Allowing FDI in aviation is only half the battle won FDI must be backed by adequate reforms in the sector Conversation with Piyush Gupta

The government has recently notified the rules approving Foreign Direct Investment (FDI) in the aviation sector by foreign airlines. Bar & Bench spoke to Kochhar & Co Partner Piyush Gupta on this latest development in the Aviation sector..The government has recently notified the rules approving Foreign Direct Investment (FDI) in the aviation sector by foreign airlines..These new rules allow foreign airlines to buy up to 49 per cent stake in local Indian carriers through government route, a move which will help distressed airline companies like Kingfisher to receive much needed cash flow. Till now, India had only allowed foreign investors not related to airline business to buy up to 49 per cent stake in domestic airlines. But now with the announcement of this new policy, foreign carriers are allowed to invest..As per the notification, the foreign investment would be subject to certain conditions. A scheduled operator’s permit will be granted only to a company that is registered and has its principal place of business within India; the chairman and at least two-thirds of the directors of which are citizens of India and; the substantial ownership and effective control of which is vested in Indian nationals..Other conditions include all foreign nationals associated with the Indian company as a result of the investment will have to undergo security clearance and all technical equipment imported into India following the investment, too, will require civil aviation ministry clearance.The government has also specifically excluded Air India from the ambit of this new policy..Bar & Bench spoke to Kochhar & Co Partner Piyush Gupta on this latest development in the Aviation sector.Bar & Bench: What is your initial reaction to this policy change by the Government allowing foreign investors to invest in Indian carriers? .Piyush Gupta: The policy change by the Government to allow foreign airlines to invest in Indian air operators is a positive and welcome step, and in some cases, a much-needed decision. Everyone knows that in today’s day and age, FDI facilitates international trade and transfer of knowledge, skills and technology. In a world of increased competition and rapid technological change, FDI’s complementary and catalytic role can be very valuable. While it is true that most of the Indian air operators are in crisis and in dire need of infusion of capital, the fact still remains that allowing foreign investment in the sector is only half the battle won. Allowing FDI in aviation must be backed by adequate reforms in the sector..Bar & Bench: Do you think foreign airlines will be willing to invest in debt-laden domestic airlines? .Piyush Gupta: Before the foreign airlines / investors march into the Indian aviation industry with their capital investments, they would need the confidence that they would not be buying stakes in continuously loss-making ventures. While it is true that most airlines in India are debt-ridden and financially unstable, yet what the foreign investors will look for, are the reasons behind the same. The operational challenges can be overcome easily enough with the infusion of expertise and transfer of knowledge by the international investors. However, what the investors are / will be concerned about, are the policy decisions by the government in the aviation sector, and whether the same are conducive for the growth of the airlines in India..Currently, the airline industry in India is plagued by issues owing to, amongst others, high cost of fuel, the sudden and exorbitant increase in airport fee, complicated legal regime, inconsistent tax structure especially amongst states, and un-coordinated government policy framework. To compound matters further, international airlines themselves are facing financial challenges due to global recession, and thus, capital infusion might not be the topmost item on such international airlines’ agenda at this point in time..Bar & Bench: The aviation sector is going through a rough patch. Do you think that foreign investors can bail out Indian carriers? .Piyush Gupta: Had the Indian airline operators’ “rough patch” merely been of a purely financial/technical nature, allowing FDI in the sector would have been the best possible decision by the Indian government and both domestic and international airlines would have welcomed the move with much gratitude. But what renders grim look to the whole sector is the restrictive and retarding environment in which Indian airlines have to operate in..That, unfortunately, is something that the foreign equity investors do not have any control over. For instance, aviation turbine fuel (ATF) constitutes around 45-50 percent of the total operating cost of an airline as compared to the global benchmark of 20-25 percent. Accordingly, Indian airline operators’ profitability is adversely impacted since they pay close to double on ATF than their global contemporaries. The high cost of ATF is attributed to the country’s severe taxation policy. Being a decontrolled product, the price of ATF is reviewed and fixed by oil marketing companies on a fortnightly basis at par with the international crude prices movement. But what make ATF more costly in India are the variable sales tax rates ranging from 4 to 30 percent across states. The increase in ATF price raises the component of tax in that ratio, making the fuel even dearer. Such irrational tax structure minimizes the profits of airline carriers in India..On similar lines, a recent decision by the Airport Economic Regulatory Authority of India (AERA) – a statutory body, established to regulate tariff for aeronautical services rendered at major airports in India – to hike airport fees at Delhi airport by almost 350 percent from immediate effect, has also lessened the credentials of India’s regulatory regime especially in the aviation industry. Such a steep price hike in airport charges is bound to burden the air travelers and the airlines would feel the pinch in terms of net decline in passenger traffic, thereby leading to even lesser returns to the airlines..Regarding the issue whether in my opinion, foreign investors can bail out Indian carriers, my stand on this is that a possible equity infusion may lead to stronger strategic and operational ties with foreign partners, which in turn, may improve the credit profile of the ailing airlines in India..Bar & Bench: What other reforms are required in this sector? .Piyush Gupta: I am of the firm view that the aviation sector in India is grossly underutilized, and if the government backs the industry with appropriate policy and infrastructure reforms, the opportunities are immense for the airlines in India to not only break even, but also to realize significant returns on investment by the foreign investors..With Mr Ajit Singh, the new aviation minister, recently announcing that ATF would be declared a ‘notified’ product, Value Added Tax (VAT) on ATF would be reduced by the states, investments in the development of airports and improvement of infrastructure, and focus on providing air connectivity to the tier-II and tier-III cities in India, the future of Indian aviation sector is seemingly bright and exciting. It will be a humbling experience if the Indian government is able to live up to the expectations and hype that has been created by the hon’ble minister of civil aviation in India..In addition to the above, the government may consider opening up foreign investment in other non core-airline functions in the aviation sector like ground handling, maintenance repair & overhaul facilities, aviation equipment capabilities etc. The government may also consider creating an environment conducive enough for foreign players to tap into the competence and expertise of skilled Indian manpower, to invest not only in pilot & ATC training but also growing the pool of technical & maintenance expertise of aircraft. India can well become a hub for aircraft maintenance and overhaul. There could be special incentives and FDI allowances for education and training in the aviation sector. This would help not only in manning critical functions within the country, but also for creating employment opportunities for Indian personnel globally. Finally, the government may also consider reviewing the route-dispersal guidelines as well as the archaic and arbitrary requirement of Indian carriers to operate in the domestic environment for 5 years, before an approval for flying on international routes can be obtained. Such a requirement is not only hampering the growth of domestic airlines in India, but no other country has any such requirement and thus, straight off, Indian carriers cannot compete with their international contemporaries on an even keel..Bar & Bench: What are your thoughts on the conditions imposed on foreign airlines to invest in domestic airlines? .Piyush Gupta: While relaxing investment rules for foreign airlines to own 49% stake in Indian carriers, the new FDI norms also require the joint venture company to be incorporated and registered in India, to have its chairman and at least two-thirds of the directors as Indian citizens, and substantial ownership and effective control must be vested in Indian nationals. Most other countries have similar protective provisions limiting ownership of their airlines..Globally, the airline industry remains subject to several restrictions – in terms of both operations and of ownership & control. A majority of the countries – both in the developed and the developing world – have imposed a 49% ownership limit in the airline industry. This is true for Singapore, China and a host of other nations across Asia and Europe. USA and Canada are even more restrictive in the airline industry and both countries limit the amount of foreign ownership in its domestic airlines to a maximum of 25%..Going by that standard, the Indian government has taken a very liberal approach towards foreign investors acceding into the shareholding of Indian air operators. The other restrictions, viz. – requiring the joint venture company to be registered in India and conduct its major business within the country are consistent with the protection accorded to Indian carriers from their foreign counterparts against an out an out acquisition, and / or using the bilateral air service rights to their advantage and to the detriment of the other Indian carriers..Bar & Bench: With allowing of foreign airlines to hold 49% stake in Indian private airlines, do you expect to see the floodgates open for investment by foreign carriers? .Piyush Gupta: The possible equity infusion may de-leverage the sector and also provide funds for long-term growth, but the structural, legal and regulatory, policy-infused, and operational challenges that mar the airline industry in India at present, may limit the attractiveness for such foreign investors at least in the short to medium-term..Having said that, however, this is an infinitely better option than a bailout using public funds, and that this certainly is a positive step in the right direction, but the reality is that there might not be too many takers among foreign airline companies for this in the immediate future. .Bar & Bench: Will these economic reforms boost the confidence of investors? .Piyush Gupta: As mentioned previously, allowing 49% FDI by international airlines into Indian airline operators, is fantastic news for the industry, and will definitely boost investor confidence, but there is still a lot of work that needs to be done for the foreign investors to genuinely and confidently start investing in airlines in India. Assuming that the reforms proposed by our Hon’ble minister for civil aviation (notifying ATF, reduction of VAT on ATF, development of low cost airports etc) are implemented, the same will act as a perfect anecdote for the ailing aviation industry in India as well as be an enormous boost to investor confidence.