Indian Airline Drama a Result of Government Intervention

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Kingfisher Airlines has seen its license revoked and has been grounded from quite some time now with little hope of getting off the ground. But much of the upheaval in the airline industry is a consequence of India’s continued intervention into its economy which is slowly responding to the reality of economic forces tearing many of its industries apart.

A quick history lesson is in order.  In January 2012, an audit was carried out by the Directorate General of Civil Aviation (DGCA) over the domestic airline sector. According to the audit report of DGCA, the aviation industry did not engage in adequate safety practices due to a cash flow issues stemming from a mix of extremely high fuel costs thanks to the falling Rupee (NYSEMKT: ICN)  -- 20% devaluation in 2012 -- and a slowdown in the economy. 

The DGCA suggested that extreme measures should be taken and argued for the revocation of Kingfisher’s and Air India Express’s permits.  But, no action was taken with respect to the DGCA recommendation at that time and today Kingfisher is now without a business but could have avoided this situation if its promoters had acted when the audit report was first released.  Kingfisher’s operating license expired on December 31, 2012 and suspended operations in October.  

Kingfisher is up to its eyes in debt and simply needs to be sold. In the latest quarter ended on December 31, The company posted a loss of Rs7.55 billion ($140.6 million US). Its debt has escalated to $2.5 billion payable to banks, staff, airports, and fuel suppliers. The Company has never posted profit in its eight years of operation and has netted investors a combined loss of Rs 33.1 billion ($616.4 million US) in 2012 alone.

According to India’s Aviation Minister, Kingfisher would need as much as $186 million in order to fly again.   The private airline has been squeezed out of the market while the government owned and operated one has been subsidized and has expanded market share.  Into the void left by Kingfisher has come an all-out “fare war” between Jet Airways and other budget carriers.   Malaysia’s AirAsia (AIABF.PK) is jumping into the fray as well partnering with Tata Group to build a local budget carrier.

Air India was struggling with similar issues a year back. But with the intervention by the government at a time when it could ill-afford to do so pushed the situation further along.  The government protected its asset at the expense of a myriad of others.   With the capital injection that it likely could not have garnered on the open market, Air India quickly managed to bounce back and posted an 8% rise in passenger carriage over the last year in a market which has slowed considerably since last May, likely picking up the passengers lost with Kingfisher out of the market.   It is also staying out of the fare war.  Why should it get involved?  Losses will be covered by government largesse.

This is a clear case of government intervention coming in and picking winners and losers.  Kingfisher and Air India both should have been allowed to fail and the best bits picked over by new investors and the rest sold to payback some of their creditors, but now Air India is simply another drain, albeit a small one on the Indian government’s revenue stream.   But this is a government that needs to conserve every rupee it takes from the private economy. 

ASSOCHAM (Association of Chambers of Commerce) said that government of India should design a similar bailout package for Kingfisher Airlines in order to revive the carrier.  What’s fair is fair, right?   But, bailouts and subsidies are what have created the economic distortions within India’s economy that led to the carriers both becoming unprofitable in the first place.  So, bailing them out only further compounds the problem.

This is an industry that is staring at a CAGR OF 11% over the next 7 years, according to credit agency ICRA.  The Ministry of Transportation is considering relaxing the travel visa rules to allow travellers to remain in country 48 to 72 hours in the hope of increasing tourism and international commerce.  This is happening in conjunction with the Ministry of Civil Aviation loosening the seat allowance to Singapore and Sri Lanka due to rising demand.   This coupled with changes to the foreign investment rules would create a bit of a feedback effects as it would help facilitate business management.   Airline travel dropped 2.1% in 2012 year over year. 

The Indian government is slowly being forced by economic conditions to reform some of its worse market interventions.  The ending of the diesel subsidy, at least the initial stages of its removal, had been enough to send the rupee up versus the surging U.S. Dollar but that surge is now over as budget deficits continue to come in higher than expectations.  I would be leery of Indian equities at this point.

The WisdomTree India Earnings ETF (NYSEMKT: EPI) has begun sliding again after a 25% rally starting last fall.  In the long run India’s economy is going to expand but it will be rocky and volatile, especially in today’s environment where the West is stuffed with deflating debt and emerging markets are being slow to relinquish control over vital areas of the economy.  

At this point I would not be buying India for macro-fundamental reasons, politically there seems to still be too much opposition to needed reforms in electricity, energy and infrastructure.  There have been signs of improvement but not enough to justify the risks, yet.  I would wait to see how things play out in the U.S. and Europe before I make a move towards India in that respect.  But when stronger reforms are made and we know the outcome of the Italian Government situation, I would take a long look at the EG Shares India Infrastructure ETF (NYSEMKT: INXX) which tracks the Indxx India Infrastructure Index and build a small core position to take advantage of the flood of infrastructure just waiting to be built. 


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