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Government allows FDI by foreign carriers in domestic airlines Published Date: Sep 27, 2012

The Government of India has notified foreign direct investment of up to 49 per cent by foreign carriers in the Indian aviation industry. This move will, in the long run, draw more serious global players into the sector, given the size of the Indian aviation market and its growth potential. However, addressing issues relating to taxes and levies on aviation turbine fuel will be critical to attract substantial FDI in the sector.

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On September 14, 2012, the Government of India announced that it would allow investment by foreign carriers into the Indian aviation industry to the tune of 49 per cent. This had hitherto not been permitted mainly because of issues related to security and the possibility of foreign players virtually taking over small Indian carriers. Until now, foreign direct investment (FDI) from foreign entities (non-airlines) to the tune of 49 per cent and 100 per cent through NRIs had been allowed.

Move to open up sector is a step in the right direction.... The Indian aviation industry has recorded a robust growth over the past 5 years, driven by economic growth and improving airport infrastructure. Domestic passenger traffic has expanded to 61 million passengers in 2011-12 from 35.8 million passengers in 2006-07, registering a CAGR of 11 per cent. Although growth will be slower in the short term due to the economic slowdown, CRISIL Research expects the sector to continue to clock healthy growth in the long run, with passenger traffic estimated to reach 90 million by 2016-17.

Domestic air passenger traffic trends and outlook

E: Estimated; P: Projected Source: DGCA, CRISIL Research

The size and growth potential of the Indian aviation market is expected to attract global carriers, few of which have already shown interest in forming alliances with Indian players. We believe that the first set of beneficiaries of this rule are likely to be airlines that currently have little or no investments from foreign entities. In addition, this move to allow foreign direct investment is expected to provide a much needed source of funding for debt-laden carriers that are highly levered. Jet Airways Ltd. has a gearing of 3.8 times in 2011-12, while the networth of SpiceJet Ltd. and Kingfisher Airlines are in the negative as of March 31 , 2012. Private carriers alone had a debt burden of Rs 400 billion as on March 31, 2012 (the collective debt burden of the Indian aviation industry stood at around Rs 900 billion as on March 31, 2012). Opening up the aviation sector is also expected to help bring global best practices to India with respect to better flying experience for passengers, and improved technology and safety aspects.

....but structural issues need to be addressed first 2 of 3

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While this is a positive and important step forward for Indian aviation, we believe that allowing FDI by itself will not be sufficient to address the numerous structural challenges, especially relating to duties and levies on fuel. Aviation turbine fuel (ATF) cost is the largest cost component for airlines (accounting for 45-50 per cent of costs), and hence, is a key determinant of operating profitability for carriers. However, these costs are largely beyond the control of airlines as they are driven by fluctuations in global crude oil prices. In India, national sales tax on ATF (25-30 per cent on average) is an additional burden for domestic carriers. This tax structure makes Indian ATF prices about 50 per cent more expensive vis-a-vis other countries. In an industry like airlines - where the price-sensitive nature of customers and severe competition restricts players' ability to pass on any increase in costs - this results in severe pressure on the carriers' financials. Consequently, Indian carriers (including Air India, a 100 per cent government owned carrier) clocked accumulated losses of around Rs 450 billion in 2011-12. These issues must be addressed in order to facilitate foreign investments, and thus ensure a substantial positive impact on airline financials and the investment climate in the Indian aviation sector.

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