Regional Aviation: Set to Surge!

Commercial aviation is on a roll. In 2016, domestic air traffic grew 23.18 per cent over the previous year, touching almost 100 million passengers against the global average of just 5.7 per cent. This year, India is set to overtake Japan as the world’s third largest domestic market behind the United States and China. And analysts expect FY 2017-18 to record the third consecutive year of growth above 20 per cent. Indeed, the new National Civil Aviation Policy (NCAP), released by the Ministry of Civil Aviation (MoCA) in June 2016, projects 300 million air travellers by 2022 and 500 million by 2027.

These are striking figures, but what’s more heartening is that India’s airline industry finally seems ready to break free of the magic of the metros and embrace the sunrise sector of regional aviation. And what can make this financially feasible is the Regional Connectivity Scheme (RCS), a key part of the NCAP. Also known by the apt acronym UDAN (Ude Desh ka Aam Naagrik), the RCS is designed to ensure affordability, connectivity, growth and development.

Unique UDAN

The twin pillars of the 10-year-long RCS scheme, which was formally launched in October 2016, are fiscal support and infrastructure development. UDAN seeks to connect hitherto unviable destinations across the country through revival of existing airports and follows several failed regional aviation initiatives over the years. What’s unique this time is that it has been formulated in consultation with all stakeholders and is backed by strong government commitment.

The first set of route proposals is under evaluation. According to the Minister of State for Civil Aviation, Jayant Sinha, there are bids from 11 parties including scheduled airlines, for 190 routes connecting 43 unserved airports such as Jaisalmer, Bikaner and Jamshedpur, 12 underserved airports that currently attract less than seven flights a week such as Gwalior and 30 already operational airports.

In progress is the first auction of UDAN routes through a reverse bidding mechanism. The winners, with exclusive rights to each route for three years, will be those who quote the lowest Viability Gap Funding (VGF) requirement per seat. Each selected operator will need to provide a minimum of nine UDAN seats and a maximum of 40 seats (limited to 50 per cent of the seats in the aircraft). The subsidised fare for these seats will be Rs. 2,500 for a one-hour journey of approximately 500 km on a fixed-wing aircraft, with proportionate pricing for routes of other stage lengths. Fares for the remaining seats can be market-driven. If all goes well, UDAN flights may start in early March.

A Regional Connectivity Fund (RCF) is being created to meet the VGF requirements. It will be funded by a levy of up to Rs. 8,500 per specified domestic departure depending on distance. The partner state government must also contribute 20 per cent share to this fund and the balance will be made up by the Central Government. Several sweeteners have been added — such as reduced taxes, concessional utility rates, nil landing, parking and terminal navigation charges, as well as discounts on route navigation facility charges.

All in all, UDAN seems an attractive scheme to tap the immense potential of regional aviation and should lead to a welcome increase of regional travellers. But the way ahead is not free of hurdles.

Infrastructure Imperatives

When the RCS plans fructify, 43 ghost airports will come alive, thus boosting the current tally of 75 operational airports to 118. But can the country’s creaky aviation infrastructure support the rapid growth envisaged by the NCAP?

The Centre for Asia Pacific Aviation (CAPA) Outlook 2017-18 warns, “Based on projected growth rates, most of the 40 largest airports in the country will exceed their design capacities within the next decade. However, it is a serious concern that there is no long-term vision for India’s airport capacity requirements. There will be unthinkable economic ramifications if air connectivity to India’s centres of commerce, industry and tourism is choked off due to airports being saturated.”

The symptoms of overload are already noticeable — airspace congestion, long holding times for aircraft, safety breaches, and an extreme shortage of operating slots and parking bays. A positive fallout of the RCS is that some aircraft can park at outlying airports overnight, relieving the congestion at the metros. They could then be used for early morning flights, leading to better aircraft utilisation. But if an UDAN flight to a metro or major hub is slotted at an inconvenient time as is perhaps inevitable, the discerning passenger might just dump it and opt to travel by surface mode instead.

Therefore, the government’s determination to improve airport infrastructure and its plan to expeditiously revive or develop up to 60 airports in the ‘no-frills’ category is welcome. Also welcome is the Airports Authority of India’s (AAI) intention to build 170 new parking bays and six hangars at various airports. This needs to be replicated on a large scale. For its part, the union budget 2017-18 proposes to monetise huge stretches of land at airports across the country so as to encourage private sector participation in developing such airports.

Cost Crunch

According to CAPA, India’s airlines reported a combined profit of $122 million in FY 2015-16, after almost a decade. But this profitability was thanks to the lower price of aviation turbine fuel (ATF), which constitutes around 40 per cent of the total cost of operations and is likely to be short-lived. It can easily slide into another prolonged period of profitless growth.

INDIA IS SET TO OVERTAKE JAPAN AS THE WORLD’S THIRD LARGEST DOMESTIC MARKET BEHIND THE UNITED STATES AND CHINA

Therefore, the private airlines are perhaps understandably aggrieved by the new levy imposed on them to form the RCF. They point out that a stated objective of the NCAP is to reduce costs, yet costs for items like fuel, leases, maintenance, airport charges and interest rates are among the highest in the world. ATF in India is already priced about 70 per cent above the global average and is again showing a rising trend. According to industry sources, about 50 per cent of an air ticket cost goes in various forms of direct and indirect taxes and fees and “every additional charge is limiting our ability to reduce fares.”

More pain is feared when the goods and services tax (GST) regime comes into effect, perhaps from July 1. While the potential benefits of GST for the economy are undeniable, the airline industry is likely to be adversely affected. This is because there will probably be a higher service tax on air tickets; yet, as ATF is outside the GST net, the taxes on ATF cannot be claimed as an input credit against the GST. Although the MoCA wants service tax on tickets to be under 12 per cent, an overall increase of fares by 9-12 per cent across the board is possible. This could significantly dent the market, given the price sensitivity of Indian passengers. The subsidised UDAN seats would be unaffected, but the remainder of the seats might well remain unsold.

The union budget 2017-18 makes an attempt to address this looming issue, because UDAN flights have been exempted from service tax on their VGF benefit. However, this exemption is only for one year from the date of commencement of operations of the RCS.

Small is Suitable

India’s airlines already have about 450 aircraft on their inventory and have placed orders for 800 new planes for delivery over the next 10 years. But over 85 per cent of these are standard narrow-body jets like the Airbus A320 and the Boeing 737. Only a few are smaller planes like the ATR 72 turboprops and the Embraer E-Jets E190/E195-E2 which the UDAN scheme considers suitable for covering short distances. Indeed, the MoCA believes that even smaller aircraft of capacity about 20 passengers would be ideal. Many of the runways identified as appropriate for UDAN are incapable of handling the Airbus A320 and Boeing 737.

However, the airlines cannot be blamed for their reluctance to purchase small aircraft, since these are much more expensive to operate in terms of per-seat cost than larger ones and will become white elephants once the VGF period expires. Regional aviation is exclusively low-cost carrier (LCC)-based and it has been proven globally that a single-type fleet is the only viable LCC model because it keeps financial and operational complexities under control. Of the LCCs, SpiceJet is the only one that currently operates two types of aircraft — Boeing 737s and Bombardier Q400s — and its mixed fleet is a definite drag on finances.

Cooperate to Conquer

The industry is unconvinced about some aspects of the RCS, including its financial viability. There are demands that operators should not be forced to fly empty aircraft in order to offer the stipulated number of flights per week. And that the period of VGF be extended from the proposed three to five years or more as the designated UDAN routes might take even longer to become self-sustaining. The MoCA is trying to address these issues.

There’s no doubt that India’s strong economic fundamentals and status as the fastest growing aviation market in the world creates tremendous opportunities. But growth is being artificially stimulated by excess capacity and cut-throat fares and could easily be squandered unless infrastructure and skills creation keep pace. According to the Regional Director of the International Civil Aviation Organisation, Arun Mishra, besides the right size of aircraft and the right runways, successful RCS operations urgently need qualified crew, “Small aircraft need specialised crew. We need a special initiative from the government to build that up. Pilots and engineers can’t come overnight. We need to train them.”

The challenges are clear. If the government and the airline industry can cooperate to solve them, there’s good reason to expect a surge in regional aviation.