By Jayant Sinha & Akhilesh Tilotia
Providing regional air connectivity is an important policy goal for the government. Such services deliver a host of benefits by fulfilling latent consumer demand for convenient travel, making businesses and trade more efficient, unlocking India’s tourism potential, enabling fast medical service and promoting national integration. Moreover, building connections to tier-2 and tier-3 cities also generates powerful network effects with many regional passengers transferring on to the national aviation network between tier-1cities.
The Udan (Ude Desh ka Aam Naagrik) programme is designed to jump start the regional aviation market by improving the profitability of under-developed regional routes.
Udan is a market-based policy intervention that builds on similar programmes in the US, Canada and Australia. It is also consistent with universal service approaches established for other network-based services such as railways and telecom. The aviation business has high operating costs, which include aircraft, capital charges, airport charges, cabin crew, fuel and maintenance.
Unless there is sufficient air traffic, airlines will not be able to generate necessary revenues to cover their operating costs and recover their cost of capital. It is self-evident that airlines will not fly unprofitable routes.
The Udan programme operates at three levels to ensure route profitability: reducing operating costs as much as possible, providing a marketdiscovered subsidy for half the seats, guaranteeing a three-year exclusivity on routes.
Operating costs are reduced in the following ways. First, Udan reduces taxes on aviation turbine fuel (ATF) and eliminates airport charges completely for Udan routes. Second, Udan improves liquidity in the regional aircraft (typically turbo-props smaller than 40 tons and less than 80 seats) thereby reducing leasing charges. Finally, the Directorate General of Civil Aviation (DGCA) is streamlining regulations for regional aircraft so that new airlines can get started with fewer upfront costs.
Udan uses a market-based approach to establish subsidy levels. Note that subsidy levels are capped based on operating costs estimated from actual industry data for different type of aircraft. Only qualified bidders are allowed to enter the bidding process and the route is awarded to the bidder bidding the lowest subsidy level for half the seats on the flight. These subsidised seats are to be priced on the basis of a varying rate schedule such that a 30-minute flight is priced at Rs 1,500 and a 60-minute flight is priced Rs 2,500 and so on.
The other half of the seats can be sold at market prices. Finally, the winning bidder gets three-year exclusivity on the route incentivising them to invest in building up the route.
Geographically, large countries like the US, Canada, Brazil and Australia support regional connectivity through public funding. Udan is the firstof-its-kind scheme, which will levy a small fee on the flights on its metro routes to fund regional connectivity.
Our levy, estimated to bring in around Rs 400 crore ($75 million) is about onefourth the size of the $290 million that the US government will spend in promoting its Essential Air Services in 2016.
Domestic air travel is expected to reach Rs 70,000 crore this year, implying that the Udan levy will be just 0.6% of total revenues. If airlines pass this levy on to consumers fully, it will be about Rs 50 per ticket. If the average subsidy amounts to, say, Rs 1,000 per seat, this levy can create 50 lakh Udan seats or 1crore seats, representing about 10% of expected air travellers this year.
Network-based services, such as railways and telecom, have developed various approaches to harness network effects and deliver universal service. The Indian telecom sector generates annual net revenues of around Rs 1.8 lakh crore and pays 5% of its net revenues into a Universal Service Obligation fund, which collected Rs 9,835 crore in FY 2016.
Indian Railways sustained a Rs 33,004-crore loss (in FY2015) in the passenger segment to bring connectivity to the country (total passenger revenues were Rs 42,190 crore in the same year).
Note that the total airline revenues (domestic and international) are around Rs 1.4 lakh crore, so that the universal service funding represents only 0.35% of overall revenues.
Udan will jump start regional air connectivity and strengthen the overall aviation network at a modest market-discovered price. Passengers will benefit from enhanced air services, airlines will see more traffic on their metro routes and India will gain through faster economic growth and national integration. Thus Udan will surely be a meaningful contributor to India’s overall transformation.
Sinha is Minister of State for Civil Aviation. Tilotia is his officer on special duty.