Indian MRO: The 1.4 Billion Dollar Opportunity

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India prides itself with producing some of the best engineering minds and technical talent. This talent is spread out across the globe and delivers results for companies and governments at home and overseas. Yet when it comes to the highly technical field relating to maintenance, repair and overhaul of aircraft (MRO), India has been lagging. The country spends USD 1.4 billion annually that is paid to overseas providers to maintain aircraft. Largely because of the prohibitive tax structure, uncoordinated policy approaches and a reluctance of private capital to enter this sector. Yet, earlier this year, in a move that caught much of the industry by surprise, this was addressed in a very direct manner. In one fell swoop, the government adjusted the rates of MRO taxation from 18% to 5% via a notification on 25th March, 2020. Further, it changed the place of supply for B2B MRO services to the location of recipient. Finally, the benefit of full input tax credit was extended. While nuances remain to be ironed out, a USD 1.4 billion opportunity is now open for stakeholders.

Until now Indian MROs did not even have a seat at the table

The global spending on maintenance, repair and overhaul (MRO) of aircraft in 2019 was estimated at ~$72 billion dollars. On average, MRO spend accounts 9% – 12% of airlines’ operational costs and with a 3% – 5% increase per annum, the market size is estimated to cross $100 Billion by 2030. In the case of India, the MRO spend was ~USD 1.4 bn in 2019 with most of the commercial aircraft sent overseas for high value inspections and work to be performed on airframe and engines.

Until now, for Indian MRO providers that attempted to compete, it was a lost cause because MRO services were taxed at 18% while the same services if done overseas attracted a tax of 5%. Additionally, no customs duties were levied on import of MRO services from overseas. This severely limited the ability of India’s MROs to compete and they were left competing only for contracts where the labour pay arbitrage made for a more economic proposition. The high-value work including heavy checks on aircraft and engine overhauls continued to be sent to overseas. Consequently, this led to a situation where the infrastructure required for high-value work was never developed and India’s airlines (with the exception of Air India) continued to depend on foreign contractors. Despite labour advantages, a qualified talent pool and exponential growth in airline fleets, Indian MROs continued to be unviable. The nature of the taxation was such that 90% of India’s MRO requirements were imported. The Indian MRO’s did not even have a seat at the table.

 

The grand correction effected earlier this year

After years of whitepapers, conferences and debates the players in the MRO space were disillusioned at best. Private capital was reluctant to enter the space and overseas providers continued to prosper because of policy misalignment. But finally there is light at the end of the tunnel. With new rates of taxation the 18% tax is now slashed to 5%. Further, the place of supply for B2B MRO services is now considered as the location of recipient. This move not only reduces taxes for India’s MRO providers but also provides them full input tax credit (ITC).  At the same time, foreign MROs continue to not be eligible for Input Tax Credit (ITC) as opposed to their Indian counterparts. The issues of subcontracting and taxation thereof have also been addressed.

Clearly, the move is aimed at encouraging India’s airlines to source their maintenance needs from providers within the country and not from providers overseas. With these corrections, India’s MROs now have the opportunity to build competitive offerings

It is the high-value services that hold the most potential

Within the MRO services there are four main segments. Namely: airframe maintenance, engine maintenance, components maintenance and daily and weekly checks of aircraft. Of this, one the most lucrative segment is that of engine overhauls. Indeed, engines and airframes constitute ~50% -55% of the work by value.

The fact that most of the high value work was sent overseas was due to policy distortions and on-ground realities. For instance, aircraft parts were subject to levy of 5%, under the tax code but aircraft parts were also described under various other nomenclatures and classified under different tax chapters as generic items, which attracted GST of 18%. If that was not bad enough, items such as paints, adhesives, consumables etc. that are extensively used in the servicing of aircraft, attracted the highest burden due to their classification. Namely: a GST of 28%. Foreign companies using the same material were not subjected to any tax burden. The justification was that the as the item reaches India in a “finished” state. Finally there was an 18% import duty on tools and spares which further drove up costs of doing business.

As a result, it was never economically viable to perform high value work in the country. But this is the work that is critical. Not only because of the premium it commands but also towards aspects such as technology transfer, advanced setups and the magnifier impact it creates. The time has come for the country to think beyond labor arbitrage and now pursue this work which was lost out to countries in the Middle East, Sri Lanka and Indonesia.

To put this in perspective, for India’s airlines the overnight and transit inspections of the aircraft – are done in-house. The more complex aircraft checks which largely comprise of labour and inspections are mostly outsourced to providers within the country. This solely due to a cost-benefit based on pure labour arbitrage. However, the extensive checks that come at the 6 year – 12 year intervals, and which include the engine and component maintenance, are all sent overseas. This is the area that is of high-value, high potential and commands a strong setup. Whether it is engine test cells or component testing — it is this area that Indian providers can finally tackle.

Comprehensive coordination still required

The challenge in aviation is that any reform requires the alignment of multiple stakeholders. And given the exacting nature of the industry, one is only as strong as the weakest link. In many cases second and third order effects of policy are often different than intended. Thus, post the tax rationalization implementation cannot be assumed to be automatic. Nuances have to be ironed out, recourse avenues have to be worked out and comprehensive and complex coordination carried out.

Outstanding issues that still require intervention include the issue of airport royalties; the issue of location (MROs ideally need to be co-located at an airport with strong connectivity as most of the parts are sourced from overseas); and the outstanding issue of certification of workers. Once addressed this will alleviate concerns for private providers and for private capital to flow into the sector.

With limited MRO capability, until now India has failed to capitalize on the massive potential this sector holds. And this past should not inform the future. As it stands, India’s commercial aviation fleet has doubled in the last decade and is set to double once again by the end of the decade. All of which translates into MRO requirements. Which will require servicing. Ideally within the country.

With the tax policy changes, India’s MROs have for the first time been able to start to see light at the end of the tunnel. A 1.4 billion dollar opportunity awaits.

 

Satyendra Pandey is an India market expert and has held a variety of roles within  aviation. His positions include working as the Head of Strategy & Planning at Go Airlines (India) and with CAPA (Centre for Aviation) where he led the Advisory and Research teams. He is also a certified pilot with an instrument rating.