The Hindu Business Line : ‘Most of the fast growth is happening in Asia’

Traffic and air freight have been shifting eastwards towards Asia. We expect that in the next five years passenger traffic in Asia will be the largest travel market, overtaking the US domestic market.

MR BRIAN PEARCE, CHIEF ECONOMIST, IATA

Ashwini Phadnis

Recently in Geneva

The increasing prices of fuel globally has forced the Geneva-based International Air Transport Association (IATA) to revise its profit forecast for the global airline industry downwards. IATA Chief Economist, Mr Brian Pearce spoke to Business Line outlining the reasons for the downward revision and a host of other issues.

Excerpts from the interview:

Now IATA is forecasting that the global airline industry will report a profit of $5 billion in 2008, down from the earlier projection of $7 billion late last year. What has changed so dramatically for such a reduction?

In fact if you look even earlier, in June last year we were looking at profits of $9.6 billion in 2008. So that is a halving of expected profitability in six months. There are basically three factors that have changed, particularly since August last year. The first is that we saw another major surge in oil and jet fuel prices after end August. Oil prices hit almost $100 a barrel. At that time if you looked at all the oil forecasting groups, the consensus for the price of crude oil in 2008 was $66 and you have almost hit $100 a barrel since then.

The consensus (among the oil forecasting groups) has now risen to $78 a barrel and that is what we use in our forecast and that is obviously a huge rise in costs. This is one of the major factors which has affected our profit forecast.

The second major factor is the credit crunch — that is credit market problems. I think that at the end of August 2007 most analysts had thought that this would be limited to financial companies; the financial institutions would take losses but it would not spread further and damage economic growth very much.

This view has changed partly because we have seen much bigger losses in many investment banks and it is becoming harder for companies and individuals to obtain credit.

The consensus also was that the US economy would grow by 2.5 per cent in 2008 but now that has been revised to 1.5 per cent. Because the US still accounts for almost 30 per cent of the travel market, this is the second major reason for a significant major downward revision.

You mentioned carriers in the Asia-Pacific region increasing their profits. Where do you see it moving and peaking?

What we have seen is that traffic and air freight have been shifting eastwards towards Asia. Most of the fast growth is happening in Asia. We expect that in the next five years passenger travel within Asia will be the largest travel market overtaking the US domestic market.

But it is a slightly different story for profits. It is true that when the industry went into a free fall after 9/11 and profits collapsed particularly in the US, Asia became the most profitable region. It stood up to shocks and delivered some substantial profits for a number of years.

The region, however, found it harder to sustain this during the period of high oil prices.

The region has lower labour costs which means that fuel takes up a much larger proportion of costs than it does in other regions. Therefore, rise in fuel prices, just by simple maths, has a larger impact on Asian airlines.

For 2008 we are negative about profits for all regions. Asia though I think will see its profits decline by a very small amount because we think that this strong traffic growth is going to sustain business and give some scope for offsetting the rise in fuel prices. This is obviously not going to happen in North America.

Asia is a large market. Can you pinpoint the growth expected in India and China?

Clearly there is a huge range of performance (by airlines) in the Asia-Pacific region. You do have some very profitable airlines. Obviously airlines like Singapore, Cathay and Qantas have been hugely successful financially particularly in the long haul business market. The Indian market has massive potential for growth and we are expecting to see continued economic growth to support demand for travel in the region.

I think one of the challenges for all airlines serving the Asian market is to do that profitably.

The big influx of capacity, new aircraft and new entrants makes it a very difficult market. The current consolidation that we are seeing is a very positive trend. It suggests that we are all moving towards the next stage of development of the Indian market and you normally get this when industries are deregulated.

A common compliant in India is that consolidation is good for the industry but bad for the customer as consolidation invariably leads to the demise of cheap tickets.

I do not think this is true. Clearly the big influx of competitors has led to prices being forced down. But in many cases we have seen cost of air travel being forced down below the cost of providing that service which is why we have seen airlines going bust. I do not think that this is in the interest of the passenger. You do not want to see the airline that you are booked on going bust so you do need a sensible strategy. I think it is in the interest of every one that you get some equilibrium.

Just because you have consolidation does not mean a further change in prices. What we have seen in the deregulated markets of Europe and North America is that there are waves of consolidation. The trend of consolidation in real terms continues to be downward because of the constant pressure of new competition. What is going on now is in the long-term interest of passengers.

You talked about negative growth in Asia. What would happen when new aircraft come into the Indian market?

I see most of the risks being in the markets linked to the United States rather than the Asian market. If anything, people have become more bullish about economic growth in the Asia-Pacific region—in India and China.

You have not mentioned losses for the airline industry for 2008.

We are not talking about losses, only reduced profitability as we do not see 2008 as a major downturn like 1991 or 2001. We see it as a slowdown rather than a recession.

We do not see a recession at this point.

The main reason being that in the past a slower US economy dragged down every other part of the world whereas this time much more independent economic growth is being witnessed in India, China and other Asian economies. This is the reason we are predicting that profits will be made.

In India there is a furore over airlines collecting surcharges rather than increasing fares. Is this something you agree with?

In any business you should expect the price of the product to cover the cost of providing that service otherwise you would go out of business. There is a need for airlines to be profitable. Actually, I think that is the underlying intention of the surcharge—to make it clear to the customer that the cost of travel is going up as the airlines have to pay more for fuel.

But are airlines justified in imposing a surcharge?

I can understand how airlines see the rise in oil prices as a tax. This is because the energy prices are controlled by Organisation of Petroleum Exporting Countries (OPEC) who have restricted supply to force prices up. It is effectively a tax. It does not reflect the underlying cost of producing oil or extracting it.

The bottomline is that passengers recognise the total cost of their travel whether this is applied to the surcharge or the underlying fare. I cannot see it make much of a difference.

Is there a worry that aircraft manufacturers may not be able to meet demand as quickly as it is rising and this could also affect the fortunes of the industry?

In a way it was helpful that Boeing and Airbus had reduced capacity because this meant that the industry did not go through the previous surge of aircraft deliveries coming at a time when the market is slowing down.

In many ways reduction in aircraft production is providing a safety valve which would limit the impact of the economic downturn as there would be a limited number of aircraft deliveries.

At the moment, capacity and demand are in a much better balance than in the past which is why we are seeing rising load factors. The reduction of production capacity by the manufacturers post 9/11 has been a contributory factor.