Air India: The necessity of
privatisation September 2017

Air India is the great aviation dinosaur of Asia. Its privatisation, or indeed disappearance, would boost the Indian airline industry and potentially position India as a rival to China as an expansionist aviation centre.

Prime Minister Narenda Modi appears to have committed to selling off the flag-carrier, a move which he hopes will enhance his reputation as a radical economic reformer. In August his cabinet approved the concept of some form of privatisation for Air India, either fully or partially; 2018 has been mooted as the target date, which may be optimistic. The Civil Aviation Ministry had been asked to prepare a plan for the sale, while the National Institution for Transforming India, or Niti Aayog, an influential government policy advisory group chaired by Modi, will make its own recommendations.

Opposition to the privatisation from vested interests is intense. The powerful unions, 15 in total, are of course resisting fiercely and protesting loudly, as are the manager with jobs for life. The company employs about 20,000 people directly, 40,000 In total including contractors. The government is in the process of drawing up voluntary severance packages for about 15,000, in the hope of quietening the protests.

With 112 aircraft in its fleet, Air India employs about 360 staff per unit, roughly four times the ratio of staff to aircraft as at western Legacy carriers. However, that comparison is not entirely fair: in India, large companies are socially obliged to take on numerous auxiliary staff, security guards etc, at a few rupees a day. Even SpiceJet, operating a pure LCC model, has more than 100 staff per aircraft, compared, say, to Ryanair’s 32.

India’s vibrant press has carried many articles enthusiastically supporting or virulently condemning the proposed privatisation. Proponents point to the $3.6bn of equity infusion and $3bn of other loans that the airline has absorbed over the past five years and regard it as the ultimate symbol of the sclerotic public sector. Opponents recall the glory days of the Maharajah, as the flag-carrier used to be called, and warn about corrupt purchases of state assets by oligarchs.

Earlier this year it seemed that there were some positive signs for Air India. In April It provisionally reported an operating profit of $50m (1% margin on revenues) for FY2016 and a net loss of $583m (-16%), which was an improvement on the accumulated EBIT loss during 2009-15 of $4.8bn (-23%) and accumulated net loss of $8.8bn (-42%). Air India is like Alitalia, but on an Indian scale.

Unfortunately for Air India, the Comptroller and Auditor General (CAG) published a 220-page review — “Turnaround Plan and Financial Restructuring Plan of Air India Limited” shortly afterwards, covering the performance of the airline during FY2012-FY2016, the first five years of a plan that is supposed to run up to 2031. One of the findings was that Air India has probably underestimated its operating losses during 2012- 2015 by almost $1bn, which must raise a question about the reliability of the 2016 EBIT number.

Three levels of depression

The CAG report is depressing on several levels. Firstly, it reveals an unreconstructed company with little or no commercial direction. In analysing the performance of Air India relative to the turnaround plan (TAP), the CAG observed the following, among many other items:

• The company received the approximate amount of new equity promised by the state in 2012 — $3.6bn — but such were the continuing cashflow problems, short-term loans escalated to $2.2bn by 2015, adding to the long-term debt of approximately $5bn at the end of March 2015.

• Consequently, finance and interest charges were 83% higher than the TAP target of $400m.

• The 2016 total revenue target of $3.9bn was missed by 19%.

• Target staff costs of $420m were missed by 12%, as almost none of the modest labour reform plans, including a voluntary redundancy scheme, were implemented.

• Flying crew are still being accommodated in five-star hotels.

• The company has a vast property portfolio but the planned sale of asset didn’t take place — only two sales were completed over the five-year period.

• There were numerous fleet deployment problems: the delay with the introduction 787s was not Air India’s fault, but the purchase of 777-200LRs proved very uneconomic, resulting in a book loss of $110m when five units were sold to Etihad.

• Aircraft utilisation was pretty awful: the planned daily hours for the 777-300 fleet was 14, the actual 11.8; for the A320 fleet, 12.3 hours, actual 6.4. Management attribute this to long out-of-service periods due to inadequate stocks of spares, which resulted in parts cannibalisation, exacerbated by credit-holds from the suppliers.

• On time performance target for 2016 was 90%, the outcome 78%.

The CAG provided some interesting data on route profitability which is summarised in this table. Only 8% of routes operated were profitable (covered total costs) and 16% did not cover even variable costs. This implies that in its current structure Air India not only cannot grow out of its financial crisis, it cannot shrink out of it either. Cut the routes operated at variable loss level, and their associated fixed costs will be redistributed on to the other routes which will move some of the few profitable routes into losses.

Moreover, the CAG report revealed that the large majority of Air India’s losses — nearly 70% — can be attributed to the international sector rather than to the domestic market where liberalisation has helped introduce a wave of LCCs. All international segments were loss making, the worst being North America, and the performance of new routes has been dire — of the four international routes launched by Air India since 2012 only one (Delhi-Birmingham) has covered variable costs.

Air India seems to have no competitive response to the rise of the superconnectors and retains a bilateral mentality, regarding sixth freedom traffic as being somehow unfair. The report focused on the growth of Emirates’ and Etihad’s operations to India: between 2012 and 2016 their combined traffic to India grew by 68% from 5.2m to 8.7m passengers, with sixth freedom flows accounting for three quarters of the increase.

The second depressing aspect is that the CAG, after making some devastating points about Air India’s failures, came up with a series of innocuous recommendations for the airline:

• Reassess funds required;

• Progress monetisation, ie sell property assets;

• Lease more A320s and improve utilisation;

• Concentrate on covering total costs rather than variable costs;

• Harmonise and rationalise labour relations;

• Implement IT systems; and

• Consider restricting bilateral rights for foreign carriers

This list reflects control-economy thinking, and references the official government myth that the airline can again be made “world class”, but does nothing to address Air India’s fundamental problem. The company cannot be reformed by government diktat. The principal, if unexpressed, corporate aim of Air India, like the worst of state-owned carriers throughout the world, is not commercial; it is to maintain the status-quo and resist change for as long as possible.

On a similar theme, the report constantly refers back to recommendations made by management consultants back in 2012, in this case SH&E, and how the recommendations were, unsurprisingly, ignored. However wise the consultants’ advice was, it could no nothing to change the culture of the company; indeed, using consultants in this way is often a way to abrogate political and/or managerial responsibility, to postpone difficult but necessary decisions.

The third level on which the CAG report is depressing is that it views the Indian aviation industry as being Air India-centric, referring to other Indian airlines in the context of negative competitive conditions for the flag-carrier. Perhaps this is inevitable given CAG’s government position, but it ignores the impact of Air India in blocking the progress of India’s dynamic new entrants (some of which, Kingfisher most prominently, have failed, but so what?).

Over the past ten years the domestic passenger market has grown at an average of 17% pa while the international market has increased by about 9% pa, driven by  India’s strong GDP expansion and more specifically fast-growing disposable incomes among the country’s urban “middle-class”, by some definitions 20% of the total 1.3bn population. The country now has 58 cities with a population of more than 1m (compared with 38 in Europe).

The manufacturers consider India to be a key area of passenger traffic growth over the next two decades; in its Current Market Outlook for 2016–2035, Boeing states that India and China are “the main engines of growth” for the Asia region, whose share of world GDP is projected to rise from 31% in 2016 to 39% by 2035. Airbus’s Global Market Forecast for 2016-2035 predicts that the Indian sub-continent (ISC) will account for five of the 20 fastest growing traffic flows over the next 20 years: ISC-China, ISC-Asia emerging countries, ISC-Japan , and ISC-Asia advanced countries and intra-ISC.

As the pie charts indicate, Air India’s physical position had diminished over the period 2010-2016, with its share of seats in the (greatly expanded) domestic market down from 21% to 15%, losing out to the new LCCs while its international share has fallen from 22% to 17%, mostly because of the superconnectors.

However, Air India still accounts for 32% of Indian airline revenues compared to 42% in 2010 (based on an analysis of the five main carriers that have reported financials over this period). This is, in effect, revenue that has been generated on a subsidised basis.

The charts of EBIT and PBT vividly illustrate the huge unprofitability of Air India over this period as well as the poor financial performance of the rest of the Indian airlines (Indigo excepted) for most of this period. The impact of Air India’s presence on the other airlines’ results is unquantifiable but it will have been significant: the perennial problem of barriers to exit in an aviation market as it moves from regulated to deregulated, but still retains a politically powerful, state-owned flag-carrier.

Returning to the privatisation, we suspect, without having any particular local insight, that the process will not be completed next year, but may take several attempts, the first being a futile attempt to find an airline willing to take over Air India. The government seems to have ruled out a foreign carrier, so that leaves Indigo and Jet Airways.

Indigo has expressed interest but only in taking over part the international network rather than part of the airline itself. Jet itself has gone through a severe loss-making phase from which it is emerging, but it is the obvious candidate to benefit from Air India’s privatisation or exit. Its strategy will probably change as the influence of Etihad, its part-owner, diminishes and it attempts to deepen links with Air France/KLM (specifically the KLM arm) which may also entail an equity infusion from Delta. Its SkyTeam partners will surely resist any pressure put on Jet to “assist” the Air India privatisation. SpiceJet, GoAir and others all have international growth plans, especially to the Middle East (Aviation Strategy, May 2017).

Ultimate privatisation

Unless there is a miraculous turn-around at Air India, the ultimate privatisation solution may be something along the “Olympic model”, which is a political strategy:

• Make the decision that, instead of pumping taxpayers’ money for ever into the company, it would be better to offer a one-off generous redundancy payment to all employees, priced to remove union opposition.

• Air India has an advantage in that it owns extensive property in Delhi and Mumbai that could be liquidated to provide funds.

• Structure the privatisation as a sale of Air India’s core assets — slots at congested airports, route rights and brand — that’s all.

• If really necessary, add some conditions about maintaining some services.

• Offer the bidders the option to take on other Air India assets — aircraft, staff, IT systems, MRO facilities, etc — but do not oblige them to purchase.

• Run a transparent sales process.