India's Aviation Industry on the Verge of Crashing
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:: Issue Analyses India’s aviation industry on the verge of crashing Imm Jeong-seong Senior Business Analyst of POSCO Research Institute Since February 18, Kingfisher Airlines, India’s second largest airline, has cancelled more than 200 flights, causing chaos in India. The gravity of this event is significant, as Kingfisher had S cancelled flights before, in November 2011. Kingfisher claimed it cancelled flights because the Indian Revenue Service had frozen its bank accounts. Currently, Kingfisher owes tax arrears of INR 1.8 billion to the tax authorities. Kingfisher was founded in 2005 with the expectation that it would turn a profit shortly. However, its dream of “dominating the sky” was shattered after the world was struck by two rounds of financial crisis in 2008 and 2011. Kingfisher Airlines accumulated losses of INR 64.1 billion and debts of INR 70.6 billion from 2005 to the third quarter of 2011. Opposition parties, including the Bharatiya Janata Party (BJP), are opposed to any move by the government to bail out the debt-ridden Kingfisher Airlines. Civilian Aviation Minister Ajit Singh said that private companies should find ways to rescue themselves. On February 22, however, the Indian government put pressure on banks to support the airline, 079 Summer 2012�POSRI Chindia Quarterly for fear that the bankruptcy of the company would break connections to small and medium cities, compromising the convenience of the public, and drive up flight fares overall. However, sixteen creditor banks are opposing further bail-out packages to the ailing airline, claiming that they would not consider providing additional financial support or extending the maturity period unless Vijay Mallya, the chairman of Kingfisher Airlines, capitalized an extra INR 15 billion, and offered collateral. In the worst case scenario, Kingfisher will go bankrupt. The banking sector, political circles, and the public are all seemingly hostile toward Chairman Mallya, because he is the owner of UB Group, a spirits company, and a billionaire with a net worth of USD 1.4 billion (according to the 2010 Forbes list of billionaires). Chairman Mallya has often been in the spotlight for his flamboyant lifestyle─luxurious parties, grandiose mansions, high-end cars, and yachts. He also owns professional teams in F1, cricket, soccer, and other sports. ○● The expansion of India’s aviation industry after doors opened to private operators In 1953, the Indian government nationalized eight private airlines, including Tata Airlines, to form Indian Airlines. For the next forty years, Indian Airlines dominated the domestic market, but the Indian people were not happy about its high fares, frequent delays, and substandard passenger services. The competition landscape changed in 1994 when Jet Airways and Air Sahara entered the market, after the government opened the sky to the private sector. However, all seven new companies, including ModiLuft, created in the 1990s, were nudged out of the market by 2001. From the government’s deregulation of the aviation industry in 2003 until 2006, five low-cost carriers (LCC), including Air Deccan, were created. As a result, the market share of Indian Airlines fell from 100% in 1994 to 40% in 2003, and to 20% in 2007, while the share of private airlines 080 POSRI Chindia Quarterly�Summer 2012 :: Issue Analyses continued to grow, to 83% in January 2012. Private funds entered the Indian aviation industry with the anticipation that demand for air travel would increase, considering the number of India’s middle class, which is higher than that of the USA, and its vast land, within which a train trip typically takes at least twelve hours. In fact, domestic demand has surged since the opening of the aviation industry. There are many reasons. Potential demand has been realized, income has increased rapidly due to India’s high economic growth since the mid-2000s, and the number of business trips has increased. The number of passengers on domestic flights increased 3.8 times, from 13.7 million to 52 million, over the ten years from 2000 to 2010. In 2011, this number was reported to exceed 60 million. The number of regular passengers, excluding duplicate passengers, is estimated to be about 20-30 million, which is less than 10% of the 300 million middle class in India. According to Airbus, Europe’s leading aircraft manufacturer, domestic air traffic in India is estimated to increase to 160-180 million passengers, while international passenger traffic is expected to reach 80 million passengers by 2020. ○● Poor performance due to oversupply and low-cost competition India’s aviation industry, which seemed to be sailing smoothly, was impeded by two global financial crises in recent years. The Indian aviation industry lost USD 500 million in 2006-07, USD 700 million to 1 billion in 2007-08, USD 2.2 billion in 2008-09, and about USD 3 billion in 2011-12. Indian carriers had accumulated billions of dollars in losses and debts as of September 2011: Air India (INR 790 billion), Jet Airways (INR 185.3 billion), and Kingfisher Airlines (INR 136.3 billion). Low-cost carrier IndiGo is known to be the only Indian airline in the black with no debts. The Indian government has injected USD 618 million into state-owned Air India over the last two years. As the company was again at risk of 081 Summer 2012�POSRI Chindia Quarterly The number of passengers and cargo traffic of Indian airlines (Unit: 1 Mil. people; ’000 ton) 2000 2006 2007 2008 2009 2010(e) AAGR Domestic 13.7 35.8 44.4 39.5 43.8 52.0 14.3% No. of passengers International 3.8 7.6 9.1 10.0 11.6 13.1 13.2% Domestic 167 266 303 278 328 430 9.9% Air cargo traffic International 101 124 143 174 219 261 9.9% Source: The Directorate General of Civil Aviation (DGCA) bankruptcy in February of this year, the government allowed Air India to raise INR 74 billion by issuing bonds. Creditor banks approved a INR 180 billion debt restructuring plan, and decided to provide the ailing airline with cash credit worth INR 22 billion. Currently, some airlines, including Kingfisher, Air India, and Jet Airways, are unable to pay their employees, and many pilots have moved companies. Since last October, approximately 80 pilots at Kingfisher, 40 pilots at Air India, and 50 pilots at Jet Airways have left for IndiGo or foreign airlines. What ails India’s airlines? First, too many airlines have been created in optimistic anticipation of the future, resulting in an oversupply of airlines. Since 2000, five Indian airlines have gone bankrupt. Oversupply of airlines is gauged by the passenger load factor (PLF), the passenger load divided by the seating capacity. The PLF in the Indian market, which was only 55.5% in 2001, improved gradually until 2008, when it fell to 63.7%. The number recovered in 2009, but only to 72.0%, far below the 2008 global average of 77%. Second, aggressive low-cost competition played a role. LCC’s entered the race, and lowered the fares for flights from Delhi to Mumbai to INR 721. Indians, known to be savvy price-checkers, flocked to LCC’s, and 082 POSRI Chindia Quarterly�Summer 2012 :: Issue Analyses Indian carriers’ market share and passenger load factor (Unit: %) Jet Kingfisher Air India Jet Lite* IndiGo* SpiceJet* GoAir* Airways Airlines M/S (2010.12) 17.1 17.7 7.7 18.6 18.6 13.8 6.4 M/S (2012.1) 17.1 20.9 7.9 11.3 20.8 16.3 5.8 PLF (2012.1) 71.2 76.8 80.1 70.2 85.9 75.6 77.4 Source: The Directorate General of Civil Aviation (DGCA) Note: 1. * refers to LLC. Figures of Air India and Kingfisher include those of their own LLC’s. 2. PLF is a ratio of passengers actually carried versus the total passenger seating capacity of an airline network carriers had to cut their fares dramatically. Network carriers started to launch their own LCC’s: Jet Lite (Jet Airways), Air Deccan (Kingfisher Airlines), and Air India Express (Air India). Kingfisher Airlines, which has implemented differentiation strategies and was conferred 5-Star Airline status, also joined the low-cost competition and soon had the highest market share. Third, the Indian government’s policies emphasizing free trade and free competition influenced the Indian aviation industry. The Indian government made agreements with other countries, as part of its open sky policy, to allow foreign private airlines to operate domestic flights in India. This led to oversupply in the domestic market. Indian airlines lost their international routes to foreign carriers. ○● Limits of integration and cost-saving India’s aviation sector seems to be passing the buck to the government. It is citing many reasons for the poor management of Indian airlines: high raw material costs, which account for about half of total costs; a steep sales tax rate (24%) on aviation turbine fuel for domestic use; and high airport 083 Summer 2012�POSRI Chindia Quarterly tax. As a result of incessant requests by Chairman Mallya, who Companies having a presence in the Indian market also need is also a Member of Parliament to respond to ever fiercer (Council of States), it was finally competition following the decided at a recent ministerial opening of the Indian market to the world. meeting that Indian airlines would be allowed to import jet fuel directly. Some anticipate the decision will bring a 10-15% cut in fuel costs, while others point out that the plan is unrealistic, citing problems such as having to set up fuel storage. Indian airlines are demanding that the government lift a ban on foreign airlines investing in Indian airlines.