draft approach paper on economic regulations of airports in india

7/31/2019 Draft Approach Paper on Economic Regulations of Airports in India.

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Dated 01/06/2012

NOTICE

Sub.: Draft approach paper on Economic Regulations ofAirports in India.

Comments/views were invited on Draft approach paper onEconomic Regulations of non-major Airports in India by 01.06.2012 videnotice dated 24.05.2012, which will now be extended by11.06.2012 forforwarding the comments/views to this Ministry on the following e-mailaddress:-

(i) [email protected](ii) [email protected]

(Oma Nand)Under Secretary to the Govt. of India

Tele-24640214Fax.: 24610542


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MINISTRYOFCIVILAVIATION

GOVERNMENTOFINDIA

APPROACHPAPER

ON

ECONOMICREGULATIONOFAIRPORTSININDIA

MARCH 2012


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Contents

Background ................................................................................................................................................... 2

Need for Economic Regulation ..................................................................................................................... 4

Policy Issues .................................................................................................................................................. 6

Regulatory Till ............................................................................................................................................... 9

International Experience in Airport Economic Regulation ......................................................................... 11

Importance of Non-Aeronautical Revenues ............................................................................................... 15

Stakeholder Interactions ............................................................................................................................. 16

Proposed regulatory approach ................................................................................................................... 23

Conclusion ................................................................................................................................................... 28


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Background

1. The Indian aviation sector is on a high growth path. Passenger throughput at Indian

airports has risen from around 44 million in FY 2002 to a projected traffic of around 160

million in FY 2012. The compounded annual growth rate (CAGR) of nearly 14% over a

long 10 year period is one ofthe highest in the world. Indias Draft 12th

Five Year Plan

(Apr 2012 - Mar 2017) expects the growth momentum to continue and the traffic in FY

2017 is projected to be around 270 million.

2. Global comparison shows that India, with air travel penetration of 5% (domestic

passengers divided by total passengers), stands far behind the developed markets like

USA and EU where the penetration is over 200%. Chinas domestic traffic is five times

that of India despite having a population that is just 10% higher. This also highlights the

significant potential of air traffic growth in India as economy grows and disposable

income rises. With increasing affordability and value of time, there is likely to be a

greater shift in the preferred mode of travel from road and rail to aviation.

3. To meet the growing aspirations of the country, the Ministry of Civil Aviation (MoCA),

Government of India has proposed a Vision 2020 of making India the third largest

civil aviation market by 2020. All the policies, procedures and decisions need to be

aligned with this Vision.

4. The projected growth in traffic requires significant increase in the capacity at the existing

airports. It would also require establishment of new airports in areas that are emerging as

new engines of economic growth.

5. The government owned Airports Authority of India (AAI) has played a key role in the

development of airport and air navigation infrastructure in the country. AAI has created

air connectivity in the remotest corners of the country, many of which are not financially

remunerative. The 11th Five Year Plan outlay of AAI was around Rs. 12,500 crores.

6. AAI has developed a unique public private partnership (PPP) model of leasing out

airportse.g. Delhi and Mumbai airportsto joint venture companies (JVC). These

JVCs have private companies holding 74% of the equity with the rest being held by AAI.While these PPP experiments have helped create world class airports, it has also helped

AAI in augmenting its revenues and focusing on developing airport and Air Navigation

infrastructure in the rest of the country.

7. Public Private Partnership (PPP) has emerged as an effective way to harness the strengths

of the private sector in the airport sector. AAI has partnered with private companies and

State Governments to setup two JVCs, with minor equity holding of 13% in each of


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these, for development of Greenfield Airports at Hyderabad and Bengaluru. The airports

being managed under the PPP model include Delhi, Mumbai, Bangalore, Hyderabad and

Cochin.

8. In addition, the Government of India has granted in-principle approval for setting up of

another 14 Greenfield airports of which majority would be through the PPP route.

9. The private sector has played a key role in development of airport infrastructure in the

country, and private investors have brought in investments of around Rs. 30,000 crore in

the 11th Five Year Plan (2007-12). During the 12th Five Year Plan period (2012-17),

private sector investment of around Rs. 50,000 crore is expected.


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Need for Economic Regulation

1. The provision for airport infrastructure in India has transited from monopoly to oligopoly

in last decade, with more and more investor coming in to the sector. While earlier, the

Airports Authority of India (AAI) was the sole airport operator in the country, today there

are many Airports being developed and operated by private players.

2. Though an element of competition has been introduced in the provision of airport

infrastructure in the country at large, the monopoly of a service provider at a local level

still exists. This monopoly emanates from the Governments Greenfield Airports Policy,

which restricts setting up of a second airport within the 150 kilometre radius of an

existing airport.

3. While the Governments policy allows certain protection to the investors in the airport

infrastructure, which may be necessary due to huge investment required in setting up of

an airport, the monopoly in this sector may become detrimental to consumer interests, as

airport charges are not market determined. It is therefore necessary that the service

quality of all activities at an airport and the charges levied by them on the passengers,

either directly or through the airlines are regulated with due prudence. It is necessary that

as a general philosophy, passengers interests should be balanced with enabling

environment for investment in this sector.

4. It was under these circumstances that the Government had set up an Airport Economic

Regulatory Authority (AERA) in the year 2009, to determine the tariff of aeronautical

services at a major airport, the fees to be levied on the passengers and to monitor the set

performance standards of the services. As per the Airport Economic Regulatory

Authority of India Act, 2008, major airports have been defined as the airports which have

or are designated to have an annual passenger throughput of more than one and a half

million.

5. At present, 15 major airports are under ambit of AERA out of which ten 1 are operated by

the Airports Authority of India (AAI). Airports other than the ones regulated by AERA

are regulated by the Ministry of Civil Aviation (MoCA), Government of India.

6. While AERA has been authorized to fix the tariff for major airports, its charter does not

mandate it to devise its philosophy in a manner, which will provide enabling environment

for investment in airport infrastructure in the country at large. Also the non-major

1Airports with an annual passenger throughput greater than 1.5 million qualify as major airports and are

under AERAs ambit. Major airports operated by AAI include Ahmedabad, Goa, Pune, Calicut, Chennai,Trivandrum, Kolkata, Lucknow, Jaipur and Guwahati.


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airports, not under the purview of AERA, do not currently have any laid down policy for

economic regulation. Therefore Government has to come up with a philosophy of tariff

regulation at these airports, in order to have a balanced approach for both investment

environment and passengers interest.

7. Global experience shows that regulatory policies need to be simple, transparent,

progressive, equitable and predictive. They should derive from the strategic vision and

the specific context of the country. They should not involve excessive monitoring and

should allow market forces to create the balance between the interests of consumers and

providers of services. They should also have adequate safeguards to protect the interests

of the consumers and providers of services in case of market failures.

8. The 12th Plan envisages a requirement of Rs 67,500 cr to meet the infrastructure

requirements of the airport sector. AAI is expected to provide for around Rs 17,500 cr.

The balancearound Rs 50,000 crhas to be brought in by the private sector. This

large amount may require significant contribution from global investors as well. There

are many airport projects coming up in various parts of the world and the financial

resources of the worlds best airport developers are finite. Indias policies have to be

attractive enough for the worlds best airport developers.

9. On the other hand, the average Indian passenger in general is highly price sensitive,

especially in the smaller cities. High airport tariffs may slow down the growth

momentum and create a vicious cycle of low traffic and low returns to the investor.

10. Given this Ministrys Vision 2020 and the need to facilitate significant investments in the

airport infrastructure of the country, there is an urgent need to develop a policy for

economic regulation of airports. This will help reduce regulatory uncertainties and

facilitate investment decisions by AAI and other prospective investors.


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Policy Issues

1. As per the general practice, the economic regulation at an airport is limited only to the

aeronautical services, the same being monopolistic in nature and having maximum

financial impact on the passengers. In respect to non-aeronautical services, it is expected

that an element of competition would exist and the charges would be market determined.

Also, the consumption of non-aeronautical services is mostly optional in nature and

therefore has limited financial impact on the passengers.

2. What are aeronautical services?

There is no set definition of what should constitute aeronautical services at an airport.

The aeronautical services at an airport has been defined in the Airport EconomicRegulatory Authority of India Act, 2008 as consisting of service provided for: navigation,

surveillance and supportive communication thereto for air traffic management; landing,

housing or parking of an aircraft or any other ground facility offered in connection with

aircraft operations at an airport; ground safety services at an airport; ground handling

services relating to aircraft, passengers and cargo at an airport; cargo facility at an airport;

and supplying fuel to the aircraft at an airport.

ICAOs Policies on Charges for Airports and Air Navigation Services, as enshrined in

Doc 9082/7 (8th edition, 2009), in respect of airport charges mentions: landing charges;

parking and hangar charges; passenger service charges; security charges; noise relatedcharges; emission related charges; and fuel concession fees.

ICAOs Doc 9562, Airport Economic Manual (2006 edition) lists airport charges as:

landing charges; lighting charges; approach and aerodrome control charges; aircraft

parking charges; aerobridge charges; hangar charges; passenger service charges; cargo

charges; security charges; noise related charges; other charges; and pre-funding charges.

For restructuring of the Delhi and Mumbai airports, an Operation, Management and

Development Agreement was signed between M/s Delhi International Airport Pvt. Ltd.

(DIAL) and M/s Mumbai International Airport Pvt. Ltd. (MIAL) respectively and the

AAI. These agreements list the aeronautical services in the Schedule 5 appended to theagreements, which is detailed list of 52 items pertaining to the airport infrastructure and

services.

In the case of Bangalore and Hyderabad Airports, the Concession Agreement signed

between M/s Bangalore International Airport Pvt. Ltd. (BIAL) and M/s Hyderabad

International Airport Pvt. Ltd. (HIAL) respectively and the Government of India does not

define the aeronautical services. However, Airport Activities have been listed in part 1 of


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Schedule 3 appended to these agreements, and this includes a host of services related to

airport infrastructure.

3. Determination of which aeronautical charges have been dealt in this Policy?

For the purpose of this Policy, we would not discuss the charges related to Air Navigation

Services (ANS), as the same needs to be discussed separately due to the intricacies of

different nature involved in its determination. Further, the ANS, being sovereign in

nature, are generally provided by AAI and to certain extent by the Ministry of Defence.

Since the provision of ANS through a separate ANS corporation under AAI is being

envisaged, the income from these services would stop accruing directly to AAI. Also no

other airport operators have any income accruing to them from this service.

The charges in respect to certain other services of aeronautical nature, like cargo, ground

handling and fuel supply to an aircraft are service specific charges and hence are notdiscussed for the purpose of this policy.

The pre-funding charge, which in India is commonly known as the Development Fee, has

also not been considered for the purpose of this Policy as it is a levy of specific nature for

pre-funding a project to the extent of shortfall of fund. There is specific provision in this

regard under the AAI Act, 1994.

Amongst the other aeronautical charges, the general practice in India has been to bundle

all the airport related charges as landing, housing or parking charges. In addition a

Passenger Service Fee (PSF) is levied on the passengers, which has two components,

namely security component and the facilitation component. Further, the UserDevelopment Fee (UDF) is levied on the passengers at certain airports in order to provide

a fair return to the airport operators on the investment made, taking into account their

projected revenue and expenses at an airport over the control period.

The PSF (security component) is a specific charge for the provision of security at an

airport and it would be desirable to treat it separately. The PSF (facilitation) can be

bundled together with the UDF, for greater clarity. Thereafter the amount of PSF

(security component) can be determined after due diligence of the security requirements

at an airport.

The aeronautical income of an airport operator out of activities like cargo, ground

handling and fuel supply to an aircraft are based on the concession fee or the revenue

share, in a similar manner as any other non-aeronautical activity at an airport. As a

general policy, all the revenue sources at an airport apart from the aeronautical revenues

discussed earlier, i.e. ANS charges, PSF (security component) and DF (if any), should be

accounted for in the non-aeronautical till, which would therefore include, the income


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from all commercial activities at an airport, including cargo, ground handling, fuel

throughput, F&B, car park, city side etc.

The instant policy would therefore only explore to find an appropriate regulatory till to

arrive at a per passenger yield of the aeronautical charge, so as to ensure a fair return on

the investment made for provision of these services. The aeronautical charges which

would be impacted by this policy would include the landing, housing or parking charges

(airline specific charges); and the UDF (passenger specific charges).

3. The contributing factors for determination of Tariff

Regulatory Asset Base:While calculating the aeronautical tariff, it would be important to

carefully determine the Regulatory Asset Base (RAB), on which the fair return is to be

allowed to the airport operator. However, prescribing what should constitute the RAB

would not be desirable from the policy perspective, as the RAB would be dynamic andairport specific. In case of AAI, if the entire AAI setup is considered as a single system,

then determination of RAB would be very different. It would therefore be proper to leave

the issue of determination of RAB at an airport to AERA or the Government, as the case

may be, at the time of determination of tariff.

Regulatory Till: The general philosophy in determination of any regulated charge is cost

plus a fair return on the investment. However, for the purpose of aeronautical tariff, it

would be relevant to factor in the income from other services as well. The classical

argument has been that the other revenue streams are a manifestation of the aeronautical

traffic, and it should be factored to reduce the burden on the passengers. The policy issuewould therefore be to determine the extent to which the other streams of revenue should

be accounted for the determination of aeronautical tariff.

Rate of Return: It would be essential to establish a rate of return on the RAB, so as to

build in adequate incentive for the investors in the airport infrastructure. However,

prescribing a specific rate of return in the Policy document may not be desirable. This is

because the fair rate of return is dependent upon several extraneous variables, and is

subjective in nature. Hence the determination of fair rate of return should be left to the

regulator, i.e. either AERA or the Government, as the case may be, at the time of

determination of tariff.


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Regulatory Till

1. The article 3.1.1 of the State Support Agreement entered into between the Government

had a with the M/s DIAL and M/s MIAL respectively, lays down that the aeronautical

charges shall be determined as per the principles set out in appended to these agreements.

The Schedule 1 of OMDA specifies the hybrid/ shared till price cap approach, where

30% of the revenue related to aeronautical related commercial activities is taken into

account for determination of aeronautical charges.

2. In the Concession Agreement with the M/s BIAL and M/s HIAL, it has been laid down

that the airport charges shall be consistent with the ICAO policies. The two relevant

ICAO documents in this context are Doc 9082 (2009 edition) ICAOs Policies on

Charges for Airports and Air Navigation Services; and Doc 9562 (2006 edition) Airport

Economic Manual. Doc 9082 inter-alia recommends that in determining the cost basis

for airport charges, contributions from non-aeronautical revenues accruing from the

operation of the airport to its operators should be taken in to account. However, neither

Doc 9082 nor Doc 9562 specifies the extent to which the non-aeronautical revenues

should be taken into account.

3. The clause (v) of Section 13 (1) (a) of the Airports Economic Regulatory Authority of

India Act, 2008 states that AERA would determine the tariff for the aeronautical services

taking into consideration the revenue received from services other than the aeronautical

services, but it does not specify to what extent these revenues are to be taken into

account.

4. AERA had issued an order in January 2011, laying down the regulatory philosophy on

the basis of single-till. This order of AERA has been challenged in the Appellate

Tribunal, the decision of which is still pending.

5. It is relevant that the analysis of the approach to economic regulation, with specific focus

on discussions and analysis in relation to the various options to the price cap approach i.e.

Single-Till v/s Dual-Till v/s Hybrid-Till methodologies, should be evaluated in respect of

the relevance and impact of each methodology in the Indian context, its consistency with

the principles of regulation, case studies analyzing the impact of the varying approaches

on the economic viability of the Major Airports and the impact on user charges. The

broad principles can be fairness, transparency, incentive based, consistency and

predictability.


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6. Single Till Approach

The Single-Till approach considers the entire airport as one system. The aeronautical

tariffs under this approach are determined in a way to ensure that the sum of aeronautical

and non-aeronautical revenues provides a pre-determined rate of return to the airport

operator, over and above his operating costs, depreciation and taxes.

Effectively, single till uses profits/ losses from non-aeronautical activities at an airport to

offset the aeronautical cost base for determining airport charges. Under this approach, the

allocation of costs between aeronautical and non-aeronautical services is less significant,

given that the allowable revenue figure is based on total costs.

7. Dual Till Approach

The Dual-Till approach considers the entire airport as two independent systemsthe

aeronautical and non-aeronautical. The aeronautical tariffs under this approach are

determined in a way to ensure that the aeronautical revenues provide a pre-determined

rate of return to the airport operator, over and above his aeronautical operating costs,

depreciation and taxes. The airport operators profit or loss in the non-aeronautical

business has no bearing on the aeronautical tariffs.

8. Hybrid-Till Approach

The Hybrid-Till is a combination of Single-Till and Dual-Till approaches. It is developed

on the premise that a part of the non-aeronautical revenues are contributed by passengers

and hence a part of the profits thereof need to be ploughed back into the aeronautical till.

The aeronautical tariffs under this approach are determined in a way to ensure that the

aeronautical revenues provides a pre-determined rate of return to the airport operator,

over and above his operating costs, depreciation and taxes, cross-subsidized by a certain

fraction of the non-aeronautical revenues. In case of Delhi and Mumbai airports, 30% of

the non-aeronautical revenues are used to subsidize the aeronautical expenses.


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International Experience in Airport Economic Regulation

1. Different countries continue to adopt different strategies for regulating their airports.

Examples of Single Till, Dual Till and Light handed approach continue to exist across

different countries and there is no global consensus as to which system is better. Each

country decides the tariff approach suitable to its national vision and public interest.

2. Countries like the United States of America and Germany have both forms of Single and

Dual till regulations in operation at different airports. While there is no single regulation

which is dominant across countries, a noticeable trend is appearing in privatized airports

(with the exception of UK) moving towards Dual Till.

3. The Australian system (except for Sydney airport) was regulated using dual till, while it

now has light handed regulation; as is the German (Hamburg) airport, while the UK

system and South Africa use a single-till system.

4. In the Canadian system, the airport authorities are formally treated as "not-for profit"

entities under the Corporation Act, so that any profits must be reinvested. Hence, in

Canada, fees and charges under the Airport Authority legislation are not regulated or

subjected to review. Airport Authorities are free to set charges and could impose different

types of charges at their discretion.

5. In the case of BAA administered airports in the UK, the single till treatment has a

historical anomaly caused by the terms of the Bermuda II Air Agreement with the United

States, dating back to 1977. It is generally noted that this agreement, the principal focus

of which was to protect the interests of competing UK and US airlines, committed the

UK to applying a Single till approach to regulation.

6. An important correlation between privatization and Dual/ Hybrid till is also evident.

There has been no major airport privatization under single till (except BAA which was

kept under Single till for extraneous reasons). The same can be seen from the table

below, where the airports privatized globally are either unregulated or are operating

under Dual / Hybrid Till.


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Source: ICAO,www.icao.int

7. The case studies of Germany and Australia described below demonstrate the movement

towards Dual Till/ Light Handed Regulation post privatization.

Germany:

The Federal Government in 1982 announced a program to privatize airports. Although

for more than a decade the program had not commenced, five out of 18 international

airports have so far been partially privatized (in the form of minority private

participation), namely, Dsseldorf, Hamburg, Frankfurt, Hanover, and Saarbrcken. Until

the late 1990s, the law did not define how airport charges would be regulated, but there

existed a common practice whereby airports were required to submit their charges (take-

off, landing, passenger facilities and aircraft parking charges) to the competent regulatory

authority for approval under Section 43 of the Air Traffic Licensing Regulations and the

state governments normally regulated airport charges. In general, a single till approach

was applied with regulation on the rate of return.
http://www.icao.int/http://www.icao.int/http://www.icao.int/http://www.icao.int/


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Hamburg Airport experience

Hamburg Airport was privatized in October 2000; however, it was earlier in January

2000 that Germanys first price cap regulation was introduced for Hamburg Airport. The

price cap regulation was spelled out in a public legal contract between Hamburg Airport

and the Ministry of Economic Affairs of Hamburg. Both parties agreed to the first five-

year price cap period from January 2000 to December 2004 for landing fees, passenger

handling fees, noise level charges and aircraft parking fees. Upon an extension

agreement, the second five-year price cap period commenced in January 2005. Hamburg

Airports price cap is characterized by a sliding scale CPI-X (Consumer Price Index

CPI minus a specific value, X), which is set on a revenue yield basis and consistent

with a dual till approach. The value for X was fixed at 2 for the five-year period, but if in

any year growth in passenger numbers at the airport exceeded a threshold number (3 per

cent a year), then X would be increased the following year. There is no provision for X tofall if passenger throughput falls short of forecast levels. The objective of the sliding

scale is to reduce the possibility of the airport achieving windfall profits. In May 2002,

however, the sliding scale was suspended because of the asymmetry issue that a

temporary decrease of demand followed by higher growth would, on average, lead to a

relatively high X. In addition to a price cap, the airport must attain the quality of service

targets, including availability of aircraft parking positions and availability and punctuality

of passenger and baggage transport systems.

Fraport experience

At Fraport, following an agreement with the airlines in April 2002, a new regulatory

regime was introduced by a public legal contract between Fraport and the Ministry of

Economic Affairs and Transport of Hesse. The core of the contract is a revenue sharing

agreement, under which the average charge per passenger is coupled to the development

in passenger volume (actual and budget) until December 2006. If passenger volume

grows faster than planned, one-third of the resulting higher revenue is to be returned to

the airlines. On the other hand, should passenger figures fail to reach budgeted levels,

Fraport can compensate for such shortfalls by higher charges, applying the same ratio.

The economic risks and opportunities could thus be shared by both the airport and the

airlines. In January 2007, a new but similar regulatory regime for airport charges cameinto force between Fraport and the Ministry of Economics, Transport, Traffic and

Development of Hesse.

Australia:

The Airports Privatization Program in Australia began in April 1994, when the

Government announced its intention, in principle, to privatize the 22 FAC-owned


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airports. The stated rationale of privatization was to improve the efficiency of airport

investment and operations in the interests of users and the general community, and to

facilitate innovative management. Phase I of the Airport Privatization Program included

Brisbane, Melbourne and Perth airports, in which the Government called for Expressionsof Interest in September 1996. In July 1997, long-term leases were granted to the

Brisbane Airport Corporation Ltd. (Brisbane), the Australian Pacific Airports

Corporation (Melbourne), and Australia Development Group (Perth). The duration of the

leases is 50 years with an option for an additional 49 years. The commencement of Phase

II of the Airport Privatization Program was announced in June 1997. Phase II comprised

eight major airports (Adelaide, Alice Springs, Canberra, Coolangatta, Darwin, Hobart,

Launceston, and Townsville) and seven regional airports. The airport sale process for the

remaining five airports began in the early 2000s and was completed in December 2003.

The regulation in Australia moved from Single Till to Dual Till when the airports wereprivatized. In July 2002, the Government decided to further liberalize the regulation and

introduced a light-handed approach to price regulation of airport services in line with the

recommendations made by the Productivity Commission (PC). Under this new approach,

price notification and price caps were discontinued for all airports. Instead, price

monitoring for Adelaide, Brisbane, Canberra, Darwin, Melbourne, Perth and Sydney

airports were introduced for a transitional five-year period along with a review of the

arrangements to be conducted by PC at the end of this period. Exceptionally, a price

notification requirement with a price cap was introduced to aeronautical services for

regional airline services at the privatized Sydney Airport. Five years later, the regulatory

approach was changed again in response to the PCs recommendations. The Government

decided in April 2007 to continue the current price monitoring for Adelaide, Brisbane,

Melbourne, Perth and Sydney airports for a further six years. Canberra and Darwin

airports were no longer subject to the formal price monitoring arrangements from July

2007, but the Government continues to monitor developments at all of its leased airports

and, if any concerns arise, considers whether further investigation is required. A show

cause process was introduced, whereby price monitored airports may be required to

demonstrate why their conduct should not be subject to more detailed scrutiny such as a

formal price inquiry under the Trade Practices Act 1974.


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Importance of Non-Aeronautical Revenues

1. Non-aeronautical revenue is gaining importance amongst airports globally as is indicated

in the growing share of non-aeronautical revenues in the total revenue of airports.

Airports have tried to maximize the share of their revenue from non-aeronautical

services. In most cases around the world, non-aeronautical revenue has grown faster than

aviation revenue; as a consequence, non-aeronautical operations are now significant

sources of revenues and profits for many major airports in the world. The table below

depicts the share of non-aeronautical revenues as a percentage of the total revenue at

select international airports:

Source: ACI Airport Economics Survey 2008

2. In contrast to international airports, revenues in Indian airports are dominated by

aeronautical revenues with limited focus on the non-aeronautical services. Non-

Aeronautical Revenues average is only in the range of 30-35% of total revenues.

However, the five PPP airports are witnessing an increased trend in non-aeronautical

revenues and going forward, the same is expected at other airports in India. This is

possible only if the airport operators are suitably incentivized and, subject to financial

accountability, large parts of the benefits of developing the non-aeronautical services are

retained with the airport company. This is also an important consideration for attracting

future private sector investments in airports sector.


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Stakeholder Interactions

1. This Ministry has been interacting with a wide range of stakeholders regarding the

appropriate regulatory philosophy for minor airports. In continuation of this approach, it

organized a stakeholder conference on 20 Jan 2012 to elicit views of different

stakeholders and to allow a healthy discussion on contentious issues.

2. The conference brought together leading speakers from different segments of the

industry, namely airport operators, airlines, lenders, private equity players, industry

groups and end users. The participants were:

i) Dr. Gajendra Haldea, Advisor to Deputy Chairman, Planning Commission of

Indiaii) Mr. Yashwant Bhave, Chairman, AERA

iii) Mr. V.P. Agrawal, Chairman, AAI

iv) Mr. Brian Pearce, Chief Economist, IATA

v) Dr. Rafael Echevarne, Director, Economics & Programme Development, Airport

Council International

vi) Mr. Suresh Goyal, Managing Director, SBI-Macquarie

vii) Mr. Amber Dubey, Director, KPMG

viii) Mr. M Shivkumar, Sr. Vice President-Finance, Jet Airways

ix) Mr. Rajeev Jain, Vice President, APAO

x) Mr. Subrata Paul, CEO and Director, BAPL

xi) Mr. Umesh Baveja, Chairman, RAHI

xii) Mr. Bharat Thakkar, President, ACAAI

xiii) Mr. D. Sudhakara Reddy, President, APAI

xiv) Mr. Sanjay Grewal, Director, IDFC

3. The highlights of the discussion are presented in the subsequent sections.

4. Regulatory Till

The relative advantages and disadvantages of the three approaches namely single-till,dual-till and hybrid-till are presented below.

The Single-Till approach

Arguments in favour of Single-Till approach are as follows:


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i) In this approach, airport is treated as an integrated business. This may be logical

as non-aeronautical revenues are dependent on aeronautical activities.

ii) The charges are set such that airport as a whole can generate appropriate returns

for its investors.iii) Single-till regulation results in lower landing fees and thus may lead to more

flights and hence more traffic.

iv) It ensures that operator is not guided in its investment decisions by profits from

non- aeronautical activities.

v) Airlines bring passengers to the airport. Hence they should be given benefit of

the non-aeronautical revenues generated through these passengers.

vi) Administration of charges in this approach is relatively easy.

Arguments against Single-Till approach are as follows:

i) There is limited incentive for airport operator to increase non-aeronautical

revenues and facilities since any additional non-aeronautical revenue earned is

ploughed back to reduce aeronautical revenue.

ii) It represents a subsidy from airport operators to airlines. Subsidy in any form

distorts markets and investment decisions.

iii) It leads to inefficient allocation of resources. Airport developers may invest their

resources in other opportunities where the returns are non-regulated.

iv) Many experts feel that the single till approach forces the airport operator to

maximize his gains by artificially enhancing his capital expenditure and operating

cost (gold plating). It then enhances the pressure on the regulator to get into adetailed scrutiny of the same and provide evidence of gold-plating.

v) Proving gold-plating, especially in case of non-aeronautical infrastructure, is a

contentious exercise that often leads to confrontation, media criticism and judicial

recourse. This ultimately leads to an avoidable waste of precious time, money

and energy of the regulator and the airport operator.

vi) The capability of the regulator and the experts that may be appointed by them

would always be open to questioning. There is a need to make regulation self-

policing and with minimal manual intervention.

vii) Airlines may lobby for unrealistically low airport charges. The resulting

infrastructural deficit (e.g. air-side congestion) will protect their market position

from further competition.

viii) Single-till approach gives no incentive to increase efficiency and reduce costs.

According to a research, shift from Dual to Single-Till results in 21% reduction in

cost efficiency.2

2Asaf and Gillen (2011)


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ix) Single-till approach is no longer supported by ICAO. This approach is

contradictory to the ICAO principles of cost relatedness and user paying its

share of the cost.

x) Mathematically speaking, in the short run, single till will lead to lower tariffs. Inthe long run, due to limited incentive for growing non-aeronautical revenue, the

aeronautical tariffs would automatically rise.

The Dual-Till approach

Arguments in favour of Dual-Till approach are as follows:

i) Dual till approach maximizes the incentives for potential investors in airports.

This is particularly critical for India as aviation in India is in a take-off stage,

poised for rapid growth. Airports require high and lumpy investmentswhether

they are low traffic or high traffic airports. As per the 12th

Plan approach paperfor civil aviation, private investors are expected to meet nearly three-fourth of the

investments required in the airport sector.

ii) Aeronautical expenses are not subsidized by non-aeronautical sources of revenue.

This creates a self-induced incentive to maximize non-aeronautical revenues at the

airport.

iii) It is the only regulatory principle which is fully consistent with ICAOs principles

and recommendations for setting charges.

iv) It has been observed that most airport operators reinvest a significant part of their

non-aeronautical profits into development of airport infrastructure and reduction

in aeronautical charges, since higher traffic leads to increase in non-aeronautical

revenue as well. Thus aeronautical charges under dual-till come down in the long

run. The extent of cross subsidization is best left to the airport operators since

they have to manage the business cycles and traffic shocks that the airport sector is

subject to.

v) Maximization of non-aeronautical revenue reduces the pressure on airports to raise

fresh capital for further development.

vi) Dual-Till ensures diligent cost allocation, transparency of costs and price

efficiency.

vii) The total profits earned by the airport operator are fully disclosed to the regulatorsand the government. There is limited risk of airport operators making super-

normal profit.

viii) Total factor productivity is greater under the Dual-Till approach.

ix) In academic literature, there is an overwhelming support for Dual-Till.


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Arguments against Dual-Till approach are as follows:

i) Dual-till approach may lead to a higher airport charges since there is no cross-

subsidization of aeronautical expenses.

ii) Dual-till could lead to insignificant focus on enhancing aeronautical infrastructure

and quality of service.

iii) Conceptual difficulty in separating aeronautical and commercial activities at an

airport may create issues in allocation of investments and operating costs amongst

these activities.

iv) A move from the single-till to the dual-till would, in the longer term, mean a

substantial transfer of income to airports from airlines, potentially undermining

regulatory credibility and creating regulatory uncertainty.

v) Dual-till proposal may lead to airports earning more than the Fair Rate of Return

(FRoR) stipulated by the regulator.

The Hybrid-Till approach

Arguments presented in favour of the Hybrid-Till approach are as follows:

i) It helps capture the advantages of Single and Dual-Till approaches while avoiding

the disadvantages.

ii) Since 70% of the non-aeronautical revenue goes to the airport operator, there is

significant incentive for him to maximize non-aeronautical sources of income.

iii) It prevents the need for the regulator to carry out a detailed scrutiny of the capital

expenditure, revenues and expenses related to non-aeronautical activities.

Arguments presented against the Hybrid-Till approach are as follows:

i) There is a practical difficulty in segregating assets and expenses between

aeronautical and non-aeronautical activities.

ii) There is no standard approach for fixation of the fraction of non-aeronautical

revenue that should cross subsidize aeronautical expenses.

Regulation by contract

Regulation by contract, as an approach for economic regulation of airports, was

highlighted by Dr. Gajendra Haldea, Advisor to Dy. Chairman, Planning Commission of

India. It essentially means that the guidelines related to the scope of work, quality and

tariffs are captured in the contract between the Authority and the Concessionaire and the

same are not reopened by any other authority; unless in extra-ordinary cases as defined in

the contract. This leads to transparency, certainty and predictability for all concerned.

This approach has been adopted in other sectors e.g. national highways and is working

well.


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Light handed regulation

Throughout the economic literature, the need for regulation of natural monopolies is well

documented and well understood3. In accordance with the need for regulation,

economists have put forward an extensive set of principles for regulating natural

monopoly suppliers. In practice, in many countries around the world, regulatory bodies

have come up with different regulatory designs to overcome the problems brought about

by the existence of natural monopolies. The regulatory philosophies can be classified

under two main titles. On one side, there is heavy-handed regulation maintaining that the

regulatory authority has a tense control over the natural monopoly and proceeds stronger

regulatory surveillance. On the other side, there is light-handed regulation, which holds

that actual regulation is conducted only if the natural monopoly is determined to have

exerted its market power or triggered some kind of market failure.

Light handed regulation would, therefore, allow airport operator discretion in how it

meets regulatory targets. This form of regulation is not intrusive, in contrast to cost plus

regulation. This process is designed to reduce information requirements and high

compliance costs, while introducing clear incentives for good performance.

5. AAIA National mandate

Airports Authority of India (AAI) is a 100% government owned entity with a mandate of

developing and maintaining air-connectivity across the country. This is similar to the

mandate of Indian Railways or the National Highways Authority of India. Many AAI

airports are at remote locations and in difficult terrains, with a low passenger throughput.In addition to the ten major airports, AAI also operates 75 other airports, many of which

are not profitable due to various constraints.

AAI manages and operates a total of 114 airports and civil enclaves in country. Out of

these, 10 airports have been designated as major airports, having annual passenger

throughput of more than 1.5 million passengers per annum (mppa). In the FY 2010-11,

for airport services alone, the combined EBIDTA of the major airports was Rs. 716

crores, whereas the other 104 airports had a combined EBIDTA of Rs. 598 crores. Hence

the non-major airports are, in a way, cross subsidized by major airports, and even after

that, the AAI has insufficient surplus to meet the significant depreciation and interest cost

that it has to bear for development of airport infrastructure all over the country. If the

tariffs for AAIs major airports are determined separately, and the entire non-aeronautical

revenues thereof are used to cross subsidize their respective aeronautical expenses, AAI,

a profit making and regular dividend-paying organization, would be in financial distress.

3Fatih Cemil OZBUGDAY, 2008
http://www.regulationbodyofknowledge.org/glossary/define/Cost%20of%20service%20regulationhttp://www.regulationbodyofknowledge.org/glossary/define/Cost%20of%20service%20regulationhttp://www.regulationbodyofknowledge.org/glossary/define/Cost%20of%20service%20regulationhttp://www.regulationbodyofknowledge.org/glossary/define/Cost%20of%20service%20regulation


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At present, AAI is levying Airport charges which are different for international, domestic

and civil enclaves; however charges are uniform for all airports within the same group. If

airport charges are fixed on airport basis, the charges may be significantly higher at the

airports with low passenger traffic, and may create a vicious cycle of lower traffic andhigher charges.

AAI has been provided free land for expansion of airport or entire airport operations has

been transferred to AAI by various State Governments. State Governments expect AAI

to charge less because of this free/ concessional land.

An upward revision of 10% in aeronautical charges was made in the year 2009 after a gap

of 8 years. While the AERA Act specifies a control period for determination of tariff for

major airports, no periodicity is specified in the case of minor airports. This needs to be

addressed.

In the past, both ANS and Airport Services were considered for determining tariffs for

AAI airports. The tariff should be fixed independently for ANS & Airport Services.

With no cross subsidy envisaged from one AAI airport to another or from ANS to AAIs

airport, the viability of the AAI as a whole becomes a major concern.

6. Greenfield PPP Airports

Fourteen Greenfield PPP airports have been proposed in the 12th

Five Year Plan. Other

than the proposed Navi Mumbai airport, the rest are in non-metro locations, where the

initial traffic is expected to be quite low. The challenges highlighted by stakeholders

were as follows:i) Basic infrastructure like runway, terminal building, security, air traffic control etc.

need to be invested in, irrespective of whether one flight lands in a day or several.

In case of low traffic, capital expenditure and operating expenses per passenger

rise exponentially.

ii) Airlines may not be interested in operating on such airports on account of low

traffic. Therefore unless the government provides support to make the route

viable, the airport may not be utilized fully.

iii) Certain Greenfield airport projects involve building aerotropolis. In such cases,

significant non-aeronautical revenue would come from real estate development

around the airport. A light handed regulatory approach would be preferable. The

non-aeronautical revenue in such cases should be restricted to revenue generated

within the airport and in relation to airport services.

iv) Most of the guidelines for major airports may not be practical for smaller airports.

For instance, the policy of having a compulsory aerodrome license to operate


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scheduled airlines would raise the operating costs for such small airports to an

unviable level. This needs to be looked into separately.

7. Cities with dual Airports

With rising passenger traffic and increasing congestion at leading airports, there would be

a need for a second airport in many cities of India. The process for development of a

second airport in Goa is currently underway. Soon a second airport may become a reality

in Delhi, Mumbai and other metros too. The issues highlighted by stakeholders were as

follows:

i) Two or more airport operators would mean perfect competition. In case of two

airports within the same city, there could be a light handed regulatory approach,

wherein both airports could be free to set tariffs subject to reasonableness and

stakeholder consultation.ii) Two airports in the same city should ideally follow the same regulatory till

system.

iii) In case of an existing airport having a regulatory framework specified in their

concession agreements, like Delhi and Mumbai, the regulatory mechanism to be

applied to the new airports in the same city should be able to provide a level

playing field.

8. Air Cargo operators

Key challenges highlighted in respect of air cargo are:

i) Cargo operators role is very crucial in the overall growth of the sector. They

would like to play a bigger role in the consultative process during policy making,

and before modernization or expansion of any airport.

ii) Tariff revision should be preceded by a detailed proposal which should be

circulated and discussed within a consultative group and then a decision may be

taken.

iii) There is a need to benchmark the performance of airlines and terminals for their

role in cargo handling. There may be penalty provisions for delays on their part.

iv) Cargo has been contributing high revenues in the overall revenues for the airports.Around 35% of revenues of some of the metro airports are generated by cargo but

there has not been enough emphasis on cargo facilities. Out of Rs. 2,500 crore

investment in metro airport modernization, only Rs. 150 crore (6%) was for cargo

facilities. There may be a policy of proportionate investment in cargo facilities.

v) In case an airport is developed as purely air cargo airport, then adequate incentives

should be given to the operators of such airports to compete with other airports.


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Proposed regulatory approach

1. The different perspectives on economic regulation of airports in India arise from the fact

that there is a wide diversity in characteristics of airports in India. While uniformity of

policy is necessary to create a level playing field, it may be noted that each category of

airports has unique challenges associated with it. It is therefore imperative that we develop

a regulatory approach that addresses these unique challenges while being simple,

transparent, progressive, equitable and predictive.

2. As mandated by ICAO, the regulatory approach for airports should derive from the specific

objectives and context of each country. Indias policy framework for airports should

therefore be aligned to the countrys vision of becoming the third largest aviation market

by 2020.

3. The regulatory philosophy should encourage the worlds best airport developers to invest in

Indias airports. It should also judiciously balance the expectations of airport users and

investors. Excessive profit booking by investors may lead to adverse reactions from users

and society at large. It may also jeopardize Indias aspiration to become a leading aviation

hub.

4. While airports can be treated as monopoly assets from a geographical perspective, global

experience shows that airports cannot charge tariffs of their own free will. The profitability

of airports comes from traffic volumes and the origin-destination traffic does not suffice.

Airports compete with each other to become a preferred hub for transfer and transit

passengers. This gives them additional landing and parking charges, passenger fees and

revenues from retail sales.

5. Thus, while proposing the regulatory approach for airports, the impact of market forces

cannot be ignored. If airports charge excessively and create an adverse impact on the

passenger throughput, airlines may reduce or stop their flights to the said airport, putting

the significant investments to risk. Airport owners are cognizant of this limitation. Further,

to reduce the impact of the aeronautical charges, the airport operator should undertake all

possible mitigating measures, like lean capital expenditure, lower operating costs,

exploitation of the non-aeronautical revenue streams and enhanced benefits to the airlines

and air passengers in order to achieve higher aeronautical revenue.


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6. The various categories of airports in India are as follows:

i) Existing PPP airportsBrownfield (DIAL, MIAL)

ii) Existing PPP airportsGreenfield (CIAL, BIAL, HIAL)

iii) AAI airportsmajor

iv) AAI airportsnon-major

v) Greenfield airportsnon-metro, non-AAI

vi) Greenfield airportsDual airport systems

7. Regulatory Till

Application of single till system at an airport may hurt its financial viability and may

discourage investments in airport infrastructure. On the other hand, applying the dual till

approach to the Airports may not be fair to passengers who do contribute to non-

aeronautical revenues accruing from retail, advertising, car parking etc. Therefore, theregulation by the Ministry of Civil Aviation shall be under the hybrid till approach, where

30% of the non-aeronautical revenue shall be accounted for, to arrive at the target

aeronautical revenue for an airport. However while accounting for non-aeronautical

revenues, due care needs to be taken in case of these non-metro Greenfield airports, which

are being developed as aerotropolis. In such airports, invariably the concerned State

Governments concessions allow the airport operator to leverage major portion of the land at

these airports for non-airport related activities, which has no correlation with the passenger

traffic at these airports. Hence the revenue from such non-airport related activities needs to

be ring-fenced while accounting for the non-aeronautical revenue in calculation of the

aeronautical charges.

8. The proposed regulatory approach for each category of airports is presented in the

subsequent sections.

9. Existing PPP Airports

Existing PPP airports, both Brownfield and Greenfield, are being regulated by AERA and

have separate Concession Agreements/ State Support Agreements entered into with the

Government, which lays down the philosophy of economic regulation. As per the AERA

Act, while determining the tariff at these airports, AERA has been mandated to take intoconsideration the concessions offered by the Government. Hence, at this stage, this

Ministry may not like to intervene in the matter.

10.AAI Airportsmajor

Major AAI airports with a throughput of 1.5 mppa or more shall be regulated by AERA.


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11.AAI Airportsnon-major

AAI has a national mandate of creating airport infrastructure. While it may be imperative

for AAI to develop airports based on economic fundamentals, there are times when airports

have to be established at a particular location for a national cause, though the traffic and

revenues thereof may not be commensurate with the investments and recurring expenses.

Further, accounting in AAI today is not done for each individual airport, and therefore,

regulating each AAI airport as a separate entity would have administrative problems. Also,

the aeronautical charges at airports with lesser traffic throughput may become exorbitant,

which may further have an adverse impact on the traffic at those airports.

Based on a careful analysis of all options, the proposed regulatory approach for AAI is as

follows:

(a) AAI airports having an annual throughput of less than 0.5 mppa shall have a lighthanded regulation. AAI would propose appropriate tariffs, after carrying out

thorough stakeholder consultations in a transparent and well documented manner.

After examining the reasonableness of the tariff rates proposed, the Ministry of

Civil Aviation shall fix the tariffs, which may be reviewed after every five years

or till the airport achieves the annual throughput of 0.5 mppa, whichever is earlier.

(b) All AAI airports with a throughput between 0.5-1.5 mppa shall be regulated as

one entity. The regulation shall be under the hybrid till approach, where 30% of

the non-aeronautical revenue shall be accounted for, to arrive at the target

aeronautical revenue for AAI. This determination of tariff shall be done once in

five years by the Ministry of Civil Aviation, after due diligence and stakeholder

consultations in a transparent and well documented manner. The tariff rate, so

determined, will be applicable to all AAI airports in the 0.5-1.5 mppa category. In

case an airport enters this category in between the tariff cycle, the applicable rates

of this category would automatically become applicable at the new entrant AAI

airport. Further, even in case airport (s) exits this category in between the tariff

cycle, the applicable tariff rates will not be altered. Therefore, any exit or entry

into this category will alter the existing tariff rates of this category, which will

remain static till fresh determination is done after the completion of the tariff

cycle.(c) Major AAI airports with a throughput of 1.5 mppa or more shall be regulated by

AERA.


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12.Greenfield Airportsnon-metro, non-AAI:

Development of new Greenfield airports is necessary to improve air-connectivity into the

interiors of the country. These airports face the risk of high capital investments and low

traffic in the short term, which may affect their financial viability. Such airports may be

provided incentives by the central and/or state government like fiscal or monetary

assistance, low cost debt, land for commercial exploitation, etc.

Regulating the Greenfield airports would imply that the government has to ensure that the

investors thereof receive a fair return on their investmentssomething that may put

significant liabilities on the government.

Based on a careful analysis of all options, the proposed regulatory approach for the non-

AAI, non-metro Greenfield airports is as follows:

(a) Such airports shall have a light handed regulation for five years from the start ofairport operations. During this period, each of these Airports would fix

appropriate tariffs, after carrying out thorough stakeholder consultations in a

transparent and well documented manner. The Ministry of Civil Aviation will be

informed about the tariff so fixed, before the commencement of airport

operations, and thereafter immediately, in case of any change.

(b) After completion of five years of operations, the airports in this category will be

regulated as under:

The light handed regulation will continue till these airports achieve an

annual throughput of more than 0.5 mppa.

When the annual throughput of these airports is between 0.5-1.5 mppa,

the tariffs of these airports shall be regulated by the Ministry of Civil

Aviation. This determination of tariff shall be done by the Ministry of

Civil Aviation once in five years, after due diligence and stakeholder

consultations in a transparent and well documented manner.

When the annual throughput of such airports crosses 1.5 mppa AERA

would regulate.

13.Greenfield AirportsDual/ Multi Airport systems:

As Indias air traffic grows, certain cities may find their airports constrained for further

growth. They may require a new airport in close proximity, say, within a 150 km aerial

distance, of the existing airport. The second airport should be planned well ahead of time,

when the current airport saturates in terms of capacity.


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While the new airport would have an apparent disadvantage of higher capex, greater

distance from the city centre and the need to build its own traffic and non-aeronautical from

the scratch, it would also have an advantage over the existing airport in terms of an open

slot register, modern infrastructure and improved multi-modal connectivity. All this mayhelp the new airport to attract traffic from the catchment area of the existing airport.

The dual/ multi airport system, in the long run, may provide a market competition, and

therefore a power of choice to the passengers. The traffic distribution between the two

airports would be decided by the Government. Ideally traffic beyond the saturation

capacity of the existing airport should be allocated to the new airport, else, unhealthy

competition between the two can destroy both. However, in the short run, the newer airport

in the dual airport system would need a cushion period to catch up with the existing airport.

The proposed regulatory approach for Greenfield airports in Dual/ Multi airport systems is

the same as mentioned in para 12 above. However, while determining the tariffs, the

Ministry of Civil Aviation/ AERA shall ensure that a level playing field is maintained for

the Greenfield airport vis--vis the older airports.

14. Exclusive cargo Airports may also be subjected to light handed regulation as outlined

above.

15. When an airport crosses the jurisdiction, i.e. from being regulated by the Ministry of Civil

Aviation it starts getting regulated by AERA on achieving an annual throughput of 1.5

mppa, the Government can issue directions to AERA, on case to case basis, forcontinuation of the economic regulatory philosophy through which the airport was being

regulated by the Ministry of Civil Aviation.


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Conclusion

The proposed regulatory approach for non-major airports has been developed on the basis of

detailed stakeholder interactions and analysis of options. It is felt that the proposed approach

would be simple, transparent, progressive, equitable and predictive.

Given the significant investments required in airport infrastructure over the 12 th Plan period, the

proposed policy may provide to be attractive enough for the best airport developers. It would

allow close oversight and monitoring by the Ministry of Civil Aviation, to ensure that quality and

user interests are not compromised. It would help India achieve its vision of being the third

largest aviation market by 2020.

draft approach paper on economic regulations of airports in india

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