India’s civil aviation sector: can the ECB and FDI help it take off?

By Rajas Kasbekar, Little & Co.

India is currently the ninth-largest civil aviation market in the world and is expected to climb to number three by the year 2020, with only the USA and China ahead. Unfortunately, India’s aviation sector has faced turbulent times over the past few years. The sector suffered severe financial woes as a result of the sharp escalation in the price of aviation turbine fuel (ATF), devaluation of the rupee, global slowdown, high operational costs, intense competition, steep taxes and climbing interest rates.

By early 2012, only one of the six main airlines in India remained profitable, while the rest were sliding towards liquidation. Combined losses amounted to over USD 2 billion and combined debt was close to USD 20 billion. Half of this debt was related to aircraft, while the remainder was attributable to working capital loans as well as payments to airport operators and fuel companies. Clearly, some cost control and fund infusion measures were urgently needed to bring this dying sector back to life. Against this backdrop, the (then) Finance Minister, Pranab Mukherjee, announced some key relief measures in the Union Budget for 2012-13.

The annual Union Budget for India contains estimated income and expenditures for a period of one financial year. It is presented in parliament by the Finance Minister each February. After it has been passed by parliament, it becomes effective on 1 April, the start of India’s new financial year. In his budget speech for 2012-13, Pranab Mukherjee admitted that “the high operating cost of the sector is largely attributable to the cost of ATF”. Fuel cost alone comprises nearly 40% of the sector’s operating cost. With a view “to reducing the cost of ATF,” he said, “the Government has permitted direct import of ATF by Indian carriers, as actual users”. It was believed that direct import would help airlines bypass value added tax (VAT) imposed by state governments across India. In most states, VAT on ATF ranges from 25% to 30% and plays a considerable role in escalating its cost. Further, “to address the immediate financing concerns of the civil aviation sector,” he proposed to permit external commercial borrowing for its working capital needs for one year, subject to a ceiling of USD 1 billion. He also revealed that a proposal to allow foreign direct investment up to 49% in the equity of local airline companies was (then) “under active consideration of the government”.

External commercial borrowing (ECB) refers to commercial loans taken out by Indian companies from overseas lenders. Foreign direct investment (FDI) is investment by an overseas entity/person in the capital of an Indian company.

Under the (then) extant ECB policy, working capital was not a permissible end-use. But pursuant to the Budget announcement, the policy was tweaked in April 2012 to allow the airline industry to avail ECB for working capital as a permissible end-use, under the approval route, with some conditions. These were:

(i) an overall ECB ceiling of USD 1 billion for the entire sector and a ceiling of USD 300 million for an individual airline company. The limit could be utilised for working capital as well as refinancing of pending working capital rupee loans availed from local banks.
(ii) The minimum average maturity period of the ECB would be three years.
(iii) Only validly registered airline companies with scheduled operator permit licences for passenger transportation could avail such ECB.
(iv) ECB will be allowed based on cash flow, foreign exchange earnings and the capability to service the debt.
(v) ECB should be raised before 23 April 2013. This deadline was later extended to 31 December 2013.

Likewise, under the (then) extant FDI policy, foreign airlines were permitted to invest in the equity of Indian companies operating cargo airlines, helicopter services and seaplane services, but not in the equity of companies operating passenger services. However, pursuant to the Budget announcement, the FDI policy was tweaked in September 2012 to allow foreign airlines to invest in the capital of Indian companies operating scheduled and non-scheduled air transport passenger services under some conditions, up to a limit of 49% of their paid up capital. A scheduled air transport service is one which is undertaken between the same two or more places and operated according to a published timetable or with regularity, each flight being open to use by the general public. A non-scheduled air transport service is one that is different from a scheduled air transport service, is operated for carriage of passengers/mail/goods and includes charter operations. The conditions attached to the FDI were:

(i) the FDI would be under the government approval route;
(ii) the 49% limit will subsume the FDI and FII limit;
(iii) FDI should be compliant with the securities laws of India;
(iv) foreign nationals in such service would need clearance from a security viewpoint;
(v) technical equipment imported into India will require clearance from the ministry and
(vi) a scheduled operator’s permit would be granted to an airline company only if it is registered and has its principal place of business in India, the Chairman and majority of its board are Indian citizens and its substantial ownership and effective control are vested in Indian nationals.

By relaxing the ECB and FDI norms, the government had hoped for a spectacular turnaround in the troubled sector. However, the pace of recovery was sluggish in 2013. ECB relaxation did not help much as overseas lenders seemed wary of lending to a debt ridden and loss making sector. FDI relaxation also did not show any instant results. Although foreign airlines are eager to invest, they have to jump through hoops in order to be able to do so. FDI in the sector needs clearance from several regulators who examine the proposals keenly from various angles. This delays the commencement of operations. Intense media scrutiny of such high profile deals compounds the problem. Nonetheless, some major deals are in the offing and some appear to be ready to roll. If all goes well, the sector may soon be ready for a smooth take off to success in 2014.

References:
1. Report of the Working Group on Civil Aviation for formulation of Twelfth Five Year Plan (2012-17), Ministry of Civil Aviation, Government of India
2. The current FDI situation in the aviation sector: Pulkit Agarwal: Legal India
3. The Budget, 2012-13, Speech of Pranab Mukherjee, Minister of Finance on March 16, 2012
4. Guidelines for FDI in Civil Aviation dated 1st March 2013: Director General of Civil Aviation, Government of India 5. Budget in parliament (http://www.parliamentofindia.nic.in)

Rajas Kasbekar
Little & Co., Mumbai, India
E: This email address is being protected from spambots. You need JavaScript enabled to view it.; W: www.littlecompany.com

published: January 2014