As airfares continue to stay elevated the country is caught in a policy dilemma. Namely, between free market dynamics and adhering to stated policy goals of affordable and inclusive travel.
Add to this the market reality of two large airlines commanding more than 80 percent of the market and the funding of weaker airlines by public money via the Emergency Credit Loan Guarantee Scheme (ECLGS) now in excess of $125 million. Even though all quarters claim that they are doing the best given the circumstances, the situation remains worrisome.
Airlines indicate it is a mix of input costs, supply chain issues and soaring demand; regulators indicate that airlines have been directed to self-regulate; and passengers maintain they are screaming into a storm.
The situation will not ease anytime soon and the October to December quarter will see even higher fare levels. The ongoing debate: whether to intervene or let free market dynamics take their own course?
Air Travel and the government’s policy vision
The much-publicised National Civil Aviation Policy of 2016 had a stated vision of creating an ecosystem to make flying affordable for the masses. This was put out at a time of “rail – air” parity or the fact that airfares were at levels at or below rail fares. Discounting was the key lever and airlines were selling below cost. But as the money flowed to the sector due to a variety of reasons not all linked to aircraft operations, several areas remain unaddressed.
The pandemic changed most of this and revealed significant weakness across airlines. It became clear that not all airlines would survive. Policy measures were taken including extending the Emergency Credit Loan Guarantee Scheme (ECLGS) to airlines and setting up of price floors and ceilings thereby limiting the ability of airlines to discount heavily. Consequently, the ability of flyers to access extremely low fares was also curtailed. At the end of the pandemic, the country emerged without any airline bankruptcy.
But that was perhaps the only saving grace. 2021 was a brutal year for the industry. Jobs were lost, salaries slashed and uncertainty prevailed. The gravity of the situation was laid thread bare when country’s most successful airline reported a quarterly loss in excess of $360 million for the April to Jun timeframe which traditionally was the most profitable quarter.
The silver lining came towards the end of the year in the form of the finalisation of the sale of the national airline Air India and buzz of a new startup airline named Akasa. Both events combined signalled a continued interest and belief in the market. But the developments notwithstanding, the market reality was that several airlines continued to be extremely fragile. Credit stood constrained and cash flows tepid at best.
The year 2022 saw the conclusion of the sale of the national airline Air India. This followed with the buyout of AirAsia India and the announcement of a merger of Vistara with Air India. All this while the strongest airline in the country, Indigo, continued to expand. By the end of 2022, it had more than 50 percent of the domestic market.
Fast forward to July 2023 and the country now has an airline industry that is a clear duopoly. With 2 airline groups commanding more than 80 percent of the market, both well capitalised and both well managed, pricing power inevitably follows. Demand is soaring and airlines like any other business price at levels that are in line with the market demand. But demand itself is showing interesting characteristics where passengers while have been consistently paying higher fares. Discounting fares in such a situation would lead to sub optimal demand supply dynamics or as economists term it: dead weight loss.
The reality is that the airline industry in India is struggling
With the topic of high airfares, there has been a disproportionate focus on narrative while wishing away the very real challenges of the industry. While it is true that airfares are at 3X to 5X from previous levels, it is also true that structural challenges of the industry remain unaddressed.
Add to that a significant capacity shortfall where flown capacity is 5 to 7 percent below pre-pandemic levels due to supply chain issues, weakened competitors and ongoing consolidation. As of today, ATF taxation continues to not provide for a level playing field; airport charges continue to be high; the lack of secondary airports further limits competition; the lack of in-country and rupee financing adds to costs; and banks are wary of the sector as a whole. This is reflected in the razor thin margins and history of losses. The numbers speak for themselves. Forecasts indicate that the airline industry in India will lose more than $1.7 billion.
This builds on losses in excess of $2 billion in 2022. Return on capital for the industry is negative. Balance sheets are brittle. Financials are fragile. Only one airline has remained profitable and it now sits on a monopoly market share.
Private investors have historically shunned the sector so this time is no different. But even bank credit to the industry stands constrained. On an industry level the balance sheets don’t give much confidence and in most cases lenders are lending due to parent company strength as opposed to the strength of the business. The credit quality spreads are to a point where there are only the strong airlines and the weak airlines; there is no middle.
Input costs for the industry remain high. This is reflected in the financial position of airlines. All airlines with the exception of Indigo continue to bleed. And in significant amounts. And the losses in no small part are driven by high fixed costs that are not covered by adequate revenue. Ironically, the current situation allows airlines to do that and thus focus on reasonable returns on capital which can then fund growth. But this is not in alignment with policy goals.
The policy dilemma facing the government
As the government continues to focus on achieving a 5 trillion dollar economy, this will necessarily include aviation. This is because of the multiplier effects the industry produces in terms of economic growth, jobs and skilling. But for that airlines that sit at the apex of the aviation ecosystem must thrive. And failing structural changes, high airfares are the way to cover costs.
The policy challenge facing the government is that of inclusiveness and affordability. Affordable for the masses means affordable for all income levels or at the very least for majority of income levels. Current airfares don’t cater to this policy goal. And there is also the market reality that in India, air travel has changed over the last two decades.
It is now not limited to the high end businessman but also the thousands of traders driving the MSME sector, the student going to meet his parents, the son visiting the village, the doctor volunteering time in remote areas, the thousands of migrant workers visiting home and the new generation exploring new places. Air travel is no longer a luxury – at least that is the policy goal.
One of the arguments put forward is that growth will take care of the challenges. And indeed, as the economy grows and as the middle class grows, air travel will become increasingly more affordable. But even in a base case scenario, that will take time. Alternatively, several quarters are pushing for policy intervention where airfares are regulated to be at levels that provide for more inclusive access. An action that is easier said than done and where implementation and monitoring remains a challenge even in the best of times.
Some argue that as India races towards the goal of a 5 trillion dollar economy, the regulatory landscape has to be more conducive to industry. Profits cannot be looked at with disdain. Which essentially means fewer regulations. Thus the slogans like minimum government maximum governance or that the business of government is not to be in business in the first place. Put in an aviation and airfares context this again poses a dilemma. Of whether to intervene or to let market forces determine prices. Two different approaches. Two different rationale. No easy answers.
—The author, Satyendra Pandey, is Managing Partner of the aviation services firm AT-TV. The views expressed are personal.
Read his previous articles here (Edited by : C H Unnikrishnan)
