When will NDA Government reform Aviation Sector?

From privatising Air India to reducing state-imposed burdens on the industry, the new dispensation has met no demand to rejuvenate the business of air travel.

India’s civil aviation sector has seen a steady growth in the past couple of decades — more than 16 per cent between the years 2004 to 2012 — even though the financial and management challenges of a few airlines may give us an impression that this sector may be in perpetual distress.

The latent potential of this sector is at least partly evident in the fact that it continues to witness increasing interest from foreign airline operators wanting to foray into the country.

The draft civil aviation policy released in November last year for stakeholder consultation recognised this fact. It hinted at several measures that the government was willing to consider so as enable airlines to meet the growing demand for air travel.

These measures included, among other things, bringing down the costs of aviation fuel, instituting reforms in the failing state-owned airline Air India, refurbishing the Maintenance, Repair and Overhaul (MRO) facilities of the country, redesigning the structure of Airport Authority of India (AAI) and also modernising airports.

The previous Budget did little to help the country’s ailing aviation sector, which has been languishing for years, thanks partly to the managerial shortcomings of the airline operators but significantly due to the State’s unwarranted intervention in the sector.

This intervention is patently visible, for example, in high taxes on aviation fuel. These taxes range from 28 per cent to 35 per cent across various states, although some states such as Chhattisgarh, Jharkhand, and West Bengal impose only four per cent.

The crippling effect of high fuel taxes is evident in the fact that fuel costs constitute around 40 per cent to 45 per cent of the total costs of running an airline. Given this, many airlines have been ardently vocal in asking for a cut in tax rates so as to enable them to cut losses and hopefully also pass on the benefit to the consumers.

The central government, on its part, has asked states to consider reducing rates (since the states ultimately determine the sales tax), but to no avail yet.

To circumvent this challenge, some experts have suggested that the government categorise aviation turbine fuel as a ‘declared good’. A declared good, as per Central Sales Tax Act of 1956, is one in which the sales tax within a state cannot exceed 4 per cent. Doing this could significantly reduce fuel costs for the airlines and enable them to run more efficiently.

Fortunately, the draft aviation policy, while acknowledging the fact that the “cost of Aviation Turbine Fuel (ATF) in India is 40 per cent to 45 per cent higher than the international costs”, assures stakeholders that steps will be taken “to rationalise the rate of taxes so that our costs are competitive.”

It is still unclear exactly what those steps will be, but very recently the government slashed ATF rates by a staggering 12.5 per cent owing to lower oil prices.

The eventual implementation of Goods and Services Tax could also be a good opportunity to reduce aviation fuel tax to 10 to 15 per cent, although that change hinges on whether ATF is included within the Goods and Services Tax (GST) ambit after consensus from various states is achieved.

Such one-off reduction in fuel prices, although came as a much-needed respite to the airlines, is hardly the kind of reform that the aviation sector would expect. A long-term, sustainable solution through reducing aviation fuel tax rates should be sought so as to make operations viable for airlines.

A second, significant change we may see in aviation is the revision of the 5/20 rule, which says that an Indian airline cannot fly abroad unless it has five years of domestic flying experience under its belt and a fleet of  at least twenty aircrafts. Originally created to ensure high safety standards, it is not difficult to see why this rule is absurd.

For one, there is no clear evidence to show that startups that fly internationally compromise on adhering to safety regulations or that their insufficient experience endangers the life of passengers.

Secondly, it creates unnecessary barriers to entry in international travel. Start-up airlines, even if efficient and well managed than some of its more experienced rivals, cannot enter the “competition” unless it qualifies under the rule. In effect, the 5/20 rule undermines competition.

Yet, even though the draft aviation policy does propose a review of the 5/20 guidelines “with a view to encouraging the entry of new Indian carriers,” we are unlikely to see it getting abolished anytime soon, thanks to protests from the lobbies of existing airlines.

It may, however, see dilution: instead of five years of experience, airlines may be required only three or even one year of experience before flying abroad; instead of a minimum of 20 aircraft, they may be required 15 or less to qualify.

To encourage competition, it is also essential that market distortions be removed to the extent possible. This involves letting inefficient airlines fail, or at least not salvaging them through using taxpayer money.

But the state-owned Air India — thanks to the deep pockets of the government, err, taxpayers — continues to thrive despite poor management and abysmal operational track record.

It is unfortunate that even the NDA government, which once talked big on market-oriented reforms, has ruled out privatising Air India anytime soon, and instead resorted to formulating an expert committee to develop a future roadmap for it.

At this point, it would be helpful to know exactly how poorly does a state-owned company need to perform for the government to realise that taxpayer money would be more efficiently used in other, high-yielding infrastructure-related projects such as roads.

But delaying reforms in Air India is not the only disappointment we have seen thus far within the civil aviation sector. Very recently, the government also hinted at capping the economy fare at Rs 20,000 so as to prevent airlines from raising prices during last minute booking.

The government fails to realise that high prices merely reflect the high demand, and that capping ticket prices is not a sustainable solution to ensure affordability. These negative developments notwithstanding, the government does plan for several reformative measures that may help facilitate the growth of civil aviation.

For instance, it plans to modernise some airports (Kolkata, Ahmedabad, Jaipur, and Chennai) through eliciting private sector’s role in the form of public-private partnership (PPP). Mumbai and Delhi airports, which were successfully revamped through PPP projects, could act as a reference point.

Furthermore, to facilitate modernisation, the government has also indicated that it could ‘corporatise’ the Airports Authority of India (AAI). Corporatisation is a process that involves taking the institution public, which means, among other things, listing it in the stock exchange.

It is believed that this move could allow AAI to run relatively more efficiently, raise funds from the public, and hopefully also ensure accountability and better management. But going by the history of India’s listed public sector units, which are anything but efficient, one should not be too excited about this development.

Although modernisation is a noble intent, it is all the more important to build new airports so that air traffic, most of which is presently concentrated in a select few cities, is dissipated and landing and parking fees are reduced by dint of resulting competition.

Another area of civil aviation which could witness a change in policy in the run-up to the Budget is MRO (maintenance, repairs, and overhaul). The turnover of this segment is over $700 million per annum.

However, a bulk of the business goes out of India owing to the cumbersome tax structure, which makes maintenance and repairs of aircrafts within India almost 50 per cent costlier than some other countries.

The draft policy acknowledges these problems and notes that “effective steps will be taken for developing the sector and attracting investment by providing land and infrastructure and suitable incentives in respect of taxes and duties.” It would therefore be reasonable to expect tax cuts in the MRO segment in this year’s Budget.

With disposable incomes and urban population forecasted to grow exponentially in the coming years, the need for implementing the much-needed changes, most notably through tax rate cuts and scrapping of old rules, is greater than ever. The Union Budget 2015-16, could be a good occasion to declare some of these changes.