View: Rupee, rates and Russia: Macro-headwinds for India’s airlines

Airlines continue to lease most of their aircraft, and the value of the rupee is a direct hit on cash outflows. These higher cash outflows have to be mitigated via higher revenues.

This has just not happened. Revenge travel notwithstanding, revenues have not quite grown in the same proportion.

The change in the quality of demand is not helping either. Hedging is not really an option because it requires specific skill sets and hedged positions can go either way. Moreover, given the fragile nature of balance sheets, a hedged position gone wrong can lead to exorbitant losses or terminal outcomes.

For airlines, in addition to aircraft costs, most major maintenance costs and parts costs are also dollar-denominated. The rupee volatility again impacts provisioning for these outflows.

Consequences have a direct impact on credit and this is reflected in airlines which are on credit-hold or at worst, cash-and-carry. Yet again, there are no simple solutions because contracts are effectively built in a premium for the rupee volatility.

These burdens may ease with initiatives such as rupee financing or in-country-major maintenance. But as it stands, in the near term, there is nothing on the horizon.

Regardless of rhetoric in-country-leasing, no airline has entered into rupee financing arrangements. Neither has the country seen competitive major maintenance facilities.

The dollar continues to dominate the world of aircraft financing and engineering and till this remains, rupee volatility will continue to affect airline margins adversely.

The rupee challenge is also aggravated by the rising interest rate scenario. The recent RBI decision to hike rates by 50 basis points came after the US Federal Reserve raised interest rates by 75 basis points. For industry and airlines, this means that everything — from working capital lines to financing costs — just became more expensive. And given that, the credit quality spread between the weaker and stronger airlines in India is fairly significant. This poses significant challenges to airlines that don’t have parent company guarantees.

Financing costs also impact aircraft financing and associated income streams as financiers adjust offerings to cover the higher cost of capital. Given the voluminous aircraft orders by India’s airlines, this doesn’t quite bode well.

When it comes to near-term cash or working capital, forward sales are the resort of the first measure. Backing that up are working capital lines. Here, rising interest rates pose another challenge to costs. Again, hedging is not an option because very few banks will offer a fixed rate facility — given the asset-liability mismatch and lack of CASA support. With razor-thin margins, the increased rates are just another hindrance to airline sustainability.

Legendary investor Warren Buffet noted, "Financial staying power requires a company to maintain three strengths under all circumstances" including "a large and reliable stream of earnings; massive liquid assets; and no significant near-term cash requirements..." India’s airline industry as a whole is found wanting on all three fronts.

Five and a half months into the Russia-Ukraine conflict, there are no signs of easing. The impact has been felt in crude prices and jet-fuel namely Aviation Turbine Fuel continues to be at elevated levels. As Russia flexes its muscle, especially with Europe and energy supplies, the next few months through December will perhaps show a clearer path to where the conflict is headed. But the spillover will impact demand.

Interestingly, Russia was also considered as a destination by several Indian airlines. Indeed, a full-service airline had filed for Russia rights and was granted 14 frequencies. Meanwhile, a low-cost carrier was mulling destinations tempered only by the range of the aircraft. This is in addition to the erstwhile national carrier. All of those plans are currently on hold.

As the Russia-Ukraine conflict continues, costs of international travel elsewhere are already at extremely high levels and the question of whether the revenge is real remains.

International travel also is impacted by Visa norms, currency fluctuation and health security concerns. The period of October to December could go either way. Other challenges like over-flight clearances, portfolio risk and rebalancing by aircraft lessors and spillover effects on sanctions – all driven by the Russia situation – are all ambiguous for now.

A clearer resolution will help airlines plan for this in a better fashion but the timing and substance of any resolution remains in question.

Overall, the macro-headwinds are adding to airline industry woes. Collectively airlines stand to lose more than USD 2.1 billion at the very least. How rupee, rates and Russia trend will show the path ahead.