08 September 2011

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Last Part Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

Last Part Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

Chronology of events leading to change in aircraft requirements of AIL

Date Brief Details of Event
30 October/ 3 November 2003
Letter from 43 member delegation of US Congress regarding AIL’s proposed aircraft acquisition forwarded by PMO to MoCA

27 January 2004 PMO forwarded two letters from Boeing (a letter of 17 November
2003 to Secretary, MoCA and a letter of 2 January 2004 to PMO) to MoCA, wherein Boeing indicated that the economics of the acquisition project were strongly dependent on the number of aircraft chosen, and that the technical evaluation could be easily influenced with the change in assumptions on number of aircraft.

19 February 2004
In response to contentions made by Boeing in these letters, AIL intimated MoCA that:
Equal opportunity had been given to both suppliers, and the number of long range aircraft had been reduced from 17 to 10 as it was not economically viable;

The evaluation was undertaken in conformity with AIL’s requirements. The question of giving Boeing a revenue benefit of 7 additional seats (reduced by them to provide the mid cabin galley) did not arise; also, estimation of residual value after 17 years life of aircraft was fraught with risk and the percentage discount offered by Boeing for 10 aircraft was lower than that offered by Airbus;

3 March 2004
Director (S), MoCA intimated PMO that the in-house TENC had evaluated different aircraft types on the basis of identical ground rules, providing fair opportunity to all bidders.
In addition to highlighting the issues raised by AIL to MoCA, he also stated that AIL had invited offers for 10 firm and 7 optional long range aircraft. Boeing had the opportunity for bringing in scale economics into their offer. After due consideration of economics, the AIL Board had recommended acquisition of only 10 A340-300 aircraft as it felt
that acquisition of 17 long range aircraft would not be economically viable.

29 June 2004
Director (S), MoCA recorded on file that there had been some “important developments” as submitted by Secretary, MoCA to the Principal Secretary to PMO that many international carriers were planning direct operations to USA/Canada and the A340-300 aircraft was going out of production in near future. Therefore, AIL needed to
review its proposal and consider suitable long range aircraft for its fleet. Further, it was understood that “Minister, Civil Aviation (CA) also impressed upon AIL in a meeting at Mumbai to examine the feasibility of direct India-US/ Canada flights”.

5 July 2004
AS&FA (Additional Secretary and Financial Advisor), MoCA expressed
ignorance about the purported note of Secretary, MoCA and stated

“I am not aware of the A-340-300 going out of production in the near future, thus calling for a re-look at the choice. The fact that Air India chose to invite offers for this type of aircraft and the Company decided to quote for the same less than a year ago, leads one to think whether Air India chose the right type of aircraft while inviting offers. If the assumption that the aircraft is going out of production is true, Air India is guilty of not having done their homework and the Airbus Company is guilty of unethical business
practice in offering an aircraft that is being phased out. …But it would be worthwhile to get clarifications on these aspects from both Air India and Airbus Company”.

“Minister (CA) in a meeting at Mumbai impressed upon the need for Air India to examine the possibility of non-stop India-US operations. But he never suggested that the present fleet acquisition plan should be dropped and only that option should be examined. Hence, it would not be correct to presume that the new option that would be examined would be ‘in lieu of’ the existing plan. It could be ‘in addition’ as well. Of course, if Air India decides to go in for the option of non-stop India-America operations, this would call for a re-look at the present fleet acquisition proposal.”

Consequently, AS&FA suggested that a meeting (like the one Minister, CA took in respect of IAL) would be in order, wherein the points of view of both AIL and MoCA could be considered, and a consensus arrived at on the future course of action.

August 2004

In a meeting on 2 August 2004 taken by the then Minister, Civil Aviation with Secretary, MoCA and CMD, AIL, it was decided that:

Air India should revisit the proposal for purchase of aircraft and submit a fresh project proposal to the Government at the earliest, which could include the revised requirements.
AI could examine whether the proposal for purchase of short range aircraft for the low cost airline is justified on a stand-alone basis and could be de-linked from the purchase of other types of medium range and long range aircraft for AI. While doing so, AI
should examine whether economics of the proposal for acquisition would be favourable, keeping in view the low-cost and low fare operations envisaged through a separate company. If the proposal is found to be justified and viable, Air India should revert
to the Government at the earliest.

At this meeting of 2 August 2004, the Chairman and Managing Director (CMD), AIL was of the view that although the present proposal did not fully cater to the requirement of AIL’s fleet, the additional requirement of aircraft could be projected separately
through a supplementary proposal after due evaluation. However, it was felt that it may not be advisable or prudent to go through the pre-PIB and PIB exercise in two separate stages with two different sets of proposals for such capital intensive projects. It
would be desirable to take a total and comprehensive view on the fleet of AIL, keeping in mind its plan and growth for the next fifteen years or so.

MoCA communicated the above mentioned decisions on 5 August
2004 to AIL and directed them to revisit the acquisition proposal and
submit a fresh proposal, which would include revised requirements in
view of:

New dimension in the competition on the India/USA route with the introduction of non-stop flights through ultra long range aircraft by competing airlines in South East Asia and the Gulf Region. Unless AIL was able to match this product and connectivity by adding suitable aircraft to its fleet (which was not a part of the present proposal), AIL’s competitiveness, load factors and revenues were likely to be severely affected.

AIL had decided (May 2004) to launch a ‘no frill’ airline called ‘Air India Express’ through a separate company (Air India Charters Limited) to destinations in South East Asia and the Gulf, which would offer lower fare to passengers. Therefore, the current
project proposal may not have taken into account the economics of these types of aircraft if operated on low cost basis and with fares that would be 25 per cent lower than existing fares.

October 2004
CMD, AIL indicated to MoCA that during the AIL Board meeting of 13 September 2004, some Board members indicated that in view of MoCA’s advice, the fleet acquisition programme needed to be revisited in its entirety (including examination of other aircraft types, apart from B737-800, for small capacity short range aircraft). CMD, however, felt that the B737-800 project should be delinked and studied separately and was to be submitted under the banner of AICL. CMD sought MoCA’s clarification in this regard.
MoCA sought clarification from CMD, AIL as to whether the B737-800 aircraft was selected after carrying out the required comparative evaluation on stand-alone basis. AIL confirmed the selection of B737-800 aircraft after comparative evaluation on stand-alone basis

Director (S) noted that “strictly speaking, it is for the AI Board to take a view in the matter. As far as Ministry’s advice... is concerned, there is a suggestion... that AI needs to take a total comprehensive view on its fleet, keeping in mind its plans and growth for the next 15 years or so”.Consequently, a clarification was issued along these lines, with the
approval of Minister, Civil Aviation, to AIL.

24 November 2004
AIL Board considered and approved a revised long term fleet plan for 50 aircraft (two thirds on firm basis and one-third on option basis), apart from 18 aircraft for its subsidiary, AICL. This process of revision took only four months!
he above sequence of events clearly demonstrates that the erstwhile Air India was
advised to revisit its proposal by MoCA into expanding its requirement of aircraft. Whilst their earlier proposal for 28 aircraft had taken two years (from January 2002 to January 2004) to prepare and submit, the revised long-term fleet for 50 aircraft6
plan was completed in four months (from August to November 2004)

The Ministry did not agree (August 2011). It stated that it never suggested to AIL to drop
the present acquisition plan and to pursue a particular option. It was the Air India Board
which resolved to acquire 35 aircraft, with 15 on optional basis. This position was reiterated by the Ministry during the exit conference (August 2011).

The Ministry’s position is not tenable. The sequence of events brought out in Table 3.2 –
“Chronology of events leading to change in aircraft requirements of AIL” clearly brings out the role played by the Ministry in the erstwhile AIL’s proposal being revised from 10 long range aircraft to 50 long range aircraft.

A comparison of the underlying assumptions for the original and revised proposals reveals the following position:

I am not here posting the chart.

Clearly, there was a massive inflation of aircraft requirement (frequency, destinations, and types of aircraft) between January 2004 and August 2004, which is inexplicable
(considering that such a dramatic shift in market requirements/ conditions could not
reasonably have occurred in such a short period of time).

Flawed Assumptions underlying revised project report (50 long range aircraft)
In our opinion, many of the key assumptions underlying the revised project report for
acquisition of 50 long range aircraft (as against 10 long range aircraft envisaged earlier)
were flawed or unduly optimistic:

As depicted in the preceding table, a massive increase in frequencies, ASKM and
destinations were projected, without adequate justification for the increase in such a
short period of time (between January and November 2004). Out of the 50 aircraft being
acquired, 27 were intended as replacement and 23 as incremental. The logic being that
expanding capacity faster than the market / competitors would enable AIL to grow and
increase market share, since the market to/ from India was booming. The assumption
that increase in capacity share would automatically lead to an increase in AIL’s market
share (projected increase from 19% to 30% by 2012-13) was not adequately validated

This leads Audit to agree with the observation thus made by the Department of
Expenditure that ‘a purely supply side response would run into huge demand side risks’
(Table 3.5). Department of Expenditure obviously had reservations and felt the PIB
proposal was ‘supply driven’.

Revenue estimates were made on the basis of one-time yield increase, at constant costs,
of 5 per cent on all classes7

. Further, the core feature of the revised project report was acquisition of 8 Ultra Long Range (ULR) aircraft for providing non-stop services to Chicago/ New York; a further one-time yield increase of 10 per cent (at constant cost) for non-stop services to New York and Chicago was assumed, which, in our opinion, was unduly optimistic. In reality, even prior to this acquisition, the India-USA sector was historically a loss-making sector, and this trend of commercial unviability continued even with the introduction of non-stop India-USA flights.

As per the original proposal (for 28 aircraft), the AIL Board reduced the requirement of
long range aircraft from 17 to 10, as the NPV for 17 long range aircraft on stand-alone
basis was negative. By contrast, the revised TENC Report (April 2005) for 50 aircraft had
a negative NPV for the 15 B777-300ER aircraft. By the stage of the revised project report
(May 2005), this became a positive NPV of Rs. 98 crore (mainly due to inclusion of
“commonality benefit” – through fleet acquisition of different variants of Boeing

Long term traffic growth rate of 7 to 8 per cent was assumed (although the average
growth rate during 1998-2004 was only 6.5 per cent); this was also unduly optimistic.

Whatever chances AI had of increasing market share through increased capacity share
were severely hampered by the MoCA’s decision to liberalise bilateral entitlements from
2005 onwards, benefiting airlines/ countries with huge proportion of 6th freedom traffic
and giving inadequate lead time for AI (after delivery of the aircraft) for gearing itself up
for competition. This is brought out subsequently in the Report

The Ministry in their reply (August 2011) stated that market share was not a complete index of an airline’s performance. In 2004-05, Air India was in no position, with its existing complement of aircraft, to even hold on to its market size, leave alone market share.

The Ministry’s reply, however, did not offer adequate explanations as to the flawed
assumptions underlying the acquisition proposal, as pointed out by us.

I am not writing next pages as its full of just information what happened.

Chapter 4 – again what happened.

Chapter 5 and Chapter 6 what happened

The CAG audit star rating out of Ten
I will give just one star for this air India CAG Report

Suggested Reading –

P – 3 Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

P -2 Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements –

Complete CAG Report - AIR India the Ministry of Civil Aviation (MoCA) and the Bilateral Agreements – Part One

Reality views by sm –
Thursday, September 08, 2011