Foreign Airlines See Beyond Clouds in India

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India's private airlines were once seen as a bright symbol of their country's modernization, as their rapid expansion allowed unprecedented numbers of Indians to fly for the first time in their lives.

It was not long, however, before carriers' hopes of boundless growth became grounded in a fog of red ink. Intense competition for the loyalties of highly price-sensitive travelers, coupled with some of the region's highest operating costs, led to years of losses and mounting debts.

But the news that southeast Asia's largest low-cost carrier, AirAsia, is planning to launch an Indian domestic airline with one of India's most respected business houses, Tata Sons, suggests foreign airlines still see opportunity in this difficult market.

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"Indian aviation has enormous long-term growth potential and is expected to produce tremendous upside for first movers," the Malaysian-based carrier said this week, as it announced its plans in a statement to the Kuala Lumpur stock exchange.

AirAsia's founder, Tony Fernandes, said on Thursday that his carrier will initially invest between $30 million and $60 million for a 49 percent stake in the Indian venture.

His airline is the first foreign operator to enter the market since the Indian government said in September that it would to allow international carriers to own up to 49 percent of domestic airlines. And, despite the turbulent conditions in India's skies, AirAsia is unlikely to be the last.

Overseas carriers, particularly from the Gulf, are also eyeing strategic tie-ups with existing Indian carriers, to help them capture more Indian passengers for their own international networks.

"India is the only country that has the growth these airlines want," says Sharan Lillaney, an aviation industry analyst at Angel Broking in Mumbai. "They need to capture good Indian demand for their overseas services."

Etihad, the Abu Dhabi-based carrier, has been in advanced talks with Jet Airways, India's largest private carrier, about buying a stake. A deal had appeared imminent although Etihad's chairman recently said the terms needed to be revised, amid concerns about the overall investment climate in India.

Meanwhile, SpiceJet, India's third-largest private airline, has confirmed that it is in preliminary talks with several potential partners over a stake sale, though it has not identified any of its suitors.

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Analysts say tie-ups with Indian carriers would help Gulf carriers synchronize schedules and seamlessly connect travelers from smaller cities with their international routes – a logic that also underpins AirAsia's plans.

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AirAsia flies direct to six east Asian countries from India's southern city of Chennai, where it says its new domestic airline will be based, and to seven countries, including Australia, from the southern city of Cochin. Its new Indian domestic carrier is intended to connect smaller cities, almost certainly providing feeder routes for its international services.

Nonetheless, India remains a challenging market. Since 2007, Indian carriers, including the state-owned Air India and the now-grounded Kingfisher Airlines, have lost a combined total of about $8.5 billion after years of below-cost ticket pricing and overambitious expansion, according to the Center for Asia Pacific Aviation, an industry body. Indian carriers together have cumulative debts of more than $14 billion to their lenders, plus debts of about $1.5 billion to their various suppliers, CAPA calculates.

Government policy is also a problem, with flying still treated, and taxed, as a decadent luxury rather than an essential element of a modern economy. Indian Carriers pay up to 70 percent more for jet fuel than regional peers, which keeps flying out of reach for many.

"Abroad, aviation is treated as an efficiency tool," says Amber Dubey, partner and head (aviation) at KPMG, the global consultancy. "In India, it's treated as a travel mode for rich people."

Still, Mr. Dubey says foreign airlines are taking a long-term view. "When you buy into an airline, you buy with a 10 or 15-year horizon," he says. "In that long horizon, India is positive. As the economy grows, more and more people will be able to afford flying."

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But India's incumbent airlines will not be rejoicing at a powerful new rival in their market. Their fortunes have improved in the past year, as the gradual collapse of Kingfisher, founded by liquor baron Vijay Mallya, gave surviving carriers the pricing power to raise fares by an average of 30 to 35 per cent.

Despite this fare increase, passenger numbers held fairly steady, contracting less than 3 percent, to 53 million people, from January to November 2012, according to India's Directorate General of Civil Aviation. International traffic, meanwhile, has grown about 4 percent. Jet Airways and SpiceJet reported operating profits for the October to December quarter of $16 million and $18 million respectively, compared with losses in the same period last year.

But if AirAsia's plans take off, it will be a formidable competitor and could cause smaller, weaker carriers to stall. "We may also see some consolidation," Mr. Dubey says. "India, with its low flyer base, regulatory challenges the high cost structure, cannot afford more than four strong national airlines."