What role does the regulator have to play in an environment where the airlines and the airports would all like to raise tariffs and expand business? Yashwant Bhave, Chairman, Airport Economic Regulatory Authority of India (AERA),explains how his team determines tariffs and development fees, and why it is fair on everybody.
Over the three years since AERA was instituted, what do you believe are the main issues you have been able to address?
The Government of India has taken proactive steps to pass an independent regulatory Act.That said, the AERA Act is a mandate and cannot act beyond the legislation.The mandate is to determine tariffs for aeronautical services, which are also defined, so there is no ambiguity.Determining the development fee is not an aeronautical service but meant to make the airports viable, both in terms of capital financing and revenue enhancement measures.Aeronautical services comprise cargo, ground handling and fuel.We have been asked to lay down a comprehensive transparent framework for going about determining these different charges.
Do you believe it has worked to the benefit of private players and users, since as a regulator, you have a role of making the sector both commercially viable and socially relevant?
I would put it like this: I have to follow the mandate of the Act, one of whose purposes is to make airports financially and economically viable.How do you do that? By giving a fair rate of return consistent with risk profilethat is the mechanics. Now let us say the rate of return comprises two parts, on equity and debt. With debt, there is no problem because the debt interest is given as long as it is taken from authorised sources.That rate of return is calculated per the Capital Asset Pricing Model (CAPM).
Once we assess the risk of an airport relative to the market and the traffic forecast is available, it is then merely a mathematical formula to determine the rate.
But calculations may lead to differential figures between yours and the developer’s?
ADF is a capital financing measure of a pre-financing nature, and not an ROE. To the extent ADF is given, the regulatory asset base (RAB) is reduced by that amount. Depreciation is not admissible on it: Suppose the capex is Rs 1,000 crore and DF is Rs 200 crore, then RAB will be Rs 800 crore.
User Development Fee (UDF) has nothing to do with ROE either, because UDF is a revenue enhancing measure to fill the gap between the revenue that the airport is receiving (or can receive after increase of services of aeronautical nature accruing to the airport) and what it ought to be, depending on the calculation of ROE and debt interest that go into the weighted average cost of capital.
What does go into ROE calculation are primarily three factors: One is the risk free rate; second, the equity risk premium, and third, the relative riskiness of the airport vis-a-vis the market.
It has been reported that there is a disconnect between the tariff hike that Delhi International Airport Ltd (DIAL) wanted (774 percent) and the increase you recommended (334 percent). Why is there a difference in calculation?
I will not explain other than what is mentioned in our order but there is a reason for it.The reason is whatever is written in consultation paper is exact, reasoning is exact and calculations.I can always understand there can be some errors and they can be corrected.
In calculation of airport revenues and airport operators’ revenues, there is another debate in regarding the single till policy, which you have always supported and the non single till. Could you please explain the rationale behind this policy?
I’d be circumspect in my views in a discourse context.The reasoning in an Indian context is that while the airport operator ought to get reasonable rate of return in equity, the interest of the airport regulator, those of the airlines and passengers would need to be balanced.The primary anchors are passengers and cargo users because for them airports and airlines are there. In AERA’s view, the interest of the airport operator should be adequately safeguarded by fair rate of return. Now what that fair rate of return should be is a matter of debate and discussion.We have calculated at 16 percent. But once that is decided, some may say it should be 25 percent, I have no a priori view of what the figure should be.
But whatever that figure be, AERA has always felt that it should be adequate for airport operator to get back his investment. Once that is assured and then how it is arrived at is a matter of mechanics.Till in our view is mechanics.Whether it is single till or shared or dual till is a matter of mechanics. It is unclear to me why that should be a matter and not the required rate of return.
DIAL is calling 25 percent a ‘good quality of return’, which, I suppose, can be reinvested into the airport.
There are two separate issues here.One is fair rate of return on pure economic theory: we’re not concerned how that money is invested. It could go in dividend, return earning or anywhere.What that return should be depends on the system for the airport. Project specific risk under economic theory should be taken care of in cash flows, while systemic risk, which should be reflected in a Beta calculation.
In shared or hybrid till, some amount of non-aero revenues remain in the airport operator’s hands.There are two further assumptions.One is the EBIDTA for non-aero is substantially higher than that of aero.Part of the reason is that the asset allocation of aero and non-aero is heavily in the favour of aero.In Delhi the asset allocation is 90 percent aero and 10 percent non-aero. But the revenue for non-aero is about 40-50 percent of the total revenue.If asset allocation is so skewed, but revenue is almost half, then obviously rate of interest earned on non-aero part is substantially higher.Now take a case of 16 percent on single till. On 50 percent shared, depending upon revenue and all that, assume the rate of return airport is getting 28 percent effectively.
On the practical side, the passengers pay more so that the airport operator gets a reasonable rate of return.Passengers also pay 100 percent of non-aero revenue.So if we fix any rate of return, the passenger pays more than the fair rate of return.The question is whether he should.
Are you optimistic that things will turn around for airlines because of this kind of mechanism, whether it is development fee or other kind of pricing regulations?
An investor looks at transparent and stable regulatory environment.We believe that our order of 12 January and directions of 28 February give a transparent stable and predictable regulatory regime for airport.In many of our stakeholders’consultations, the point that has been deliberately and with responsibility brought up is that the AERA regime is unpredictable.
I have not been able to understand the unpredictability part. So far I do not have any concrete example as to the element of that unpredictability. But then, for example, what the ROE will be certainly is unpredictable in the sense whether it is 16, 14 or 18 percent would depend on the risk factor.No airport regulation around the world has the predictability that I will give you 16 percent.What is predictable is the methodology of going into the process of determining.
What about tariff regulation of ground handling which has not really opened up because of security reasons?
Ground handling is aeronautical service.AeroÂnautical services tariffs have to be regulated and the regulation has to be done by AERA.We have not gone into detailed regulation but we have gone into what can be loosely called light-handed regulation.
Light handling means provided that there is competition, defined as two or more independent service providers.Then we approve the rates which have been suggested by them.What happens is that it is a bouquet of services: airport landing, parking and housing charges.So we do not want to go in for price cap regulation.
Tariff hike
“Fair rate of return is important to trigger developer interestâ€
After declaring a Rs 229 crore loss in Q3 2012, Delhi International Airport Limited (DIAL) has asked for a tariff hike. If this does happen, it would be the first time since AERA came into existence in 2009, and only the second since 2000. DIAL responded to our questions via email through a company spokesperson.
You have recently stated that DIAL will incur losses after the AERA-mandated airport charge hike of 334 percent. Do you believe that the AERA has allowed a fair increase under the new ADF ruling? Are you happy with AERA’s method of arriving at the hike figure?
It is important to note that AERA is yet to approve the tariff.The consultation paper is only a proposal for stakeholder response.That said, DIAL feels that various issues need to be addressed by AERA which include:
1.The methodology of computation of cost of equity has various lacunae, which need to be rectified.
2.A fair rate of return has not been provided to land security deposits used for financing the project.
3.The traffic forecasted by AERA is much higher than the one forecasted by other independent bodies like ICAO, ACI etc. In some cases it is as much as 50 percent higher than comparable.
4.The assumptions for forecasting commercial revenues are not consistent and ignore actual achievement and leads to overly ambitious targets.
Is there scope for expanding your non-aero activities to reduce the margin of loss?
DIAL has a focus on growing non-aeronautical revenues, which is not dictated by the regulatory outcome.DIAL will definitely continue to make full efforts to maximise non-aero revenues.This is fully reflected in our submission to the regulator in terms of targets on non-aero revenues.Assuming overly ambitious targets will only moderate aeronautical revenues and lead to losses in DIAL.
AERA has said that they are keen that the interest of the airport operator should be adequately safeguarded by a fair rate of return, but what a fair rate of return should be is a matter of debate. What, according to you, is a fair rate of return?
Fair rate of return is determined by a scientific methodology of CAPM model. This model considers the risk-free rate of the country reasonable premium for equity and the inherent risk for the business as compared to the index stocks. Unfortunately, there are no listed airport stocks in India which can provide a benchmark. For DIAL, an independent assessment was carried out by international experts Leigh Fisher and they recommended a rate of 25 percent. However, we have requeÂsted for a rate of 24 percent from AERA.Similar analysis was also carried out by KPMG and they also have recommended a similar range.Provision of a fair rate of return is very important to ensure appropriate incentive for developers to come into the sector and ensure long term investment in the sector.
On another front, do you agree with the current policy on ground handling, or would you find it somewhat restrictive to operations?
The new policy is also required keeping in view safety.We fully support the new ground handling policy considering safety and also for bringing in efficiency, competition and benefits of scale of operations to the industry.
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