India must learn from China about aircraft leasing

The announcement of this policy statement in the Budget follows the release of the ‘Rupee Raftaar’ report at the Global Aviation Summit in Mumbai in January earlier this year.

India, China, aircraft leasing, maiden budget, International Financial Services Centre, Special Economic Zones
The report was penned together by a group which included a large number of Government, regulatory and industry representatives. (Reuters)

The Finance Minister, in her maiden budget, laid the foundation of building an important component of the aviation sector: “As the world’s third largest domestic aviation market, the time is ripe for India to enter into aircraft financing and leasing activities from Indian shores. This is critical to the development of a self-reliant aviation industry, creating aspirational jobs in aviation finance, besides leveraging the business opportunities available in India’s financial Special Economic Zones (SEZs), namely, International Financial Services Centre (IFSC). Government will implement the essential elements of the regulatory roadmap for making India a hub for such activities.”

The announcement of this policy statement in the Budget follows the release of the ‘Rupee Raftaar’ report at the Global Aviation Summit in Mumbai in January earlier this year. The report was penned together by a group which included a large number of Government, regulatory and industry representatives. The Budget commitment and the actions taken therein have created a strong impetus for taking this initiative forward.

Global and Indian landscape

The aircraft leasing industry has traditionally been based in Ireland. For Ireland, this industry creates jobs not only in the financial services sector but also in aircraft MRO, asset management, ancillary products, etc. The aircraft leasing sector directly employs around 1,500 people with an average salary of EUR 165,000 (~Rs 1.2 crore) a year. There are another 3,500 indirect jobs and a whole host of jobs and incomes in the associated industries. The sector is estimated to contribute $660 million to the Irish economy.

Over the last decade, China has been able to successfully seed the industry locally. This has two implications: (1) local Chinese banks and investment firms have created their own aircraft leasing operations and (2) some of the leases are now denominated in Renminbi (or Yuan). This offers local savers, depositors and investors an opportunity to access aircraft financing which is a liquid and low-default asset class. The local currency leases allow airlines to create a natural hedge on their leasing expenses.

As India becomes a large domestic and international aviation market, the need to create a local leasing community will increase in importance. With more than a thousand planes on order, India is expected to import more than $40 billion of equipment (at an average price of ~$40 million per narrow-body aircraft) over the next decade or so. These numbers are expected to be higher—both on account of growth which will propel further orders and also the inclusion of more wide-body planes as more Indian airlines start their long-haul international operations.

Current options for Indian carriers

Most Indian carriers rely on leasing their planes: more than three-fourths of planes of airlines in India (with the exception of Air India) are leased. These leases are typically for six years and are denominated in USD. Annual lease rentals of around Rs 10,000 crore is sent to lessors based out of India, accounting for ~15% of the total revenues of the India-based airlines (except Air India). As the growth in Indian aviation continues, this total outflow is expected to triple in the next decade or so.

Since these leases are denominated in USD and most of the airlines continue to run largely domestic operations, there is no natural hedge for these expenses. In times of, say, an oil price shock, the airlines face a triple-whammy: (1) prices of oil/ATF goes up, (2) Indian rupee tends to depreciate as its current account balance deteriorates which pushes up the local prices of ATF higher, and (3) the USD-denominated leases also get more expensive. Since the hedging market for USD/INR hedges is not liquid beyond the 12-month range, airlines tend to leave this exposure unhedged. In a year of significant deprecation of the Indian rupee, this creates an intense stress on the airline business model.

New accounting standards (Ind-AS 116), requires that even the operational leases (as opposed to only finance leases earlier) need to be capitalised in the books of the airlines. According to industry estimates, this amounts to a capitalisation of Rs 35,000 crore of assets in the books of India-based airlines. Any changes in the value of the USD-denominated liabilities so created at the time of capitalisation will now need to be routed through the profit and loss account. This can introduce significant volatility in the accounts of the airline companies. If, however, the leases were denominated in Indian rupees, the need for revaluation would not arise.

Building an India-based rupee leasing industry

The development of this industry requires significant contribution from various stakeholders. China, in order to attract business away from Ireland, created a specific low-tax dispensation. India imposes a wide variety of taxes (stamp duty, import duty, GST, income and capital gains taxes, among others) that require rationalisation—some steps have been taken recently and in this Budget. Local regulators need to allow long-term financing entities like insurance companies, mutual funds and pension funds to invest in securities of entities engaged in rupee-based leasing. Starting an NBFC or an investment trust in the GIFT City will require specific approvals from RBI. The ‘Rupee Raftaar’ report contains a detailed list of proposals.

Creating a rupee-based leasing industry will address many objectives: (1) high-skill job creation in financing and across the value chain, (2) retaining economic value in India, (3) offering local savers a new investment class, (4) creating a product more-suited to the needs and requirements of the local industry. The Budget commitment has given a good start—India should work towards doing its first rupee-lease in this financial year.

(Author of ‘The Making of India’. Views are personal)

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First published on: 09-08-2019 at 00:38 IST