the current fdi situation in the aviation sector (1)

7/29/2019 The Current FDI Situation in the Aviation Sector (1)

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The current FDI situation in the aviation sector

Pulkit Agarwal

Sakshi Vijay

Trouble in peaceful skies

Introduction

It is a dream for every Indian to fly, there are still looking only 2 or 2.5% of Indians

that are flying every day. People in the country are eager to fly, the industry is readyto expand, but still there are losses.

Where is the problem? What is the solution?

Indian Aviation Minister, Ajit Singh has come up with a solution of allowing foreignairlines to participate up to 49 per cent in the equity of an air transport undertaking inIndia.

Aviation Industry in India

India is expected to be amongst the top five nations in the world in the next 10 yearsin the aviation sector. On the sidelines of the International Civil Aviation Negotiation(ICAN) Conference, Ms Pratibha Patil, President of India highlighted that currently,India is the 9th largest civil aviation market in the world. Recent estimates suggestthat domestic air traffic will touch 160-180 million passengers a year, in the next 10years and the international traffic will exceed 80 million passengers a year, added MsPatil.

On one hand there is display of potential of the aviation sector in India but on the

other hand Indian Aviation sector has been facing the worst turmoil resulting in lossesof about Rs.10,000 crores for the financial year 31st March 2012. Kingfisher Airlines,one of the major airlines in India, is under heavy dues to various Authorities like TheIncome Tax Authority of India and Rs.278.52 crores to the Airport Authority of India(AAI). Out of the 6 major airlines operating in India, only one is making profits, thatis, Indigo Airlines.
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The reasons for such huge losses can be the extremely high rate of taxes levied on airtickets, rising operational costs, expensive fleet, workers standoff and so on. So even

though Travel demand has grown but low fares have not allowed airlines to recovertheir cost. Spiralling cost of aviation turbine fuel (ATF), global economic slowdownand low yield due to intense competition and consequent widening gap between

revenue and expenses have contributed to their problem .

SENSITIVITY AND RESTRICTIONS IN THIS SECTOR GLOBALLY

The airline industry has remained an exception globally, to the process of economicliberalization. Globally, the airline industry remains subject to several restrictionsinterms of both operations and of ownership & control. All countries impose restrictionsin this one sector; restrictions that benefit national entities; and debar foreign investors

generally for security reasons

As a general practice a majority of the countriesboth in the developed and thedeveloping worldhave imposed a 49% ownership limit in the airline industry. Thisis true for Singapore, China and a host of other nations across Asia and Europe. TheUS, otherwise a free economy, is even more restrictive in the Airline sector. US limitsthe amount of foreign ownership in its domestic airlines to a maximum of 25%.

CURRENT FDI POLICY IN INDIA:

MEANING OF FDI:

FDI as defined in Dictionary of Economics (Graham Bannock et.al) is investment in aforeign country through the acquisition of a local company or the establishment thereof an operation on a new (Greenfield) site. To put in simple words, FDI refers tocapital inflows from abroad that is invested in or to enhance the production capacityof the economy .

Foreign Investment in India is governed by the FDI policy announced by theGovernment of India and the provision of the Foreign Exchange Management Act(FEMA) 1999. The Reserve Bank of India (RBI) in this regard had issued a

notification which contains the Foreign Exchange Management (Transfer or issue ofsecurity by a person resident outside India) Regulations, 2000. This notification hasbeen amended from time to time.


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FDI IN INDIA:

In recognition of the important role of Foreign Direct Investment(FDI) in theaccelerated economic growth of the country, Government of India initiated a slew ofeconomic and financial reforms in 1991. India is now ushering in the second

generation reforms aimed at further and faster integration of Indian economy with theglobal economy. As a result of the various policy initiatives taken, India has beenrapidly changing from a restrictive regime to a liberal one, and FDI is encouraged inalmost all the economic activities under the automatic route.

India is the second most important FDI destination (after China) for transnationalcorporations during 20102012. Mauritius, Singapore, the US and the UK wereamong the leading sources of FDI. According to Ernst and Young, foreign directinvestment in India in 2010 was $44.8 billion, and in 2011 experienced an increase of25% to $50.8 billion.

FDI IN AVIATION SECTOR

Current rules do not permit foreign airlines to invest in domestic carriers, althoughnon-aviation-related investors can hold up to a 49-percent stake.The proposal to allowforeign airlines to invest in domestic airlines is under active consideration of theParliament.

If we trace the history of investment by foreign airlines in India we notice thatpoliticians blocked a 1997 proposal by Indias Tata group to start an airline in

association with Singapore Airlines.In his book An Outsider EverywhereRevelations by an Insider, M.K Kaw, Indias former civil aviation secretary,

underscored the significance of the governments move. The history of civil aviation

in this country would have taken a different trajectory, if Tata-SIA had been allowedto float an airline, he wrote.

At present the rules are as follows:

(a)Air Transport Services would include Domestic Scheduled Passenger Airlines;Non-Scheduled Air Transport Services, helicopter and seaplane services.

(b)No foreign airlines would be allowed to participate directly or indirectly in theequity of an Air Transport Undertaking engaged in operating Scheduled and Non-Scheduled Air Transport Services except Cargo airlines.


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Scheduled air transport service means an air transport service undertaken between thesame two or more places and operated according to a published time table or withflights so regular or frequent that they constitute a recognizably systematic series,each flight being open to use by members of the public;

Non-Scheduled Air Transport service means any service which is not a scheduled airtransport service and will include Cargo airlines.

(c)Foreign airlines are allowed to participate in the equity of companies operatingCargo airlines, helicopter and seaplane services.

Simply put, FDI in Scheduled Air Transport Service/ Domestic Scheduled PassengerAirline is allowed upto 49% (100% for NRIs) through automatic route. FDI in Non-

Scheduled Air Transport Service is allowed upto 74% (100% for NRIs) where upto49% is allowed through automatic route and beyond 49% and upto 74% throughgovernment approval route.

PROPOSALS IN THE UNION BUDGET 2012-13

The following were the proposals made by the Finance Minister, Pranab Mukherjee inthe Union Budget in 2012-13:

1. To address the immediate financing concerns of the civil aviation sector, It wasproposed to permit external commercial borrowing (ECB) for working capitalrequirement for the airline industry for a period of one year subject to a ceiling of $1billion

2. A proposal for allowing foreign airlines to participate up to 49 per cent in the equityof an air transport undertaking engaged in schedule and non-schedule transportservices was to be under active consideration of the Parliament.

3. For reducing the ATF (aviation turbine fuel) price burden, the government allowedthe airlines to directly import jet fuel as actual end users thereby escaping the statevalue added tax (VAT), which ranges from 3 to 33%. This move is expected to helpthem reduce overall costs as ATF constitutes around 45 per cent of their operatingcosts

4. Recommendation for allocating Rs.4,000 crore to the cash-strapped Air India.


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5. In a bid to encourage maintenance, repair and overhaul (MRO) sector, the budgetproposed to allow full exemption from customs duty and countervailing duty toaircraft spares, tyres and testing equipment

6. As a sop to Indians travelling abroad duty-free baggage allowance, which was last

revised in 2004, was raised from Rs.25,000 to Rs.35,000 and for children of up to 10years from Rs.12,000 to Rs.15,000

Aviation analysts felt that some of the measures in Budget 2012-13 that will bringdown input costs for the airline industry which has been burdened with mountinglosses. When implemented, the proposals would help in making India competitive inthe international maintenance and repair of aircraft

EFFECT OF ECB:

ECB is a financial instrument used by the government to facilitate the access toforeign funds by Indian corporations and public sector undertakings.

ECB, according to analysts, will not only provide an additional source of muchneeded capital at low cost for the airline industry but also enable them to cushionthemselves against the current financial crunch. The cost of borrowing from overseasis much lower than domestic debt and nearly 60 per cent of ECBs raised in 2011-12cost 5 per cent less than the domestic borrowings. It is felt that this is the opportune

time to raise foreign loans for Indian entities as interest rates in most developedcountries are lower than in India and the aviation sector should be allowed to getmaximum benefit of the prevailing situation.

PROPOSAL FOR ALLOWING FDI

Currently, foreign investors not related to the aviation business are allowed to holdstakes of up to 49 per cent in Indian carriers. However, on the recommendation of the

aviation minister Ajit Singh, the government feels foreign airlines should be allowedto buy stakes of up to 49 per cent in Indian ones.

The decision to allow foreign airlines such as Emirates, Lufthansa, British Airwaysand Etihad to invest in domestic carriers was taken to save the cash-hungry Indianaviation sector, reeling from soaring fuel costs, swelling debts, high taxes and cut-


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throat competition. The move would also usher in international technical know-howand global expertise .

The Indian Airline Companies are hopeful that the foreign Companies will invest inIndia as it is a potentially big market with18% compound annual growth , more thanUSA and Europe.

For customers this step will be good or not will have to be seen later . However FDI inaviation will ensure reliability , efficiency , less delaying of flights and betteroperations . With taxes in control , the prices are also less likely to be affected.Operational advantages will be provided to the huge market. Above all , the key tosurvival will be customer satisfaction .

Even the Estimates Committee of Parliament has recommended removing the cap inForeign Direct Investment in the civil aviation sector. The committee noted that theaviation industry is heavily burdened with taxes and levies like sales tax on aviation

turbine fuel, withholding tax on leased aircraft, high airport charges and levy ofroyalty, service tax on agency fees, expenses incurred abroad on loans raised and alsoservices rendered and consumed abroad They concluded that apart from addressingthe shortage of funds, this would help raise the level of services for the consumers andpromote healthy competition .

In an interview, Ajay Singh, the founder of Spice Jet highlighted how the scheme ofFDI will promote efficiency amongst the competitors for foreign funds in India. Heexplained that eventually the market will determine which airline is going to surviveand which is not, even in terms of foreign investment. Foreign airlines are not justgoing to come in and start investing money in inefficient airlines. So, in a sense FDIwill actually promote efficiency because investment will gravitate towards thoseairlines that are more efficient.

Foreign Investors Concern Regarding FDI Policy in India

In todays difficult environment, generally speaking, many airlines are trying to keep

their balance-sheets strong rather than investing in other airlines. . Investing in loss-making business like the Airlines in India is obviously not a winning strategy, IATA

Director General and CEO Tony Tyler told PTI in an interview. He also proposed that


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more aviation friendly policies are required, particularly lifting the dead weight oftaxation.

A similar view is expressed by Tim Clark, President, Dubai-based Emirates, sayingthat the euphoria over FDI in airline has the potential of turning into a damp squib asno airline would invest in Indian carriers unless the Indian government gave ultimatecontrol to outside investors. What is highlighted is that Indian companies only wantforeign airlines money and not their advice. They would like to continue operating in

their old way, draining shareholders money in the process. Emirates were expected tobe the knight in shining armour whom other international players would have

replicated by investing in India. The airline has made it clear that this is no longergoing to be the case.

CERTAIN RIDERS:

Any proposal by any foreign carrier will not be put on the automatic route but will beapproved on a case-to-case basis by the government. For the sake of safety thegovernment has come up with a number of stiff riders. Each proposal will be vettedcarefully before an approval is granted. The threat perception from individuals wouldbe more than established for airlines that come forward for investment.

Even after a foreign carrier has invested in an Indian one, majority control mustnecessarily remain with a resident Indian. And, the board of directors of the target

airline should continue to have two-thirds of its members as Indians. Besides, anysuch transaction for investment should fall within the SEBI guidelines. At no stageshould the foreign shareholding in an airlineeither by the foreign carrier, foreigninstitutional investors (FIIs) or through any other investmentexceed the sectoral capof 49 %.

Conclusion

A Start Has Been Made

India is the 9th largest civil aviation market in the world and the recent estimatessuggest that in next 10 years, domestic air traffic will touch 160-180 millionpassengers a year and international traffic exceed 80 million passengers. The sector,which is growing at the rate of close to 20 per cent and likely to generate about 2.6million jobs in the next decade, needs to grow at a handsome speed to be used to itsbest potential.


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Tony Tyler, IATAs Director General and the CEO in his keynote address at the India

Aviation 2012 conference displayed immense confidence in the Indian AviationIndustry saying, I am passionate about aviation. And I am an India optimist. TheIATA (International Air Transport Association) will be fully engaged in the teameffort to turn Indian aviation into the great success story that it has the potential to

become. India should not settle for a bronze medal in the world of aviation. It has puregold potential,

the current fdi situation in the aviation sector (1)

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