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16 Oct 2019, Rohini Sanyal, ISI Research Economist

India's Aviation Industry - The Downward Drift

India’s aviation industry has been struggling for a while, but recent developments in this sector have plunged the sector into one of the most difficult times. The shutting down of Jet Airways in April 2019, the longest functioning private carrier of India, as it ran out of cash, has finally brought to the forefront the issues that are hampering the growth of the industry. Even with an increase in both domestic and international passenger movement, the industry has been unsuccessful in converting the business into a profitable one.

The passenger aviation industry in India started with Tata Airlines in 1932. Post-independence, the Indian government decided to nationalize aviation through the Air Corporations Act, following which, Tata Airlines along with Deccan Airways and six other airlines were merged to form Air India, and Indian Airlines, for international and domestic travel, respectively, in 1953. As a majority of the population used the Indian Railways for travel, air-travel was considered a luxury, affordable only for a handful. However, after decades of government sector monopoly, the liberalization policy of 1991 paved the way for private companies to enter the aviation industry in India.

The industry saw its biggest reform in the 2000s, with the entry of companies such as Air Deccan, SpiceJet, Indigo, and GoAir that used a low-cost model to build higher passenger loads. As a result of these low-cost carriers (LCCs), the face of air transportation in India completely changed. Domestic passenger traffic increased by an average of 15.9% from 2003 to 2018 annually. Simultaneously, there was another notable change in this period – the advent of travel aggregators. Makemytrip started in 2005, followed by Yatra, and Ibibo in 2007, and many others. Essentially, the travel aggregators leveled the playing field and introduced an almost perfectly competitive market for passenger air travel.

The introduction of LCCs, and travel aggregators caused the industry, which can be termed as a double whammy. While LCCs disrupted the standard operational dynamics, especially for the full-service companies, the travel aggregators made airline companies push down prices for attracting more customers. The introduction of travel aggregators chalked out a unique behavioral aspect of Indian passengers, high price sensitivity and a lack of loyalty, which translated into highly elastic demand, with little or no change in the supply. The dearth in supply of carriers is a result of high barriers to entry such as lack of transparency in the application process and criteria of approvals.

Furthermore, the Substantial Ownership and Effective Control (SOEC) policy of the government limits foreign nationals from holding majority stake in airline companies. AirAsia, Malaysia’s largest LCC, was launched in India through a partnership with Tata Sons, where Tata Sons holds 51% stake.

Due to this demand-supply mismatch, the customers have essentially turned into price makers. Designing this situation into a game theoretic setup, most carriers would choose passengers over profits, because any particular company can gain a substantial amount of passengers by marginally lowering their price, lest a central rule is enforced. In addition to the ticket price wars, the operating costs of airline companies have been soaring. The price of aviation turbine fuel (ATF) has risen remarkably and currently contributes up to 45-50% of total operating costs, compared to 32.3% globally (CAPA Spectrum, 2015). Furthermore, there is a burden of steep taxes on ATF, fluctuating oil prices, a depreciating Indian rupee against the US dollar, a dearth of commander pilots, and severe managerial and functional inefficiencies. The Maintenance, Repair, and Overhaul (MRO) industry are almost non-existent in India, and most carriers have to seek such services from Sri Lanka or Singapore. The mixture of low revenues and high operating costs have left airline companies barely breaking it even.

As a consequence, several airline companies started experiencing financial troubles. Some low cost carriers were acquired, one example being Air Deccan, which was acquired by Kingfisher. However, Kingfisher ran into its own financial troubles a few years after (in 2012), and was acquired by Jet Airways. Indian Airlines was also merged with Air India in 2011 in the face of rising costs and stiff competition. The 2019 Jet Airways shutdown only helped provide temporary relief to some competitors such as IndiGo and SpiceJet, since not long afterwards, the former, which is also the market leader, announced losses, and the latter announced the need for fresh investments to keep business up and running. As can be seen from the graph below, Air India has actually performed far beneath the industry standard, and is only able to run as it’s a government carrier. However, the government, in the Budget for 2019-20, has planned to disinvest several loss making public companies to private players, Air India being one such firm.

In order to enhance the competitiveness of the passenger aviation industry, there is a need for strong policy and regulatory framework that would also aid in driving investments. Some of the short term measures can include a reduction of taxes on ATF or bringing it under the ambit of GST, a reduction of airport development fee, and user development fee. The development of an in-house MRO industry would help in reducing the cost of carriers, and simultaneously support the Make in India initiative of the government. Longer-term reforms would require a greater focus on providing affordable and yet quality pilot training programs, which are currently considered expensive in India. Skill development is also essential for ground support staff, and air-traffic controllers. Airport development and capacity constraints, in particular, can be another key area of reform. Most importantly, intervention is required in terms of regulating the baseline prices for tickets, so companies cannot undercut each other, and maintain a healthy and affordable pricing range that would cater to a variety of customers. Despite years of operations, India remains the cheapest country to fly (CAPA Spectrum, 2015), and therefore, the spectacular growth in air travel has been at the cost of profitless growth.

References: India Today, India Express, Economic Times, QZ, Hindu Business Line