Economy

Why Emirates is flying high

On a recent Emirates flight to Dubai from India, I was surprised when I was asked where I was flying to by the flight attendant. Not the kind of question you would expect while flying any carrier to its hub. Equally surprising was her reaction when I replied Dubai. Shortly afterwards, upon landing at Dubai, the inflight TV screens displayed the flight schedules and gates of other Emirates departing flights which was interesting considering that other flights generally would showcase the sights and sounds of the particular destination.

While these incidents may have caused any passenger to feel unwelcome at Dubai, they subtly explain the reason Emirates is a hugely successful Airline. Emirates is the worlds biggest airline in terms of passenger traffic and operates over 300 flights daily to around 100 destinations from Dubai.

This, however, does not necessarily imply that the success of Emirates is due to Dubai being a major global city where people from all over the world live and work. This is hardly the case. A majority of these passengers use Dubai merely as a transit destination while flying Emirates. Its success relied on providing an alternate route, through Dubai, for connecting major destinations.
The rise of Emirates and the establishment of Dubai as its hub has primarily depended on the superior connectivity at competitive fares it provides. Better connectivity implies more destinations and more flights.
Consider this, Emirates operates around 30 odd daily flights from India and 80 odd to the US. A single stopover at Dubai would suffice to get you from Ahmedabad or Trivandrum to Dallas. Far more convenient than changing 3 or 4 different flights. Emirates also is increasingly preferred for travel between major cities even though direct flights exist between them like London- Bangalore or New york – Sydney. This is because Emirates offers much cheaper fares and a transit at Dubai would also split a tiring long haul journey.

Emirates has also benefited from Dubai. Its ideal location serves as a great connectivity option since roughly around three-quarters of the world are within a 8 hour journey from Dubai. Also, its fantastic airport provides a seamless transit path to your flight unlike some of the congested European airports where departures can be nightmarish. Add to this, Emirates also offers attractive packages for stay in Dubai which can also serve as a holiday appetizer en route to more exotic destinations.

Though Emirates has virtually plotted its own path to success, it has also benefited from a lack of noteworthy premium carriers in the Asia- Africa region. This has led to Dubai becoming an alternative hub for thousands of Indian, Chinese and African passengers whose national carriers are no match to Emirates in terms of quality and service.

But the path ahead might be tricky with rivals Etihad and Qatar Airways growing quickly. Their services are excellent too; Qatar was awarded the 5 star airline tag by Skytrax(Emirates is a 4 star airline).Their hubs; Abu Dhabi and Doha respectively, enjoy the same geographical advantages as Dubai and their airports, undergoing massive redevelopment may outshine Dubai’s in the near future.

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Airliner’s Dilemma

It is no secret that sustained profitability remains a dream for most, if not all Indian carriers. Barring a few sporadic quarters or profit, airlines have mostly suffered losses over the past few years.  The well publicized Kingfisher lock-down and Air India bailout highlighted the consequences of accumulating sustained losses.  The Indian aviation market is in such a tough state that airlines are more focused on surviving let alone return to profits.

So, where does the problem lie? Surely, it cannot be empty seats since passengers traffic continues to increase. In fact Kingfisher was among the top in terms of passenger traffic, when it locked down its operations. Can it be oil prices? But then airlines can increase ticket prices to accommodate the effects of oil prices.

The problem lies in the very approach of trying to survive and not build profits. A classic case of the popular Prisoners Dilemma problem.

Let me quickly brief you about it. PD explains why two people/competitors might not co-operate, even if it appears that it is in their best interests to do so. Let’s say 2 murderers are caught by the police but without sufficient evidence to charge them and are questioned separately. They are promised that they would receive a lighter sentence(1 year) if they co-operate(admit guilt) and a harsher one(3 years) if they don’t. But if one cooperates and the other refuses to accept guilt then the co operative person will face the maximum term(15 years) while the other is let free.

Ideally, both would like to co-operate and get the minimum sentence of one year. But this very thinking would give a greater leverage for one of the persons to deny their murder so that he could go free while the other co-operative guy languishes in prison. Hence, both should rationally refuse to co-operate as this ensures that each doesn’t receive the maximum punishment.

In the current market heavily dominated by low-cost carriers and middle class passengers, ticket prices play an important role in luring people. So, if one airline cuts their ticket prices, naturally other airlines will follow suit lest they would lose their customers. Clearly, this would lead to an ideal solution in terms of passenger traffic for all the airlines since they are similarly priced.

For a better understanding consider the following example.

Airline/ its ticket price A/same A /cut
B/same 50-50 70-30
B/cut 30-70 50-50

(The numbers a-b represent the market share of A and B respectively)

Ideally, the best solution for both A and B would be to maintain their airfares for optimum market share and sufficient revenues. However, the prisoner’s dilemma advises not to increase their airfares though it is in their best interests to do so. This is because; if any one airline increases its fares and the other doesn’t then the passengers would flock to the one offering the better price.

This is what has happened in India all these years. With the presence of low-cost carriers there is immense competition to cut prices even if it is below profitable level. Airlines are looking at every minor opportunity to squeeze their costs to stay in the price race in fear of losing out on passenger traffic.  Add to this the fluctuating oil prices and airport taxes where every minor change can significantly their balance sheets, it becomes clear why the airlines are on turbulent weather. With FDI being introduced, fares are likely to drop further and perhaps it would be the airline with the deepest pockets which shall survive this race to the bottom.

Why fuel prices must rise

As another fuel price hike looms large, it is expected that it would elicit a backlash from many; for every hike in the past has been met with public protests and scornful remarks about the governments that had implemented the hike. In some cases, the government has rolled back the fuel prices immediately after a hike to avoid its collapse.

While the hike can put a stress on the pockets of many, we must understand why fuel price hikes are necessary and how it can be helpful in the long run.

Fuels being the basic energy sources have to be made available to everyone for the nation to develop and the majority of our requirements are met from expensive imported oil. The government of India subsidizes these fuel prices i.e it pays a certain amount of the real price on our behalf so that the millions of poor people can afford to buy fuel for their energy needs. So, the amount spent on fuel subsidies depend on the global oil prices, the exchange rate and the energy demands of the people.  An increase in fuel prices means a reduction in the subsidies offered by the Government.

But why cut the subsidies?

India now suffers a budget deficit of $40 billion which is around 6% of the GDP (for the last year). It means that the net revenue of the Government collected through taxes and government enterprises is lower than the net amount spent by it by $40 billion. To finance this debt, the Government borrows from other countries or sells government bonds to investors, with an interest. To counter this widening budget deficit, the government can either reduce spending or cut subsidies or increase taxes. Reducing spending on areas like infrastructure and healthcare would be disastrous since a growing nation needs better facilities to develop and satisfy its requirements.  Taxes have been marginally increased in the previous budget but its not enough to close the burgeoning deficit. Therefore the only way to enforce budget discipline is to reduce the subsidies on fuel in line with the global crude prices.

Is the budget deficit really important to the economy?

One might wonder how countries continue to prosper in spite of having a budget deficit. For example, India had continued to develop at around 8% in the last few years in spite of having a budget deficit, albeit a smaller one compared to this year and the US which has always been in deficit zone for many is the strongest economy still.  Well, small budget deficits are acceptable due to necessary spending on developmental areas like infrastructure, education, welfare schemes and healthcare. The government can take care of interest repayments so long as the economy is in a healthy state. However, large budget deficits like the current one can affect the economy. To finance large debts, the government has to borrow more and hence repay with more interests.  So, the future budgets of the government would concentrate on repaying the creditors and less on public spending. As public spending falls, invariably development will slow down.

But how did the budget deficit increase?

The budget deficit can increase either due to increased government spending or reduced revenue. In India’s case, the rising crude oil prices, the weakening rupee and the growing energy demand ensures that India has to spend more on fuel subsidies to make fuel available at the same rate to the public.  So, the budget gap widens.  Another significant reason is the weakening industrial sector due to reduced demand from foreign countries thanks to the global economic crisis.

While we may feel the pinch of higher fuel prices, we must realize that this is a sacrifice we have to make to ensure healthy budget deficits and the savings earned from cutting subsidies can be converted to higher public spending in the future. Investing more in developmental areas is always beneficial in the long run than subsiding services because public spending can bring more employment and ensure a steady income for the millions of poor people while subsidizing fuel doesn’t guarantee employment for the poor. This brings an analogous situation to my mind wherein if a teacher would lower his evaluation standards so everyone can get good grades without actually learning the subject much or set high standards which may lead to reduced overall performance but which can make sure that students are more knowledgeable about the subject and improved performance over a period.

On a concluding note, I would like to say that these decisions are being taken by the most educated Indian PM, a Harvard graduated FM, a LSE alumnus who is the economic advisor to the PM and an IIT/IIM/MIT educated advisor to the FM. (I am not taking any political sides but I believe that highly educated people with loads of experience get it right more often than not).

The positive side of the Rupee depreciation

The depreciating value of the Indian currency is a cause of worry for many these days. Much has been said about how this indicates a slowing economy,  growing fiscal deficit,  drying up of capital inflows, trade imbalances etc. (Terms I have always failed to understand). While these concerns are no doubt valid, could the devalued Rupee actually prove to be a boon to the Indian economy presently?

Firstly, let me try to explain the funda behind the effect of currency valuations on global trade.
Lets say A in India wants to sell his product to B in USA. A does his math and finds that by selling his product for Rs 500 he would get a profit of RsX. So he fixes the price to be $10(overseas transactions are generally in USD) keeping in mind the current rate  $1= 50Rs.
Now, say the rupee deprecates to Rs 55. So in effect he receives Rs 550 which means a profit of Rs.50+X.
If the rupee appreciates to say Rs 45 per US Dollar, A would technically earn Rs.450; a lower profit of Rs. X-50.( He could even suffer a loss if X>50.)

Keeping the above in mind, the rupee devaluation could boost the economy by helping the two major driving forces of the economy:
The IT industry and the manufacturing industry; both of which are struggling.

Most of the clients of the IT companies are based abroad, so the major chunk of their revenues are coming from outside i.e in US Dollars. Clearly, the rupee depreciation would benefit them due to larger revenues as explained above. The manufacturing sector would similarly be benefited with higher revenues arising  from exports.

Hence, the depreciated rupee could actually prove to be beneficial to the economy.