NEW DELHI (Reuters) - In the highly price-sensitive Indian aviation market, Vistara, a full-service carrier backed by local conglomerate Tata Sons and Singapore Airlines Ltd SIAL.SI, is betting it can convince passengers to buy higher fares in return for superior service.

FILE PHOTO A Vistara Airbus A320-200 passenger aircraft prepares to land at Chhatrapati Shivaji International airport in Mumbai, India, July 11, 2018. REUTERS/Francis Mascarenhas/File Photo

Though all airlines in India are feeling the pinch - with debt-laden Air India and Jet Airways JET.NS in such a parlous financial state they have been struggling to pay staff salaries on time - Vistara says its upmarket strategy is starting to bear some fruit.

The carrier has narrowed its losses and seen average fares rise this year as customers take to its product offering, including a domestic premium economy class, even though ticket prices at most rivals are falling, Vistara CEO Leslie Thng said in an interview at the carrier’s headquarters.

“We have seen a steady improvement in terms of demand, in terms of load factor as well as in terms of the fare passengers are willing to pay,” said Thng, a Singapore Airlines veteran who previously ran its Southeast Asian regional arm, Silkair.

India’s domestic airline market, the world’s fastest growing at 20 percent a year, represents an enticing long-term opportunity for Tata and Singapore Airlines. But in the shorter term it has turned into a financial sinkhole - high oil prices and a weaker currency are not being recouped in fare prices, driving carriers into the red.

"That is a paradox," Association of Asia Pacific Airlines Director-General Andrew Herdman said of India. "It has a lot of exciting potential but from a business point of view, very challenging." Vistara, which started flying in 2015 and now has 22 Airbus SE AIR.PA A320 narrowbody jets and a 4 percent domestic market share, has struggled financially as it scales up.

It narrowed its losses to $58.9 million in the financial year ended March 31 from $70.9 million a year earlier, according to accounts filed with the corporate regulator this month, but it faces tougher market conditions this year, with consulting firm CAPA India estimating it could lose $150-200 million.

“It was tough. It is getting tougher because of the macro conditions, the higher fuel price, the lower rupee,” Thng said of the operating environment.

GRAPHIC-India's aviation market - tmsnrt.rs/2xlWaet

PATH TO PROFITABILITY

Budget airline IndiGo, the Indian market leader with a 43 percent share, is adding capacity rapidly to protect its dominant position even though fares fell almost 10 percent in the quarter ended Sept. 30.

As a full-service carrier, Vistara is more focused on obtaining a premium ticket price to cover the higher costs of offering perks such as food, a checked baggage allowance and a frequent flyer program.

Vistara sees a path to eventual profitability through plans to launch international flights as soon as it obtains regulatory approvals and to more than triple its fleet over the next five years to give it a larger share of the Indian market, Thng said.

A major strategy shift is to own some of its fleet rather than leasing all of it. Vistara will own 19 jets worth a combined $3.1 billion ordered from Boeing Co BA.N and Airbus earlier this year, and lease another 37, underscoring its growth plans and strong financial support from its top shareholders.

“This is a market that is strategic for them in terms of aviation and this is a market where Vistara will continue to grow and be profitable,” said Thng. “They will have to inject a lot more (capital) going forward.”

Tata [TATAS.UL] and Singapore Airlines this month invested $273.4 million in the airline, according to a regulatory filing.

For Singapore Airlines, the growth in India far outpaces its established markets and Vistara provides a strategic opportunity to build a business in a country of 1.3 billion people and a growing middle class that can now afford to fly.

For Tata, which once owned Air India, it represents a way back into the full-service airline business 65 years after that carrier was nationalized.

The idea is to build up a premium Indian brand that stands on its own, rather than an offshoot of Singapore Airlines, the Singapore carrier’s general manager for India David Lim said.

“I see benefits for Indian customers. It is an Indian product,” he said.

The international route network will be similarly India-focused, Vistara’s Thng said, with the airline looking to send passengers from its New Delhi hub to a variety of international destinations to the east and west - not just Singapore - particularly after six long-range Boeing 787s arrive from 2020.

In India, the government requires an airline to have more than 20 jets before operating international flights. Vistara reached that milestone in June but has been waiting on regulatory approvals before launching into the more lucrative international market.

A government official who spoke on condition of anonymity said Vistara’s hopes of doing so by December appeared optimistic but approvals should be granted within “a matter of months”.

ECONOMY LITE

Vistara’s entry into the market has not been without its challenges. Little more than a year after its first flight, the airline reconfigured its planes to cut the number of business and premium economy seats in favor of a larger economy class.

The Indian market is dominated by low-cost carriers like Interglobe Aviation Ltd's INGL.NS IndiGo and SpiceJet Ltd SPJT.BO, and selling tickets at a premium is particularly difficult in less wealthy second-tier and third-tier cities where Indian regulators require carriers to place 10 percent of their capacity.

“What the full-service carriers have started doing is pricing like a low-cost carrier and downgrading their services value - that is the mistake Jet Airways has made,” Elara Capital analyst Gagan Dixit said.

In August, Vistara added a new economy-lite fare class that excludes a complimentary meal and has a smaller baggage allowance, raising questions over whether it was changing its business model to compete.

Thng, however, said the lite fares were being offered mostly on smaller routes rather than popular ones such as New Delhi-Mumbai, with the intent of giving more price conscious customers the opportunity to get a taste of the premium Vistara product.

“Hopefully they will move up the value chain,” he said. “The economy is still growing. The number of people who can afford to pay, I believe will in the coming years continue to grow very aggressively.”