The potential for developing a domestic MRO sector is immense, especially given the steep growth curve the in-service aircraft fleet of Indian airlines expects to achieve. Despite the temporary hiatus due to the COVID-19 pandemic, the in-service fleet anticipates a compound annual growth rate (CAGR) of 5% p.a. against the pre-COVID-19 estimate of 8% p.a. over the next five years. In 2019, there were around 31,200 in-service aircraft across the world. The Indian subcontinent represented 3% of that global fleet (980 aircraft), and India alone represented approximately 2.3% (702 aircraft). With the current pending order book of around 900 aircraft for Indian airlines, the underlying market prospects are huge.
Strides in the right direction
We strongly believe there is a pragmatic approach to developing the requisite means within the country to meet all its MRO requirements. The government of India has displayed strong advertency towards this sector by taking many necessary steps in this direction:
- Reducing the indirect tax rate applicable on MRO services. A March 2020 reduction in the indirect tax rate (GST) on MRO services from 18% to 5% was a much-needed boost for advancing this country's segment.
- Amending the definition of “place of supply” of services. An amendment to identify the “place of supply of service” as the “location of recipient” will attract an additional tax liability of 5% for Indian airlines on availing services from foreign MROs (since it will be a service provided within India). This might discourage the use of foreign MROs by Indian airlines in the long term, without any immediate impact, since the dependence on foreign MROs shall continue until the domestic MRO industry can match its foreign counterparts in size and competency.
- Aligning policy with regard to the applicability of the dividend distribution tax. The taxing regime for dividends has been aligned further with international practice wherein “dividends are taxed in the hands of the shareholders.” This alignment has led to considerable relief for foreign shareholders, resulting in tax on dividends at lower rates applicable as per tax treaties. It has also enabled them to claim a tax credit in their home country.
The next key reforms required as the most pivotal stepping-stones on this journey:
- Resolving tax anomalies on the import of materials, spare parts, tools, and test-benches. This resolution is especially important in view of the fact that engine and component MRO, which are highly material intensive, generate almost 70% of total MRO spend. An Indian MRO importing tools and test-benches is subject to 18% GST against 5% charged on aircraft components. Also, imports of consumables like adhesives and paints require a 10% import duty coupled with 18% GST.
- Incentivizing the return of the country’s skilled labor. Despite significant cost advantages and a large talent pool, the country is unable to reap the benefits since most skilled professionals prefer to work abroad (due to the existing fiscal tax imbalances). The brain-drain to countries like France, Germany, Singapore, and Thailand is huge. While skills development is essential for the longer term, this return is the way to go for immediate needs.
The COVID-19 pandemic as a catalyst
Due to the COVID-19 pandemic, we forecast that 2019 levels will not recover until 2023 for the global MRO market.
However, we anticipate MRO demand in the Indian subcontinent to grow at a much faster rate than the rest of the world: displaying a CAGR of 4.7% against the expected global CAGR of 1.9% during the same period. This rate could surpass 2019 levels between 2022 and 2023, making it an attractive investment opportunity for foreign investors, original equipment manufacturers, and leading MROs across the globe to set up a local shop in India.
Time and again, various foreign investors have expressed their inclination toward investing in this sector in India, either by way of alliance for the development of green-field MRO facilities (see Figure 5) or by availing outsourced engineering and research-and-development services, like the strategic partnership signed between Rolls Royce and Infosys in December 2020.
The government of India has provided another substantive incentive by canning the dividend distribution tax to revive the economy and kick-start an investment cycle. Further, the industry has observed a sizeable repatriation of labor back to the country from various countries including the United Arab Emirates, Qatar, Bahrain, and Oman (owing to reduced employment opportunities across the world due to the COVID-19 pandemic).
The road ahead for the MRO sector in India
A thriving domestic MRO sector will be a win-win situation for the country in multiple ways, including:
- A curb on foreign exchange spend (by creating self-sufficiency for the domestic fleet).
- An influx of foreign investments.
- The creation of employment opportunities.
- The improvement in cost-efficiencies for airlines (through advantages arising out of labor pay arbitrage).
- A reduction in foreign exchange risk and savings on ferry costs to the foreign MRO for airframe checks.
A thriving domestic MRO sector is also a critical element in the overall aviation value chain, and it can be instrumental for the industry to flourish in the long-term. However, India needs to create a complete MRO ecosystem to enable airlines to turn to indigenous players from existing foreign service providers.
India’s MRO industry has begun to see some light at the end of the tunnel. The industry’s current state, however, is still wide off the mark before its final takeoff.