The airline has not posted a profit since merging with former duopoly partner Indian Airlines in 2007 and relies on handouts from New Delhi to survive.
It is behind on its payroll obligations and was forced one day last month to cancel a handful of flights because it had not paid its fuel bills.
Air India and 26 banks are in talks to restructure $4 billion of working capital debt in a deal that would force lenders including State Bank of India to accept equity in the carrier and cut lending rates to about eight percent from 11-13 percent, saving it $133 million in interest costs.
Banks are not happy about the plan but may have no choice.
“There is no other option for banks but to go for it. But what they are asking for is not reasonable,” said a banker involved in the ongoing negotiations. “If it is reasonable, we will approve it,” he said.
Even if it can persuade banks to revise a payment schedule for $3 billion in local currency debt due on June 30, Air India needs a drastic revamp or privatization that may require more money and political will than the government can muster.
With New Delhi opposed to privatization but unwilling to put it out of business and banks poised to agree to a restructuring for lack of a more attractive option, Air India may well limp along in its current zombie state.
“Fundamentally, Air India has reached a dead end,” said Kapil Kaul, chief executive for the Indian subcontinent and Middle East at the Center for Asia Pacific Aviation (CAPA).
“From a business case standpoint it should have ceased to operate a few years back had it been a private company.”
Air India lost more than $1 billion in the year that ended in March 2010, the last year for which it posted figures. Its domestic market share has dropped to fourth from third, behind private sector rivals Jet Airways, Kingfisher Airlines and budget carrier IndiGo.
A recent 10-day pilot strike forced it to cancel 90 percent of domestic flights, costing it nearly $56 million , further denting an already battered image and prompting it to lure back customers with costly discounts.
Air India, which is scheduled to take delivery of the first of its 27 Boeing Dreamliners by the end of the year, may defer some deliveries, according to people familiar with the matter. The carrier itself says the orders are on track.
The government of Prime Minister Manmohan Singh has been pushing for the airline to be restructured, but has otherwise been quiet on its future.
An earlier turnaround plan by the airline was rejected by creditors and the government as unrealistic. Air India then hired consultants Deloitte Touche Tohmatsu to come up with another proposal.
The latest plan would focus on a hub-and-spoke route model, cut costs by redeploying staff and unload non-core real estate. It plans to lease some of the 14 vacant floors in its landmark building in south Mumbai to raise about $1 billion over five years, according to a banker.
“It’s a Catch-22 situation for them,” said one person familiar with the plan. “On the one hand you require more investments to regain market share, but your financial position does not allow you to invest.”
And rivals are investing heavily in an Indian aviation market growing nearly 20 percent a year.
Last Thursday, budget carrier GoAir said it ordered 72 Airbus planes worth $7.2 billion. Earlier this year, IndiGo placed a $15.6 billion order with Airbus for 180 planes in what it called the biggest-ever commercial jet order.
Air India has more than $9 billion in debt as well as outstanding dues both to airport developers and state oil firms, which since December have forced it to pay for its fuel as it uses it, not on credit.
Lenders include ICICI Bank, a private sector player that in January won a mandate to refinance loans worth 55 billion rupees ($1.2 billion), and Bank of Baroda, with exposure of 38 billion rupees, a banking source said.
State Bank of India has a comparatively modest exposure of 12 billion rupees to Air India. SBI’s investment banking arm is managing the debt revamp.
According to the restructuring plan, part of the debt would be converted to long-term loans at fixed rates of interest with the remainder converted into preference shares to be redeemed after 15 years, giving the lenders equity in the airline.
Air India’s more-than $3 billion in overseas debt, held by lenders including Citibank, Standard Chartered and JP Morgan, is not part of the restructuring.
There is recent precedent for such a deal. Earlier this year, rival Kingfisher ceded a 5.68 percent stake to ICICI and a 23.4 percent stake to a group of 13 banks led by SBI as part of a debt restructuring.
Bankers say the Kingfisher deal was comparatively easy given what they believe are brighter prospects for the private sector carrier controlled by beer and liquor tycoon Vijay Mallya.
Indian banks rarely demand a major borrower’s assets and go to great lengths to avoid classifying a loan as non-performing.
Civil Aviation Minister Vayalar Ravi said recently that a restructuring plan had been approved by bankers and would head to the cabinet in coming weeks, although bankers told Reuters they have not yet signed off on it.
“From our side the plan was ready quite some time back,” said an Air India spokesman. “The next step is to send it to the government.”
In a letter to staff last week, Air India’s chairman, Arvind Jadhav, apologized for the delay in salary payments.
“You are well aware that Air India is passing through a very challenging and critical phase. Increasing debts, mushrooming interest burden and increasing fuel costs are financially crippling the company,” he wrote in a memo obtained by Reuters.
Beyond buying breathing room from its bankers, Air India must tackle a bloated cost structure, a difficult task given a workforce that is heavily unionized.
Air India has 28,000 permanent staff, double Jet’s headcount. It operates 127 aircraft, compared with Jet’s 115.
Trimming unprofitable routes would be politically difficult because local officials would object to losing flights and such a move would go against the airline’s mandate as a public utility.
The airline’s former chief operating officer, Gustav Baldauf, an Austrian, quit his post in February less than a year into the job after he gave a newspaper interview in which he was quoted as speaking out against government interference in Air India’s day-to-day operations.
“Privatization or denationalization will not be politically acceptable. The politics of the day will not allow it,” said D. H. Pai Panandikar, president of the research group RPG Foundation.
“They are overstaffed and it is very difficult to correct that situation unless they come out with bold policies, but that the government would not want to do,” he said.
Founded in 1932 by J.R.D. Tata, who headed India’s leading business family, Air India was taken over by the British colonial government in 1946.
For decades, it had little competition and the few Indians who could afford to fly had little choice. With India’s boom that began two decades ago, incomes have surged and New Delhi has opened several sectors, including aviation, to more players.
But just as India’s creaky state phone companies, infamous for poor service, have been swamped by private sector firms, Air India has been left behind by rivals that compete fiercely.
Competition on Air India’s bread-and-butter overseas routes is intensifying. This month, IndiGo said it will begin international flights, starting with Dubai, Bangkok and Singapore.
New Delhi is in the midst of a plan to sell stakes in dozens of state firms, but Air India is not on the list. At the same time, a deficit-strapped government will have a hard time justifying throwing money at a continually loss-making firm.
Even if it could attract fresh investors, full privatization for Air India is unlikely given political constraints.
“It is almost unavoidable to privatise Air India or at least rope in a private enterprise even if the government remains a stakeholder,” said Hikmat Mahawat Khan, a Netherlands-based consultant at the Center of Excellence Aviation of Capgemini Consulting.
“It’s current form is not sustainable in future.”
