Preparing for Long Term Growth of Indian Aviationwww.capaindia.com

ATM, Airports & Airlines Conference

Organised by the Air Traffic Controllers’ Guild

New Delhi, 20-21 October 2010

About CAPA

CAPA was established 20 years ago with a mission to become a leader in global aviation knowledge. In that time we have established an enviable reputation for insight and integrity, and we are in daily contact with the leaders of the aviation industry throughout the world.

CAPA India, launched 7 years ago, has become synonymous with aviation in the country. Our breadth of knowledge, research capabilities, databases and extensive contacts with key stakeholders in government and industry are unmatched.

In this short space of time, we have become acknowledged as the leading aviation consulting, research and knowledge practice in South Asia, with more than 450 clients around the world.

We set out to provide our clients with sound advice and analysis that is strongly research driven. This is achieved through extensive industry consultation, data gathering and analysis and continuous monitoring of trends.

New intiatives include:o CAPA AeroParko CAPA Ventureso CAPA Aircraft Advisoryo CAPA Knowledge Process Outsourcingo CAPA GVIC Aerospace City

Peter HarbisonExecutive Chairman & Regulatory Affairs

Derek SadubinCOO & China Specialist

Elizabeth ThompsonHead of Research & Low Cost Carriers

Simon ElsegoodAerospace Desk

Ron KuhlmannInternational Affairs Desk

David BentleyAirport Research Desk

Janet KimYields and Schedules Desk

Global Research

CAPA has published more than 7,000 reports for the global aviation community. We have a regular portfolio of 20 geographical and sectoral reports, with worldwide coverage. Our analyst team covers a comprehensive range of global issues, with high level contacts and regular interaction across the industry:

Kathryn CreedyNorth America & Regional Airlines Desk

Kyung-sup LeeKorea Desk

Geoffrey TudorJapan Desk

Melissa StuartEurope Desk

Jackson FlintMiddle East Desk

Samantha ChanAfrica Desk

Sharon DaiTraffic & Capacity Desk

Government & Industry

Government ProjectsCAPA has been invited to submit numerous Position Papers on a variety of issues including foreign direct investment, policy, economic regulation of airports, ATM, reform of the Aircraft Act, prepare documentation for use in elections to the ICAO Council, or to appear before the:Ministry of Civil Aviation; Parliamentary Standing Committee on Aviation, Tourism and Culture; Prime Minister’s Aviation Coordination Committee.

Industry CommitteesCAPA is a member of the following industry committees:MOCA Civil Aviation Safety Advisory Council;MOCA Committee to Review ICAO Recommendations for establishment of a Civil Aviation Authority CII National Committee on Civil Aviation; CII National Committee on Tourism; Aviation Sub-Group of the Rakesh Mohan Committee for National Transport Policy, convened by PM FICCI Aviation Committee DGCA Air Transport Planning Committee

Consulting clients include…

CAPA Market Analysis and Research clients include…

CAPA AeroParkGlobal Announcement about Launch Plans to be made on

1st November 2010

Artist’s impression of US$125 million campus

Rapid Growth: Indian aviation has experienced a revolution in the last 7 years. Domestic traffic has more than tripled, international traffic has doubled.

Recovery: Post slowdown, recovery has been strong. Domestic traffic for the 8 months to 31 August 2010 is up 19% year on year.

But huge losses accumulated: Despite unprecedented growth, carriers have accumulated losses of almost US$5bn during this time.

Unprecedented Traffic Growth

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Domestic International

Source: Airports Authority of India, CAPA.

Indian Domestic & International Passenger Traffic

What went Wrong?Too much capacity introduced too fast 2006-2008:

o Aircraft were inducted at a rate of 6-6.5 per month o 3 would have been more appropriate to absorb demand growth

The aviation system was too weak to handle this capacity expansion:o Airport and ATC infrastructure could not cope;o Congestion and delays increased airline costs;o Passenger experience deteriorated;o High structural costs were amplified;o Human resource shortages became a problem.

Airlines discounted heavily to sell excess capacity – euphoria about traffic growth masked the fundamental imbalance in the sector.

o This was ruthlessly exposed by the fuel price shock in 2008. Financial stress led to consolidation, but did not go well:

o Air India/Indian merger is good on paper, but poorly executedo Sahara and Deccan have been expensive for Jet and Kingfisher

What went Right? The Ministry of Civil Aviation played a very strong and pro-active role and was

particularly successful in the areas of liberalisation and setting in motion the airport upgrade and modernisation program, which will serve India well going forward.

Growth

Unprecedented Growth

Today less than 2% of Indians fly domestically each year, and only 0.5% internationally.

With a population only slightly larger than India, China’s domestic air traffic is 5 times the size. Australia with a population of just 22 million, generates more domestic passengers than the whole of India.

Long Term - India has Huge Growth Potential

Population Domestic Traffic Trips per Capita GDP per capita

Australia 21 million 50 million 2.38 $38,100

USA 307 million 650 million 2.12 $46,900

Malaysia 26 million 14 million 0.54 $15,200

Brazil 199 million ~50 million 0.25 $10,200

China 1,339 million 198 million 0.15 $6,000

India 1,166 million 45 million 0.04 $2,900

Source: CIA World Fact Book; FAA, DGCA India, CAAC, Malaysia Ministry of Transport, BTRE Australia, ANAC Brazil.

Airports Council International projects that India will be the third largest aviation market in the world within 12-15 years. Airbus projects that the Domestic Indian market will be the fastest growing market in

the world over the next 20 years.

Long Term Planning is Essential

In fact several forecasts – Airbus, Boeing, Airports Council International -project that India will have the fastest growth rate in the world in air traffic over the next 20 years (close to 10% per annum).

But CAPA believes that the growth in traffic and aircraft movements over the next decade may be even stronger and more sustained than anticipated.

CAPA projects that total passengers numbers at Indian airports will grow from 123 million last year to 420-450 million by 2020.

Massive Growth Potential

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00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20

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Conservative Mid Scenario

Actual and Projected Annual Passenger Numbers at Indian Airports 2000-2020

Key Messages

It is sobering to stop and think what this means.

The challenges are becoming much greater as the size of the industry increases.

Over the last 10 years, the Indian aviation industry had to develop the capability to cope with an additional 84 million passengers. At times, this truly stretched the system.

But over the next 10 years the industry may have to handle an incremental 270-300 million passengers, 3-4x what was achieved in the last decade.

In absolute terms the challenge ahead will dwarf recent history.

Key Messages

This is a transformational growth profile.

Ad hoc responses will no longer suffice.

Long term planning in line with a clear vision is imperative.

The situation will be chaotic if growth is not managed well.

Is Indian aviation ready to meet this challenge?

How do we create the appropriate framework for the long term?

A New Framework

New policy framework required to create long term competitiveness;

In the absence of structure, progress has been ad hoc;

Key issues are subject to uncertainty:

bilateral rights;

airline licences;

airport policy;

ground handling policy;

foreign airline investment and international access for domestic carriers, we makes strategic planning extremely challenging. For a capital intensive industry this is a major concern.

Policy Framework

Policy Framework

Regulation

Unified Regulator: Need a single authority instead of multiple agencies.

Professional: The regulator must be an independent agency, that keeps in mind industry viability in its thinking. UK CAA may is an appropriate model.

Expertise: Pockets of excellence exist, but regulator lacks depth in competence and expertise.

Focus on Safety: Strengthening required, particularly in areas such as airworthiness and flight inspection, to ensure safety as a central priority.

New Issues: Environment, air quality, noise pollution and competition.

Aviation is more than scheduled passengers: Important sectors, such as cargo and general aviation are neglected, will be key growth areas over the coming years.

Legal Framework: based on an outdated 1934 Aircraft Act, new measures introduced with little or no industry consultation.

Policy Framework

Legal & Regulatory Framework

Safety First: Safety must be paramount. And incident rates cannot stay constant in a fast growth market otherwise accidents will increase.

Enforcement: More important than having a safety framework is ensuring that the regulations are enforced, ideally through self-regulation.

Skills Shortage: Capability in safety oversight and management is weak and insufficient to meet current challenges.

Skills Loss: No clear mechanism for developing succession planning for when experienced staff leave the organisation.

Restructuring: A more pro-active approach to restructuring is necessary which requires the DGCA to have additional powers.

Indian Aviation

Safety Framework

Air India lacks direction: Air India’s weakness is likely to continue with no clear recovery plan, which could benefit Jet Airways and Kingfisher.

Jet/Kingfisher under pressure: But Jet/Kingfisher have huge debt and stretched balance sheets - they cannot exploit market to full potential.

Consolidation: Without consolidation, India’s network airlines will not be able to expand profitably. We expect further activity this fiscal.

Alliances: Carriers may join global alliances to compete, but this may curb growth.

Competition from Gulf: Middle East carriers continue to make in-roads.

Positioning: Jet/Kingfisher will need further restructuring and greater differentiation between full service and low cost operations.

Domestic: LCCs, particularly IndiGo and SpiceJet, continue to take market share. Independent LCC market share at 37%, including FSC subsidiaries close to 70%, global leader.

Profitability: Private carriers could post combined profit of US$250-300 million or more in FY2010/11. Air India expected to lose US$650-700 million.

Aircraft Orders: Indian carriers once again looking at expansion, IndiGo to acquire up to 150 aircraft.

Key Issues

Analysis of Airlines

Access to Capital: Restriction on foreign airline investment denies access to potential sources of capital, which could also bring strategic value and expertise. Could encourage cross border JVs.

Level Playing Field: The 5 year/20 aircraft rule for Indian carriers to operate international services makes no sense. Ultimately India’s interests are damaged.

Route Dispersal Guidelines: Unpopular and punitive, does not deliver the best outcomes. Other models should be considered to achieve the desired objectives.

Bilateral Agreements: Relaxation and tightening of bilaterals has not followed a defined path, impossible for airlines to plan. Access for Gulf carriers has been too rapid.

Swollen Debt Levels: Over-ambitious expansion have left the 3 major airline groups (representing 65% of domestic capacity and 100% of Indian international capacity) with a huge debt (US$11 billion) and interest burden.

HR: Looming skills crisis is largely being ignored, threatens to be one of the greatest challenges for the growth of the sector.

Indian Aviation

Key Issues for Airlines

The viability of the airline industry is central to the health of the entire system and yet the sector is faced with a negative fiscal environment which ignores this.

Sales Taxation on Fuel: Multiple layers of duties and taxes on aviation turbine fuel, costs up to 60% more than the international benchmarks.

Service Taxation: Service tax on domestic and economy international travel, increases the passenger fare by just over 10%. Passenger demand is price sensitive.

Witholding Tax: Impost on aircraft and engine leases increases another major cost input for the airline industry.

MRO: Taxation regime for third party maintenance operations negates India’s labourcosts advantages, pushing the activity and jobs offshore.

Indian Aviation

Fiscal Framework

Airport Modernisation: In 2005, the first UPA government announced a US$9 billion airport upgrade and modernisation program, consisting of:

Delhi & Mumbai airports on PPP basis;

Greenfield airports at Bangalore & Hyderabad;

Modernisation of existing Kolkata & Chennai airports by AAI;

Upgrade of 35 non-metro airports by AAI;

Operationalisation and upgrade of 45 smaller airports by AAI;

Greenfield airports at locations such as Navi Mumbai, Mopa, Pune.

Airport modernisation was a highlight of the first UPA government.

Massive Investment Required: US$30 billion in investment in airports is expected in the next 15 years.

Economic Regulation: Delays in establishing economic regulator have created difficulties for investors.

Post 2004/05

Airports in India post 2004/05

Concession Models: PPP model successful in driving the flow of capital and expertise into airports. But the concession models – with 37-46% revenue share - in DEL/BOM jeopardise the viability of the airports. Charges could increase dramatically.

Economic Regulation: Late establishment of AERA means investments made in the absence of clarity about pricing regulation. Some investors frustrated at sense of moving goalposts.

Capital: Capital remains expensive as long term fixed interest rate loans are not available.

Better Coordination: Airports cannot be built in a vacuum. There needs to be seamless coordination with other state agencies to develop ground transport and logistics.

Catchment Areas: Airport planning needs to consider viability of different airport projects within similar catchments

Distribution of Traffic: International traffic is becoming fragmented with growth of non-metros, reduces the hub potential of DEL/BOM

Clearer Objectives: In the next stage of modernisation, the objectives of airport development must be clearer, to ensure that the outcome is better aligned with requirements.

Lessons

Key Issues for Airports

LCC Market Share is Growing RapidlyAirport infrastructure development needs to recognise this trend

Are we building airports that are appropriate for the market??

LCC Domestic Market Share January 2004 to January 2010, Source CAPA estimates

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

2004 2005 2006 2007 2008 2009 2010

Structure: AAI is also a very complex company with over 120 airports to manage, may need to break into smaller groups that are more viable. Some airports could be handed over to state governments although this could lead to greater state-central conflict.

Revenue: 60% of traffic is now in private hands resulting in a decline in revenue. Proposed corporatisation of ATC will further reduce revenue;

Costs: At the same time, modernisation commitments for Kolkata, Chennai and non-metro airports means that capex requirements are high. This is creating a shortfall; but the regional airline policy has not supported traffic to non-metros.

Business Model: AAI needs to adopt a more commercial focus to airport charges, traffic development and non-aero revenues;

Air Traffic Management: Requires significant investment in upgrading and to handle projected growth, within the context of a long term plan, which needs to be developed. Uncertainty about future governance model may impact this.

Long Term Planning: AAI requires a long term plan to understand its role over the next 5, 10 and 20 years with an integrated national vision.

Future of AAI

Status of AAI

Modernisation of DEL/BOM will continue;

Bangalore Airport has started planning for expansion and 2nd terminal;

Non-metro modernisation slower than planned, due to cash crunch;

Greenfield airports at Navi Mumbai & Goa expected to proceed in 2010/11;

Airport at Chakan, Pune may also be fast-tracked;

Merchant airport at Durgapur, West Bengal will move ahead;

AERA will be activated in the coming months;

Navi Mumbai is essential to maintain Mumbai’s competitiveness;

But, for the first time we will have multiple airports in a city, raising issues on how traffic should be distributed. By 2020 CAPA estimates all metro cities will have two airports, Mumbai may need a third.

Beyond 2010

Where to Next?

Airspace: Airports are only half the story. The other key issue is airspace. Need to:

Invest in airport infrastructure;

Upgrade CNS/ATM and Met equipment;

Enhance manpower and training infrastructure;

Harmonise with global initiatives.

Broader Issues: Other issues include the environment, implementing a safety culture, civil-military cooperation, building a seamless airspace.

Corporatisation: Need for significant and continuous investment. May require a new operating structure such as corporatisation.

Air Traffic Management

Airspace Issues

Regulation: Lesser understanding of the GA sector at the policy and regulator level – progress is slow.

Infrastructure: Absence of dedicated terminals, heliports and FBOs; restricted timings at metros;

Maintenance: Limited facilities in-country, extra costs to send offshore;

Fiscal: High tariffs and duty on private aircraft imports;

Operations: Permissions for some airports can be slow;

Resources: Pilot and engineer shortages more acute than in scheduled sector.

Safety & Security: Reduced scrutiny means that safety and security lapses could occur in this area.

Key Issues

Challenges for General Aviation

India’s business jet fleet has grown rapidly in the last 5 years, it is now the largest in Asia, and based on current orders it will be the fastest growing market in the world over the next 5 years.

Challenges for General Aviation

Business Jets Operating in India, 2005-2010

Source: CAPA, Ascend Worldwide

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2005 2006 2007 2008 2009 2010

Ratio of Confirmed Orders to Current Fleet Size, June 2010

Source: CAPA, Ascend Worldwide

0.00 0.20 0.40 0.60 0.80 1.00 1.20

VenezuelaSouth Africa

MexicoGermany

CanadaPortugal

BrazilUSA

AustraliaFranceRussiaSpain

ItalySwitzerland

AustriaSaudi Arabia

United KingdomUnited Arab Emirates

India

Education & Training: Skilled and competent workforce is essential for safe and efficient operations. Industry has a poor track record on HR planning.

Demand: CAPA forecasts aviation workforce will need to triple from 150,000 today to 450,000 within 10 years. India also supplies a large proportion of staff for the Gulf.

Supply: Current training infrastructure is insufficient even for today’s requirements. Quality is poor. Most flying and maintenance academies do not meet international standards.

Implications: Failure of skills to keep pace could mean 1) growth will be curbed 2) costs will increase or 3) safety could be severely compromised.

Opportunities: A skilled workforce is a massive export opportunities – India as a low cost, high quality training hub; supplier of manpower; to support competitive aerospace sector.

Indian Aviation

A Skills Crisis is emerging in the aviation sector

CAPA estimates that the total number of operational staff at Indian carriers will need to grow from 32,000 in 2008/09 to just over 90,000 by 2019/20. The total airline workforce is approximately twice the operational staff numbers. Including airport employees, air traffic controllers, ground handlers, catering companies, retail and

security personnel the total aviation workforce in the country may need to triple from 150,000 today to 450,000 within 10 years. In addition, India supplies a large proportion of the workforce in the fast growth Gulf aviation

industries which creates additional pressure on the local industry.

A Skills Crisis is emerging in the aviation sector

CAPA Research Projections for Pilots, Engineers and Cabin Crew in Indian Aviation

1. National Agenda: A long term, structured national plan

2. Regulator: A modern, unified, professional regulator

3. Public Sector: Air India and the AAI need to be gradually privatised

4. HR & Training: World class education & training infrastructure is essential

5. Safety: Implementation of safety systems and culture

6. Liberalisation: Liberal access but level playing field for Indian operators.

7. Taxation: A less punitive fiscal regime which recognises that airlines must be viable

8. Investment: Private sector capital should be encouraged in airport development.

9. Profile: Enhanced profile and recognition of aviation within central and state government.

10. Vision: Ministry to concentrate on policy and providing strategic leadership.

10 Key Success Factors for the Next Decade

CAPA estimates domestic traffic will reach 160-180 m pax per annum. International will be approximately 90 m.

Investment of up to US$120 bn in aircraft, airport development and ancillary services such as ATC, MRO, catering, training.

Commercial fleet likely to touch 1,000 aircraft, up from 380 today.

Market for up to 1,000 GA aircraft, with estimated investment of US$4 bn.

Airport investment of US$20 billion required for upgrades, greenfields and secondary airports in metros.

US$5 bn required for ground handling, cargo and logistics facilities.

Significant investment opportunities in the MRO sector to support the fleet of over 1,500 aircraft.

Ancillary services in training, safety, security and ATC will need to be brought up to international standards.

Outlook 2020

Outlook 2020 for Indian Aviation

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