Why are India’s Airports so hard to run? | The Daily Brief #364

In today's episode of the daily brief, I'll talk about two interesting stories.

I first talk about the long winding journey of India's airport industry and finally I talk about the credit rating business. Welcome back to the daily

business. Welcome back to the daily brief show by Zeroda where our aim is to simplify the biggest news in the financial markets in a way that's one level deeper as compared to news

channels. I am your host Axara and today

channels. I am your host Axara and today is Friday 5th December.

[Music] Coming to the first story, India's airports are busier than they've ever been. Between 2011 to 2019, they logged

been. Between 2011 to 2019, they logged an impressive double-digit growth rate, reaching a peak of 157 million passengers in 2019. While CO 19 dampened

global air travel, India rebounded strongly in just 3 years and it's expected to continue its excellent run.

It's on the back of this growth that Adani Airports, India's largest private airport operator, said that by 2030, it shall invest $15 billion on airport

infrastructure. This might nudge you to

infrastructure. This might nudge you to think of gleaming terminals, worldclass lounges, and other luxuries. But behind

those polished facads is a complicated, constantly evolving policy experiment.

At the heart of this experiment is a dilemma. On one end, airports want the

dilemma. On one end, airports want the freedom to price and make profits. On

the other, both airlines who pay those fees and the government which wants air travel to be affordable for passengers want those fees to be reduced. This

experiment has changed shape multiple times and understanding it explains a lot of things from why your airport coffee costs so much to how even the largest airport operators can be brought

down to their knees. So first let's try and understand the evolution of Indian airports. To understand the Indian

airports. To understand the Indian airport business, let's take a little history lesson. Coming to the PPP model,

history lesson. Coming to the PPP model, for most of independent India's history, airports were governmenrun. The airports

authority of India or AI owned and operated everything. But these often

operated everything. But these often looked old and dilapidated. And by the 1990s, it was increasingly clear. The

government simply didn't have the funds to modernize our airports. As India

liberalized over the 1990s, airports went down the route of public private partnerships or PPP. This would bring in private capital and expertise while the state provided land and security. Both

would share revenues. In 2006, GMR group won the bid to modernize the Delhi airport while GVK group won Mumbai.

Around the same time, Greenfield Airports in Hyderabad and Bengaluru were developed by privateled consortia. Now

the model seemed to work. These cities

now have worldclass terminals that are also among the busiest in the world. But

there was a catch. The AI got a really high revenue share raking in 46% of gross revenue at Delhi and 39% at Mumbai. Nearly half of every rupee the

Mumbai. Nearly half of every rupee the Delhi airport earned for instance would never come to the private operator behind the scenes. Meanwhile, those

airports require a lot of capex often flooded by debt and often operators found themselves crushed under the burden of rising interest payments. For

instance, GVK Group, the former operator of the Mumbai airport was forced to sell off their airports due to debt and then it was one privatization after another.

By 2019, the government wanted to raise more funds to run their existing airports. That meant inviting more

airports. That meant inviting more private capital, but drawing them in needed a major shift in the business model. And so instead of revenue sharing

model. And so instead of revenue sharing under the PPP model, biders for new airport leases would now pay a per passenger fee or PPF to be paid to AI.

And this gave them transparency. It was

easier to plan around a fixed fee per passenger rather than a percentage of unpredictable revenues. So the

unpredictable revenues. So the government held PPF bids for six airports with a bidder promising the highest PPF winning the right to operate an airport for 50 years. And this

heralded the arrival of a new player, Adani. To the industry surprise, Adani

Adani. To the industry surprise, Adani airports swept all six airports on offer with aggressive bids that more than doubled competitors offers. For

Ahmedabad, for instance, Adani bid rupees 177 per passenger versus GMR's rupees 85. And by 2021, Adani took over

rupees 85. And by 2021, Adani took over ownership of the massive Mumbai airport from the distressed GVK group.

As privatization took over the airport industry, an age-old conflict emerged.

Should crucial infrastructure like airports be run purely for profit or much like railways, should they also be seen as social service? After all,

airports are geographic monopolies. A

city can realistically support only one airport or two at the most. If the city is very big, every passenger from that city has to use them. And this makes airports akin to essential public

infrastructure. If private operators get

infrastructure. If private operators get unchecked pricing power, these passengers will have no choice but to pay them. So this is why despite

pay them. So this is why despite increasing privatization, the government has always regulated how airports make money. To understand this better, let's

money. To understand this better, let's break down how airports earn. This can

broadly be bucketed into two categories.

The first category is aeronautical revenue, which is directly related to flying operations like landing fees and parking charges against airlines, which usually pass it on to passengers. These

are regulated by the airport's economic regulatory authority or AER which sets aero tariffs every 5 years to ensure operators earn a fair return without gouging airlines or passengers. The

second category is non-airrow revenue money from hosting retail shops, restaurants, car parking, advertising, international duty-free and real estate.

In theory, these aren't price regulated.

Airports can negotiate whatever deals they want with tenants. In fact, with the liberalization of the airport business, non-airrow revenue has taken as much importance or more in some cases

as a revenue. Since aerero revenue is generally subject to price ceilings by the regulator, non-arrow offers the only flexible way to make profit. In fact,

over 60% of Delhi airport's business, for instance, comes from non-arrow revenues, nearly triple that of aero revenues. Real estate in particular is a

revenues. Real estate in particular is a massive source of non-airrow revenue.

Big airports sit on hundreds of acres of prime land which can be used to develop projects like luxury hotels, office parks and warehouses. This was a big reason that Adani which already has a

strong real estate business entered the airport industry. Coming to single tail

airport industry. Coming to single tail versus dual tail in practice for the longest time non-arrow revenues were regulated but indirectly. Understanding

this requires grasping one of the most crucial debates in airport policy.

Should revenue sharing be single till or dual till? So imagine you run an airport

dual till? So imagine you run an airport that in a year earns rupees 100 cr in fees from airlines and rupes 50 cr from non-errow sources. Under a single tail

non-errow sources. Under a single tail regime, both revenue streams are pulled together when the AER is setting tariffs. If the airport's non-air

tariffs. If the airport's non-air business is booming, AER will factor that in and lower the landing fees airlines are charged. As the argument goes, non-airrow revenues don't exist

without flights. After all, flying is

without flights. After all, flying is the most important purpose of an airport. Without that, airport food and

airport. Without that, airport food and shopping doesn't exist. So, excess

profits from shops should subsidize flying costs. Under a dual till regime,

flying costs. Under a dual till regime, though, the two are treated separately.

Aero tariffs are set based only on aviation costs. The airport keeps all

aviation costs. The airport keeps all its retail profits without worrying about them hurting plane landing fees.

Single tail benefits airlines and passengers with cheaper flying but limits airport profitability. Dual tail

is the reverse. Airports keep their commercial upside but flying may get more expensive. For a long time, India

more expensive. For a long time, India followed single tail. However, in

December 2015, a crisis reshaped the entire regulatory framework. When era

set Delhi airport's tariffs for 2014 to 2019, it applied the single formula strictly. The regulator determined that

strictly. The regulator determined that the airport was earning too much partly because of an aero tariff hike from earlier and partly due to booming non-ero retail income. As a result, ERA

ordered an approximately 89% average reduction in aerero charges. The user

development fee passengers paid for instance was slashed from rupees 275 to 550 to just rupees 10. Arriving

passenger fees were eliminated entirely.

This left airports deeply unhappy. Delhi

airport argued that this would make operations unviable and trigger loan defaults. The decision was challenged in

defaults. The decision was challenged in court creating years of regulatory uncertainty. In response, the government

uncertainty. In response, the government introduced a hybrid till model in 2016, a compromise between single and dual till. Under this model, only 30% of

till. Under this model, only 30% of non-airrow revenues would be used to subsidize aviation tariffs while the operator keeps the rest of the 70%. The

hope was that this left some incentive for airport operators and some social benefit. India is now one of the few

benefit. India is now one of the few countries where every large airport within its borders is mandated to follow the 7030 model. Elsewhere, individual

airports often have their own arrangements. London's Heathro airport,

arrangements. London's Heathro airport, for instance, operates on single, while many other British airports are either dual or various versions of hybrid dill.

Since the pandemic, airport finances have been getting better, partly due to the hybrid till model and partly due to hikes in aerot tariffs. For instance,

just last quarter, GMR finally scored one of its highest quarterly aida margins. Adani, meanwhile, recorded a

margins. Adani, meanwhile, recorded a 43% increase in Aida in FY25. Netnet,

however, most airports continue to be in the red. Hybrid hasn't done enough to

the red. Hybrid hasn't done enough to change the fact that airports still bleed money every year, regularly recording negative BAT. This is partly because the government continues to take

a massive cut of revenues. Not profit by the way, revenues. Meaning that this is a large and immediate expense for airport operators. These payments are

airport operators. These payments are why AI, a PSU with volatile finances, became profitable in recent years. This

risk continues with the PPF model, albeit in a different way. Now, these

airports have to pay AI for every passenger that enters an airport, losing money unless that passenger uses their restaurants or shops. The second is that airport's dependence on non-arrow

revenues means that they're constantly trying to maximize everything outside of airline fees. Airport restaurants and

airline fees. Airport restaurants and retail, for instance, operate on razor thin margins because they must pay steep rents to the airport operator who in turn is trying to maximize non-ero

income because aerero tariffs are capped. This is perhaps why your airport

capped. This is perhaps why your airport coffee costs so much. Indian airports

also underperform compared to global peers on non-airrow. Major Indian hubs average just $4.3 of non-air revenue per passenger in 2023 24 compared to $7 to

$14 at global airports. Indian travelers

are costsensitive. They browse duty-free but spend relatively little on luxury goods. Indian airports also tend to get

goods. Indian airports also tend to get more domestic passengers rather than international ones who are likely to spend more on a trip. The third reason is one we briefly mentioned earlier.

Airports are debt heavy businesses that also depreciate. Terminals, runways,

also depreciate. Terminals, runways, parking structures, all of them require massive upfront capital typically funded by debt. And that debt servicing often

by debt. And that debt servicing often needs raising more debt. GMR, for

instance, is still paying off its old loans by raising new bonds. India's

airports look and feel premium but behind the scenes they operate as high capex high debt heavily regulated utilities with thin margins even after

privatization. The state regulator faces

privatization. The state regulator faces a constant balancing act. Encourage

private investment while preventing monopoly abuse and keeping air travel affordable and that requires a lot of experimenting failing and trying again.

They've adjusted accordingly too. The

shift from single till to hybrid till was one such idea. The move from revenue share to per passenger fees was another.

But they haven't reached an equilibrium.

Things will get increasingly complex as tier 2 cities take up a bigger share in air traffic as we've covered before. But

maybe the trick as India has done so far is to not figure out a single winning formula but constantly adapt to newer contexts. Coming to the second story, we

contexts. Coming to the second story, we have covered large parts of the financial world before on the daily brief. Banks, stock brokers, mutual

brief. Banks, stock brokers, mutual funds, or even insurance companies.

There's a critical capital markets player though that usually stays outside the limelight. Credit rating agencies or

the limelight. Credit rating agencies or CRAAS. These are the invisible

CRAAS. These are the invisible gatekeepers of finance. They don't lend money or facilitate transactions. Their

core product is an opinion, a credit rating on how likely a borrower is to pay back debt. This simple service has huge implications. A single decision by

huge implications. A single decision by a rating agency can literally move markets. And we saw this in action this

markets. And we saw this in action this August when S&P global ratings upgraded India's sovereign credit rating from BBB minus to BBB the first time in 18 years.

Markets reacted immediately. The rupees

suddenly firmed against the dollar while yields on 10-year government bonds fell by approximately seven basis points.

Despite this power though, CRAAS are poorly understood. So today we decided

poorly understood. So today we decided to learn about them from the ground up.

Let's dive in. So what do credit rating agencies do? CRAAS evaluate the

agencies do? CRAAS evaluate the creditworthiness of borrowers, whether they're governments, companies, or even specific debt instruments. Put simply,

they ask how likely is this borrower to default on their borrowings. Based on

that, they assign a rating. These range

from the highest grade AA indicating extremely low risk of default down through double A, A, and then triple B, the cutoff for investment grade, and

downwards all the way to D or default. A

good rating is a stamp of approval. It

signals to lenders and investors that this borrower is solid and will most likely repay on time. A poor rating, meanwhile, points to significant risk.

But none of this is a guarantee. CRAAS

are just professional sebregistered opinion givers. But in a world that's

opinion givers. But in a world that's constantly on the hunt for safe spaces to park their money, even a mere opinion from a trusted voice can go a long way.

It can move trillions of dollars in capital worldwide by influencing what investors buy and the interest rates that companies pay. There's only so much money that ratings alone can bring in

though. And so many CRAAS have

though. And so many CRAAS have diversified into related services, usually playing off their reputation for research and risk assessment. For

instance, many CRAAS produce in-depth research reports, offer risk management and analytic solutions, provide advisory services, or give out ESG or environmental social governance

ratings. Think of these as side hustles.

ratings. Think of these as side hustles.

After all, CRAAS already pour over companies and government's finances.

They already have a large base of knowledge that they could repurpose into research reports. Apart from bringing in

research reports. Apart from bringing in extra revenue, these additional business lines also help smooth out what can be a rather lumpy business. Structurally

though, these side hustles usually come with far lower margins than ratings.

After all, ratings are where they have pricing power. They are protected by

pricing power. They are protected by regulations and credibility, letting them charge well. These other business lines, in contrast, are all crowded with competition from consulting firms and

boutique analytic shops. A CRA's

business mix then is a matter of what trade-offs it'll accept. Crystal, for

instance, sees 70% of its business come outside ratings. While this makes their

outside ratings. While this makes their business less cyclical, it also means they have the lowest margins in the industry. So, how do they run their

industry. So, how do they run their business? Who pays for ratings? It's not

business? Who pays for ratings? It's not

the lender or investor who actually uses ratings. It's the borrower that pays to

ratings. It's the borrower that pays to be rated. Companies that are looking for

be rated. Companies that are looking for outside money approach a CRA, have them analyze their business, and assign a rating. Now, there are practical reasons

rating. Now, there are practical reasons for this. For one, a good rating can

for this. For one, a good rating can eventually reduce borrowing costs, saving you money. If a rating agency gives you a high grade, for instance, investors that know nothing about your

business see you as low risk and will accept a lower interest rate on your bonds. This is especially important if

bonds. This is especially important if you're a firsttime issuer or not a household name. Second, ratings are

household name. Second, ratings are often compulsory, whether due to regulation or the internal policies of major lenders. Mutual funds, banks,

major lenders. Mutual funds, banks, pension funds, and insurance companies often can only invest in bonds above a certain rating. If you don't have a

certain rating. If you don't have a rating, these won't even consider your debt. Essentially, while giving out

debt. Essentially, while giving out money, lenders are perennially afraid that they might be duped. CRAAS give a signal that they're safe. Hence, issuers

are willing to shell out money for that signal. Naturally, this also creates

signal. Naturally, this also creates conflicts of interest, and we'll get there shortly. So, CRAAS have two key

there shortly. So, CRAAS have two key revenue streams. First, transactionbased fees. Whenever a company or government

fees. Whenever a company or government comes to the market with a fresh bond or loan that needs a rating, the CRA charges an initial fee. This revenue is transactional. It depends on the flow of

transactional. It depends on the flow of new deals, making it dependent on market cycles. When markets are flush with

cycles. When markets are flush with money and lots of companies are borrowing, fees gush in. But when

capital markets hit a dry spell, new borrowers disappear and this revenue dries up. Second, recurring fees. Once

dries up. Second, recurring fees. Once

an initial rating is given, borrowers pay a recurring annual fee for the agency to monitor and maintain that rating. These surveillance fees are

rating. These surveillance fees are usually much smaller than the initial fee, but they repeat every year until the debt matures or is paid off or in the rare case, a borrower decides to

switch. This creates a small but steady

switch. This creates a small but steady stream of revenue. Meanwhile, CRA's

non-rating services also usually generate steady recurring revenue. For

example, they might sell subscriptions to their research or annual contracts for risk assessment tools, all of which bring in recurring revenues. Let's talk

about how the mix matters. The overall

business model of a rating agency then depends on their specific mix of these revenue streams. A business that depends on one-off ratings has better but more uncertain margins. Those that rely on

uncertain margins. Those that rely on recurring or non-rating businesses get stability at the cost of low margins.

Either way, it's solid. A knowledged

asset light business with fantastic economics. CRAAS run on people,

economics. CRAAS run on people, methodologies, and data. They only spend on salaries, offices, and the maintenance of their information databases and technology. They don't

need factories, heavy machinery, or capital investments. And this gives them

capital investments. And this gives them very high margins approximately 30% plus compared to traditional businesses.

Growing this business too doesn't require capital expenditure. You just

need more talent and more deals. As a

result, these companies often have strong cash flows and pay out much of their earnings as dividends. For

example, Care Ratings has historically paid out around half its profits as dividends. Now, let's talk about trust,

dividends. Now, let's talk about trust, the real currency of ratings. So there's

a problem at the heart of this business.

After all, rating agencies are supposed to give unbiased opinions, but are paid by the entity they judge. So

occasionally these conflicts become glaringly apparent as they did in the 2008 financial crisis when instruments that American rating agencies called investment grade turned out to be

hollow. This has happened in India as

hollow. This has happened in India as well. In 2019, for instance, DHFL or

well. In 2019, for instance, DHFL or Dwan Housing Finance Limited defaulted on its debt, shocking everyone. Just

three months before, Care Ratings had graded some of its debt as AAA, indicating that the company was spotless. K's reputation took a bad hit

spotless. K's reputation took a bad hit for failing to flag the risk early, making issuers and investors wary of engaging them. This illustrates a brutal

engaging them. This illustrates a brutal truth. Trust once lost, is hard to

truth. Trust once lost, is hard to regain in this industry. And this is critical because the entire business runs on trust and reputation. In fact,

the real product they're selling is credibility, not the rating itself.

Anyone could give a rating. Investors

only trust the rating if the agency appears competent and honest in its evaluation. If that faith is shaken,

evaluation. If that faith is shaken, their opinion becomes meaningless. Now,

a license alone can't buy this trust.

This is why despite there being seven sebregistered rating agencies in India, the industry is dominated by an oligopoly of three players. Crystal,

IKRA and care who together command approximately 95% of the market. This

concentration is reinforced by the fact that it's only mandatory to get rated by any one agency only. Anyone outside the big three then must essentially fight

them off for business which is an uphill battle. Now there are perception

battle. Now there are perception differences among the big three as well.

Crystal for instance partly owned by S&P Global is often regarded as the gold standard. Its ratings are seen as more

standard. Its ratings are seen as more conservative and credible which means a Crystal AAA might carry a bit more weight with investors than an equivalent rating from a smaller agency. This

prestige allows Crystal to charge a premium for its services. Icra, which is linked to Moody's and care ratings are also respected. But Crystal's rating

also respected. But Crystal's rating processes and scale give it an edge in reputation. And this isn't something

reputation. And this isn't something you're likely to see in an official report, but it's common market chatter.

And reputational edge is everything.

It's why the top three keep the top three spots and the others fight over scraps. From the issuer's perspective,

scraps. From the issuer's perspective, the choice of raider often comes down to trust versus cost. If a company is planning to raise money from the public or from discerning global investors,

it'll likely lean toward a rating from a reputed agency even if it costs more.

For example, an Indian company might insist on a crystal rating because overseas investors look up to them. On

the other hand, if a company already has a few banks or private investors lined up and just needs a mandatory rating for formality, it might shop around for a costefficient deal. This dynamic leads

costefficient deal. This dynamic leads to the rating shopping phenomenon. firms

hunting not just for a good rating but for the agency that'll give it to them with the least hassle. Another factor

reinforcing the dominance of the big players is inertia and switching costs.

Once a borrower has an existing rating from say Ikra, they have an established relationship and the agency already knows their business inside out. If the

borrower wanted to switch to another agency, it means going through the hassle of the analysis process of fresh with someone new, playing a fresh fee, and probably even getting a different

outcome. Unless they're really unhappy

outcome. Unless they're really unhappy with their current agency, most issuers stick with their current CRA for updates and new borrowings. So, here's the bottom line. When you think about it,

bottom line. When you think about it, credit agencies don't need a lot of things to do their business, just honesty and skilled talent. With that

they generate large amounts of cash.

Their asset light model also means most of what they earn eventually finds its way back to shareholders. Their growth

engine is equally straightforward.

Credit growth. The more borrowing an economy does, the more ratings get issued, monitored and renewed and historically credit growth has a habit of outpacing GDP growth. So if India

compounds at 7%, credit could easily compound at 10 to 11% and the rating business that sits on top of this cycle can ride along. But with great power

comes great responsibility. Their

product revenue and margins are all reflective of a single trait, trust. In

the long run, that's the biggest factor that can make or break their business.

Now coming to the tidbits. JSW Steel

will move Bushan Power and Steel's business into a 50/50 JV with Japan's JF Steel for rupes 24,483 cr or $2.72 billion to fund expansion.

JF will invest rups 15,750 cr in phases with the JB targeting 10 MTPA crude steel capacity by 2030. The move follows the Supreme Court's recent approval of

JSW's takeover. Coming to the next

JSW's takeover. Coming to the next tidbit, India imported over 10 million tons of iron ore in Jan to October, more than double last year due to shortages of high-grade or and cheaper overseas

prices. JSW steel was the largest buyer,

prices. JSW steel was the largest buyer, aided by proximity of its Maharashtra plant to ports. Imports are expected to reach 11 to 12 million tons in FI26 if domestic supply doesn't improve. Coming

to the final tidbit, Ola has quietly suspended its food and grocery offerings including cloud kitchens and based deliveries as it restructures its non-core portfolio. The company has

non-core portfolio. The company has fallen to third place in mobility behind Uber and Rapido and is now refocusing on core ride healing profitability after past retreats from Ola Cars and Ola

Dash. You can check out all the links in

Dash. You can check out all the links in the description below. That's all the news I have for you today. Thank you so much for watching and see you in the next one.

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