There is an urgent need to review restrictions on foreign investments in Indian airlines

Several vital policies in aviation can trace their roots back to the Chicago convention of 1944. The convention saw participation by fifty-four countries and led to the establishment of the International Civil Aviation Organization (ICAO) which continues to act as the global multi-lateral policy body for aviation. A key foundational principle that emerged was that of substantial ownership and effective control (SOEC).

The substantial ownership and effective control provision stipulate that a country’s airlines must be owned and controlled by local interest. This can be traced back to US domestic law that required US airlines to maintain 51 percent of their voting shares under US ownership and to ensure that 66 percent of the members on the board of directors were US citizens.

The important reasons for this law were to protect the airline industry – a jobs multiplier; to alleviate safety concerns about access to US airspace, and also because during war-time the US military can call upon civilian airlines for airlift capacity. In both, the US law and the Chicago Convention, state sovereignty is an overarching theme. As such, SOEC became and continues to be an expression of state sovereignty. It is also a key regulatory barrier that serves as a source of significant competitive advantage by limiting market access.

Developed countries continue to abide by stringent SOEC norms while pushing for "dilution" of this clause elsewhere. The US continues to have some of the most stringent norms with foreign ownership limited to 25 percent; the European Union in spite of the common aviation market did not dilute SOEC or supersede SOEC rights of member states and has ownership limited to 49.9 percent; Japan limits ownership to 33 percent; Canada limits ownership to 49 percent and Israel limits ownership to 34 percent. China too has a restriction of 35 percent ownership that is further aided by other access barriers including language and policies. The “effective control” norms are also very stringent and regulators have the ability to enforce these strongly.

While the SOEC was not a point of discussion a decade ago, India now finds itself in a unique position. The International Air Traffic Association (IATA) estimates that India will be the third-largest aviation market in the world by 2030.

With 500 million passengers moving in and out of Indian airports by that time, this is a very attractive proposition — to Indian and foreign airlines alike. Ideally, foreign airlines would love to capture this traveller base, fly it to their home countries and then onwards connecting via their airports. Indeed, many of the thriving airport hubs overseas, especially in the Middle East, owe a significant part of their success to the Indian traveller. And in times to come this will only grow.

Recognising the potential of the market, foreign airlines are rushing towards gaining access. This via enhanced bilateral access and dilution of SOEC provisions. Technically, foreign entities can own 100 percent of Indian airlines the only caveat being that only 49 percent can be owned by a foreign airline.

The balance has to be via an investment fund or any non-airline entity. Yet, due to the challenge of establishing “effective control” and limitations it imposes, foreign airlines have been reluctant to invest.

A case in point is the failure of Jet Airways, the second-largest airline in 2019. That apart, the government’s struggle to sell national airline Air India underscores the skittishness of foreign investors. Both are valuable assets for capturing traffic, but without “effective control”, any investment simply fails to make strategic sense.

On the issue of SOEC dilution, several arguments are being made including facilitating investment in Indian airlines in a climate of slowing growth and constrained liquidity; towards attracting additional foreign direct investment at a time where companies are cautious with cash and capex; and towards privatisation of state-owned assets including the national airline. Diluting SOEC, at least in the short term, alleviates these challenges.

As it stands, several airlines are keen to set up base in India. After all, this is a market that in the next decade will likely see traffic levels that are higher than the entire US population. And setting shop here is a key way to capture and redirect the traffic flows. Further, setting up here may actually be less cumbersome than immunised joint ventures, cross-border equity and alliances – which are some of the ways SOEC provisions, have been circumvented.

Indian domestic airlines are naturally opposed to the SOEC dilution. The argument they put is that due to the multiplier effect aviation has on growth, jobs and development, dilution of this clause is detrimental to India’s own aviation interests.

National security reasons are also cited including access to defence airfields that would have to be considered. Finally, the issue of reciprocity is put forth with foreign markets either not giving equal access to India’s airlines or where the market access does not quite make for a level playing field.

It has not helped that India’s airlines do not have a united front or at the very least a united body that puts forth their position. This because of varying ownership structures, legacy issues and misplaced motivations. But it is this very failure to unite that maybe the poison pill and the avenue for foreign airlines to make a case.

Why? in spite of double-digit growth in traffic, the balance sheets of India’s airlines continue to be fragile. The quality of revenue is weak. Liquidity constraints abound. And while the government after taking on the Air India debt via the special purpose vehicle stands firm in its resolve that it will not intervene to save any private airline, the fact remains that the market simply cannot stomach another airline failure.

And with incumbents locked into their current models and methods, this may pave the way for a new entrant.

(To be continued…)

Satyendra Pandey is the former head of strategy at a fast-growing airline. Previously, he was with the Centre for Aviation (CAPA) where he led the advisory and research teams. Satyendra has been involved in restructuring, scaling and turnarounds.