Whos afraid of FDI?

Dhiraj Mathur India cannot aspire to sit on the global high table of economic powers without a robust civil aviation sector. It is a sensitive and critical infrastructure sector and this is possibly why it has traditionally been highly regulated. In particular, while FDI up to 49% is allowed in commercial airlines, foreign airlines are prohibited from participating. There is a strong belief in industry and some sections of the government that the regulation has been overdone and has stifled the growth and today, threatened the very existence of commercial airlines. There is an urgent need for reform that would facilitate growth and provide commercial airlines with long-term capital, management and access to international networks. In short, the government must allow foreign airlines to invest in domestic airlines. Before assessing the benefits of foreign capital, it is essential to look at the key challenges that the sector faces today. These can be broadly put in three buckets: company-specific, global, and national policy-related. Airlines have no control over the last two while can significantly benefit from strategic FDI in addressing the first. Among company-specific factors, the most important ones are the lack of focus, faulty M&A decisions and failed mergers. Globally, more than 75% airlines mergers have failed. In India, integration in none of the three M&As is complete nor successful, and led to huge debt for Kingfisher and Jet. The main reason for this is the difficulty in running full service and low-cost operations under the same managementthey require different DNA. There are also management issuesinability to keep costs low, purchase rather than leasing, not going in for buyback and lease, and finally, the insane price war that airlines got into. Principal among the global factors contributing to the challenges is the volatility in crude prices---it shot up from $85 a barrel in Oct 2010 to almost $125 a barrel in April 2011. IATA estimates that a $1 increase in the average price of a barrel requires the industry to recover an additional $1.6 bn in costs. Rupee depreciation has further increased the fuel bill for all airlines. The airlines business is cyclical and closely correlates with the economy. The global economic slowdown, the Euro-zone crisis, and the political turmoil in MENA have exacerbated the situation. IATA downgraded industry outlook in December '11, projecting airlines to post profits of $6.9 bn globally, down from its March forecast of $8.6 bn and predicts further slowdown globally with a dip in business and consumer confidence. National policy measures have added to the carriers' woes. India has among the highest tax on ATF imposed by the state governments (3-30%). This, along with the social obligation to fly uneconomic routes, deals a double whammy on airlines. The high interest rate regime has hit airlines with large debt. Poor infrastructure at the airports, resulting in delays in takeoff and landing, high airport charges, interference in pricing, imposing a five-year track record requirement for international flying etc have all contributed in stifling growth, raising costs and making airlines non-viable. The result: all five listed airlines have posted losses this year with at least two facing severe working capital crises. There is little that airlines can do to control global factors and under the present vitiated atmosphere, the Indian government cannot offer a financial bailout package like the US government did for its auto companies. What it can and must do is to create an enabling policy framework for the airlines to run their business in a freer environment. There is thus a need for some bold decisions if the sector is to sustain itself. Liberalisation of the FDI policy regime can significantly address many of the problems that airlines face. The policy to keep out foreign airlines has not borne any fruit: though FDI is allowed up to 49%, according to government data, inflows into this sector have been dismally low at $400 million (from April 2000 to Sept 2011), constituting a meagre 0.30% of all FDI inflows during this period. Allowing foreign airlines in commercial airlines will be beneficial for several reasons. For one, they will enter as strategic partners and bring in much-needed long-term and stable capital. This will alleviate short-term and long-term fund requirements like upgrading their fleet to more fuel efficient aircraft. Besides, equity infusion would also provide comfort to the banks that are reluctant to lend. The countrys macro economics is equally expected to gain with increased FDI inflows. Second, keeping out foreign airlines restricts the options for foreign investors largely to private equity. However, there has been limited interest from PE players, possibly on account of the high risks associated with this sector in India. Though FII investments are allowed, they are highly volatile, risk-averse and short-term. Besides, they are in the secondary market. The obvious option left amongst the investor group then is the foreign airlines themselves. They know the industry well, can bring in global best practices and management expertise, upgrade service quality standards, bring in better aviation systems and technology, provide better training platforms for the pilots and crew members, have code-sharing arrangements on international segments---all in all, help reduce costs while improving service and benefitting the Indian airline segment. Most countries allow foreign airlines, though with caps. There is no rationale in keeping them out. One can consider a graded approach, 26% to start with (anything less will not be worth it). The country will have to allow them eventually. So, why fear the inevitable? The author is executive director, PwC India. Views are personal.

(Published in the Financial Express)