Will Foreigners Save Air India, Kingfisher, IndiGo And India's Other Airlines?

India has risen in the past decade to become the world’s fourth-largest economy, and together with its technology sector, one industry in particular has mirrored the nation’s growth: aviation.

India's domestic aviation market has tripled in the past five years and, even as its growth rate has slowed this year, the number of passengers carried by domestic airlines rose 0.5 percent to 39.82 million during the January to August period, compared with a year earlier. India, long an underdog in commercial flying, is now the ninth-biggest civil aviation market in the world in terms of traffic.

The days of harrowing flights to crumbling airports in rickety Soviet-made airplanes are long gone. Now, the nation’s airlines fly the newest Boeings and Airbuses, and flag carrier Air India is one of just a handful operating the Boeing 787, the most advanced jetliner in the world. No one in Europe, for example, does yet.

However, most of India’s airlines are struggling. Hampered by heavy regulation, inflexible taxation and problems ranging from labor unrest to infastructural weakness, they find themselves financially weak (the industry has a collective $20 billion in debt) and, in the case of former heavyweight Kingfisher, just one step from going bankrupt.

The government’s answer to the problem has largely been to turn to a three-letter initialization that is all the rage in the country these days: FDI. It stands for Foreign Direct Investment, and it means just what it says. Indians at a loss for solutions hope that overseas investors may bring ideas, connections, and most of all, capital.

Last month, Prime Minister Manmohan Singh’s government relaxed rules for foreign direct investment in several sectors including aviation, allowing foreign airlines to own up to 49 percent of any Indian carrier. Before the reform, foreign investors except for other airlines were allowed to own stakes in Indian carriers -- but that was not enough to attract suitors because, due to the industry’s uniqueness, it’s mostly airlines that want to invest in other airlines.

But it won’t be so easy to get the big international carriers, which are facing their own troubles, to invest in India’s tightly regulated aviation sector.

Hoping For Gulf Money

The number one problem, analysts say, is taxes on fuel, which constitutes approximately 40 to 50 percent of the operating expenses of Indian carriers, compared with around 30 percent for Western airlines. Jet fuel in India is taxed through excise duties from the central government and then burdened with a sales tax levied by the state governments. And that’s on top of airport fees.

Those issues are keeping some potential investors on the sidelines. “Carriers from the Gulf, as well as the likes of International Airlines Group [the parent company of British Airways and Spain’s Iberia], Lufthansa and Singapore Airlines have all been watching the sector with interest, and informal discussions have taken place in several cases. But the balance sheets of most of the incumbent carriers are relatively weak, and the sector faces numerous structural challenges, so foreign airlines will make their own assessments about whether they consider a carrier to be a suitable investment at this time,” the global aviation consultancy Centre for Asia Pacific Aviation (CAPA) said in a report.

Airlines around the world are no strangers to dealing with hard-to-control costs. But in India, those costs can be especially hard to control.

Recently, Delhi International Airport Limited was granted permission to increase charges for landing and parking by a staggering 346 percent for the next two years, making it the most expensive airport for passengers in the country. Mumbai Airport sent a proposal to the industry regulator asking permission to increase tariffs by 660 percent. The airports in India levy the same charges for the full-service carriers and the low-cost carriers, which makes life hard for the low-budget business models that have spurred passenger growth so far.

Infrastructure bottlenecks are another issue. The largest airports are crowded, and until the secondary ones are turned into viable, modern facilities, low-cost carriers will be forced to use major airports, waiting for their turn to land, which increases fuel costs and disrupts schedules. These constraints can be resolved only if there is a significant improvement in the infrastructure.

Low-Cost Domination

And low-cost carriers (LCC) are, in Indian commercial aviation, the biggest player in town. The sector is made up of six major scheduled airlines: Air India, Kingfisher, Jet Airways, Spicejet, Go Air and IndiGo. The first three are full-service, the other low-cost.

According to statistics from the Director General of Civil Aviation, the leader is low-cost carrier IndiGo, with 27.6 percent market share in August. Jet Airways, combined with its LCC subsidiary JetLite, stood at second place with 25.2 percent. Low-cost Spicejet was at 18.5 percent; the legacy player, government-owned Air India, was at 18.2 percent; Go Air, had 7.4 percent; and Kingfisher had 3.2 percent.

The growth of the budget airline industry in India has changed the perception that air travel is a luxury and that it is only for the upper segment of the population. Spurred by the budget players, domestic passenger traffic increased from 14.2 million in 2003, when the first low-cost carrier, Air Deccan (which later morphed into full-service Kingfisher) was started, to 60.66 million in 2011.

According to the Centre for Asia Pacific Aviation, budget airlines GoAir and SpiceJet are the best-placed to attract foreign investment.

"FDI will benefit the industry in the medium to long term, as the problem of the industry right now is of profitability and not investment-related. The profitability-related issues need to be addressed, which clearly cannot be done by foreign carriers as they cannot change the tax or the fare structures here. But yes, in terms of investment required in adding capacity or expansion, that capital will work well for Indian carriers," Amrit Pandurangi, senior director of consultancy Deloitte India, told the Economic Times.

Goodbye, Kingfisher?

One struggling actor that may not find a foreign savior is Kingfisher. With debts of over $1.5 billion, the airline owned by liquor billionaire Vijay Mallya has not posted a profit since 2005. It grounded its entire fleet on Oct. 1, after reducing it to just 11 aircraft from its peak of 67.

The company owes about $600 million to creditors, lenders, suppliers and to employees in back salary; strikes have disrupted its operations repeatedly.

That is a sad state of affairs for the airline that essentially pioneered the boom of commercial aviation on the Indian market. It borrowed aggressively during the global downturn; it even ordered the giant Airbus A380, the biggest commercial jet in the world. (It has since canceled its order.)

Kingfisher lobbied hard for FDI reform in the aviation sector, but not surprisingly, the government’s opening to foreign airlines may have come too late to save it. No airline has publicly expressed an interest in buying a stake in Kingfisher.

Others, according to the results for the quarter ended on June 30, are in much better health. In fact, four of the six major Indian carriers posted a profit: SpiceJet announced net income of nearly $10 million; Jet Airways plus JetLite $6.4 million; IndiGo and Go Air (both are not listed and do not publish their financials) posted a net profit of $18.9 million and $5.4 million, respectively, according to CAPA estimates; only Kingfisher and Air India posted a loss.

In other words, LCCs are doing much better compared with full-service airlines. But that success may be in danger. A research report from ICRA pointed out that the longer-term viability of the LCC model in India remains to be seen, citing fuel costs and airport charges as reasons. Already, some budget airlines have raised fares, and on some routes, a full-service airline offers lower fares.

But still, there are attractive factors. The market, which grew 83 percent from July 2006 to July 2012, still has lots of room to expand: Air travel penetration in India is less than half of China’s, where people take 0.2 trips per person per year, suggesting strong long-term growth potential in the coming years. The world’s second-largest population will keep flying more and more, and one of the strongest endorsements of that view came from no less a source than Boeing, which recently raised its forecast for the Indian plane market: According to the plane maker, by 2031 the country would need 1,450 new aircraft, worth $175 billion.