The success of the policy is contingent on the support from states and while it entails significant impetus for development of regional airports and provides incentives for airlines to operate on regional routes availing viability gap funding (VGF), it fails to address structural issues such as air turbine fuel (ATF) taxation in the metros and provide clarity on the 5/20 rule for operating overseas. Ind-Ra therefore expects the private LCCs and FSCs such as Interglobe aviation (Indigo), Jet Airways India Ltd, Go Airlines India (Go Air) and Spice Jet (Spice Jet) to take a cautious stance to expand in the regional areas and to enter this arena only after assessing the performance and profitability of regional airlines. Consequently, capacity additions in the regional markets will initially remain limited and will pick up only once FSCs and LCCs have an opportunity to expand in this market.
Ind-Ra further believes that the government of India's target to increase domestic passenger traffic to 300 million by 2022 from 70 million in FY15, is aggressive, as the industry would have to register an annual CAGR of 23% which appears challenging in the midst of a global slowdown. The passenger traffic at the existing airports grew at a CAGR of 7.6% between FY10-FY14. Even in the years of booming domestic passenger traffic, FY04-FY10, the industry clocked an annual CAGR of 18.4%. A VGF of INR15bn/ year for affordable regional ticket fares as stated in the draft policy, would be able to support passenger traffic to the extent of 12.5 million passengers annually. This expected improvement in the regional traffic in Ind-Ra's view would still be a marginal contributor to the overall passenger traffic.
Ind-Ra believes that regional players such as Air Costa Aviation Private Limited (Air Costa), Abc Aviation And Training Services Private Limited (FlyEasy), Air Pegasus Private Limited (Air Pegasus), and Turbo Megha Airways Private Limited (TruJet) would benefit the most from the policy as they would be exempt from airport charges, would not need to pay service tax, and would get free police and fire services. This coupled with the lower MRO cost will further benefit the players. Furthermore, these players will benefit in the event of the abolition of the 5/20 rule and introduction of domestic flying credit (DFC), as a majority of these players are new entrants into the sector. Revenue from trading and sale of DFC would be an incremental source of revenue for the regional players. However, state support would be crucial for the Regional Connectivity Scheme to be successful, as the most important incentive of the policy - the decision to reduce tax on ATF to less than 1% rests with the state.
The tax on ATF presently ranges between 4%-30%. The state would also have to provide free land and security, as well as water and power at concessional rates. Ind-Ra believes that non-compliance/ resistance by states may result in higher fuel costs and therefore make the entire model unviable. Additionally, the regional players face inherent challenges. The technology for low capacity aircrafts, which seat fewer than 100 passengers, has become obsolete and less efficient. The model also involves a high cost for training pilots for multiple destinations, since the passenger turnout is less and the same aircraft is used to fly to multiple destinations in order to maintain efficiency.
The policy which aims at transforming India into a MRO hub, introduces several incentives and rebate to develop an INR50bn MRO business in India. A significant part of the MRO business is the redelivery check of aircrafts at the time of termination of the lease period. Currently the Indian MRO players are non-competitive due to the high tax regime whereby they cater to less than 10% of the total redelivery business in India. However, Ind-Ra believes that the government's proposal of service tax exemption on Indian MRO services could prove to be a game changer for the aircraft redelivery business. This will help MRO players to capture the diversion of aircrafts availing services overseas and also help airline companies to reduce their expenditure of flying abroad.
The policy to allow foreign aircrafts (brought to India for MRO work) to stay for the entire period of maintenance or up to six months as against 60 days presently will provide new business avenues for the MRO players. Another positive move is that these aircrafts would be allowed to carry passengers at the beginning and end of the stay period in India, turning them into revenue flights. Thus the new policy will not only attract domestic players flying in and around India but also pull other international players flying across Asia and the Middle East to avail MRO service in India. Ind-Ra expects international aircrafts to form around 30% of the total aircraft mix being serviced by the Indian MROs in the long run, in the event the policy is implemented well.
The policy proposes to improve the air cargo traffic significantly by bringing all relevant central government authorities under one roof, at the cargo terminals which will reduce dwell time of air cargo (from 'aircraft to truck') to below 24 hours by 31 December 2016 and to six hours by 31 December 2017 as against the current higher than 72 hours (in case of imports). Shorter dwell times would bring in discipline thereby increasing throughput and reducing cargo holding levels and carrying costs. Shorter dwell times will essentially lead to lesser land requirement and therefore a lower investment for setting up green-field cargo terminal projects. Ind-Ra believes that the actual dwell time in the short term could still be higher than the proposed norms, due to prevailing systemic issues. This, in the initial years, is likely to benefit cargo players as they will earn higher revenues from demurrage charge for delays beyond the stipulated dwell time (24 hours from December 2016). However, in the long run it is the increased cargo volumes that are likely to have a positive impact on revenues of the air cargo players.
The policy however remained silent on its promise to address the core issues plaguing the sector, such as concession on the ATF fuel cost for metros which accounts for 40%-50% of the total cost. Furthermore the policy remains ambiguous on the continuation of the 5/20 rule. This rule states that a domestic flier should operate in a domestic market for a minimum of five years and should have at least 20 aircrafts to be eligible to fly in the international market. Established LCCs and FSCs will not be willing to do away with the rule as they have already adhered to the majority of this rule, and its abolishment would give an undue advantage to the new players.
Airlines generally avoid multiple technology aircrafts as it restricts their buying power as well as increases MRO costs. Private players such as Indigo, Go Air and Spice Jet have restricted their aircraft types to 1-3. To cater to regional markets, aircrafts with capacities of less than 100, prove economical. Thus private players would find it economically unviable to fly their bigger-passenger planes (100 plus seaters) in the regional market. These players had intentionally been staying away from serving the regional markets due to potential lower volumes in these regions compared with the higher investments required.
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However the free/concessional incentives for regional markets stated in the policy to cap the ticket price per passenger for a one-hour flight at INR2,500 indexed to inflation and fuel prices as against the average price of INR4,000-INR4,500 presently may compel private players to relook at the opportunity. Government plans to fund the INR1,500 gap from the 2% cess it plans to levy on all international and domestic tickets from January 2016. Thus the revenue from large players will indirectly flow into the pockets of the regional players. Private players will find it difficult to trade-off between investments required to enter into regional markets with the corresponding growth in the undiscovered market. This is precisely the reason why the private players are seeking an extension to respond to the policy. The Civil Aviation Ministry has extended the deadline for submitting public comments on the draft policy till November 30 from its earlier deadline of November 21.
In order to develop the regional markets, the government has made it mandatory for major private players to operate a certain minimum number of flights in the regional markets. Although uneconomical, private players have to comply with this regulation. This is one of the prime reasons for lower profitability of FSCs and LCCs. However with the successful implementation of the policy, if the traffic at regional airports revives, major players will increase their operations in the region putting pressure on the regional players. This will further help major players to minimize their overall losses. Ind-Ra however believes that private players such as Indigo, Go Air and Spice Jet will test the waters and will be cautious in increasing regional operations in the initial years. Ind-Ra believes that the draft policy fails to address the issues related to the cost structures of the bigger private players. Furthermore, major players would not be willing to take any additional hit on the revenues in the event of extremely high inflation or a high ATF regime. In such a scenario an alternative source for VGF funding in order to keep the ticket prices affordable is unknown.
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