* Q3 profit 850 mln rupees vs loss of 1.01 bln rupees yr-ago
* Improved yields help profit
* Seen selling a stake to Etihad soon (Adds details, background)
By Anurag Kotoky
NEW DELHI, Feb 1 (Reuters) - India's second biggest carrier Jet Airways, close to a tie-up with Abu Dhabi's Etihad Airways, swung to a quarterly profit of 850 million rupees ($15.98 million) on Friday on lower costs and rising fares in an under-serviced market.
Jet shares have almost doubled in the past three months as Etihad's plans to pick up a stake in the airline have become clearer.
The Jet deal, if closed, will be the first since India relaxed ownership rules in September last year and allowed foreign carriers to buy up to 49 percent in domestic carriers that are battling stiff competition and high operating costs.
Jet's earnings surprised analysts, who according to Thomson Reuters I/B/E/S, were expecting a profit of 278.5 million rupees. It was the third straight quarter it has exceeded estimates.
The October-December earnings were a sharp turn around from a 1.01 billion rupees loss from a year earlier.
Pricing power in the market has improved leading to a 17.1 percent jump in yields - a measure of average revenue per passenger - and that is likely to continue, Jet said in a statement to the Bombay Stock Exchange.
Kingfisher Airlines, controlled by liquor baron Vijay Mallya and once India's No. 2 carrier, has stopped flying since the start of October, allowing other carriers to raise fares on key routes.
Budget carrier SpiceJet, which is also in talks with foreign airlines to sell a stake, swung to a quarterly profit at the end of 2012, and said it would target a bigger slice of revenue from international flights in the future.
Fiercely competitive Indian carriers are struggling under massive debt, as they have to sell tickets below-cost in a market marred by high taxes on fuel and high airport charges.
"We continue in our endeavour on cost cutting measures, exploring various avenues of ancillary revenues and process improvements across all segments of the business, which will help us improve the business further," Chief Executive Nikos Kardassis said in a statement.
Jet has discontinued flying to many loss-making routes in the past few months, which sometimes meant aircraft getting grounded "in the short term," and that hurt revenue by 550 million rupees, Jet said.
POTENTIAL ETIHAD DEAL
Top executives from Gulf carrier Etihad and Jet met Indian civil aviation minister Ajit Singh and Trade minister Anand Sharma on Thursday, in a sign that a deal is likely to be announced soon.
"Pursuant to the announcement of liberalised FDI (foreign direct investment) policy permitting foreign investment in Indian airline, the company is in discussion with a reputed airline for a strategic investment in the company," Jet said on Friday.
Jet expects to finalise a stake sale deal with Abu Dhabi's Etihad Airways in a week or so, an executive at the airline, who declined to be named, said.
The terms of the possible deal have not been disclosed, but a government source said earlier this month Etihad was in talks to pick up a 24 percent stake in Jet for up to $330 million.
Any deal between an Indian carrier and a foreign airline has to be cleared by the Indian government.
Jet shares closed 0.32 percent up at 623.30 rupees on the National Stock Exchange, outperforming the broader market which fell 0.57 percent.
($1 = 53.1900 Indian rupees)
(Reporting by Anurag Kotoky; Editing by Jeremy Laurence)