Market leader Jet Airways (JET.NS) and third-placed SpiceJet (SPJT.BO), which unexpectedly reported quarterly profits last week, were upgraded by Bank of America-Merrill Lynch to 'buy.'

The carriers should post smaller losses this financial year and turn profitable in the year ending March 2014, the bank said on Monday.

"The recent first-quarter results of SpiceJet and our own checking of ticket prices every two weeks suggests that pricing recovery has already started. Airlines appear to have achieved some ticket price hikes in the last three months," it said.

"We expect another hike may come during the third quarter, which is the peak season," Anand Kumar and S. Arun, analysts at Bank of America-Merrill Lynch, wrote in a note to clients.

Passenger yields on Jet's domestic flights rose about 9 percent in the quarter to end-June, while average revenue per passenger at SpiceJet jumped 24 percent. Yield is a measure of the average fare paid by passengers for a particular distance.

Challenges remain for an industry plagued by high fuel taxes and airport charges, stiff competition, subsidised losses at state-owned Air India and regulatory uncertainty.

Kotak Institutional Equities maintained its 'sell' rating on Jet on Monday, citing the company's high leverage, but said improving yields are a positive for the industry. It has a 'buy' rating on SpiceJet, a budget carrier.

"From here, any reduction in costs could lead to significant improvement in profitability as the sector has high operating leverage," analyst Jasdeep Walia wrote in a note.

In the fiscal year that ended in March, of India's six big airlines, just one, unlisted IndiGo, turned a profit while the industry lost a combined $2 billion. (Editing by Ryan Woo)

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