India is now among the top 10 aviation markets in the world. According to Praful Patel, the country’s minister for civil aviation, the sector’s growth in recent years is a result of the government’s loosening of control. In a conversation with Wharton management professor Saikat Chaudhuri during the 2010 Wharton India Economic Forum, Patel talks about some of the changes in the sector and what more needs to be done. On the merger between Air India and Indian Airlines, Patel says that although it has not been well executed, the problems are not insurmountable, and the merger will be fully functional in a year of two.

An edited transcript of the conversation follows.

Saikat Chaudhuri: Thank you very much for coming here, Mr. Patel. Under your leadership India’s aviation sector has experienced tremendous growth, as well as some ups and downs in recent times due to some external factors. How do you see the aviation market shaping up both in India and abroad?

Praful Patel: Well, you are right. India is a major aviation market now. It wasn’t so, just a few years ago. In fact, it is almost the ninth largest aviation market in the world. It went through a few years of very high growth. In 2005, 2006 and 2007 especially, we saw growth in the high 20s and 30s [percentage points]. In 2008, the oil price rise and subsequently the world recession impacted aviation worldwide and in India, too. I feel that [recent months have] been very encouraging in India. We have seen about 25% growth. I don’t look at such high numbers for the whole year. Maybe even 15% growth would be quite good, and that would be, in a way, leading aviation back on the path of recovery.

Chaudhuri: Undoubtedly, given the population and the economic growth that is projected, we do expect growth, and so this may have been a small bump with these various external factors. You have obviously worked on the policy side quite a bit in terms of aviation infrastructure. I believe that India is headed on a good path to modernize airports, air traffic control and so forth. How do you view bilateral rights for instance? This has been one of those discussion points. Have Indian carriers benefitted or been disadvantaged? Obviously competition is good for the consumer. Where do you strike the balance, because that must have been one of the aspects which you have had to deal with very, very critically over time?

Patel: You are right. In fact, one of the key areas that we worked on was on the regulatory side, especially on technical regulation. But as far as the overall sector [is concerned], it has only grown because we have in a way started to free it of government control. And it has helped the Indian consumer. It has helped the country. It has helped the economy. It has helped tourism. And that is the reason you find that India is being recognized as an aviation power. But that notwithstanding, it is very important that we balance the growth in a methodical way. We have now very liberal aviation agreements with many countries, so we see more flights of other countries coming to and from India. We also have an open skies agreement with the U.S. — a first of its kind. We have a lot more connectivity now between India and the U.S. Of course, much more will happen in the future.

But it is a question of balancing the needs of a country. The local airlines, the domestic airlines, also must have an equal level-playing field. So on one side, while we have opened up the international skies, on the home front we still have a lot of regulation; we don’t allow foreign airlines to operate within India yet. But it is a calibrated approach; we will be balancing and opening up progressively.

Chaudhuri: Is the balance between low-cost carriers and full-service carriers appropriate right now?

Patel: It’s not a question of choice; it is compulsion. All airlines [are facing higher] costs of operations and a shrinking customer base in case they increase fares. A combination of this has forced all airlines worldwide to look at cutting costs. The full-service and the legacy carriers have not been able to reduce costs as efficiently as they would have liked to. You can’t dismantle the high costs and the whole structures. In the case of the low-cost carriers, they came in afresh. They didn’t have to go through the learning curve — all the pressures of having a larger organization. And that’s why they have been able to win away a lot of customers, even in India. Almost more than 55% of air travel now is with the lower cost segment. It is happening all over the world. It is happening in Europe. It is happening in America. It is happening in Asia. And it is happening in India. As a result … we will have to see a transition in a larger percentage migrating from the full-service legacy carriers to the low-cost model.

Chaudhuri: It makes sense, especially given the distribution of our population’s income, right?

Patel: In India, travel between one city to the other is not more than two hours. So in that kind of situation domestically it makes absolute sense to have a low-cost model. Also, in nearby regions like the Middle East where there is a large Indian expat population, distances are not more than three or four hours. Or Southeast Asia. A lot of travel [occurs] between India and these countries. So the low-cost model in the domestic or the nearby region would definitely make a lot more sense in the future.

Chaudhuri: On the cost side, one of the important factors is oil and fuel. Indian carriers are disadvantaged by the fact that taxes are so high on aviation fuel. I know you’ve been trying to advocate lowering this and that — this is in the state’s hands to a large extent. How do you think that can be tackled, because we are operating at a cost disadvantage vis-à-vis others and that is not translating into a competitive advantage but a competitive disadvantage at this stage?

Patel: I do agree that taxation, at least on fuel, is a cause of concern for Indian carriers and the whole industry as well. In the ministry we see reason in the demand for lower taxes. But it’s not been easy so far to be able to convince various states, especially because in India we have states which collect local taxes. I don’t want to comment on their reasons, but the fact is, yes, this does put pressure. And that’s why — one of the reasons why — fixed costs cannot be brought down or the fuel costs cannot be brought down. Therefore, the low-cost model has probably been more successful in terms of trying to reduce costs on the other fronts.

Chaudhuri: I want to turn a little bit towards Air India and Indian Airlines and the merger. I will tell you my bias, and that is, I believe in the merger. I have openly done that because I believe the strategic compulsion is there to have domestic and international [operations] combined. But obviously the challenge has been to integrate appropriately. So I don’t see it as a flawed decision. The question is: is the integration too complex to ever be possible or can it be done in some structured fashion? I know you have been working on this. There are various committees and we see comments. How can this be approached so that the implementation is successful and effective?

Patel: I do agree that the merger makes imminent sense. There was a lot of thought, well intentioned, well advised. What has actually not really gone right is that the two entities have slight cultural differences. Well, it is not insurmountable. But probably a little bit of resistance from the people who work in both the organizations has led to the situation. But I don’t think it is going to be impossible to solve. We are working on it, delayed though a little bit [it may be]. Not as well executed as planned. But, at the end of the day, in a year or two, we will be able to make it a fully-functional merger.

Chaudhuri: I hope so, especially with the IT platform. Frankly speaking, I know that it was not entirely the government of India’s fault because the providers also were unable to deliver on a technical solution and combine and harmonize the reservation systems.

Patel: On the PSS [passenger services system], I think they have sorted it out. By the end of this year, the PSS integrated system will be functional. So that is one major concern that has been, I think, addressed.

Chaudhuri: FDI [foreign direct investment] in the aviation sector has been talked about for a while. Obviously there is a careful balance of the needs financially, professionally, but also protecting to some extent and giving equal playing fields for the local carriers. What is your stand on this? And how should this be done?

Patel: FDI is a fairly reasonable percentage. It is 49% at the moment. But in terms of aviation-related [areas] — like airport infrastructure, greenfield airports — we are going to have 100%. In the Mumbai and Delhi joint ventures [for airports] we have 74%. So I think it is a calibrated approach.