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Business News/ Opinion / Online-views/  Shipping: Will domestic fleet reach 43 mt by 2019?
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Shipping: Will domestic fleet reach 43 mt by 2019?

Current norms require India-based shipowners fly Indian flag. That law prevents access of capital for the majority of Indian shipping firms

The government introduced a scheme in 2014 that allowed Indian owners to register vessels under a foreign flag as long as 50% of their existing fleet is under Indian flag. Photo: Bloomberg Premium
The government introduced a scheme in 2014 that allowed Indian owners to register vessels under a foreign flag as long as 50% of their existing fleet is under Indian flag. Photo: Bloomberg

In December 2014, India’s deputy shipping minister Pon Radhakrishnan announced in Parliament plans to grow the domestic shipping fleet from 10.3 million tonnes (mt) to 43 mt by 2019. Has the fleet grown at the required pace to meet his target? The answer is no. As an Indian, I would feel proud if the Indian-controlled fleet grew to that level. Having said that, it will be impossible to raise the funds required to grow the local fleet to that level in the current environment. Or at least, foreign financiers, who do the heavy lifting in terms of providing capital to Indian shipping companies today, are unlikely to support that level of growth in the Indian fleet. Major changes are required and I shall highlight some of them below.

The Indian flag is unfortunately not an acceptable flag for the vast majority of global shipping financiers.

The current regulations require India-based ship-owners fly the Indian flag. That law, which is unique from a global perspective, prevents access of capital for the majority of Indian shipping companies. Foreign flag vessels controlled by Indian entities should be given the same cargo preference as Indian flag vessels.

An exception could be made for say crude oil and liquefied natural gas (LNG) tankers, which can potentially be requisitioned by the national government at a time of conflict (requisition being the principal benefit of flagging under a national flag).

It is after all highly unlikely that the government will find it necessary to requisition, say, an anchor handler (used to support offshore oil drilling operations) at the time of conflict. This does not have as much of an impact on big shipping companies, as the foreign financiers are able to overlook the inherent weaknesses of the Indian flag.

This, however, has a huge impact on the smaller companies who have no access to much required (competitive) foreign capital.

The government introduced a scheme in 2014 that allowed Indian owners to register vessels under a foreign flag as long as 50% of their existing fleet is under Indian flag. Such a restriction would also apply to, for instance, investor owned single purpose companies (similar to German KG and Norwegian KS structures, which are ship funds). Ship investment funds are a huge source of capital for the shipping industry.

For example, 50% of the world container fleet is owned by these single purpose companies or investor-owned funds.

Requiring single-purpose companies to be registered under the Indian flag would mean that this industry has no hopes of getting off the ground in India, as debt financiers in particular, would continue to be averse to financing Indian flag vessels. Indian owners who could have benefited from access to these funds would be the losers.

The reasons that the Indian flag is not acceptable globally are manifold. They include: i) It is only possible to register a principal and interest mortgage as opposed to an account-form mortgage. A principal and interest mortgage does not allow financiers to recover amounts relating to repossession expenses which are normally several million dollars. ii) Mortgage registration can take several months until after a loan is drawn-down. The current norm is to provisionally register a vessel, whereas worldwide the norm is to register a full mortgage at the same time a loan is drawn-down. iii) Protracted time for auction: A vessel is a wasting asset and it would typically lose several million dollars in value idling after an arrest. Financier-friendly jurisdictions allow for pendent lite (awaiting the litigation) sale of vessels within 2-4 months of arrest (court proceedings can continue after vessel auction). This is not the case in India where courts do not allow auction until the full court proceedings are completed, which can take years. It is therefore not commercially viable for financiers to arrest vessels in India.

It is indeed unfortunate that India is a market where financiers feel they will have to spend years following an arrest before they get auction proceeds. The risk return is just too high in an environment where financiers make no more than 1-2% margin over their own cost of funds for shipping loans. This certainly does not help in attracting capital to India’s shores.

Capital controls: Shipping by its nature is an international business and large international transfers are a daily occurrence. This is challenging in an environment with significant capital controls. Further, external commercial borrowings (ECB) loans have to be of a certain margin and average life in order for local companies to avail them—a unusual requirement in the international context. Additionally, restructurings are impossible in an environment where one has to meet the central bank’s norms. Shipping is a highly volatile industry and restructurings are extremely common, so these requirements significantly add to the cost of doing business in India.

Tonnage tax: The majority of profits in shipping globally are not made chartering ships, but rather by sale and purchase of ships since the industry is highly volatile. The tonnage tax (a levy based on the cargo-carrying capacity of a ship) law in India requires that a vessel must remain under ownership for 10 years for an owner to avail tonnage tax.

This is unusual in the international context and prevents owners from selling ships without incurring a significant tax hit. Investors would indeed try their best to avoid registering vessels in India, with this requirement.

Tonnage tax needs to be brought in line with what is prevalent globally in that shipping income cannot be taxed regardless of the number of years a vessel is owned.

Gautam Khurana is managing director at Singapore-based Shipping Finance Advisors Pte Ltd.

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Published: 04 Jan 2016, 01:06 AM IST
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