NICHOLAS IONIDES / SINGAPORE
In a nine-page special to coincide with Aviation Expo China in Beijing from 17-20 September, we begin by looking at China's aviation market, which has seen more change in a short period than any other country
In recent years many of China's airlines have merged as part of a sweeping consolidation exercise. Its dozens of state-owned manufacturing companies have revamped their operations, airport and air traffic management infrastructure is being improved, the regulatory environment is being radically overhauled and ground-breaking liberalisation efforts are being tested.
This is necessary as the still-developing market continues to expand and many believe the revamp will be a success because China in no small part can draw on the experience of other countries.
"They are consolidating 20 years of evolution in the European and North American markets into just a few years," says Derek Sabudin of the Australia-based Centre for Asia-Pacific Aviation. "It hasn't been an easy process, but it has occurred more quickly than we thought it would," he says.
The most visible element of the market's radical overhaul has been consolidation of the airline sector - a massive undertaking.
In the late 1980s China split the former Civil Aviation Administration of China (CAAC) airline into six regional arms, creating Air China, China Eastern Airlines, China Northern Airlines, China Northwest Airlines, China Southern Airlines and China Southwest Airlines.
Deregulation, China-style
The industry was further deregulated as provincial and municipal governments were allowed to establish their own carriers. Many did so with just one aircraft and no airline experience, causing safety troubles and financial woes for the industry as a whole, just as domestic traffic was growing at over 10% annually.
The CAAC began to consider consolidation in the early to mid-1990s after a spate of high-profile accidents, and at a time when more than 30 airlines were flying in China, saying over-capacity and unviable ticket discounting were causing huge losses to the industry. However, only a handful of small mergers took place, causing the CAAC to get tough - especially after the Asian economic crisis that began in mid-1997 pushed more airlines into the red in the following two years.
In July 2000, the CAAC announced that the 10 carriers under its direct administration would be merged into three large groups, around Air China, China Eastern and China Southern, in a move aimed at eliminating "disorderly" competition.
Airlines immediately began scrambling to find partners, and under the consolidation blueprint that followed, Air China agreed to merge with China Southwest and China National Aviation (owner of Zhejiang Airlines); China Eastern's parent agreed to acquire China Northwest and Yunnan Airlines; and China Southern's parent agreed to take over China Northern and China Xinjiang Airlines. China Eastern also acquired Great Wall Airlines as part of the process.
Integration efforts have been moving ahead since late last year, and eventually the 'big three' will control around 80% of the market. The mergers are not the only ones in the country, however, as second- and third-tier regional and provincial airlines have also been seeking partners.
Fast-growing Hainan Airlines has taken over Changan Airlines, Shanxi Airlines and China Xinhua Airlines, becoming the fourth-largest airline grouping in the country. And some of the smaller "independents", such as Shandong Airlines, are now seeking equity partners among the 'big three' to help ensure their very survival.
Some regard the consolidation work as a return to the past for China, but for the CAAC it is a step forward. Larger, stronger airlines will result and this is necessary in a world where liberalisation is unavoidable.
"We can't say whether or not it will be a success as the consolidation process is still going on, " says a CAAC official in Beijing.
"But it is a step forward. The airlines need to consolidate so we can build bigger and stronger airlines at home, but also so they can compete with foreign airlines."
The CAAC has given up ownership of the airlines under its direct control and is now focusing solely on a regulatory role. Ownership of the enlarged airlines has been transferred to other government agencies.
The CAAC is also taking steps to reduce internal bureaucracy and speed up decision-making. It will abolish 24 local arms, leaving only seven CAAC "regions" across the country. Aviation service companies, such as jet-fuel supplier China Aviation Oil Supply, are also being restructured, while management of most airports is passing into the hands of provincial governments.
China is also liberalising air services regulation. It has long maintained restrictive air services policies to protect its state-owned airlines, but that is changing. The CAAC, which negotiates bilateral air services agreements for the government, has been giving foreign carriers progressively more rights to operate to the country's gateway airports at Beijing, Guangzhou and Shanghai.
More competition
Additionally, China has been signalling its willingness to open up further and allow more competition between foreign airlines and the country's major carriers. Earlier this year, Singapore Airlines became the first foreign carrier to win rights to operate services beyond China to a third country. Its cargo subsidiary, SIA Cargo, has been operating fifth-freedom services to Chicago via Xiamen and Nanjing since May.
This was seen as a small but important first step and authorities have hinted that similar rights could be awarded to other carriers, possibly through the booming commercial city of Shanghai.
Now a more liberal policy is being pushed through. Authorities recently agreed on a ground-breaking "open skies" regime for the southern island province of Hainan that will see foreign airlines given unlimited rights to operate passenger and cargo services to and beyond the province.
No changes will be required to existing bilateral air services agreements between the CAAC and other countries. Foreign airlines will not be allowed to operate from Hainan province to other points on the Chinese mainland, however.
The liberalisation is seen as experimental, and CAAC officials say the scheme could be applied to other parts of the country if the Hainan test is a success.
China has put liberal ownership restrictions in place in recent years, allowing up to 49% foreign ownership of the country's airlines, having raised the ceiling from 35%, although a single foreign party will still be limited to 25%. It is also widening financial channels by seeking foreign investment in airports to help improve infrastructure and management, partly by allowing airport operators to raise cash through initial public offerings.
Improved safety
The CAAC has at the same time focused heavily on improving safety, and is being conservative about allowing airlines to expand too quickly. Millions of dollars have been spent upgrading the country's air traffic management systems, while the major gateway airports have been upgraded and smaller airports are being improved, particularly in underdeveloped Western parts of the country.
While there is reason to be positive about the way China's aviation sector is progressing, there is much that is still frustrating in the massive market, say Western industry executives. The country's economy remains a planned one but plans change, and sometimes with little warning. A case in point is when small passenger airlines were told in 1999 to aggressively add regional jets to their fleets to help create a US-style "hub and spoke" system. Many did so, leading regional jet manufacturers to pump funds and resources into the market to support sales and marketing efforts. But then China stopped approving regional jet deals.
Early in 2001 the government introduced tariffs of nearly 23% on purchases of regional jets with a structural weight of less than 25t in an apparent attempt to force foreign manufacturers to place more production contracts with local industry. The taxes made it all but impossible for Bombardier, Embraer and Fairchild Dornier to sell their products in China. But Western companies see little choice but to stick around, given the huge sales potential.
Domestic aerospace manufacturers have also seen major changes since the 1999 split of the former Aviation Industries of China (AVIC) giant, with its more than half a million employees, into two separate entities. AVIC I, or China Aviation Industry Corp I, focuses on large- and medium-sized aircraft while AVIC II focuses on smaller aircraft and helicopters, in addition to manufacturing non-aerospace-related equipment, through component manufacturing deals and their own aircraft manufacturing programmes.
Both conglomerates have dozens of subsidiaries and research institutes and are seeking foreign partnerships to keep their plants operating. As well as manufacturing turboprops and helicopters, they are focusing heavily on regional jet development - AVIC I is working on a regional jet of its own, dubbed the ARJ21 (see P47), seating 79-99 passengers, while AVIC II has formed a joint venture with Embraer to build the Brazilian company's 50-seat ERJs in China.
Both state-owed aerospace manufacturing giants can see the bullish growth forecasts for the Chinese market and want a piece of the pie. There are forecasts of hundreds of regional jet sales in China over the next 20 years.
AVIC I research institute Aviation Industries Development Research Centre of China forecast late last year that the country's airlines will add 1,762 airliners to their fleets in the next two decades, of which 575 will be regional jets seating 100 or fewer passengers. The research institute based its forecasts on expectations that revenue passenger kilometres will increase by an average of 8.2% annually over the next two decades.
Growth forecasts
The CAAC has also forecast strong growth, predicting average annual increases in Chinese airline traffic of around 10% in the years ahead, based on 7% economic growth per year. By 2020, annual revenue tonne kilometres (RTKs) for the country's airlines are expected to reach 84 billion, compared with 16.2 billion last year, ranking China's air transport market second in the world, according to CAAC minister Yang Yuanyuan. He says that by 2010 annual RTKs should reach 30 billion while passenger numbers should reach 140 million and freight volumes 4.7 million tonnes.
For 2002, the CAAC reported year-on-year RTK growth of 14.9%, and growth in the number of passengers carried on Chinese airlines of 12%, to 84.25 million. Cargo throughput also increased, by 15.8% in 2002 to 1.98 million tonnes, and freight traffic is expected to grow faster than passenger traffic in the years ahead as the country's exports grow, particularly since its entry into the World Trade Organisation late in 2001.
This year's passenger traffic figures have been affected by a drop in demand during the SARS outbreak, but recovery has been much stronger than expected and full-year growth is still likely.
China has been more progressive than many give it credit for, but the regulatory authorities admit more needs to be done. There is also the question of how all the infrastructure improvements will be paid for. "The qualifications of the personnel still have to be improved dramatically, and it is a tough task ahead for us. We are working hard and pushing forward and still catching up - with the government regulations, the airlines' business and the airport development - and we are still learning from the Western countries and Western experiences. There is still a lot of work to do," says the CAAC official.
Source: Flight International
