India Ratings says that the government of India’s recent decision to allow the foreign direct investment (FDI) limit in aviation up to 49% is expected to improve the capital structure of airlines with viable business models. The possible equity infusion would not only deleverage the sector but also provide funds for long-term growth. However, structural challenges may limit the attractiveness for such foreign investors at least in the medium term.
In addition to equity infusion, stronger strategic and operational ties with foreign partners with stronger credit profile, may potentially improve the credit profile of domestic airlines. This may have a beneficial impact on the funding cost of this sector known for its high capital intensity.
While the long-term growth potential of the Indian market may draw interest from International Airlines, the continuing structural weakness and regulatory risks may increase the perceived risk in such tie-ups. Other key considerations of prospective JV partners would be the lack of majority equity control in addition to specific board constitution.
The key structural weakness of the Indian airlines industry is its higher operating costs, driven primarily by a higher tax on aviation fuel, compared with that of the other emerging markets. The cost of infrastructure development is also higher for the Indian industry which usually translates into higher airport usage charges. This is in addition to the currently limited airport infrastructure which acts as a bottleneck to significantly improve scheduling efficiency - which is a direct drag on operating cost.
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