1991 Reforms: Liberalization and the Impact on the Indian Aviation Sector

The shift from a public sector economy to a private-enterprise economy brought significant alterations and upgrades to the sclerotic and junked state of the Indian aviation industry in 1991. The government infused privatization in the sector by initially handing out licenses as ‘air taxes’. Damania Airways was the initial recipient of this privatized venture. With a fleet of 5 and holding up to 2% of the market share, the airline stayed afloat for 3 years and liquified within 3 years. This was the inception of privatization and competitive realms in the Indian aviation industry.

Deregulation began with the passage of the Air Corporations Act, of 1994^[1], which provisioned for private domestic and private airlines to operate flights within India. The government formulated and modified bilateral agreements with other nations and allowed expansion to international routes. Foreign airlines were allowed to operate and set up a base in India and further enact the Open Skies Agreement^[2]. The Public-private partnership was made easier, and airports were privatized too (Delhi & Mumbai). Research has shown that the motivations behind this drastic deregulation of the aviation sector were the government’s aims to promote economic development, improve air services, and align internationally toward liberalized airline competition. The road ahead was smooth and revolutionized the aviation sector, with many new legacy and low-cost carriers alongside an increase in passenger capacity and growth, however, multiple airline failures and mergers have been very sound throughout India’s civil aviation history. The failure of Kingfisher Airlines due to bankruptcy and Jet Airways bankruptcy in 2019, are prime examples of some issues in the Indian aviation sector.

The Demand Side: Rise in Middle-class Incomes and Price Elasticity

The industry has grown exponentially over the years, mainly by upward pressures from a rising middle-class population, incomes, and increased tourism. DGCA reported that in the first quarter of 2023, 5.03 crore passengers traveled in India compared to 3.52 cr during the same period last year, indicating a vibrant demand for air travel across India. “Revenge traveling”, post the COVID pandemic is also a reason for the post-pandemic air travel demand across India. With increased disposable income, people prefer air travel to other modes of transportation and are willing to pay the premium for the time saved, which would have been longer on trains. At the regional level in India, research has shown that distance to the nearest airport and accessibility affect traffic volumes at the airport. Many foreign airlines have been showing interest in Indian civil aviation and have been battling for increased air rights too. Government policies like allowing foreign airlines to invest 49% in Indian airlines are another driving factor too.

While the future looks secure and promising, one of the main challenges is price-conscious consumers which makes cost transmission difficult for carriers. There is a significant mismatch between the production cost and the cost of the ticket. Customers are price sensitive, any rise in price say by airline A, customers will choose B. If Airline A reduces its price, it stands to lose out on profitability. 25-30% of seats remain unoccupied on popular air routes. For optimization, it is necessary for airlines to sell every seat in the equipment. Price rises have led to a decline in passenger load factor on popular air routes. Price competition is hence bleak, and like most oligopolistic industries, prices are sticky and move together categorically. Airlines use the RASK-CASK^[3] spread as the profitability metric, this indicator along with demand elasticity^[4] must be managed wisely. Fare rises have not been reflected in ticket costs, and airlines especially LCCs^[5] have been shouldering the rise in fuel costs, in order to keep their market share intact and not lose out on potential revenue from price-sensitive Indian customers. From an industry point of view, Airline ‘A’ is an LCC and so is ‘B’. ‘A’ sets abnormally lower prices, in quest for higher market share, and B follows suit to remain competitive and not lose out. ‘A’ & ‘B’, hence maintaining a joint equilibrium, both LCCs optimize revenue and profit.  Airline ‘C’ which is an FCC^[6] loses out. It is incredibly tedious and unviable for an FCC to lower prices to that level, since it has a larger cost base, and caters to a smaller percentage of passengers (who are willing to pay for an FCC relative to an LCC). Overall industry prices remain low and sticky with very few opportunities and room for FCCs. There are some instances of the evident failure of FCCs like Kingfisher Airlines and Jet Airways. Currently, more than 90% of the market share is held by low-cost carriers. Vistara and Air India are the only two FCCs in India. Hence the real question is while India’s aviation future looks bright and solid, will there be space for more FCCs? Vistara has been loss-making since inception and is reporting relatively higher YOY losses post the pandemic.

The Supply Side: ATF Cost, Weakening Rupee, and Operational Inefficiencies

Air ticket prices have been moving in the upward direction for the last few weeks. Post the cancellation of airfare caps that the government had put in place due to the pandemic, airfares have been volatile and have been moving upwards. Dynamic prices^[7] are usually determined by seasonality, route popularity, demand-supply gaps, currency fluctuations, holidays, festivals, events, operational aspects, crude oil price movement, and time-relative demand elasticity. In recent times, the ceasing of GoAir has further led to price rises due to the resultant capacity restraint. Increases in rental, leasing, and purchasing costs and the prevailing capacity shortage have aggravated ticket costs. Despite the rise in airfares, data suggests that monthly demand or passenger movement has been on the rise. This suggests that demand has somewhat been inelastic in the last few months. Henceforth the surge in air fares in recent times can be attributed to an increase in seasonal demand coupled with supply-side factors like lower capacity, operational issues, and a rise in ATF costs. It is argued that some airlines have deliberately not been operating at the approved or full capacity, creating an artificial seat shortage in the market.

Oil price (ATF) rise and the rupee depreciation is the external factors that affect ticket prices. The effect is further amplified by taxes that do not move in tandem with these prices. Depreciation of the INR leads to increased costs, these costs mainly arise from foreign operations, hence raising the overheads. During and post the discourse of the pandemic, airlines operated in a period of high costs and weaker consumer demand and offered cheaper tickets. Fuel accounts for up to 30-40% of the airline’s total costs. The inability to adequately transmit these costs to the end-user has consistently led to profitability issues. This is very difficult for LCCs. If the airline passes these costs, which it will at some point, the flier’s pocket is burdened.

The Situation with Finance 

Airline finances have been turbulent in India. Indigo, which has been a long-term and consistent market leader and seemingly the most successful airline in India, reported continuous losses to post the COVID quarters, which was much anticipated. Estimates suggest that Indian airlines are bound to have losses of around USD 1.2 to 1.8 billion in the next fiscal year, as per aviation consultancy CAPA India. A huge proportion of the aggregate losses in the industry would be incurred by FCCs.

The failure of Jet Airways and Kingfisher Airlines marks a pinnacle feature of the Indian aviation sector, characterized by tight space for FCCs and greater emphasis of Indian consumers on point-to-point travel. Both airlines failed due to a mix of factors ranging from a poor financial situation, confused product positioning, increasing dominance and competition from LCCs, and operational and managerial issues finally leading to bankruptcy. The recent failure of GoAir, marks yet another shortfall in the managerial and financial aspects of Indian carriers, this being peculiar since it was an LCC that went downhill.

The Market Structure: Fiercely Oligopolistic?

An oligopoly is where there are a small number of very large firms in an industry, that hold a huge proportion of market share and sell similar yet slightly differentiated services/products and where pricing is not independent and is usually interdependent. Consumer loyalty may exist. Oligopoly lies between the extremities of perfect competition and monopoly, for instance, somewhere between a town’s sabzi mandi and IRCTC. The Indian aviation industry can be characterized as an oligopoly. 2 airlines- Indigo and Air India combined (Air India +Vistara + Air Asia India) owned and consolidated and enjoy 88% of the total market share. Indigo alone holds around 62% of the market share. Hence more specifically this may be a case of duopoly, a subset of oligopoly. Airlines offer differentiated services on facets like customer experience, inflight services, broader or narrower airfare brackets, etc. Differentiation broadly depends on whether the airline is an FCC or LCC. Prices for a given category are broadly interdependent. Price competition occurs on the basis of price leadership for each LCC and FCC category, where the equilibrium prices can be that what would be drawn in a game theoretical type scenario.

Indigo, which has been the market leader for a very long time, its success is partly marked by a “first-mover advantage” and incepting the low-cost segment. This form of sequential competition can be characterized by the Stackelberg model^[8]. Indigo operates only narrow-body A320s, keeping overheads and operating costs like staffing and extras very low. This allowed Indigo to offer low fares. The fleet consists of 259 aircraft of which 25 are ATRs and 234 are A320 models. Strong marketing, brand power, impeccable operational efficiency, economies of scale, swift and easy ticketing Experience, quick turnaround times, and consistent on-time performance are some of the critical factors that have aided Indigo in achieving and holding on to the market leadership position. Indigo is a crucial driver of growth in the domestic aviation segment of India.

The Scuffle for “Air Rights”: Why do Foreign Carriers want Bigger Chunks in the Indian Aviation Market?

For the December 2022 quarter, the share of Indian airlines in international traffic to and from India was around 43%, as per DGCA. This was primarily led by Vistara and Indigo. As per reports, the aviation authorities aim to go “Atmanirbhar”, and are planning to stop providing any marginal air rights to foreign carriers. India has bilateral air agreements with other countries except the UK and US, wherein an open skies agreement.  Air rights^[9] agreements are mostly in place with West Asian or GCC nations, which want greater access to international traffic from India. For instance, Emirates Airlines can operate 65,000 seats weekly over 160 flights in the Dubai-India sector in both directions. This quota was framed in 2015 and has been the same till now, despite the constant push to increase the number of seats. Kuwaiti LCC Jazeera Airways too recently pushed for increasing the capacity from 12,000 to 28,000 seats per week.

While the government has taken a position to promote Air India and re-capture the lost international traffic share from foreign carriers, foreign carriers will face the brunt. Economic growth and passenger movement have soared exponentially in the last decade, however as mentioned air rights remain un-revised. Air traffic and passenger movement are further bound to increase swiftly in the future, reduced or suppressed supply would lead to higher prices in the short to medium run or until Air India fills the void. India is the 3rd largest aviation market in the world. It is plausible and prudent for an indigenous airline to hold a healthy market share in the international sector, as so is for many countries.

The Future: Resilient yet Turbulent?

Massive aircraft orders by Indigo and Air India, the privatization of Air India, strong economic growth credentials, increase in middle-class incomes and affordability, government push for improvement of airport infrastructure, etc. are some of the factors that put the trajectory of Indian aviation under bright light. The recently launched LCC Akasa Air is another example of promising spaces in the Indian aviation market. Today, more people are able to travel by air than ever before. It is estimated that 2/3rds of the Indian population has traveled by air, so far.

However, not everything is so bright. The Air rights issue, quality of air travel, price-sensitive customers, depreciation of the rupee, operational issues, and financial distress amongst airlines are some of the grave challenges in India’s modern-day civil aviation. The failure of Go Air recently due to operational and financial issues and the failure of Jet Airways and earlier Kingfisher Airways are instances that highlight the loopholes in the industry and signify shortfalls in the regulatory aspects, managerial aspects, financial aspects, operational aspects, and lastly the extremely volatile and difficult nature of the Indian civil aviation in general.

^[1] Air Corporations Act, 1994: The act repealed the Air Corporation Act of 1954 and ended the state monopoly of Air India and Indian airlines, and essentially provisioned private ownership in the Indian aviation sector.

^[2] Open Skies Agreement: These are air transport agreements between two nations, that allow either airline from both nations to fly freely between the two nations commercially, without any government interference on aspects like pricing, capacity, etc.

^[3] RASK-CASK: Revenue per available seat kilometer – Cost per available seat kilometer.

^[4] Demand elasticity: Numerical measure of the responsiveness of the change in demand followed by a change in price. More elastic demand means customers are more price sensitive and vice-versa.

^[5] LCC: Low-cost carriers. An airline that places importance on cost minimization, offering lower airfare and lesser amenities. These have to be purchased separately.

^[6] FCC: Full-cost carriers. Airline that provides all ancillaries, comfort, and amenities, included in the ticket cost.

^[7] Dynamic Prices: A pricing strategy wherein prices are very flexible and move in tandem with market demand.

^[8] Stackelberg model: A model explaining quantity-based competition in an oligopolistic industry. It is a non-cooperative sequential competitive game. Firm A enters the market and first sells some quantity X, and then Firm B enters the market and sets quantity Y based on X.

^[9] Air Rights: Bilateral agreements between two nations, where the degree of air freedom between the two nations can be decided, and the number of seat quotas and other aspects are agreed upon and decided upon.