An Analysis of Impact of Budget 2012-13 on the Indian Aviation Sector

Authors:

SUBBA REDDY POLIMERA

VASUNDHRA SARASWAT 

TheIndian aviation sector is one of the fastest growing civil aviation industriesin the world. It has moved from an overly regulated industry to one that isopen, liberal and investment friendly. With entry of a lot of private players,higher household incomes, strong economic growth and favourable economicpolicies, the Indian Aviation Sector is treading on a path of high growthtrajectory. Domestic airlines have been allowed to fly overseas and strategic partnershipwith foreign carriers is being promoted while these foreign carriers in turnhave been interlining with domestic airlines to access secondary destinations.Greenfield and modernization project are developed with PPP model.  Private airlines account for more than 75%share of the domestic aerospace market.

Inrecent years, despite potential for huge growth, most of the airlines arerunning into losses. Major drivers for these losses are price of aviationturbine fuel which alone accounts for over 40% of operational costs, which isnearly more than double the international statistics of its counterparts and theother factor is interest paid towards its debt service. As per recent report byAviation regulator Directorate General of Civil Aviation (DGCA), IndigoAirlines is the only profit making airlines with an yearly profit of Rs 650crore.So in this situation current Budget 2012-13 has become a crucial point forthe future course of Indian Aviation Industry.

InBudget 2012-13, Mr.Pranab Mukharjee, the finance minister of India, hasdelivered several incentives to the ailing Aviation Industry.
Firstone is direct import of Aviation Turbine Fuel; this can reduce costs of fuelthereby increasing operating profit margin of Airlines. But the problem withthis is the storage of imported fuel, as the infrastructure for storage lieswith the State owned oil companies. In India Aviation turbine fuel accounts fornearly 40% of an Indian carrier's operating cost, compared to 20-25 per centglobally. With the direct import of fuel Airlines can save some money, therebyreducing some burden on them  

  Graph below gives how Power and Fuel costsare varying as part of Sales for Jet Airways

      

Due to thesewide fluctuations in fuel prices most of the Airlines are not able to maintainsustainable operations, leave alone them making any profits on the whole.

Secondone is permitting External Commercial Borrowings (ECB) for Working capitalrequirements for a period of one year, subject to a ceiling of $1billion. Thiswill help struggling airlines like Kingfisher airlines and Jet airways to raisemoney from overseas markets. The key to this step lies in the fact that thecost of debt in global markets is comparatively low. In domestic markets, Kingfisheris raising money at high interest rates. If we look at the 2011 annual reportof Kingfisher airlines, its capital structure and leverage figures of Debt areas follows,

• Rs.7,501 million of Loan from thebankers was converted into 7.5% Compulsorily Convertible Preference Shares.
• Rs.5,531 million of Loan from thebankers was converted into 8% Cumulative Redeemable Preference Sharesredeemable at par after 12 years.

Loans / Inter corporate deposits fromcertain business associates aggregating to Rs.7,093 million were converted into7,09,31,985 8% optionally convertible debentures of Rs.100/- each (“OCDs”)which are convertible into equity shares for until a period of 18 months fromtheir issue, after which they are redeemable.

Costof debt raised by Kingfisher in domestic market is more than 7%, where as inthe international market, capital can be raised at 5% or even below thandepending on the credibility of the company. In future by this form of raising capital, considerable savings can bemade by the Airlines.

Thethird one is active consideration allowing foreign airlines to participate inup to 49% equity of an airline company, operating scheduled and non scheduledservices. This will impact the overall growth of the sector by providing the muchrequired capital for Airlines.

Theabove mentioned three incentives provided by Government of India can give tremendousrelief to our Aviation Industry which is highly required at this juncture. 

Fourthone is tax concessions for part of aircraft and testing equipment for thirdparty Maintenance, Repair and Overhaul (MRO) of Civilian aircraft including full exemption from customs duty andcountervailing duty to aircraft spares, tyres and testing equipment. Indiais becoming the fastest growing market in the world for aircraft Maintenance,Repair and Overhaul services over the next decade tripling its worth to $1.5Billion, as airline companies buy more number of planes. According to globalconsultancy firm KPMG, over the next decade India is going to be the leader inthis space, which is currently split between North America and Western Europe,because of the higher economic growth rate that the country is going towitness. Till now due to customs duties and service tax for rendition ofservice local MRO industry has become less competitive compared to Globalpeers. With incentives offered in Budget, this Maintenance, Repair and Overhaulcan grow at rapid pace providing employment opportunities. This will alsobenefit low cost carriers which send their aircraft to Europe, Middle East orSouth East Asia for major maintenance.

Fifthone is Provision of increasing the service tax from 10 % to 12 % is going tomake airfare costlier. This can levy additional burden on consumer turning upfrom air travel. A reduce in small fragment of ticket sales, can have adverseaffect on ailing Aviation Industry.

Sixthone is the sop for Indian international travellers- proposal is made to raiseDuty free baggage allowance. This was last revisited in 2004. Duty free baggageallowance is from Rs. 25000 to Rs. 35000 for adults and for children up to 10years it ranged from Rs. 12,000 to Rs. 15,000. This can bring some cheers toInternational travellers who are burdened by increase in service tax of from10% to 12%. But for domestic travellers this very same Service tax burden isgoing to impact them adversely, which in turn affects the domestic carriers.

TheseIncentives given are intended for giving some respite to the Indian AviationIndustry. It didn’t specifically focus on some of the core issues which areailing the Industry. Some of these are-Ad valorem taxes of 20-29 per cent aremaking domestic airlines shell out nearly 52 per cent more for the fuel comparedto the average global price and High airport and handling charges in India,that are adversely affecting Indian airports' prospects of emerging asglobal/regional aviation hubs in gigantic proportions.