FDI is not a panacea; but a step in the right direction

When new Indian civil aviation Minister Ajit Singh announced that the national government would soon begin the process of allowing 49% foreign direct investment (FDI) by international carriers into India’s airlines Tuesday, India’s flailing airline industry breathed a heavy sigh of relief. Following a 75 minute meeting with finance minister Pranab Mukherjee, Singh stated, “the question was to allow foreign airlines to participate in FDI. I discussed it with the finance minister and he has agreed. We will bring out a note for the Cabinet now.” Cabinet approval is not a foregone conclusion; however the wishes of the aviation minister are expected to hold considerable weight.

The result is in part a validation of the theatrics exhibited by Kingfisher Airlines and their flamboyant CEO Vijay Mallya late last year, with the dramatic cancellations/capacity reduction that they enacted in November appearing to pay off. Regardless of the validity of their duress, Kingfisher at the very least appears to have finally created a meaningful discussion around the legal environment for airlines in India: hopefully allowing the market to be re-structured into a more equitable and less restrictive model.

49% is a very significant figure for a pair of reasons; firstly, it is typically the maximum FDI allowed in most Indian sectors. Earlier figures that had been bouncing around included 24% and 26%, with the latter expected to be the upper bound of the cap. However, the dire financial situation of Indian carriers, which may have been exaggerated by the safety audit performed by the DGCA earlier this month, apparently convinced the government to soften its opposition even further. Secondly, a 49% investment cap ensures that foreign carriers would be able to control at least one (possibly more) seats on the boards of directors of Indian carriers, allowing these foreign airlines a voice into the decision-making of IndiGo, SpiceJet, Kingfisher, Jet Airways, and GoAir. The importance of this clause cannot be understated. A large chunk of the Indian airline industry’s problems can be attributed to mis-management by airline leaders (especially with regards to capacity discipline- or lack thereof). Allowing well-managed foreign airlines a voice in the affairs of Indian carriers could improve their management.

Not all FDI is Equivalent

That being said, there are 3 different types of FDI that will result from this decision. For the purposes of this article, I am dubbing them stabilization FDI, partnership FDI, and profit FDI.

Stabilization FDI is most directly applicable in the case of Kingfisher (though it certainly could apply to Air India as well). In their November 2011 crisis, Kingfisher noted that it especially needed equity to survive their short term financial crunch. Lack of liquidity might have forced Kingfisher to shut down (though it obviously did not), and in that scenario, a concerned foreign airline (probably a Kingfisher partner or potential partner) could have stepped in to save the company. For example, British Airways and its OneWorld partners have a vested interest in the survival of Kingfisher Airlines (as their gateway feed partner for the rapidly growing Indian market), and as such would have likely stepped in to prevent a collapse of Kingfisher.

FDI by British Airways would also be partially qualified over the long term as partnership FDI: which allows foreign carriers to dictate partnerships in strategic markets such as India. This avenue is open to any carrier who needs a local partner in the region, and is not unheard of around the world. Delta Airlines has launched a recent expansion into Latin America, buying partners like Gol and Aerolineas Argentinas through equity investments. If SkyTeam were to jointly invest in Jet Airways for example, they’d be engaging in partnership FDI.

The third type of FDI is one that is already technically possible for private foreign investors; investing in airlines for the return (profitability). Airlines tend to attract an unhealthy amount of foolhardy, romantic, investments. But the actual return on invested capital (ROI) is typically so low that smart private investors stay away. However, another airline’s definition of sufficient profitability is typically very different from that of an average citizen, and as such; foreign airlines could be lured into investments in the Indian market by tantalizing growth and tangible, if marginal, profits. This sort of investment would primarily be directed towards IndiGo, as well as potentially Jet Airways and SpiceJet.

FDI alone will not return the sector to profitability

While FDI is a good first step in solving the endemic issues affecting the Indian airline industry, it will ultimately take a whole lot more for a true return to profitability. FDI will help solve the liquidity problem of airlines and allow them to more easily stabilize in times of crisis. But the government has not yet attempted to ease the pressures of high fuel prices; which drove the losses of most Indian carriers in 2011 and are created in part by exorbitant fuel taxes. The market distorting influence of Air India has not yet been expelled, and the team that negotiates India’s bilateral hasn’t been enhanced in any way.
From the airline side, FDI will not prevent them from mindlessly expanding capacity, though it could make their business decisions sounder. And passengers are not going to pay more to fly because of FDI: the expectation of low fares will persist into the foreseeable future.

But the approval of FDI is finally a step in the right direction. Hopefully, it will be the step that catalyzes a chain reaction to solve the problems catalogued above.

About Vinay Bhaskara

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