Tuesday, April 25, 2017

The Contents and Discontents of the National Civil Aviation Policy

[Guest post by Pratiek Sparsh Samantara, who is a 5th year BA, LLB (Hons) student at NALSAR Hyderabad]

The National Civil Aviation Policy (NCAP) was released on 15 of June 2016 with a view to making travel by air more accessible, and the related infrastructure more efficient. This is the first time an integrated aviation policy has ever been released, and it was long overdue. It has been forecast that India has the potential to be among the top three nations in terms of domestic and international passenger traffic: “It has an ideal geographical location between the eastern and western hemisphere, a strong middle class of about 30 crore Indians and a rapidly growing economy”.[i] However, it is currently languishing at the 10th position in terms of total traffic, and the domestic market has become volatile. Many regional airlines have failed in the last decade. These include Paramount Airways, Air Mantra, Air Cost and MDLR Airlines.[ii]

In such a scenario, it has become extremely important to address some long-existing concerns in the industry – entry-barriers and outdated pricing or financial strategies. The government has introduced some key changes in this regard, first, by allowing 100% foreign direct investment (FDI) in scheduled commercial airlines under the automatic route, and second, through policies set in the NCAP.

This post aims to critically appraise three of the most important policy changes introduced, which have majorly impacted three distinct categories of stakeholders. First, the Regional Connectivity Scheme, which affects the consumers, is analyzed for its long-term feasibility. Second, the partial scrapping of the 5/20 rule, which affects the airlines, is weighed against opposing considerations.  Finally, the third section critiques the establishment of the ‘hybrid till model’ for affixing the revenues earned by private airport operators. The author aims to evaluate the viability of all three policies, and comment on changes required to satisfy the aims of the NCAP.

1 The Regional Air Connectivity Scheme

One of the most ambitious and imperative goals of the policy is to ensure better domestic connectivity by air at affordable rates. The Regional Air Connectivity Scheme, or UDAN (“Ude Desh Ka Aam Naagrik”) attempts to reduce the financial burden on operators by (a) having central or state bodies grant concessions in taxes and tariffs, and (b) introducing a Viability Gap Funding (VGF) corpus to bridge the gap between expenditure and revenue. A list of 398 ‘under-served’ cities and towns has been drawn up in the scheme, the routes between which would be allotted to operators on a demand-driven, reverse-bidding process.

The concessions that would be provided include a complete waiver of costs for police and fire services. Utilities would be provided at highly subsidized rates, while no airport charges would be levied for operations in any of the aforementioned airports. However, the most attractive segment of the policy for operators seeking an entry into the market is the VGF scheme, whereby State Governments would be required to reimburse an applicable portion of costs[iii] to the operators. The tenure for the VGF scheme remains capped at 3 years from the date of commencement of operations, while the overall RCS would be applicable for 10 years, subject to periodic review.

As of 6 March 2017, bids have been received for more than 50 ‘under-served’ airports, and the Union government has cleared a stimulus package of Rs. 4,500 crores for reviving routes between them. Some of the airports include smaller cities such as Kadapa in Andhra Pradesh, Jeypore and Jharsuguda in Odisha and Agra in Uttar Pradesh. As per a recent press release, the government plans to revive the designated airports in 3 phases – 15 in 2017-18 and  2018-19 each, and 20 in 2019-20.

From the consumers’ point of view, airfare would also be capped at certain rates. Concrete rates have not been provided as they are volatile, and subject to a number of variables such as ATF prices and inflation. Instead, a formula would be used to index rates as per these variables.[iv] As things stand, the fare for a one-hour journey on a fixed-wing airplane, for 500 km, would be fixed at Rs. 2,500. Clearly, the charging of such rates demands a degree of subsidization by the airlines.

In order to facilitate this and to ensure that no carrier is inordinately disadvantaged by the loss in revenue, the government has directed a ‘levy’ ranging from Rs. 7,500-8,500 per flight operated by all Indian airlines. Early in December 2016, this move was challenged before the Delhi High Court in the case of Amit Sahni v. Union of India through Ministry of Civil Aviation and Another (2016) [W.P. (Civil) No. XX/2016]. The argument forwarded by the petitioners, i.e., the Federation of Indian Airlines (FIA)[v] was that the levy is in the nature of a tax, and not a fee, and would therefore require statutory sanction to be valid. The levy currently finds its basis in the notification, which was made under Rule 133 A of the Aircraft Rules, 1937. The issue is sub-judice, with the High Court bench having issued a notice to the Director General of Civil Aviation (DGCA) to explain how the levy does not place a severe burden on the airlines, and run contrary (indirectly) to the UDAN scheme itself. It could also prove to be a severe dent in the business model of ‘low cost carriers’, as they would be forced to pass on the levy to passengers, thereby increasing ticket prices. Thus, the feasibility of this scheme in the long-term, and its utility to the consumers, is questionable.

2 Scrapping of the 5/20 Rule

The 5/20 rule has been in operation since 2004, and critics point out that it has inhibited entry into the aviation market. It proposes that national carriers have a minimum of 5 years of commercial flight experience and a fleet of 20 aircraft to qualify for overseas services. It is a rule unique to India, and has been the cause for much consternation among members and aspiring entrants in the aviation industry. Specifically, Vistara and Air Asia India had petitioned the government to scrap this rule and allow them to start overseas services irrespective of experience.

The reason behind this is economics. The state of the domestic aviation market is very competitive and routes are price-sensitive, which makes short-term feasibility difficult for newer entrants. In such a case, the more lucrative option of international routes would act as a protective cushion; but the government’s rationale has been that the 5/20 rule is a necessity for better domestic coverage. Other reasons are nebulous – back in 2004, the Minister for Civil Aviation Mr. Praful Patel had stated that the rule was necessary to ensure domestic airlines conform to extensive safety guidelines before taking on international routes. This begged the question as to just how much Indian safety standards deviated from those standardized by the International Air Transport Association (IATA). The other reason stems from a rumour that the 5/20 rule was brought in specifically to help Jet Airways break the monopoly that Indian Airlines and Air India had over international routes. This may not be substantiated with hard evidence, but it is true that the biggest beneficiary of the rule was Jet Airways at the time, and it also helped the company ward off competition from newcomers such as SpiceJet and Kingfisher.

The NCAP has partially relaxed this rule. An airline will now have to allocate 20 aircraft or 20% of their total fleet of aircraft, whichever is higher, to the domestic sector if they wish to fly overseas. This effectively means a carrier must have a minimum of 20 aircraft in its domestic fleet. The Ministry’s explanation for this hinges on the aforementioned need for airlines to prioritize serving domestic avenues in India. This new plan has also met with resistance from seasoned carriers such as IndiGo, Jet and GoAir, who have argued that this unfairly advantages newer entrants and will create an unequal playing field. This argument was rebuffed by the aviation secretary Rajiv Nayan Choubey. Tata Group’s Chairman-Emeritus Ratan Tata remarked that the 5/20 rule should be done away with completely, and is “reminiscent of the protectionist and monopolistic pressures practised by vested interests in other sectors.”[vi]

Thus, even those looking to do away with the 5/20 rule are unsatisfied with the partial scrapping. Effectively, it would take any new airline 3-4 years to ramp up operations to 20 aircraft, and procure the requisite number of experienced flight commanders, of which there is a shortage.[vii] Hence, the new policy may well be called as the ‘3/20 rule’. The presence of such a rule makes even less financial sense than it did in 2004, as international routes have become even more competitive and some domestic airlines like Vistara and Air Asia have their primary investors abroad, and thus see a ready market that has been obstructed. On the flip side, foreign players have been allowed to operate in India since 1992 without fulfilling any of these conditions. Given India’s enormous untapped domestic potential, this does disadvantage local players. Hence, the new policy has left both sides with a sour taste.

3 The Hybrid Till model

Airports in India are constructed in any of three methods, with varying degrees of state participation – by the Airports Authority of India (100% state ownership), privately, or through a public-private-partnership (PPP method, with the proportion of contribution contingent on the concession agreement). In the latter instance, the private party earns revenue through an initial rate of return (IRR) - the calculation of which is contingent on the till model used. A ‘single till model’ would have both aeronautical charges (flight landing, parking and related ground handling charges etc.) and non-aeronautical charges (restaurant, duty free and shopping mall charges etc.) being pooled into a common ‘till’, a percentage of which is designated as the IRR. In the ‘dual till model’, only aeronautical charges are taken into consideration for calculating the IRR. In the proposed ‘hybrid till model’, the entirety of aeronautical charges, and 30% of non-aeronautical charges, would be used.

In an order released on 23 January 2017, the Airports Economic Regulatory Authority (AERA) has mandated the adoption of the ‘hybrid till model’ across all airports where a PPP-model is prevalent. It argues that this model is used in most such airports internationally, and it is legally permissible under the AERA Act, as well as in the interests of both consumers and airports. However, some of the obvious repercussions of the adoption of such a model make one question if that really is the case. It is a given that if only 30% of non-aeronautical revenue is used to calculate the IRR, the airport operator walks away with a sizeable surplus earned from the remaining amount. However, the amount of IRR will necessarily be lowered. As a consequence of this, airport operators will start charging a higher User Development Fee (UDF) from consumers, driving up ticket prices and contradicting the stated aims of the Civil Aviation Policy. Such a scenario has precedence too. In 2014, the AERA had directed the Shamshabad Airport operated by GMR in Hyderabad to adopt the ‘single till model’ so as to make the UDF zero. But the company had petitioned before the High Court against this, arguing that it violated the terms of the concession agreement, was detrimental to its economic interests, and was unenforceable under the AERA Act. After the High Court accepted the petition, GMR raised the UDF by almost 30%, charging Rs. 1,938 from international passengers and Rs. 491 from domestic passengers. Airfare increased correspondingly.

The Ministry argues that such a model would attract more private investment in airports both from India and abroad. The construction of more airports per se, and of ‘no frills’ airports specifically, is also one of the stated aims of the aviation policy apart from cheaper airfare. The AERA is trying to adopt a balancing act, but a significant increase in the UDF might tip the scales against the favour of passengers and airlines.

Conclusion

While the NCAP does try to comprehensively address many of the systemic problems plaguing the aviation industry in India, it has many lacunae that have left stakeholders unimpressed. Chief among these is the pressure that a VGF scheme would put on state financial resources, the perpetuation of the inhibitive 20-aircraft rule for international services and the possible rise in prices as a consequence of the ‘hybrid till model’. Additionally, the policy does not address some issues that would have helped achieve its overall aims. For example, the rule that no airports shall be allowed within an aerial distance of 150 km from existing airports has rendered many smaller bases like that in Begumpet unable to service passengers. Rather, it could be used to cater to smaller cities like Vijayawada, Warangal and Tirupati – keeping in line with the aim of enhancing access to ‘under-served’ cities. The policy also does not address the failings of the loss-making Air India.

Regardless of these lost opportunities, the intent of the government in introducing key changes through the NCAP looks positive, and can only buttress the phenomenal growth rates that India is witnessing. Domestic air traffic grew by 28.1% in 2015, and initial forecasts place the number at 15% for 2016, which is three times higher than China (the nearest competitor). If some of the very valid concerns raised by the stakeholders, including the airport operators, the airline lobbies and passengers can be incorporated into the implementation of the policy, then the growth rates can only increase. The biggest takeaway from the NCAP is the shifting attitudes of the policymakers towards aviation. While it was once viewed as a luxury, the fact that the government is making a huge investment in making air-travel affordable, and accessible to even remote areas, demonstrates its interest in making aviation more inclusive.

- Pratiek Sparsh Samantara




[i]        Reddy, Balakista (2007): Emerging Trends In Air And Space Law, New Delhi: ABE Books.

[ii]       Tarun Shukla, Govt Clears Rs4,500 Crore For 50 Regional Airports Under UDAN Scheme, Live Mint e-Paper, http://www.livemint.com/Politics/FHm9tEhJ8341miVfdRi2GP/Govt-clears-Rs4500-crore-for-50-regional-airports-under-Uda.html, (March 6, 2017).

[iii]      The applicable percentage stands at 20% for states other than for North-Eastern States and Union Territories of India, where the ratio will be 10%.

[iv]      The variable amount, per annum, is designated by a change in Consumer Price Index, or ∆CPI.

[v]       FIA is the lobby group constituting major airlines like IndiGo, SpiceJet, Jet Airways and GoAir.

[vi]      Hindu BusinessLine News Bureau, Ratan Tata, Ajay Singh Spar Over 5/20 Rule For Airlines, The Hindu BusinessLine, http://www.thehindubusinessline.com/news/ratan-tata-ajay-singh-spar-over-520-rule-for-airlines/article8264509.ece, (February 21, 2017).

[vii]     Anirban Chowdhury, Civil Aviation Policy: Airasia, Vistara Biggest Beneficiaries Of 5/20 Rule Change , The Economic Times, June 16, 2016.

Wednesday, April 19, 2017

Companies Act, 2013: Cross-Border Merger Provisions Notified

Under the previous Companies, Act, 1956 (sections 391-394) it was possible for a foreign company to merge with an Indian company, but an Indian company could not be merged with a foreign company. This was intended to ensure that the company that continues after the merger is an Indian company over which the Indian regulatory authorities continue to exercise control. This position was also accepted by the courts (see Andhra Pradesh High Court in re Moschip Semiconductor Limited).

Under the Companies Act, 2013, however, section 234 allows cross-border mergers both ways, subject to the fulfillment of certain conditions. This is intended to provide additional stimulus to cross-border mergers. However, it was only last week that section 234 was notified, with effect from April 13, 2017. The Indian legal regime hence recognises mergers of Indian companies into foreign companies, which were hitherto impermissible.

The Ministry of Corporate Affairs (MCA) has also amended the Companies (Compromises, Arrangements and Amalgamations) Rules, 2017 (the “Rules”) and inserted rule 25A that deals with cross-border mergers. Apart from expressly recognizing cross-border mergers in both directions, the Rules explicitly require the approval of the Reserve Bank of India (RBI) for such a cross-border merger. This is understandable given the foreign exchange implications involved in such a transaction. It goes without saying that valuation will be an important consideration in this regard, and hence the Rules set out the requirements of obtaining valuation reports and the principles to be applied regarding the same. It is only thereafter that the National Company Law Tribunal will consider the application to give effect to the merger.

Importantly, Indian companies can only merge with foreign companies in certain specified jurisdictions. These are (i) jurisdictions whose securities regulator is a member of IOSCO or has a bilateral memorandum of understanding with SEBI, (ii) those whose central bank is a member of the Bank for International Settlements (BIS), and (iii) those who have not been identified in the public statement of the FATF as regards certain specified matters. These details are contained in Annexure B of the Rules.

The notification of section 234 marks an important step, and will certainly provide greater flexibility towards cross-border M&A and restructuring. However, as noted in this column in BloombergQuint, several other matters such as taxation must fall in place before one can expect a market for cross-border mergers to develop.