Reflections 
Better connectivity drives regional economic growth and job creation. Moreover, building connections to tier-2 and tier-3 cities creates a network effect by bringing in more people into the aviation network. New passengers create economic value across the chain: for the newly-connected cities, already-served airports and the airlines. This makes businesses more efficient, opens India’s vast tourism potential by making it accessible, makes responding to medical emergencies viable and promotes national integration.
UDAN (Ude Desh ka Aam Naagrik) program is designed to jump-start the regional aviation market by improving profitability of under-developed regional routes. UDAN is a world-leading policy intervention that builds on similar programs in the USA, Canada, and Australia. Minimum government for maximum governance approach is laying the foundation of a new regional segment in India’s aviation market.
Minimum government for maximum governance approach is laying the foundation of a new regional segment in India’s aviation market.
UDAN Creates New Connections While Ensuring Route Profitability
Citizens from tier-2 and tier-3 cities lacking air services have a latent demand for efficient and fast transportation to state capitals, regional or national metros and global destinations. However, aviation business has high operating costs, which include aircraft capital charges, airport charges, cabin crew, fuel, and maintenance. Unless there is sufficient air traffic, airlines are not able to generate necessary revenues to cover their operating costs and recover their cost of capital. It is self-evident that airlines do not want to fly unprofitable routes.
UDAN was developed through extensive and multiple consultations with stakeholders to make this a win-win scheme for passengers and airlines. Passengers get air connectivity in their cities and an ability to fly for Rs 2,500 an hour. The routes to be connected were chosen by airlines themselves based on their assessment of the market potential between various sectors. It is a first-of-its-kind scheme globally to stimulate regional connectivity through (a) ensuring route profitability and (b) introducing a market-based mechanism to allocate subsidy.
UDAN operates at three levels to ensure route profitability: (1) reducing operating costs significantly; (2) providing a market-discovered subsidy for half the seats; and (3) guaranteeing a three-year exclusivity on routes. Operating costs are reduced by reducing taxes on aviation turbine fuel (ATF) and eliminating airport charges for UDAN routes, improving liquidity in the regional aircraft (typically turbo-props smaller than 40 tons and less than 80 seats) leasing market, and streamlining regulations by DGCA for regional aircraft so that new airlines can get started with fewer upfront costs.
Before UDAN, India had 76 operational airports. In one stroke, 27 currently served airports, 12 currently underserved airports and 31 currently unserved airports (for a total of 70 airports) will be connected through 27 UDAN proposals.
UDAN uses a market-based approach to establish subsidy levels. Subsidy levels are capped based on operating costs estimated from actual industry data for different type of aircraft. Routes are awarded to the bidder bidding lowest subsidy level for half the seats on the flight. These subsidized seats are priced on the basis of a varying rate schedule such that a 30 minute flight is priced at Rs. 1,500 and a 60 minute flight is priced Rs. 2,500 and so on. The other half of the seats can be sold at market prices. Finally, the winning bidder gets three-year exclusivity on the route incentivizing them to invest in building up the route. It is heartening to see that many bids asked for no subsidy – the reduction in costs and the exclusivity were enough to jumpstart the market.
Before UDAN, India had 76 operational airports. In one stroke, 27 currently served airports, 12 currently underserved airports and 31 currently unserved airports (for a total of 70 airports) will be connected through 27 UDAN proposals.
6X: The Leverage of a Good Policy
Geographically large countries like the USA, Canada, Brazil and Australia support regional connectivity through public funding. UDAN is the first-of-its-kind scheme, which will levy a small fee on the flights on its metro routes to fund regional connectivity. Our levy on flights on the major routes, estimated to collect around Rs. 500 crores annually (or US$ 75 million) is about one-fourth the size of the US$ 290 million that the US government is estimated to have spent in promoting its Essential Air Services in 2016.
Passengers will benefit from enhanced air services, airlines will see more traffic on their metro routes, and India will gain through faster economic growth and national integration.
The first bidding round of UDAN has seen 27 proposals which requested an annual viability gap funding (VGF) of Rs. 205 crores to provide 13 lakh seats on UDAN flights. On a base of 15 crore tickets sold in 2016 (10 crore domestic and 5 crore international), this scheme will create 0.87% extra capacity. Air travel market in India is expected to be Rs. 150,000 crores industry this year (Rs. 50,000 crore for domestic and Rs. 1 lakh crore for international), implying that UDAN levy (for this round of bidding) will be about 0.13% of total revenues of the aviation sector.
A market-friendly policy can provide significant impetus to the growth of a sector. Even without getting into the second-order and network effects of increasing aviation coverage, 0.87% extra capacity at 0.13% reallocation of resources between the aviation eco-system demonstrates a more than 6X leverage of a good policy.
Minimum Government, Pro-Market Iterative Approach
Bidding for UDAN routes is to be done twice a year. The bidding is unique in the sense that the government does not decide on the routes which will be opened up for bidding: this is decided by the airlines themselves on the basis of their assessment of demand. After airlines make a VGF bid for a particular sector or network, such a route is then opened up for counter-bidding to see if the market can improve upon the subsidy ask, thereby reducing its quantum.
UDAN’s minimum government for maximum impact will surely make the PM’s dream of “hawai yatra for the hawai chappal citizen” a reality.
Over multiple iterations of UDAN bidding, aviation ecosystem will begin to generate data on which routes work and which do not. Entry and exit of operators and routes will create a vibrant market understanding of the challenges and opportunities that the regional aviation market throws up. Some routes which are not found viable with a particular aircraft type may be viable with a smaller or a larger craft, with different connection or with a change of timing. There will be learnings on the change required in the regulatory landscape. An iterative approach which allows for experimentation will create a stronger foundation for a more viable regional aviation market.
Government will play a facilitative role in helping the industry meet public expectations. UDAN will jump-start regional air connectivity and strengthen the overall aviation network at a modest market-discovered price. Passengers will benefit from enhanced air services, airlines will see more traffic on their metro routes, and India will gain through faster economic growth and national integration. UDAN’s minimum government for maximum impact will surely make the PM’s dream of “hawai yatra for the hawai chappal citizen” a reality.
(Jayant Sinha is India’s Minister of State for Civil Aviation and a Member of Parliament from Hazaribagh, Jharkhand. These are his personal views.)
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