9-Sep-2011 9:49 AM

Comptroller and Auditor General criticises Air India aircraft acquisition; Indian Airlines merger

India's Comptroller and Auditor General (CAG), in a damning report on Air India (AI) tabled in parliament on 08-Sep-2011, criticised Air India's decision to acquire 68 Boeing aircraft in 2005, a decision approved by the government, stating it imposed an "undue long-term financial burden on the carrier". CAG added the potential benefits of the Air India-Indian Airlines (IA) merger "would have been far higher had this been undertaken before finalisation of the massive and separate fleet acquisition exercises undertaken by Air India and Indian Airlines". It said the merger of the two carriers just a few months after the large aircraft were ordered "appears somewhat ill-timed, with loss of significant synergistic opportunities".

CAG also criticised the liberalisation of route access, particularly to the Middle East, which also contributed to the national carrier's current financial challenges. Details include:

  • Aircraft purchases: The CAG report said the airline had initially planned on acquiring 18 smaller capacity and 10 medium capacity aircraft in Jan-2004, but submitted a revised plan in Nov-2004 for 50 medium- and long-range aircraft worth around USD7.2 billion, and 18 more for Air India charters. In 2006, Indian Airlines had placed a separate order for 43 Airbus aircraft. CAG said that the sudden increase in the number of aircraft to be purchased "does not withstand audit scrutiny". The larger aircraft were deployed on long-haul routes, which were unprofitable. "This sector on which American/Canadian airlines were already operating non-stop flights and based on which fact AIL was made to reconsider its fleet requirement, turned out to be a loss-making sector right from the date of commencement and continued to be so," the report said. CAG also noted the inconsistency with the approval for the acquisition. The speed of approvals is suspect and the decision to buy aircraft was driven by supply and not by demand, a fact endorsed by former employees of Air India, CAG added;
  • Debt funding of aircraft: CAG was critical of the financing and timing of the acquisition of aircraft. “The entire operations (for both Air India and erstwhile Indian Airlines) were to be funded through debt (to be repaid through revenue generation), except for a relatively small equity infusion. This was a recipe for disaster…and should have raised alarm signals in the Ministry of Civil Aviation and the Planning Commission,” the report said;
  • International routes: CAG said the carrier's single largest loss-making routes for the airline were sectors between India and US, which contributed 41-90% of Air India's total operating losses during the period 2005/06 to 2009/10, the report said. All international routes of the carrier were loss making by 2009/10, the report added;
  • Air India/Indian Airlines merger: CAG added it was unable to ascertain the detailed justification for the in-principle approval of the Government for the merger of Air India with erstwhile Indian Airlines, adding that the merger was "ill-timed". CAG added the financial case for the merger was “not adequately validated prior to the merger” and that the decision came “strangely from the top with inadequate validation of the financial benefits”. It said that the merged entity's financial position has been "abysmally poor", from 2004/05 to 2009/10. "The potential benefits for the merger would have been far higher had this been undertaken before finalisation of the massive and separate fleet acquisition exercises undertaken by AIL and IAL (Indian Airlines Ltd)," the report said;
  • Government equity: The CAG report said that merged entity has been heavily dependent on debt and the Government should promptly infuse more equity in a timely fashion to bring down the debt-equity level to industry standards. Last month, the cabinet approved an equity infusion of USD112 million into the carrier. CAG also stated the piecemeal infusion of small amounts of equity is merely going to delay the “certain” closure of the airline; 
  • Open skies policy: CAG stated the liberalisation of the bilateral air traffic entitlements with other countries "did not provide a level playing field to AI (and to a lesser extent other Indian private airlines)". CAG stated the "massive increase" in bilateral air traffic rights to Gulf nations occurred despite Air India's "strong reservations" as this was the carrier's most profitable international sector. "Clearly, the Gulf sector was AI/IA's most profitable international segment before the liberalised policy on bilateral entitlements. AI repeatedly expressed strong reservations to the Ministry against the proposals/requests from Gulf countries for an increase in seat entitlements as well as additional points of call at interior locations in India," the report said, adding the grant of bilaterals demonstrated "the one-sided nature of benefits to Emirates/Dubai". The report continued: "These (bilateral) agreements, besides not affording adequate time to AI/IA to set their houses in order and gear up for a highly-competitive environment, very evidently worked to the detriment of the national and Indian private carriers," the CAG said."At this stage, Indian carriers (including AI) will have to tackle renewed and serious challenges to compete effectively with established international 'mega carriers'," it added;
  • Reaction to the report: Reacting to the CAG report, the former Aviation Minister whose tenure oversaw the aircraft acquisition and the merger, Praful Patel, said the new aircraft were required to replace Air India's ageing fleet and was a jointly-reached decision with the Government. "Two committees were also appointed to oversee the negotiations" with Boeing, Mr Ravi said, adding that there was no question of taking any hasty decision and the Cabinet, the Empowered Group of Ministers (EGoM) and other bodies were involved in taking the decision. He commented: "Most of the aircraft with Air India and Indian Airlines in 2004 were 20 years old and there was no way the airline could have withstood competition or survived with these planes," he said. He continued: "For 20 years, Indian Airlines and Air India did not buy planes and when this Government came in 2004, we were left with very little choice. To run the airline, new planes were required. The competition had new planes," Mr Patel said. On the Open Sky policy, Mr Patel said that the policy was adopted and implemented by the Government to give passengers more choice in terms of product and destination.“The traffic to and from India has grown at a CAGR of 15% since 2004. Had we not negotiated bilateral traffic rights, what would have happened to passengers? The policy is not for an individual or one entity. It is in the interest of the nation,” Mr Patel said. Mr Patel also labelled the CAG report as "full of contradictions", stating the Civil Aviation Ministry would give adequate reply to the Public Accounts Committee (PAC), which will look into the report. Mr Patel's name was, however, not mentioned in the report, despite his tenure as Civil Aviation Minister over the period in question;
  • Human resources: CAG said the delay in integration of human resources (HR) has been a "critical impediment" to the completion of Air India's merger. "HR integration below the Deputy General Managers (DGM) level – pilots, engineers, and other staff representing 98% of the total employees – of erstwhile Air India and Indian Airlines has not yet taken place," the report said. Terming it a "critical impediment to the merger", the CAG said pay and allowances, seniority, promotions and transfers had yet to be harmonised. "The key issue with regard to HR is not one of job security or protection of compensation/perquisites, but one of perceived disparities between employees of the erstwhile separate airlines," the report said, adding that the issue needs to be handled swiftly, if the merger of Air India and Indian Airlines is to be a success. The CAG also suggested restructuring of payment of performance linked incentive (PLI), which is being given as part of the salary to the employees;
  • Future: CAG put the onus of turning Air India around squarely on the Government, suggesting it lay down a roadmap for liquidating its large debt liability, reassess bilateral agreements on certain routes (mainly routes to the Gulf region) and provide the airline with “more than a level” playing field. It has also suggested that the Government should immediately provide a bailout package, comprising equity, outright grant and soft loans to bring the airline back to profitability. CAG also recommended "a total hands-off approach (by the Government) with regard to the management of the airline". If these measures are not enacted, CAG warned the airline does not have a future as a vibrant public sector entity.

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