Privatizing Air India: Is the Price Too High?

Air India

In March 2017, India became the third largest buyer of passenger aircraft in the world, with only the U.S. and China ahead of it. The aircraft order book of the Indian airline industry will soon cross 1,000, which means that for every aircraft in service, there will be 2.2 aircraft on order, notes a report by the Centre for Asia Pacific Aviation (CAPA). “The compound annual growth rate (CAGR) is now 19%,” says Rashesh Shah, senior aviation research analyst at online trading house ICICIDirect. In 2016, total air passenger traffic within the country stood at 100 million, led again by the U.S. (719 million) and China (436 million). Recently, private carrier GoAir, which is preparing for an initial public offering (IPO), placed an order for 72 Airbus A320neo aircraft, doubling its firm order book for the aircraft family to 144. Rival SpiceJet has announced an order for 100 new Boeing 737 Max aircraft for $4.7 billion, the second largest aircraft order ever from India.

But national carrier Air India (AI) is not creating any excitement in Toulouse or Chicago. “There will be no fresh aircraft orders until there is clarity on privatization,” AI chairman and managing director Ashwani Lohani told business website MoneyControl. “AI is now focusing on privatization,” says G.R. Gopinath, founder of Air Deccan, India’s first budget-fare airline. “No more additions [to its fleet].”

AI’s plane purchase phase is over. The Central Bureau of Investigation (CBI) is currently looking into the decade-old deal which saw AI (after its merger with Indian Airlines) acquiring 111 aircraft in what was billed as a bailout bid by the government. This is responsible for around Rs.500 billion ($7.76 billion at $1 = Rs.64.48) of the national carrier’s debt.

“When 84% of the aviation market can be run by private airlines, there is no reason why it cannot go to 100%,” noted finance minister Arun Jaitley. On June 28, the government appointed him to head a panel to recommend a route to sell Air India. By December 2016, AI’s domestic market share had dropped to around 15%; it is now No. 3 after private carriers IndiGo (39.8%) and Jet Airways (15.5%). Meanwhile, on June 29, IndiGo announced it was interested in purchasing a stake in Air India. Although the government has preliminarily cleared the way for the sale of a stake in AI, it’s still unknown if any portion of AI’s debt will be written off if such a sale goes through.

“Even if there were a buyer, what would be the likely outcome, say, a decade later? Is it realistic to expect that a world-class airline would somehow emerge?” –Jitendra V. Singh

“AI was first referred to Disinvestment Commission of India in 1988,” says Jitender Bhargava, former AI executive director and the author of The Descent of Air India. The more recent attention on AI emanates from a proposal from the Niti Aayog (the replacement for the Planning Commission) that the loss-making white elephant be sold off. “The recommendation of Niti Aayog is perhaps the outcome of not knowing what to do with the airline as the government can’t keep infusing funds to keep it afloat,” says Bhargava. “It is very unlikely that AI will attract any potential investor because of the high debt, cumulative losses and low market share.”

The government is not particularly hopeful. Civil aviation minister Ashok Gajapathi Raju says that there are “hardly any bakras (fools or scapegoats) around” to buy the loss-making national carrier unless its massive debt is written off first.

“This is not the first time the question of privatizing AI has come up,” says Jitendra V. Singh, emeritus professor of management at Wharton. “Why do we have to go through this melodrama every few years? Is there really a serious interest in renewing the airline, or is this mere window dressing?”

According to the broad details of the bailout package announced in 2012, there was to be an infusion of Rs.300 billion into the airline. Some Rs.250 billion has been pumped in so far. There is debt of nearly Rs.500 billion of which about Rs.200 billion is on account of aircraft loans and Rs.300 billion for working capital. The cumulative losses since the merger (with India Air) are upwards of Rs.400 billion. Says Ravi Aron, a professor of information systems at Johns Hopkins Carey Business School: “Its debt servicing alone amounts to about Rs.40 billion a year.”

“I would myself not be interested in being a buyer,” says Singh. “But even if there were a buyer, what would be the likely outcome, say, a decade later? Is it realistic to expect that a world-class airline would somehow emerge?”

Aron goes deeper into the numbers. “A term that will surely merit its place in the Orwellian Newspeak is ‘negative profits.’ AI is perhaps the finest exponent of the art of making negative profits,” he says. “Consider the case: AI claims that it made an operating profit of Rs.1.05 billion in 2015-2016; the CAG (Comptroller and Auditor General) disagrees, claiming it made an operating loss of Rs.3.21 billion. We will not know which one of these claims is true. But what we do know is that AI did not make a net aggregate profit; AI carries a debt on its balance sheet of about Rs.460 billion. About Rs.160 billion is for aircraft acquisitions. Where did the remaining Rs.300 billion come from? These are working capital loans raised from a consortium of banks. These loans are proxies for the accumulated ‘negative profits’ that AI has posted year after failed year.”

According to Aron, AI’s debt “is a double whammy for India. First, it is an enormous drain on the scarce resources that should be spent where needed desperately. For instance, [it] would be roughly equal to the salary bill for about a million teachers in India’s government schools — about the number of vacancies that the government is trying to fill by scrounging resources from other ends. There is a second hazard that this poses to the economy. It is on the banking system. The aircraft loans are guaranteed by the government. The working capital loans have been financed by borrowing from a consortium of banks. That is money that banks will not be able to lend to productive sectors of the economy. Think of the small businesses and the large enterprises that could be financed by these loans. Instead, they have disappeared into the maw of a relentless machine that produces year after year of negative profits. Even if the profit claim is true, this thin sliver is the first time the airline posted a profit in about a decade. Is there any reason why the taxpayer should foot the bill for a horrendously-run enterprise that works for the benefit of its employees, political masters and babus ensconced in power?”

Aron notes that supporters of the status quo offer specific reasons for keeping the airline in the public sector. One is that AI serves a compelling social purpose by connecting far-flung cities to international travel hubs. “This is untrue,” Aron says. “Just about 10% of the traffic in India is not between metropolitan cities. Even in those cases, such travel is not undertaken by India’s poor. We are subsidizing what is essentially an upper-class service.”

Secondly, he adds, “if those remote cities do need to be connected, then it is better to offer marginal subsidies to existing airlines to serve those routes thereby making them profitable rather than the government paying Rs.460 billion to keep AI afloat.”

Others argue that India needs a carrier for ferrying around high-level officials. “Heads of state and government (the president and the PM) can fly on specially-sequestered carriers,” Aron counters. “They do not need a whole fleet. Other VVIPs should pay commercial fare and travel.” A second benefit of this is that it brings transparency to the costs of VVIP functioning, he adds.

“Other countries subsidize their domestic carriers,” Aron points out. “National carriers such as Emirates do receive subsidies. But they post substantially better results even after factoring in those benefits. More to the point, these carriers — such as Etihad, Emirates and Qatar Airways — do not have large domestic flying populations to cater to. India has a burgeoning market in travelers. A recent report found that in the period from April 2015 and January 2016, the number of international passengers flying to and from India grew 7.6%, while domestic passenger traffic was up 20.6%.” With numbers like these, there is no reason to subsidize a national carrier, he says.

“There are two large negative externalities that AI imposes on the Indian economy,” adds Aron. “First, airlines are an ‘upstream’ industry that a lot of businesses and industries depend on. Consider the impact of AI on the tourism industry. India suffers from very poor international connectivity in air travel. While most of the leading airports of the world provide connections to over 200 destinations, New Delhi is connected to about 75 destinations, most of them in Asia. Compared to the 150 or so international destinations that Qatar and Emirates fly to, AI flies to a mere 37 international destinations. This makes India a difficult tourist destination to travel to for international travelers. A second negative externality that AI imposes on other Indian carriers is that it takes up valuable landing spots in key airports that are then not available to the private carriers.

“AI provides an Indian illustration of Gresham’s Law – bad money drives out good. A badly-run, state-owned airline drives out efficient rivals and diminishes other industries.”

The Union View

But for every criticism of AI, there is another saying just the opposite. The unions have come out strongly against the move to privatize, and they have their unique reasons. “The Bharatiya Mazdoor Sangh (BMS) is opposing the privatization of AI because all the public sector undertakings (PSUs) have some social obligations as well,” says BMS general secretary Virjesh Upadhyay. “Most of the top professions like doctors and engineers are the children of the employees working in PSUs. It is ultimately an investment in the human capital of the country. These employees can afford higher education for their children. The rest of the workforce (93%) of our country is in the unorganized sector or self employed. The private sector supports a flexible or contractual workforce; workers in the unorganized sector cannot afford such higher education or better education. If we look at the private sector today, the big employers have never been exemplary ones. Their motive is only profit-making and not any social obligation. In this privatization [of AI] we are moving from the organized to unorganized sector.”

“[Air India] provides an Indian illustration of Gresham’s Law – bad money drives out good. A badly-run state-owned airline drives out efficient rivals and diminishes other industries.”–Ravi Aron

AI, he feels, can make profits again. “We only analyze the performance of a company by looking at the numbers on the balance sheet,” says Upadhyay. “As I said earlier, every organization has some social obligations as well; we must see every enterprise overall on all parameters.” He is also certain that India needs a national airline. “Yes; it does prevent monopoly in this sector. If prices go up, it will definitely impact the economy. Airlines are the means of public transport where competition may endanger the lives of people by compromising on safety.”

“The unions, as expected, have opposed privatization,” says Bhargava. “This is on expected lines because no one in authority has ever demonstrated to them with conclusive evidence that they are as much responsible for AI’s current state as the politicians and bureaucrats. They have consistently opposed changes in work culture. Flawed government decisions on aircraft acquisition, the merger with India Air, and interference and misuse of the airline’s resources have given them an excuse to deflect blame. Ironically, systemic weaknesses are not being attended to. These include high labor cost and low productivity, an obsolete work culture, weak leadership, a non-performing board and ministerial interference in day-to-day affairs. Lack of expertise is another key factor. Qantas, which recently effected a successful turnaround, was provided a strong leader who excelled in ‘faster with decisions, productive with assets, and economical with costs.’ Qantas also deferred deliveries of B787 aircraft for two years to consolidate. AI, on the other hand, has not only continued to induct aircraft but is also aggressively expanding networks besides being slow with decisions, indifferent to costs and taking no measures to enhance productivity of men and machines.”

“The unions are understandably going to do their best to hang on to whatever they can,” says Singh. “But it is useful to focus on whether the whole pie is going to be substantial and grow over time. Otherwise, it will all amount to arguing over small details.”

The merger with India Air in particular – a disaster as it turned out to be – has a whole clutch of critics.

“The merger was scripted to fail,” says Bhargava. “It was hastily done. Even though Accenture had recommended various actions for it to succeed, the ministry did not implement them. Harmonization of the workforce, pay scales and work culture were red flagged, but the Justice Dharmadhikari committee that went into it was constituted four years after the merger.”

Merger Blues

“I had watched with great interest when AI was merged with India Air,” says Singh. “It was never clear to me just what would be achieved by the decision. Clearly, there were opponents to the decision within the two airlines themselves. Nevertheless, what were the objectives of the merger? To what extent have they been achieved in the years since the merger?

“This perhaps not very successful merger of the two holds some much deeper lessons. I would assert that a series of past decisions suggests that leading decision makers in India seem to act as if there are no limits to organization. To wit, if AI and India Air are both struggling in different ways, let us combine them, and voila! The problems will somehow disappear. The empirical evidence of the post-merger results will likely give the lie to this belief. But there seems to be no learning from the past.”

Recently, there has been talk of merging all the petroleum companies like Indian Oil, Bharat Petroleum and Hindustan Petroleum, Singh notes. “What this thinking ignores is the outstanding work in economics on this problem of the limits to organization which led to Nobel Prizes for Ronald Coase and more recently Oliver Williamson. Here is the summary: There are very finite limits to how large organizations can grow, primarily because even as revenues grow with size, the costs of organization grow non-linearly. As such, the profitability of firms usually declines with size, even though the best organizational architectures can raise that size ceiling to some extent. It has always been a source of some concern to me that these questions do not often get raised during the energized public discourse preceding any such decision in India. Hence the pattern of repeating past mistakes.”

“In the domestic market, several private airlines have shown great potential for serving the needs of the public.” –Jitendra V. Singh

So what is the future of this mothballed behemoth? There are the optimists. “The operating environment is turning favorable for airline companies,” says Shah. “This is the right time for privatization. Given the huge debt pile, it would seem difficult to find a buyer. However, given the rising demand for air traffic, it might generate interest from a few leading deep-pocket enterprises.”

Air Deccan’s Gopinath offers another suggestion. “AI can be hived off into three separate entities,” he says. “Its land and buildings across the country can be put into one company. From that sale, all employees who have to be laid off can be compensated with a golden handshake. The government would then be left with an airline with lean staff levels, the operational assets necessary to run it, and sustainable debt. It can be sold with zero debt, and will attract a premium, as it would be a very attractive proposition for any investor. As for the third entity, while AI is overstaffed and filled with deadwood, it also has excellent people in engineering. Taken together with AI’s massive investments in maintenance, repair and overhaul (MRO) and engine shop, they could form Air India MRO. This could then be privatized, as was done with Lufthansa Technik after it was hived off from Lufthansa Airlines.”

Singh points to the question of whether it would be possible to sell AI back to the Tata Group. (Tata Airlines, set up in 1911, was India’s first licensed commercial carrier. It was later nationalized to become AI.) “It would surprise me if they are interested,” he says. The Tatas now have an airline JV — Vistara. However, rumors are flying after a Tata meeting with the government. He ventures another possibility: “Maybe a management buyout would be one option? I do not know if that is being considered.”

The other option, notes Singh, “is to let things play out as they are currently unfolding. In the domestic market, several private airlines have shown great potential for serving the needs of the public. And for foreign travel, there are plenty of good alternatives present. What if nothing gets done? The marketplace will decide, in any case, although the process will be slower.”

He continues: “I am reminded of the old adage that sometimes the problems of an organization become so intractable that it is better to just shut the doors and let the firm go out of existence, as there is not much value left there to be salvaged. In any case, that is precisely what brutal but efficient capital allocation does in the free market: It freezes out inferior use of capital and redirects capital to more efficient allocations, thereby putting out of existence weaker competitors.”

Meanwhile, the civil aviation ministry and the Niti Aayog continue their search for potential bakras. Not the trade unions, though. “We do not understand these terms,” says Upadhyay.

Image: By T. Laurent –, CC BY-SA 4.0,

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