system has been in place for many years. This requires airlines operating on the most lucrative metro routes to deploy a certain proportion of their capacity to connect remote regions. But this framework restricts commercial freedom by forcing airlines to fly routes which are unviable for them. There was a provision allowing airlines to sell excess seats on RDG routes to other carriers but it did not function well and was subsequently abolished.

In 2007 a new regional airline licence category was announced. Operators of regional aircraft seating less than 80 passengers are exempt from landing charges and sales taxation on fuel (although Delhi Airport has recently obtained an exemption from the regulator to be able to apply landing charges to small aircraft and may be followed by other airports).

Despite this India has no successful, standalone regional airline; this should be a cause for concern. Earlier attempts such as Paramount and MDLR have failed and most recently Mantra has also suspended operations. Intra-state air taxi operators such as Ventura in Madhya Pradesh are struggling while Captain Gopinath's Deccan Shuttles in Gujarat closed within months of starting. There is clearly a fundamental issue with the viability of regional operations due to the cost structure, airport infrastructure limitations and the overall policy environment.

The Ministry is evaluating a seat credit system to replace the RDG, along the lines of an emissions trading system. This would be partly funded through subsidies paid from an Essential Services Fund of USD50-60 million for which a fee will be levied on all domestic passengers.

A key weakness in this approach is that there is no clear definition of "regional" operations. The category spans a wide range, from 20 seater air taxis to 50-80 seat turboprops and regional jets and these have very different business models and requirements. It is only after defining the objective that the efficacy of a policy measure can be assessed. The proposed subsidy pool will be insufficient to support operators in the 50-80 seat category while the 20 seater air taxi model has some inherent weaknesses. There are no modern aircraft available in this segment and by their very nature the per seat mile cost on small aircraft is relatively high.

Offering high fares on old, small aircraft is not going to stimulate the market. And if subsidies are going to be used to bring down fares, who is going to monitor these small operators to ensure that public funds are being used correctly? An oversight committee will be required to manage the process adding yet another layer of bureaucracy and costs. In addition the limited seat capacity on air taxis is such that the number of aircraft required to meet RDG targets is likely to outstrip their availability.

Although the proposed system is more structured than the RDG, CAPA is of the opinion that there are challenges to its practical implementation. The government first needs to focus on identifying why the current business model is unviable and why ventures such as Deccan Shuttles and Mantra have failed.

Aircraft Acquisition Committee: now you see it, now you don't!

In Mar-2013 the government abolished the Aircraft Acquisition Committee (AAC), a bureaucratic construct established less than five months previously to vet and approve the fleet induction plans of all scheduled and non-scheduled operators. CAPA welcomes the decision as we have always advocated that the Committee was not required and was an intrusion in the commercial decisions of operators.

However it is puzzling that within months of the Ministry arguing in parliament for the establishment of the AAC it is now no longer considered necessary. Such sudden changes in key regulatory and policy matters send the wrong signal to investors and other stakeholders.

The regulator must recognise that ancillaries are now an integral part of the airline business model. AirAsia is likely to deliver a welcome wake-up call

Two years ago leading LCC IndiGo introduced an option for passengers to pay a premium to reserve exit row seats, a common practice around the world. Regulatory advice was communicated via email to all airlines at the time stating that charging for premium seats was discriminatory and should be discontinued. However there was no officially documented restriction on ancillary revenues in the Civil Aviation Regulations nor in policy documents.

As a result the announcement by the Ministry in Apr-13 declaring that airlines will now be permitted to unbundle fares and apply charges for preferred seating, checked baggage, oversized items, lounge access and onboard catering is not the major reform that it is being pitched as. Aside from preferred seating, several Indian airlines have in one way or another already been charging for many of these features.

The DGCA has stated that it will review the impact of unbundling on consumers in six months time. One of the key challenges is that the regulator does not have a good understanding of the evolution of airline business models globally and the increasing complexity and variety of ancillary features. The government has granted permission for carriers to charge for a list of specified features.

But what happens if an airline wants to offer zero free baggage allowance or charge passengers for services that do not appear on the approved list e.g. charges for unaccompanied minors, in-flight entertainment, wireless internet, blankets and pillows, or to check-in at the airport? Already within days of the announcement permitting airlines to charge for preferred seating the DGCA has stepped in to say that it may limit the number of such preferential seats.

With the planned entry by AirAsia in the Indian domestic market later this year we can expect to see a much more market-based approach to ancillaries. For a travelling public that has become accustomed to certain basic inclusions there will be sensitivities around unbundling and airlines will need to ensure that they communicate changes clearly to passengers. But the market has already evolved, only 10 years ago a complimentary hot meal was standard in economy class on Indian domestic sectors whereas today it is common to pay for onboard catering.

Ancillaries are now an integral part of the airline business model and should be recognised as such by the regulator. Rather than a piecemeal approach consisting of a time-bound permission to charge for specific, defined ancillaries the industry requires the certainty and flexibility to innovate and to apply charges as is commercially appropriate for the airline. CAPA estimates that Indian airlines could generate an additional USD500 million per annum in revenue through ancillary initiatives.

The regulator continues to be seriously stretched and the pressures are likely to increase as growth resumes

India's aviation regulator the Directorate General of Civil Aviation (DGCA) remains stressed due to a serious shortage of resources, with several key departments remaining well below sanctioned staffing levels. And there is insufficient investment in training the existing staff. This situation is only set to become more acute with market growth expected to resume this year.

In addition a further change may occur at the top shortly due to the end of the Director-General's secondment from West Bengal. This would bring in the third Director-General in two years. This lack of stability at the top is further compounded by the fact that senior ranks below the Director-General level are not well-equipped to handle the challenges faced by the regulator.

A proposal to establish a Civil Aviation Authority (CAA) to replace the DGCA is expected to be approved by the Cabinet and parliament before the end of the year. As a result the government has taken its eye off the task of institutionally strengthening the DGCA thereby increasing risks during the interim period until the CAA is established. There appears to be a misplaced assumption that the establishment of the CAA will by itself solve many of the current issues, but the reality is that it will inherit whatever weaknesses exist today.

Civil Aviation Authority (CAA) could be delayed until 2014. CAPA calls for independence of CAA and need to appoint domain specialists to key roles

The Civil Aviation Authority is expected to be functional by Nov/Dec-13 however it is possible that this could be postponed until after the Central government elections which are due within 12 months. This will be an important milestone - if greatly overdue - for Indian aviation but it is critical that it be much deeper than a simple re-badging exercise. The objective should be to establish a professional and independent regulatory agency, and not just to change the name of the DGCA. It is intended to operate along the lines of the UK CAA with responsibility for air safety; airspace; airline licensing; pilot, engineer and air traffic controller licensing and consumer protection.

The set-up costs of the CAA will initially be funded by the Ministry of Finance with ongoing revenue generated by passenger levies. It is expected to have full financial autonomy but will operate under the supervision of the Ministry of Civil Aviation although the precise nature of this relationship is to be defined.

A career civil servant is expected to head the CAA, counter to ICAO's recommendation that the key posts be held by experienced aviation safety professionals. Since the CAA will absorb the DGCA it will also inherit the shortage of staff and expertise which makes it imperative that the government continue to actively strengthen the regulator over the coming months.

CAPA maintains that the independence of the CAA from Ministry intervention, direct and indirect, is critical to its effective functioning. Domain specialists rather than bureaucrats should be appointed to the leadership positions. Otherwise there will be little change from the DGCA today.

CAPA India Aviation Outlook Report 2013/14

This analysis is an extract from the keenly anticipated 2013/14 edition of the annual CAPA India Aviation Outlook Report to be released on 25 May 2013.

The coming year will be a defining period for the long-term prospects of the Indian aviation market. In this complex environment, having access to up-to-date research and insights into the direction of the market is critical for any business with exposure to Indian aviation.

For more information about the full 200+ page report click here or contact Binit Somaia on bs@centreforaviation.com

CAPA has a strong and established track record in accurately identifying key trends and developments in the Indian market. We operate India's leading dedicated aviation advisory and research practice offering unrivalled analysis and data across the value chain.