By William Vivian Johan and Sumithra Suresh
The recent transformation of the Indian airport sector and modernization of significant Indian airports represents the culmination of more than a decade of effort by successive Indian Governments to upgrade airport infrastructure in India. Recognizing the need to keep pace with steep traffic growth and the changing expectations and profile of the Indian air traveler, the Government undertook several initiatives to revamp the legal framework to encourage private participation and reduce entry barriers for foreign investment into the nation’s airport infrastructure. These initiatives resulted in the privatization and modernization of key Indian airports. While this journey has brought with it many lessons, there is still a long way to go, with several new airport projects remaining to be developed and older airports requiring an overhaul in their functioning, management and infrastructure.
We shall seek to examine what we believe were, and continue to be, key challenges in the legal framework, which affect airport economics and should be re-evaluated, to continue to incentivize private sector investment into future airport projects. These challenges relate to the relatively recent Indian airport economic regulatory regime and the legal framework governing privatization of airports owned by the Government of India-controlled statutory corporation, the Airports Authority of India (“AAI”).
To set the context for this discussion: the preferred vehicle for modernization of Indian airports has been the Public-Private Partnership (“PPP”) model, the essence of which is a ‘concession’. In simple terms, a concession is the grant of a right to undertake an activity (frequently a public function discharged by a government authority) and collect the revenues generated by such activity, in consideration of payment of a ‘concession fee’ to the grantor (frequently the government authority that is responsible for that function). Under the PPP model, a concession is typically granted by a government authority, the ‘public’ side of the partnership, to a private party selected typically through a tender process, the ‘private’ side of the partnership, which discharges the concessioned functions within a framework defined by the public side. The private side leverages its strengths and resources to undertake the project and the public side circumscribes, regulates and supports the project and hence, the ‘partnership’.
In the case of airport infrastructure in India, while any person could apply for an aerodrome license and establish an airport, historically, airports in India were set up by the Government of India and eventually came to be vested in AAI. Private participation in airports is a relatively recent phenomenon with Cochin International Airport being the first Indian airport to be set up by a private entity in 1999. In 2003, the Airports Authority of India Act, 1994 (“AAI Act”), the parent statute governing the establishment, powers and functions of AAI, was amended to permit AAI to grant concessions in respect of airports owned by it, to private parties for their operation and development. Subsequently, concessions to establish and operate an airport under the PPP model were granted to private parties in consideration of a concession fee determined as a percentage of the gross revenue of the airport. In 2004, the concessions to establish new international airports at Bangalore and Hyderabad were granted by Government of India. These airports were set up as greenfield projects at new locations on the outskirts of their respective cities, with the older AAI-run airports, which were by the time landlocked with little room for expansion in the heart of these cities, being closed down. Then in 2006, the Delhi and Mumbai airports which were operated by AAI, were concessioned to private parties as brownfield projects for their expansion and modernisation.
The attractiveness of airport concessions, and indeed any other concession, for private participation lies in the difference between what you make, i.e., the revenue the concession can generate, and what you pay for the concession, i.e., the concession fee. The revenue that can be generated from the concession is typically subject to regulation because most infrastructure projects are natural monopolies.
What is interesting to note is that while the concession fees (arrived at through tendering process) in case of Bangalore and Hyderabad airports, was 4% of the gross revenue, in case of Mumbai and Delhi airports, the concession fee was an unexpected 38.7% and 45.99%, respectively, of the gross revenue. One obvious reason for this difference would have been that Delhi and Mumbai were operating airports, with steady revenue streams compared to Bangalore and Hyderabad, which would yield revenues only after the construction phase. The other reason would have been the relatively higher potential for real estate development (an integral part of the airport concessions), in these two cities, with the airports being located in the heart of the cities, and the relatively higher importance of Delhi and Mumbai as travel destinations (one being the national capital and the other the ‘financial capital’ of the country), compared to Bangalore and Hyderabad.
In case of airport concessions, revenue arises from two types of sources and is broadly classified as aeronautical and non-aeronautical. Aeronautical revenue may be understood as that which arises directly from the airport’s operations, such as landing and parking charges paid by airlines using the airport. Non-aeronautical revenue on the other hand is that which arises from incidental activities such as the operation of food and beverage and retail outlets, lounges and car parks at the airport. While the global trend has been of higher non-aeronautical revenue, in the range of 40-60% of total revenue, in India, non-aeronautical revenue potential was long under exploited, with non aeronautical revenue constituting only 30-35% of the total revenue; a trend that is being reversed only in recent years in privatized airports.
The tangible benefits of airport privatization in India have been many. These include new, improved and modern facilities, evidenced by the significant rise in rankings of privatized airports by Airport Council International (“ACI”), a global airports body, and increase in revenues to Government; the revenue share to AAI from the Mumbai and Delhi airports has steadily increased and has contributed significantly to its ability to invest in infrastructure development at its other airports. On the other hand however, privatized airports have faced flak in recent times for increasing the costs to passengers, airlines and service providers operating at the airport. It is against this background that we discuss two issues, which can have a significant impact on airport economics, viz., the single till v. dual till debate and the issue of land use at AAI airports.
One of the distinguishing features of an airport concession compared to those in other sectors such as roads or ports is that a significant portion of its revenue arises from non-core activities, i.e. non-aeronautical operations. It is in this context that these two issues become extremely significant.
Single Till Versus Dual Till
Independent economic regulation of Indian airports came into effect after the privatization of the Bangalore, Hyderabad, Mumbai and Delhi airports, with the establishment of the Airport Economic Regulatory Authority (“AERA”) in 2008. Soon after its establishment, AERA, after consultation with various stakeholders, issued regulations for fixation of tariffs at airports, under which it, inter alia, proposed to set airport tariffs on the single-till model as opposed to the dual-till model. These regulations were challenged almost immediately by the privatized airports on several counts before the appellate authorities and the issues raised in these appeals are yet to be conclusively determined.
Before we can understand ‘till’ in this context, we may briefly delve into the capital asset pricing model which forms the basis for airport economic regulation. Airport tariffs are set under this model, in very simplistic terms, as follows. The capital expenditure in creating fixed assets is determined – referred to as the Regulatory Asset Base (“RAB”). A fair return is allowed to the airport operator in the form of a fair rate of return determined by the regulator and applied to this asset base. The aggregate revenue requirement (“ARR”) for the airport is then determined as a sum of the fair return, depreciation on assets, operation and maintenance expenditure and tax, and the tariffs to be charged are derived from the ARR. It is at the stage of arriving at ARR that the concept of till becomes relevant.
‘Till’ in airport economics is used in the sense of a money drawer. The fundamental question of till is whether when ARR is determined, the non-aeronautical revenues of the airport should be set-off to lower the ARR and correspondingly lower the aeronautical tariffs. In other words, should non-aeronautical revenues subsidize the airport project? If this question is answered in the affirmative, the model is referred to as the ‘single till’ model i.e., one money drawer for all airport revenues aeronautical and non-aeronautical. If answered in the negative, the model is referred to as the ‘dual till’ model, i.e. aeronautical and non-aeronautical revenues are kept separate.
There are convincing arguments for both models. Proponents of single-till argue that the airport project is one, and that non-aeronautical revenues are a by-product of the aeronautical operations of the airport. The customer visits the airport bookstore because he was brought to the airport by the aeronautical services he wishes to utilize. The arguments for dual till on the other hand are centered around incentivizing investments into airport infrastructure and that the reduction in airport charges to airlines (which it is argued in any case do not form an appreciable part of the airlines fare) due to adoption of single till, will not necessarily be passed on to passengers by airlines, more so in congested airports, where air fares are determined by the scarcity value.
The Capital Asset Pricing Model and single and dual till are visually depicted in Figure 1:
A third model, which lies between the above two, referred to as the ‘shared’ or ‘hybrid’ till is where not all non-aeronautical revenues, but only a certain part of it is used to subsidize airport tariffs. This has been followed in the case of Mumbai and Delhi airports, because the concession agreements for these airports, which anticipated the coming of airport economic regulations, included an obligation on the Government to make reasonable endeavors to ensure that aeronautical tariffs will be set on the basis of the hybrid till model elaborated in the concession agreements. This turned out to be more favorable for these airports, compared to the cases of Bangalore and Hyderabad, where the concession agreements merely stated that tariff fixation should be consistent with ICAO (“International Civil Aviation Organisation”) policies, as a consequence of which these airports were subjected to the single till model.
From the perspective of encouraging private sector investment into airport infrastructure, we are of the view that having a dual or hybrid till will attract private investors as these models allow the developer to benefit from the upside of non-aeronautical revenues – which acts as a hedge against the uncertainties and volatilities air traffic demand in a growing aviation market like India. Also from the perspective of increasing revenue to government, in the tenders for future airport projects, if the return to investor is to be capped by regulation, there will be limited flexibility for a bidder to propose a unique value proposition and make a better financial proposal than its competitors. This issue gains significance in the context of upcoming projects such as Navi Mumbai Airport, which has already seen several delays, and environmental and land acquisition issues drive the estimated project cost up to about US$ 2 billion.
Land Use At AAI Airports
The other issue that would have an impact on non-aeronautical revenues relates to the extent to which airport land can be used for non-aeronautical purposes. This is relevant in case of AAI airports, because AAI being a creature of statute cannot do more than what is permitted under its parent Act. And since concessions to private parties are granted by AAI under the Act, the private party concessionaire cannot do more than what AAI could have done.
The question therefore is what AAI can do under the statute. This question first arose when the Mumbai and Delhi airports, were privatized. Initially, in the concession agreements for these airports it was proposed to permit the concessionaire to develop on the airport land: commercial offices, business parks, golf courses, shopping complexes, sports complexes and other similar facilities. However, there was a difference of opinion within the Government on whether this was permitted and opinions on the matter were sought from the legal advisors to the Government of India. Two views emerged from this. One view essentially was that one of the functions expressly permitted to be undertaken under the statute by AAI was the carrying out of ‘any other activity at the airports… …in the best commercial interests of the Authority’, and therefore that AAI could undertake these activities. The other, contrary view was essentially that from the context of the statute, ‘airport’ is meant to include only passenger facilities and therefore ‘any other activity’ that AAI was empowered to undertake under the above function was confined only to passenger facilities. This was the view that the Government eventually took and consequently the list of permitted commercial activities under the concession agreements for Delhi and Mumbai were curtailed to exclude the activities referred above. The current concession agreements for these airports include only facilities relating to passenger services, such as hotels, restaurants, bars, refreshment facilities. Other facilities such as retail shops, business centres and conference centres are permitted, but only if they are located within the terminals.
Without going into the merits of the view finally taken, it can be stated that the result of this approach is that a very limited set of real estate development activities have been permitted on airport land. Between Mumbai and Delhi airport, about 400 acres of land was available for real estate development. It is also telling that when this view was taken some of the bidders, who were real estate firms, dropped out of the tendering process for the Mumbai and Delhi airports.
At present both Delhi and Mumbai airports have tendered out several sub-concessions for real estate development, which are almost entirely for hotels. Given the number of hotels already in the vicinity of these airports, it remains to be seen whether there will be sufficient demand for the new hotels and whether the sub-concessionaires will be able to fruitfully exploit their hotel sub-concessions. This is manifest in concerns recently by the Delhi airport concessionaire about the need to expand permitted land uses beyond the limited activities like hotels and warehousing, as there were already a significant number of hotel projects on the lands developed so far.
Also relevant to this discussion is the concept of ‘aerotropolis’ – a form of urban development centered around, and fuelled by, an airport – that is being heard of increasingly in the context of airport development projects. This development is seen as arising out of the advantages afforded by the location of certain types of industries and commercial activities near airports, such as offices for business people who travel frequently by air, time-sensitive manufacturing, logistics, hotels, retail outlets, entertainment complexes and exhibition centers. Another observed effect is the increase in real estate prices in the vicinity of an expected greenfield airport development.
It is in this context that we submit: should the airport project, the very anchor for these developments, be prevented from partaking in this growth in real estate value? Should not the legal concepts of ‘airport’ and ‘passenger facilities’ be re-examined in light of the emerging concept of aerotropolis?
The need for re-considering these questions becomes relevant in the context of AAI’s stated intention to concession Chennai, Kolkata and other airports run by it, for what is expected to primarily be city-side development. The necessity for statutory amendments should remain an impediment for airports being able to derive and appropriate some part of the value that they bring to the urban economic landscape to which they contribute.
In conclusion, we believe that the favourable resolution of the two issues highlighted above by suitable policy intervention can dramatically improve the viability and attractiveness of airport development projects for private sector participants, and bring long term benefits to the government, the AAI and other stakeholders.
The importance of encouraging private sector participation in airport infrastructure cannot be overstated in light of Government of India estimates that Indian airports would require investments of about US$ 12 million (close to 75% of which is expected from the private sector) to meet the traffic growth projections, during the 12th Five Year Plan (2012-2017). More immediately, global tenders for the overdue new airport at Navi Mumbai along with six significant AAI-run airports including two in the metro cities of Chennai and Kolkata, is imminent.
William Vivian John is a Partner in the Infrastructure Practice of Luthra & Luthra Law Offices, specializing in the Airport sector. Prior to this he was in-house counsel at GVK’s Airports Business, where he was closely involved with the Mumbai airport development and modernization project. William can be reached at firstname.lastname@example.org.
Sumithra Suresh is an Associate in the Infrastructure Practice of Luthra & Luthra Law Offices, and a graduate of NALSAR University of Law. He can be reached at email@example.com.