Policy Foibles of the Government Destroying Vibrant Sectors

This has been the most destructive period of regulatory environment I have seen in 16 years” is the exasperated voice of Mr. Sunil Mittal of Airtel on the recent regulatory prescriptions for the 2G spectrum auctions.  This statement is remarkably true not only for telecom sector but for several crucial sectors such as Power, Roads, Textiles, Airlines etc., and captures the quintessential characteristic of the current dispensation – adhoc policy measures that saps the confidence of the entrepreneurs and deters them from making fresh investments.

Barring a few decisions such as FDI in retail, most of these policy blunders of the Government have nothing to do with tantrum-throwing allies; it is a deadly combination of apathy, foolhardiness and greed. Over a series of articles, let us examine each sector closely to understand the specific policy actions / inaction that have destroyed a hitherto vibrant industry.

Airline Industry

Airline Industry in India is THE fastest growing market in the world, with passenger traffic growing at 16% in 2011, overtaking Brazil at 13% and even China at 11%. Contrast this with the Rs. 10000 crore losses that the Airlines in India have reported for the year 2011-12! What gives? Government’s apathy and greed!

Back-breaking tax levels: The total tax levied on the airfares in India is among the highest in the world! Consider these facts:

–  The total taxes on Aviation Turbine Fuel (ATF), levied at various levels (Sales Tax, Excise duty, etc.) add up to over 75% on the base cost of producing ATF (cost of producing and transporting a kilolitre of ATF, at current price of USD 100 per barrel would be less than Rs. 40,000, while the price it is sold currently is at Rs. 70,000).

–  ATF accounts for almost 40-45% of operating costs of airlines and ATF prices in India are 60% higher than in competing hubs such as Singapore, Bangkok and Kuala Lumpur, making India’s airlines distinctly uncompetitive in international air travel.

–  The airport charges India are estimated to be the second highest in Asia, which is exorbitant considering the quality of India’s airports

–  Service tax on air fares introduced in March 2010, and user development charges levied by recently modernised airports, add to the total airfare cost, hurting profitability.

–  User Development charges in Delhi and Mumbai are being planned to be increased by 350-500% to improve the viability of these airports

Lets look at how this adds up. A short haul flight from Bangalore to Chennai could cost Rs. 3500.  Of this, about Rs. 1000, that is 40% taxation on the base fare of Rs. 2500, goes directly to the taxman’s kitty. And this does not include tax on salaries, tax on profits (if any!) etc.  A rough estimate would indicate a total tax collection of at least Rs. 20,000 crores a year, from the airline industry!  And what does the industry get in return, at a time when it is in its most dire state of affairs? Nada!

Government’s apathy

When the industry is sinking, with every player barring one (Indigo) reporting loss despite robust demand growth, the apathy of the government is appalling! No initiative is being planned by the Government to improve the health of this sector.  One is not sure if the Government is even serious about keeping this industry thriving, or let it perish so that it can extract rent-seeking from Air India and the remaining few players who will be lot more pliable!

A valid argument can be raised by sceptics on why should Government do anything at all to a competitive industry, largely dominated by private sector?  The following points should address such sceptics:

–   Indian airlines and Air India, together own over 160 aircrafts, by far the largest among all airlines in India (Jet Airways comes distant second at 100 aircrafts). With limited accountability of the state-owned airline in terms of profitability, cash flows, debt repayment, etc., this airline can (and often does) set the pricing range for every major sector, with scant regard for the costs involved and profitability. This in turn forces private sector players to set their pricing at levels that does not allow sustained profitability.

–   The taxation level, which is clearly a public policy item, suffered by airlines in India is among the highest in the region, rendering them uncompetitive in International routes.

–   World over, every government treats airline industry as an important sector and have provided safety nets in times of distress. In USA alone, over 40 airlines have gone bankrupt since 1980, some of them more than once, which have subsequently been reorganized and have subsequently emerged out of bankruptcy.

–    Given the large public impact of failure of airlines, this sector deserves to be treated (and in many countries do treated) akin to banks, where regulations are designed to encourage healthy competition, while at the same time prevent sectoral failure.

So, there exists a strong case for the government to wake up from its slumber and apathy, to take certain initiatives to bring back the vibrancy of this sector.

Policy initiatives

The specific policy initiatives that the government can do, to improve the health of the sector include

  • Reduce the incidence of overall taxation on this sector, such as moderation on taxes levied on ATF, airport charges, user development fees, passenger safety fees, service tax on tickets, etc.
  • Address the perennial issue of losses in Indian Airlines / Air India, through either privatisation, or at least induction of professional management with minimal government interference (and no free seats for politicians, please!).
  • Allow foreign direct investment in Indian airline sector, with liberal ownership norms, but with same or stringent regulation on the operations of airlines.
  • Bargain strongly on reciprocal routes in international airports, using diplomatic clout to support better access for India’s airlines to popular international routes.
  • Lower the eligibility of “5-year of domestic operations + minimum 20 aircraft” rule for international operations.
  • Advice RBI to allow one-time restructuring of debt for the airline sector (akin to a one-time restructuring allowed for real estate sector in 2009) to prevent significant credit loss for the banking sector
  • Attract private sector participation to develop several new airports, thereby improving connectivity to industrial clusters and tourist destinations to support continued demand growth rates.

Several more initiatives can be taken by the Government to help the industry tide over its current crisis. Today, the industry is in such a sorry state that the market capitalization of Makemytrip, the travel booking site listed in Nasdaq, is higher than the market capitalization of the three listed airlines of India viz. Jet Airways, Kingfisher and Spice Jet put together!  Apathy is no longer an option, unless we all want to go back to the days when we have to use all our influence to reserve a seat in Indian Airlines!

Coming up: A similar sad story on the India’s Power Sector…

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Muthuraman

Muthuraman is a friend of CRI.

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