SpiceJet:

Key Developments

In February 2017, Spicejet announced Dhaka as its 7th international destination.

In January 2017, Spicejet announced a deal with Boeing for purchase of upto 205 airplanes.
The deal is estimated to be worth around USD 22 billion.
In September 2016, SpiceJet signed an interline agreement with Hahn air.

Background

SpiceJet is the fourth largest domestic carrier with 11.5% market share (based on RPKM) in 2015-16.
The airline has commenced its operations in 2005. After completing 5 years of domestic operations in
May 2010, SpiceJet has commenced its international operations in September 2010. In November
2010, Kalanithi Mara, promoter of the Sun Group has taken 37.7% stake in the airline. SpiceJet,
erstwhile known as Modiluft, currently operates to 44 destinations including 38 domestic and 6
international.

In December 2014, the airline faced financial crisis as the lenders refused to provide credit facilities.
The company cancelled over 1,800 flights across the country as it faced supply issues from creditors.
This made the airline shut down its operations for a temporary period from December 5, 2014 to 18
December, 2014. In January 2015, Mr Kalanithi Maran (previous promoters) sold their entire stake to
Ajay Singh (current promoter).

Profile
Shareholding pattern as on December, 2016

Source: BSE, CRISIL Research

Operational Performance

The overall demand (domestic and international) as measured in Revenue Passenger Kilometer
(RPKM) grew 26% y-o-y to 8.4 billion-km for 9 months 2016-17, while the overall capacity (domestic
and international) as measured in Available Seat Kilometer (ASKM) grew by 25% to 9.1 billion-km to.
As a result, the overall passenger load factor (PLF) has improved by 91 bps to 91.6%.

In 2015-16, the overall RPKM (domestic and international) remained flat y-o-y at 11.7 million while its
overall capacity (domestic and international) measured in ASKM decline by 11 % during the
year. Given the decline in ASKM's, domestic PLFs jumped to 92% in 2015-16 from 81% in 2014-15.
Operational snapshot

Source: DGCA, CRISIL Research, Company annual report

Market share

During 9 months 2016-17, the domestic market share of SpiceJet is at 12% as compared to 11% in
the same period in the previous year and the international market share is at 5% as compared to 3%
y-o-y.

During 2015-16, domestic market share of SpiceJet declined by 380 bps y-o-y to 11.6% due to
decline in passenger traffic, whereas the international market share expanded by 90 bps y-o-y to
3.6%.
Share in the domestic and international market (based on pax-km)

Note: International market share represents share of international traffic carried by Indian airliners, originating from and
terminating in India. It has been calculated based on international pax- km performed by Spice Jet divided by
International pax- km performed by all Indian airlines.

Source: DGCA, CRISIL Research

Fleet

As on March 2017, SpiceJet had a fleet size of 47 aircrafts. It primarily operates Boeing 737-800s
aircrafts for domestic routes and 737-900ER aircrafts for international destinations. It has smaller
Bombardier Q400 aircrafts to meet growing demand and enhance connectivity to Tier II and Tier III
cities.

Existing Fleet

Source: DGCA, Company, CRISIL Research

Financial Highlights
Quarterly review

Revenues of SpiceJet increased 12.5% y-o-y in Q3FY17 primarily due to 23% increase in
overall passenger traffic. During this period, domestic passenger traffic (which contributed
 about 89% of total traffic) and international passenger traffic saw an increase of 22% and
37% respectively.
Despite a 4% rise in fuel cost per ASKM, the operating costs remained flat on-year due to a
2% on-year decline in ex-fuel operating costs. As a result, the operating margin has declined
850 bps on year to 10.6% mainly due to a steep decline in realization. On the contrary, a 50
bps on-year increase in PLF to 91.2% has supported the margin to a small extent.
Even though the operating margins contracted 850 bps on-year, Net profit margins contracted
only by 540 bps to 11% due to a 100% increase in other income from ancillary services, a
68% decline in finance costs and Rs 385 million of exceptional income on account of write
back of provisions done on contractual dispute.

Quarterly Financial performance

Source: Company, CRISIL Research

Annual review

Revenues declined by 3% in 2015-16. The domestic passenger traffic declined marginally y-

o-y to 10.7 million while international passenger traffic increased by 26% y-o-y to 1.25 million.
EBITDA margin improved substantially from negative 12.6% to 8.4% due to the increase in
passenger load factor and decrease in the prices of aviation turbine fuel.
Following the improvement in EBITDA, net profit margin increased from negative 13.8% to
8%.
Annual financial performance

Note: n.a - not available

Source: Company

Kingfisher:
Kingfisher Airlines
Key development

In November 2016, Karnataka High Court had ordered the winding up of Kingfisher Airlines
and asked the official liquidator to take charge of the airline's assets.
The flying license of Kingfisher Airlines expired on December 31, 2014.
Kingfisher Airlines ceased international operations effective April 2012, followed by
suspension from IATA, and domestic operations from October 2012. This was on account of
financial difficulties arising out of high debt and non payment of salaries to staff causing
operational difficulties.
Accordingly, DGCA cancelled the airline's flying permit and the license got suspended till the
airline submits a concrete and reliable plan on its debt restructuring and solve other
operational disputes. However, DCGA rejected the revival plan submitted in May 2013.

Background

Kingfisher Airlines, headquartered at Bengaluru, India, is part of the United Breweries Group. The
airline commenced operations in May 2005. In 2008-09, Kingfisher Airlines acquired Air
Deccan and renamed it Kingfisher Red. Kingfisher Airlines started international operations
on September 3, 2008, by connecting Bengaluru to London. The airline operated from domestic hubs
at Bengaluru, Mumbai and Delhi.

Profile

Note: Kingfisher airlines is non-operational on the hubs mentioned in the table above due to suspension of its flying
license by DGCA.

Source: CRISIL Research

Shareholding pattern as on 31st March, 2013.

Source: Company Annual Report

Note: Annual Reports are not available post 2012-13

Kingfisher Airlines operated more than 374 daily flights to 60 domestic destination and 11 countries
across Asia and Europe with regional and long-haul international services as on September 28, 2011.
The airline halted its international operations post April 2012, and its domestic operations post
September 2012. Prior to September, its schedule of daily domestic flights underwent frequent
modifications due to cancelation of flights on account of issues related to labor and safety norms.

In 2012-13, the operating revenues of Kingfisher Airlines decreased sharply by about 91 per cent to
Rs. 5,014 million. As per the last annual report of 2012-13, the airlines had a total long term
outstanding debt of around Rs 69,393.7 million and a negative net worth.

The airlines overall pax- km (domestic and international) and its overall capacity (domestic and
international) as measured in terms of ASKM decreased by 90.6 per cent and 88.7 per cent
respectively during the year. This decreased its overall PLFs (domestic and international) to 64.4 per
cent.

Operational snapshot

Source: CRISIL Research

Fleet

As DGCA has suspended its flying license, the airlines does not have any operating fleet since
October 2012. Also in March 2013, DGCA de-registered 15 aircraft of the airlines to enable the global
leasing companies to take them back on grounds of default on their lease rentals by the airlines.

Market share
In 2012-13, the airlines domestic market share dropped drastically to 1.9 per cent as it ceased
operations since September 2012. Its international market share also decreased to 0.3 per cent
during the year as the company had suspended its international operations since April 2012.

Domestic and international market share (based on pax- km)

Note 1: The airliner has suspended its international and domestic operations from April 2012 and October 2012
respectively.
Note 2: International market share represents share of international traffic carried by Indian airliners, originating from
and terminating in India. It has been calculated based on international pax-km performed by Kingfisher divided by
international pax-km performed by all Indian airliners.

Source: CRISIL Research

Financial performance

Source: Company Annual Report

GoAir:
Key developments

In July 2016, GoAir placed an order for additional 72 A320 neo aircraft, taking the total count
to 144.
In August 2016, GoAir received permission to fly international routes to 9 countries and the
airline plans to start international operations in Early FY18.
In June 2016, GoAir received delivery of its first A320 Neo. This will approx. reduce the fuel
costs by 12 - 15%. The airline expects to induct eight A320neo aircraft in the fleet by March
2017 as a part of its expansion plan.
In December 2016, GoAir started operations between Jaipur and Delhi.

Background

GoAir, a low fare air carrier (LFC) headquartered in Mumbai, India, is wholly owned by the Wadia
Group. Established in June 2005, the airline began commercial operations in November 2005. The
airline has its primary hub at Mumbai and its secondary hub at Delhi.
Profile

Source: CRISIL Research

GoAir operates around 975 weekly flights to 23 destinations across India- Ahmedabad, Bagdogra,
Bengaluru, Bhubaneswar, Chandigarh, Chennai, Delhi, Goa, Guwahati, Hyderabad, Jaipur, Jammu,
Kochi, Kolkata, Leh, Lucknow, Mumbai, Nagpur, Patna, Port Blair, Pune, Ranchi, and Srinagar.

Operational Performance

In H1 2016-17, the domestic passenger traffic carried by GoAir increased by 19%. The airlines' RPKM
rose by 18% while it's ASKM increased by 11% during the year. With demand outpacing capacity,
PLFs improved by 530 bps on-year to 88% in H1 2016-17.

Operational snapshot

Source: CRISIL Research, DGCA

Growth in passenger traffic and PLFs

Source: CRISIL Research, DGCA

Performance snapshot

Market Share

During H1 2016-17, the market share of GoAir has declined to 8.2% compared to 9% during 2015-16.
Share in the domestic market (based on RPKM)

Fleet

As on June 2016, GoAir has a fleet of 20 leased aircrafts including their first A320 neo aircraft. The
airliner only uses Airbus A-320-214 aircrafts for all its operations. Currently, the airline does not
operate on international routes as its fleet size is less than 20 aircraft, which is mandatory for
operating international flights.

Existing Fleet

Financial performance

During 2014-15, the revenues of Go Air increased by 26% on-year due to a 24% on-year increase in
passenger traffic. Despite a 10% decline in fuel prices the operating cost per ASKM has increased by
6% on-year a steep increase in other operating costs.

However, EBITDA margin of the airline improved from 4.6% a year ago to 6.7% due to a 490 bps
improvement in PLF to 79%.
Financial snapshot

Vistara:

Key developments

Vistara plans to increase its fleet to 20 aircrafts, including A320neos, by the end of the fourth
year of operations.
In November 2016, Vistara announced a strategic partnership with Booking.com.
In February 2016, Vistara announced its new seating configuration of 8 business class seats,
24 premium economy seats and 126 economy seats increasing the total number of seats on
Vistara's aircraft from 148 to 158.
In September 2016, Vistara inaugurated flights to Port Blair from Delhi and Kolkata.

Background

TATA SIA Airlines Limited, known by the brand name Vistara, is a 51:49 joint venture between Tata
Sons Limited and Singapore Airlines Limited. Formed in 1972, Singapore Airlines operates a fleet of
over 100 aircrafts in 40 countries. In December 2014, Vistara received the Air Operator Permit (AOP)
from the regulatory authority, Directorate General of Civil Aviation (DGCA), allowing the airline to
begin commercial operations.
Vistara, the full-service airline began operations on January 9, 2015. With Delhi as its hub, Vistara
currently connects Ahmedabad, Bagdogra, Bengaluru, Bhubaneswar, Chandigarh, Goa, Guwahati,
Hyderabad, Jammu, Cochin, Kolkata, Lucknow, Mumbai, New Delhi, Port blair, Pune, Srinagar, and
Varanasi.

Shareholding of Vistara

Source: Company, CRISIL research

Operating performance

The domestic passenger traffic for Vistara jumped 130% on-year to 1.3 million in H1 2016-17. The
airlines' RPKM increased 140% to 1.4 billion-km in H1 2016-17 from 0.6 billion-km a year ago. On the
other hand, its capacity measured in ASKM, increased by 103% to 1.8 billion-km. This has improved
passenger load factor (PLF) significantly from 63.7% to 75.4%.

Operational snapshot

Source: DGCA, CRISIL research

Growth in passenger traffic and PLFs

Source: DGCA, CRISIL research

Performance snapshot

Source: DGCA, CRISIL research

Market Share
During H1 2016-17, the market share of Vistara has increased to 2.9% compared to 1.8% during
2015-16.

Source: DGCA, CRISIL research

Fleet

As on October 2016, Vistara has a fleet of 13 A320 aircrafts. In Feb 2016, Vistara changed its seating
configuration from 148 to 158 which now offers three cabin classes business (8 seats), premium
economy (24 seats), and economy (126 seats).

Source: DGCA, CRISIL research

AirAsia India:
Key developments

In August 2016, promoters of AirAsia India have agreed to infuse Rs 2.3 billion through
equity.
In September 2016, AirAsia India has commenced operations from Hyderabad airport through
the induction of eighth aircraft.
Tata Sons increased their stake in Air Asia India to 49% in March 2016 from 30%, which is
equal to Air Asia Berhad.
 In March 2016, Air Asia announced to add two A330 aircraft to its fleet in order to fly new
routes in India as a part of its expansion plan.

Background

AirAsia India was incorporated on March 28, 2013 as a scheduled airline carrier. It was granted Air
Operating Permit by the Directorate General of Civil Aviation on May 8, 2014. As of June 2016, the
airline operates between Bengaluru, Chandigarh, Cochin, Delhi, Goa, Guwahati, Hyderabad, Imphal,
Jaipur, Pune and Visakhapatnam.

The airline is a joint venture between AirAsia India Investment Ltd. and Tata Sons Limited. It
commenced operations as a low-fare carrier effective June 12, 2014, with its domestic hub in
Bengaluru. During H1 2016-17, the airline holds about 2.6% market share as per revenue passenger
kilometers (RPKM) in the domestic market in India.

Shareholding

Source: Company reports

AirAsia India Chairman S Ramadorai and Director R Venkataramanan together puchased remaining
2% holding. Mr. Amit Bhatia, an Independent Non-Executive Director of the Company, is the son of
Mr. Arun Bhatia, who held an indirect stake in AirAsia India through his 99% owned company Telestra
Tradeplace Pvt. Ltd., which earlier held 21% of AirAsia India has now exited.

Operational performance

The domestic passenger traffic for AirAsia India jumped 58% on-year to 1.1 million in H1 2016-17.
The airlines' RPKM almost doubled to 1.3 billion-km in H1 2016-17 from 0.7 billion-km a year ago. On
the other hand, its capacity measured in ASKM, increased by about 51% to 1.5 billion-km. This has
improved passenger load factor (PLF) significantly from 76.3% to 85.5%.

Operational snapshot

Source: DGCA, CRISIL Research

Growth in passenger traffic and PLFs

Source: DGCA, CRISIL Research

Performance snapshot

Note: On time Performance of the airline is not reported during May to October 2016

Source: DGCA, CRISIL Research

Market Share

During H1 2016-17, the market share of AirAsia India has increased to 2.6% compared to 2.3%
during 2015-16.

Share in the domestic market (based on RPKM)

Source: DGCA, CRISIL Research

Fleet

As on October 2016, AirAsia has 8 Airbus A320 aircraft with a seating capacity of 180 per aircraft.

Source: DGCA, CRISIL Research

Financial performance

Despite a 41% on-year increase in passenger traffic, revenues for AirAsia India have increased by
32% on-year to Rs 1.75 billion due to a 11% decline in realisations during Q2 2016-17. Due to a 2%
decline in fuel prices and increased aircraft utilization the operating cost per ASKM has declined by
3% on-year in Q2 2016-17.

However, EBIT margin of the airline improved from negative 44% a year ago to negative 38% due to
a 1074 bps improvement in PLF to 84%.

Financial snapshot

Source: Company, CRISIL Research

Air Pegasus:
Key developments

In November 2016, DGCA has suspended the license for the airline due to the
unavailability of a plan for revival of the airline.
The airline has halted its operations from August 2016 due to an issue with aircraft lessors.
In June 2016, DGCA suspended 5 pilots of Air Pegasus for serious safety violations.
Air Pegasus plans to invest Rs 1 billion in 2016-17 to expand operations and connect more
cities in South India.

Background

Air Pegasus is a regional airline, promoted by Decor Aviation. The parent Decor Aviation is a
ground handling provider headquartered at Bengaluru. In March 2015, Air Pegasus received the
Air Operator Permit (AOP) from the regulatory authority, Directorate General of Civil Aviation
(DGCA). On April 12, 2015, the airline commenced operations with inaugural flight from Benguluru
to Hubli. With Bengaluru as its hub, Air Pegasus operated flights between Bengaluru, Cochin, Goa,
Hubli, Cuddapah, Madurai, Thiruvanthapuram, Chennai and Mangalore.

Operating Performance
Operational snapshot

Source: DGCA
 Fleet
As of July 2016, Air Pegasus had a fleet size of 3 ATR 72 aircrafts, which has a capacity of
66 seats.

Trujet:

Key developments

TruJet plans to have 10 aircrafts by the end of 2016. They have also sought an approval from
the civil aviation ministry to start services from West and North India apart from southern
region.
In November 2016, the airline has started services between Hyderabad and Cochin.
In September 2016, TruJet started operation of daily flights between, Vijayawada Chennai,
and 4 times a week between Bangalore Goa and Bangalore Rajahmundry.
They have identified Mumbai and Ahmedabad in the western region, along with
Visakhapatnam, Tirupati, Hubli, Coimbatore, Tuticorin and Salem in southern region for
expanding their network.

Background

Hyderabad-based Trujet is a regional carrier which is promoted by Turbo Megha Airways Pvt Ltd. The
airline commenced operations on Jul 12, 2015 and currently operates between Aurangabad,
Bengaluru, Cochin, Chennai, Cuddapah, Goa, Hyderabad, Rajahmundry, Tirupati and Vijayawada.

Operational performance
The domestic passenger traffic for TruJet jumped 341% on-year to 0.2 million in H1 2016-17. The
airlines' RPKM increased 412% to 0.1 billion-km in H1 2016-17 from 0.02 billion-km a year ago. On
the other hand, its capacity measured in ASKM, increased by 428% to 0.11 billion-km. This has
reduced the passenger load factor (PLF) from 81.3% to 78.9%.
Operational Snapshot

Source: DGCA, CRISIL Research

Growth in passenger traffic and PLFs

Source: DGCA, CRISIL Research

Performance snapshot

Source: DGCA, CRISIL Research

Market Share

During H1 2016-17, the market share of TruJet has increased to 0.2% compared to 0.1% during
2015-16.

Source: DGCA, CRISIL Research

Fleet
As on October 2016, Trujet operates a fleet of 3 ATR-72 Aircraft which have a capacity of 72 seats.

Source: DGCA, CRISIL Research

STATISTICS of INDUSTRY:
IMPACT:
DRAFT AVIATION POLICY OCT 2015
Draft aviation policy wants middle-class to fly more
The focus of the much-awaited draft aviation policy released on October 30, 2015, is
on making the middle-class fly more. While the policy proposes a capped price
system to enhance regional connectivity, and service tax waiver for maintenance,
repair and overhaul (MRO) companies, it lacks clarity with regard to the government's
position on when new airlines can start overseas services. It is also silent on the long-
pending issue of high sales tax on aviation turbine fuel (ATF), taking the sheen off the
sector.

On October 30, 2015, the Government of India unveiled the much-awaited draft civil aviation
policy, offering a bouquet of measures to make air travel more affordable to the masses. The key
propositions include a capped price system to boost regional connectivity and service tax waiver
for maintenance, repair and overhaul (MRO) companies. On the flipside, it lacks clarity on the
government's position on the 5/20 rule. The policy also does not dwell on the long-pending
structural issue of high sales tax on aviation turbine fuel (ATF), which diminishes the attractiveness
of the sector. The government has sought feedback from various stakeholders before the final
policy is released.

Thrust on boosting regional connectivity in a price-capped system

The regional connectivity scheme (RCS), effective April 1, 2016, would be designed such that
fares for a one-hour flight will be capped at Rs 2,500 - applicable only in states which reduce
value-added tax on ATF at RCS airports to 1% or less. The government is not just aiming to revive
un-served or under-served airports, but is also considering setting up no-frills airports at a cost not
exceeding Rs 500 million each.

This scheme will be implemented via viability gap funding (VGF) for scheduled commuter airlines
(aircraft capacity of less than or equal to 100 seats). Accordingly, airlines such as Air Costa, Air
Pegasus, Turbo Megha, Jet Airways, SpiceJet, Air India, etc, would qualify for VGF. While the
Ministry of Civil Aviation will provide viability gap funding on air tickets from 80% of the regional
connectivity fund (RCF), the rest will come from the state. The RCF will be funded by charging 2%
cess on air tickets on international and domestic routes excluding remote locations. The
government is also offering a host of incentives (to operators) such as ATF drawn from RCS
airports shall be exempt from excise duty (8% currently) for a period of 10 years.

CRISIL Research believes this move would cap the prices on regional routes, which is a negative
for airline companies given the government intervention and price control. Besides, more details
are awaited in terms of whether a fare of Rs 2,500 per hour will be capped even for a last-minute
booking under RCS, identification of specific routes and associated regional impact, if any, and
specific modalities and procedures to be adopted in administering this scheme, etc. The 2% levy
proposed to be charged on air tickets for RCF and free regime to charge for ancillary services
would marginally add to overall ticket cost. However, even factoring this upside, we expect
domestic air fares to decline by 5-7% in 2016-17, owing to the steep decline in fuel prices and
intense competition.

Government's position on 5/20 rule continues to lack clarity

In October 2004, the Union Cabinet stipulated that for Indian carriers to fly abroad, they must
service domestic routes for 5 years and have a fleet of 20 aircraft. Even in the October 2015 draft
of the policy, the Union civil aviation ministry has kept all options open on this count -- (i) the 5/20
rule to continue, (ii) the 5/20 rule to be scrapped completely and (iii) replace the 5/20 rule with a
domestic flying credits system. Hence, the draft does not offer any incremental clarity on this front.

Lays out tax incentives for development of MRO in India - a positive

move

To provide a fillip to the maintenance, repair and overhaul (MRO) industry in India, the government
has proposed to abolish 12.36% service tax, exempt customs duty on aircraft maintenance tools,
tax-free storage period of spare parts imported by MROs extended for three years and simplified
procedure for custom clearance. MRO, ground handling, cargo and ATF at the airport would also
be accorded the benefits of the 'infrastructure' sector.

If this results in MRO activity picking up, there will be some foreign exchange savings as currently
90% of the MRO work for Indian airlines is been carried out in Sri Lanka, Dubai and Hong Kong.
The tax regime in India has been a key dampener for MRO activity in India. Abolition of these
taxes may now encourage Indian airlines to get MRO work done domestically. Besides, with the
fleet size of domestic carriers expected to grow over the long term, the local MRO industry
becomes critical because maintenance expense constitutes 10-15% of the total operating cost of
an airline. This would be a potential revenue boost for airport operators, while simultaneously
reducing cost for airlines.

Process to fast track greenfield airports would be more vital;

extension of open skies

For fast-tracking of brownfield airports, the need for environmental clearances is proposed to be
exempted, which is a positive. However, any policy on upcoming greenfield airports would have
been more vital as we expect about 80-85% of the upcoming investments in that area. Besides,
the policy has also indicated that all future airports would be developed on a 30% hybrid-till model,
which would regulate 30% non-aeronautical activities that is partly negative for airport operators.

Effective April 1, 2020, the government would open the skies for short-haul routes. If indeed this
happens, there will be an increase in foreign direct investment in airlines from 49% at present to
more than 50%. Open skies for short-haul destinations could potentially invite intense competition
from Gulf carriers.

Silent on the long-pending structural issue of sales tax on ATF

Though the previous draft aviation policy in November 2014 emphasised rationalisation of sales
tax on ATF, there is no mention of it in the latest draft. High sales tax on fuel in India is a key
structural challenge that diminishes the attractiveness of the sector. In the context of the
parliamentary logjam impacting the implementation of Goods and Services Tax, the draft policy
has been silent on this critical issue.

ATF cost, which constitutes 40% of the operating cost of an airline, is an important determinant of
operating margin. In India, sales tax on ATF (which varies from 4% to 30%) is an additional burden
for domestic carriers. This tax structure makes ATF prices in India 30-35% higher than in most
countries. Though domestic airlines were permitted to directly import ATF from February 2012,
they are yet to do so for want of infrastructure (landing, warehousing and transportation facilities
for fuel). Clarity on this structural aspect can significantly improve growth prospects in Indian
aviation.

FINAL AVIALTION POLICY 2016:

Final civil aviation policy enables level-playing field
On June 15, 2016, the union cabinet unveiled the much-awaited final civil aviation
policy. The final policy emphasized on the easing of 5/20 rule, enhancing the regional
connectivity, seat allotment under bilateral rights and tax incentives for maintenance,
repair and overhaul services. It is silent on the long-pending issue of high sales tax on
aviation turbine fuel (ATF), taking the sheen off the sector.

On June 15, 2016, the Union Cabinet unveiled the much-awaited final civil aviation policy,
announcing relaxation of overseas flying norms and thrust on boosting regional connectivity. The
long-pending issue on the 5/20 rule has been resolved, it has been replaced with 0/20 rule which
would enable level playing field on foreign routes. Additional seat allotments to foreign carriers
under bilateral rights on short haul routes would intensify competition from foreign carriers. Other
highlights include a capped price system to boost regional connectivity and tax incentives for
maintenance, repair and overhaul (MRO) companies. On the flipside, the policy also does not
dwell on the long-pending structural issue of high sales tax on aviation turbine fuel (ATF), which
diminishes the attractiveness of the sector.

5/20 rule replaced with 0/20, enables level-playing field on foreign routes
In October 2004, the Union Cabinet stipulated that for Indian carriers to fly abroad, they must
service domestic routes for 5 years and have a fleet of 20 aircraft. The draft policy released in
October 2015 had kept all options open on this count. The final policy replaced 5/20 rule with 0/20
which implies that airlines can commence international operations provided they deploy 20
aircrafts or 20% of total capacity; whichever is higher, for domestic operations. With this, new
entrants such as Vistara and AirAsia India can fly overseas once they have 20 aircrafts. As on
date, Vistara and AirAsia India operated 10 and 6 A320 fleets respectively. This would enable
level-playing field on overseas routes among the existing airlines such as Indigo, Jet Airways,
SpiceJet, Go Air and the new entrants such as Vistara and AirAsia India.

Thrust on boosting regional connectivity in a price-capped system

Regional connectivity scheme (RCS), effective Q2 2016-17, would be designed such that fares for
a one-hour flight will be capped at Rs 2,500 - applicable only in states which reduce value-added
tax on ATF at RCS airports to 1% or less. The government is aiming to implement this by reviving
un-served or under-served airports.

This scheme will be implemented via viability gap funding (VGF) for airlines. While the Ministry of
Civil Aviation will provide viability gap funding on air tickets from 80% of the regional connectivity
fund (RCF), the rest will come from the state. The RCF will be funded by a levy charged on
domestic flights operating other than Category II/IIA (as defined by civil aviation) and RCS routes.
The government is also offering a host of incentives (to operators) such as lower excise duty at 2%
on ATF drawn from RCS airports (compared to 14% currently), nil airport charges, etc.

CRISIL Research believes this move would cap the prices on regional routes, which is a negative
for airline companies given the government intervention and price control. The final policy still
needs clarity in terms of whether a fare of Rs 2,500 per hour will be capped even for a last-minute
booking under RCS, identification of specific routes and associated regional impact, if any, and
specific modalities and procedures to be adopted in administering this scheme, etc. The levy
proposed to be charged on air tickets for RCF would marginally add to overall ticket cost. However,
we expect air fares to marginally decline y-o-y in 2016-17 owing to an expected reduction in fuel
prices.

Additional seat allotment to foreign carriers under bilateral rights to invite

competition

For countries within 5,000 km radius, where Indian carriers havent utilised their 80% of capacity
entitlements but foreign carriers have utilised their bilateral rights, a method will be devised for
allotment of additional capacity entitlement. Given that Indian carriers are currently way below the
allotted entitlements under bilateral agreements, it could invite intense competition from foreign
carriers.

Lays out tax incentives for development of MRO in India - a positive move
To provide a fillip to maintenance, repair and overhaul (MRO) industry, Union Budget 2016-17
announced exemptions of excise duty, custom duty, countervailing duty for certain inputs procured
by MRO. Additionally, the final civil aviation policy indicated they would persuade state government
to make VAT zero on MRO services.

If this results in MRO activity picking up, there will be some foreign exchange savings as currently
90% of the MRO work for Indian airlines is been carried out in Sri Lanka, Dubai and Hong Kong.
The tax regime in India has been a key dampener for MRO activity in India. Abolition of taxes may
encourage Indian airlines to get MRO work done domestically. Besides, with the fleet size of
domestic carriers expected to grow over the long term, the local MRO industry becomes critical
because maintenance expense constitutes 10-15% of the total operating cost of an airline. This
would be a potential revenue boost for airport operators, while simultaneously reducing cost for
airlines.

Silent on structural issue of sales tax on ATF

High sales tax on fuel in India is a key structural challenge that diminishes the attractiveness of the
sector. ATF cost, which constitutes about 30% of the operating cost of an airline, is an important
determinant of operating margin. In India, sales tax on ATF (which varies from 4% to 30%) is an
additional burden for domestic carriers. This tax structure makes ATF prices in India 30-35%
higher than in most countries. Though domestic airlines were permitted to directly import ATF from
February 2012, they are yet to do so for want of infrastructure (landing, warehousing and
transportation facilities for fuel). Clarity on this structural aspect can significantly improve growth
prospects in Indian aviation. However, implementation of GST on ATF will be a monitorable.

DRAFT RCS SCHEME JULY 2016:

Draft scheme for regional connectivity solves the
puzzle, but its implementation is a state subject
In July 2016, the Ministry of Civil Aviation unveiled draft Regional Connectivity
Scheme (RCS), which provides clarity on the scheme's implementation. However, it is
subject to a reduction in value-added tax (VAT) to 1% on aviation turbine fuel (ATF) at
RCS airports. Even the 20% viability-gap funding (VGF) contribution by the state
governments will be critical for bringing the scheme into force. Though the scheme
aims to stimulate regional connectivity through the underserved and unserved
airports, VGF bidding and passenger traffic at RCS airports will be key to determine
viability of a route
The National Civil Aviation Policy 2016, released in June, provided thrust for regional connectivity
through a price-cap system. However, the policy lacked clarity in terms of identification of routes,
modalities and procedures to be adopted in administering regional connectivity. Hence, the
ministry unveiled the draft RCS, which is currently placed for feedback from the stakeholders.

Escrow-based viability-gap funding provided for a limited period to

stimulate regional connectivity

Under the scheme, the government will create a viability-gap fund (VGF), of which 80% will be
contributed by a regional-connectivity fund (RCF) and the rest by state governments. The RCF will
be funded by charging a levy on domestic routes other than category II/IIA routes, RCS routes and
small aircraft with less than 80 seats. The Airports Authority of India (AAI), designated as an
implementing agency, will be authorized to act as the escrow agent to deposit and withdraw funds
from the account for disbursement of VGF to selected airline operators. The VGF will be provided
to RCS flights for minimum three years from the commencement of operations, subject to a
maximum of seven years from the date of notification of the scheme. If the airline wants to operate
on the existing RCS routes without the VGF, the airline can indicate its intent to government while
submitting its proposal, and will be subject to competitive bidding based on the number of RCS
seats (the bidder with the highest quote wins).

At least 50% of seats (maximum 40 seats) would be subject to price

control for qualification of RCS

The draft scheme has proposed an airfare cap per RCS seat for a particular flight distance. This is
indexed to inflation on a quarterly basis. Airlines flying on the RCS routes should allocate at least
50% as RCS seats, which are subject to a minimum nine to a maximum of 40 seats per flight. In
certain situations, if the airline chooses to sell its tickets of non-RCS seats below the airfare cap,
VGF will be deemed to have been applied over all such seats, for which the airfares are below the
cap. The positive proposition is that the airfare on an RCS seat will not be subject to any levies or
charges imposed by airport operators, including passenger service fee (PSF), development fee
(DF) and user-development fee (UDF). Besides, service tax will be levied at 10% of taxable value
for RCS seats during the first year, which can be charged over and above the specified airfare cap.

RCS route allocation to be done via competitive bidding for VGF

RCS routes will be allocated to airlines on competitive bidding for VGF. Two months will be
provided to all other interested airline operators to submit counter proposals against an initial
proposal. The amount of VGF provided to the airline is indexed to quarterly movements in CPI-
based inflation and ATF prices as well as annual passenger-load factor (PLF) for the route. In any
given route, if the airline wants to increase the frequency of flights in future, the VGF per week will
not change. To avoid a large exposure of a single entity, no airline can have more than 50% of
RCF allocated for a region and 25% of total RCF for all regions, whichever is less. Additionally, an
airline operating on an RCS route should pay Rs 5 million for operational and Rs 15 million for non-
operational airports as a performance guarantee. The draft scheme also proposes to grant
 exclusivity of operations on a route to the airline for 1-3 years, depending on the feedback from the
stakeholders.

At least one unserved/underserved airport criteria to aid

infrastructure development

The draft scheme indicates that RCS is applicable only on those routes, where at least one of the
airports is unserved or underserved. The scheme highlights that there are currently 16
underserved airports and about 400 unserved airports. Though this scheme aims to facilitate
infrastructure development, its implementation will depend on the states?? willingness to
reduce VAT to 1%.

Tax concessions for operating at RCS airports to lure airlines

The draft scheme proposes tax incentives for airlines at RCS airports, such as a benefit of 1% VAT
that would be available for 10 years. In addition, the excise duty on ATF will be levied at just 2% for
three years, as against 14% currently. Moreover, no charges would be levied for landing, parking
and terminal-navigation services for RCS flights.

FINAL RCS SCHEME (UDAN) OCT 2016:

Final RCS raises VGF cap, additional 10% for
connecting two RCS airports
In October 2016, Ministry of Civil Aviation has announced the final RCS scheme. The
scheme aims to improve regional connectivity through a price capped system by
providing support through infrastructure and incentives for a period of 10 years. Apart
from cost incentives, the scheme also provides Viability Gap funding (VGF) for the price
capped seats as decided through bidding. However, the scheme is limited to the airports
listed in the document and subject to states with VAT on ATF less than 1% with
acceptance to contribute 20% to VGF.

On October 21, 2016, the Ministry of Civil Aviation (MoCA) has launched the Final Regional
Connectivity Scheme called as UDAN. The scheme aims to promote regional connectivity by reviving
Unserved/Underserved airports requested by the airlines. The major alterations observed in the final
scheme is increase in VGF cap and the addition of 7 airports while eliminating 3 airports from the
purview of the scheme. Even the 10% additional Viability Gap Fund (VGF) for airlines operating
between two RCS airports is also a key addition.

VGF cap raised; funding through a levy on domestic departures to

increase fares on non-RCS routes

Final RCS scheme has seen an increase in VGF cap per seat over the draft scheme, for instance the
VGF cap for a 501-525 km stage is about Rs 3,790 as per the draft scheme and it is revised to Rs
4,220 in the final scheme. Also an additional 10% of VGF is offered over the applicable VGF for all
stage if both the airports are RCS airports.

The RCS scheme would be applicable for a period of 10 years from the date of its announcement. As
per the scheme, a Regional Connectivity Fund (RCF) would be created which will be funded through
a levy or fee per departure on all domestic departures other than Category II/IIA under Route
Dispersal guidelines (RDG), RCS routes and flights with maximum seating capacity lesser than 80
seats. It will also be funded by the premium realized from the allotment of additional capacity
entitlements on foreign routes as mentioned in the National Civil Aviation Policy (NCAP 2016).

Airports Authority of India (AAI) has been designated as the implementing agency for the scheme and
it would be responsible for the payment of VGF to airlines, and collections of levies and
reimbursements from state governments from time to time. Also, only 20% of the VGF will be funded
by respective State governments (10% in case of North-East states and Union Territories) and the
rest is funded by RCF.

At least 50% seats would be subject to price control; service taxes

borne by non-RCS

The scheme has proposed an airfare cap per RCS seat for a particular flight distance. This is indexed
to inflation on a quarterly basis. Airlines flying on the RCS routes should allocate at least 50% of
capacity as RCS seats, which are subject to a minimum 9 to a maximum of 40 seats per flight. In
certain situations, if the airline chooses to sell its tickets of non-RCS seats below the airfare cap, VGF
will be deemed to have been applied over all such seats, for which the airfares are below the cap. The
positive proposition is that the airfare on an RCS seat will not be subject to any levies or charges
imposed by airport operators, including passenger service fee (PSF), development fee (DF) and user-
development fee (UDF).

Deviating from the draft scheme, UDAN includes service tax as part of the air fare cap which will be
reimbursed at actuals from the RCF. To prevent additional risk due to competition, route exclusivity
has been introduced for a period of 3 years.

RCS seats not to offer benefit under Route Dispersal Guidelines

The available seat kilometers (ASKM) realized by the airlines on RCS seats are not considered under
Category-II,IIA, III routes and hence only the ASKMs accrued on non-RCS seats will be eligible to
set-off under RDG. Also the minimum number of departures from the same RCS airport is set at 3 up
to a maximum of 7 per week. Post the initial proposals, network proposals will be considered on a half
yearly basis.
Scheme subject to routes with atleast one RCS airport and no
scheduled flights for the past one year

The scheme indicates that RCS is applicable only on those routes, where at least one of the airports
is an RCS airport with no scheduled commercial flights on such route during the past 1 year with a
minimum stage length of 150 km. The scheme highlights the eligible 16 underserved airports and 398
unserved airports across the country. Though the scheme aims to facilitate infrastructure
development, its implementation will depend on the states willingness to reduce VAT to 1% and
interest from airlines.

RCS route allocation to be done via competitive bidding for VGF

RCS routes will be allocated to airlines on competitive bidding for VGF subject to a ceiling as
mentioned in the scheme. Also, the limit goes up by 10% if both the airports (Origin as well as
destination) are RCS airports. The amount of VGF provided to the airline is indexed to quarterly
movements in CPI-based inflation, ATF prices and exchange rate. In any given route, if the airline
wants to increase the frequency of flights in future, the VGF per week will not change.

To avoid large exposure of a single entity, no airline can have more than 50% of RCF allocated for a
region and 25% of total RCF for all regions, whichever is less. An airline operating on an RCS route
should pay 5% of the annual VGF subject to a minimum of Rs 0.5 million as performance guarantee.
In case of a non-operational airport, an additional performance guarantee of Rs 10 million is to be
paid if the investment to operationalize the airport exceeds Rs 50 million. However, the performance
guarantee will be refunded after 1 year from the commencement of operation.

Incentives to control costs and lure airlines

The incentives offered for the RCS flights include but not limited to reduction in excise duty on
Aviation Turbine Fuel (ATF) from 14% to 2% for a period of 3 years, reduction of Value added tax
(VAT) on ATF to less than 1% for a period of 10 years, as State governments are allowed to offer
additional incentives like underwriting of seats etc outside the purview of the scheme. Also, the
airports shall not levy Landing, Parking and Terminal Navigation charges on RCS flights, however
Route Navigation and Facilitation Charges would be applicable with a 57.5% discount.

Annexure
Source: Ministry of Civil Aviation, CRISIL Research