KEVIN O'TOOLE with CHRIS TARRY at COMMERZBANK, LONDON
The US economic boom finally looks likely to falter, but this time around slowdown may not mean disaster for the world's airlines
Not for the first time, the New Year starts with all eyes trained nervously on the US economy. And although it has defied the pessimists before, this does finally look like being the year when the boom finally falters. In times past that has been the signal for the airline industry to hit the panic button. This time around there are at least a couple of reasons to believe that things may be different.
First, despite the gathering economic clouds in the USA, the smart money is still on a gradual slowdown rather than outright recession. True, the forecasters have been busy with some aggressive pruning of their numbers for US growth after last year's surprise performance of over 5%. Only a few weeks ago the consensus was still for expansion in the 3-3.5% range. But the climate has already changed and the focus is now on markedly slower rates. Economists at Commerzbank itself have recently cut forecasts back to a more bearish 1.8%.
Of course, forecasts made so early in the year may still prove wide of the mark. They are inevitably something of a sighting shot and will only get closer to the actual outcome as the year progresses. That was apparent in 2000. It began with talk of slowdown, but the year has apparently ended as marking the peak of the cycle. Downswings can build in momentum too, but with that warning issued, the probability of a true recession (a fall in the economy over two consecutive quarters) remains low for either the US or world economy.
While most recent forecasts point to a marked slowdown in the rate of economic growth for the major industrial countries, the landing is not expected to be too hard. The expectation is for a deceleration in growth from the 4% or so experienced in 2000 to some 2.8% in 2001. That would still be broadly in line with the long-term trend, given that the moving average has stayed within the 2-4% band over the past decade or so.
A second reason for optimism stems from the numbers within the airline industry itself. Last time recession hit in the early 1990s, not only did it hit hard and fast (thanks in part to war in the Gulf), but it also caught the industry with a huge backlog of aircraft on order. This time there is not the same excess capacity in the pipeline. Although aircraft delivery rates will pick up again to peak in 2002, they remain within a margin of comfort. In the previous downturn the industry had placed some 6,000 jet aircraft orders over the preceding four years of boom, then representing around 50% of the world's in-service fleet. This time around the corresponding figures are 4,250 and 31%. In fact, the "absorption ratio" of new deliveries to installed fleet is falling at present, having peaked in 1999.
| Underlying traffic demand estimates/forecasts | |||||
| Destinations from Europe: | 1999 | 2000e | 2001f | ||
| North America | USA/Canada | 7.3% | 9.4% | 5.1% | |
| Latin America | Caribbean | 8.2% | 9.8% | 5.4% | |
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| Central America | 7.9% | 9.7% | 5.4% | |
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| South America | 7.6% | 9.6% | 5.3% | |
| Asia-Pacific | Central Asia | 4.9% | 7.4% | 7.7% | |
|
| South Asia | 3.1% | 10.4% | 9.9% | |
|
| North East Asia | 3.1% | 8.0% | 5.6% | |
|
| South East Asia | 8.8% | 10.4% | 7.8% | |
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| South West Pacific | 7.2% | 8.3% | 6.8% | |
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| South Africa | 7.3% | 8.3% | 7.4% | |
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| Other Africa | 7.2% | 8.1% | 7.3% | |
| Middle East |
| 5.3% | 7.7% | 6.5% | |
| Total international | 6.7% | 9.5% | 6.1% | ||
| Intra-Europe | 5.6% | 7.9% | 6.8% | ||
| Domestic/national | 6.0% | 7.4% | 6.7% | ||
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| Destinations from USA: | 1999 | 2000e | 2001f | ||
| Latin America | Caribbean | n/a | 9.1% | 5.6% | |
|
| Central America | n/a | 9.2% | 5.6% | |
|
| South America | 4.1% | 9.2% | 5.6% | |
| Europe |
| 5.8% | 8.2% | 4.6% | |
| Asia-Pacific |
| 3.8% | 9.1% | 4.0% | |
| Total international | 4.9% | 8.7% | 4.6% | ||
| Domestic USA | 3.8% | 5.2% | 1.8% | ||
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| Destinations from Asia: | 2000e | 2001f | |||
| Europe | from South East Asia | 14.3% | 10.7% | ||
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| from North East Asia | 12.7% | 6.6% | ||
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| Total to Europe | 13.5% | 8.6% | ||
| North America | 11.7% | 5.0% | |||
| Total international | 12.9% | 7.5% | |||
| Note: 2000=estimate 2001=forcast Underlying demand represents the rise passenger traffic as a consequence of economic growth, excluding the impact of the airline market strategies. Source: Commerzbank Securities/Airline Business TDI model | |||||
It is this familiar balance between demand (driven by economic activity) and supply (driven by fleet activity) which is fundamental to the well-being of the airline industry. And it was in order to model this balance that Commerzbank and Airline Business launched the Traffic Demand Indicator (TDI) last year (see January 2000). The concept that economic growth, measured in Gross Domestic Product (GDP), determines the underlying rate of airline market demand is hardly unusual. Multiples of GDP have been used for years as a rough guide to airline traffic growth. But, in reality, the equation is more complex than implied by the traditional rule-of-thumb GDP multipliers. Estimates have been made that, while economic growth may once have explained around 80%of reported traffic growth, its explanatory power has declined to 60%.Rather more emphasis needs to be placed on the supply/demand equation.
The TDI model attempts to produce a GDP-based number for underlying traffic demand. If the industry raises capacity faster than demand, then it may well fill more seats but at the expense of yields. If seat supply is kept below the level of underlying demand, then naturally fares should start to rise. In short, the TDI number gives the allowed rate of capacity growth at which yields should remain stable.
The experience of the past two years has perfectly illustrated the point. A year ago when the TDI model was first launched, the major US and European carriers had just gone through a particularly painful summer season on the North Atlantic. But that was not primarily due to weak economic growth as both Europe and the USA were growing relatively robustly over 1999. The real pain came from a massive excess of capacity, resulting directly in a decline in yields.
That experience, however, appears to have encouraged the industry to reign back capacity, and with the economy booming, summer 2000 on the transatlantic was a transformed experience. Although fuel was a problem on the cost side, the deficiency of demand that characterised 1998 and 1999 turned into one of traffic sufficiency. In that environment fare increases were generally absorbed.
The outcome was pleasingly close to the predictions of the TDI model (see table). They suggest that underlying demand on the key markets out of the USA and Europe was up at a level of 8-9% last year, and not far behind in the intra-Europe and US domestic markets. Given relatively modest rises in capacity, that created a positive "gap" between supply and demand of 3-5 percentage points. In other words, yields should have risen steadily, and indeed they did. Back in 1999 when yields fell, the TDI model had then shown a negative "gap" of several points.
| Underlying traffic growth for European carriers by market area - 2000e | ||||||||||
| Destination from Europe | AEA growth result 2000** | Underlying growth | ||||||||
| RPK | ASK | Nominal gap | Estimate | TDI gap* | ||||||
| North America | 7.8% | 5.2% | 2.6 | 9.4% | 4.2 | |||||
| Central America | 7.5% | 8.0% | -0.5 | 9.7% | 2.2 | |||||
| South America | 13.5% | 1.1% | 12.4 | 9.6% | 8.5 | |||||
| Asia-Pacific | 4.4% | 2.5% | 1.9 | 9.2% | 6.7 | |||||
| Total international | 7.2% | 4.3% | 2.9 | 9.5% | 5.2 | |||||
| Intra-Europe | 7.7% | 5.3% | 2.4 | 7.9% | 2.6 | |||||
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| Underlying traffic growth for US carriers by market area - 2000e | ||||||||||
| Destination from Europe | AEA growth result 2000** | Underlying growth | ||||||||
| RPK | ASK | Nominal gap | Estimate | TDI gap* | ||||||
| International | 8.0% | 5.8% | 2.2 | 8.7% | 2.9 | |||||
| Domestic USA | 4.2% | 2.2% | 2.0 | 5.2% | 3.0 | |||||
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| NOTE: Underlying growth represents the rise in passenger traffic due as a consequence of economic growth, excluding the impact of market strategies. *TDI (Traffic Demand Indicator) equators to the gap between capacity growth and underlying demand. **Regions have been adapted from the Association of European Airlines figures for Jan-Nov 2000 to align more closely with the TDI model. ***US figures from Air Transport Association returns. Source: Commerzbank/Airline Business | ||||||||||
| Economic growth estimates 1999-2000 | ||||
| Region/country | Economic growth/forecast | |||
| 1999 | 2000e | 2001f | ||
| Africa |
| 2.2% | 3.4% | 4.0% |
| Asia | North East Asia | 0.3% | 3.9% | 2.2% |
|
| South East Asia | 5.5% | 6.0% | 4.1% |
|
| South Asia | 0.5% | 6.0% | 6.0% |
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| South West Asia | 4.0% | 4.2% | 3.3% |
| Euro Area | Austria | 2.2% | 3.5% | 2.8% |
|
| Finland | 4.0% | 5.0% | 4.0% |
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| France | 2.9% | 3.5% | 3.0% |
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| Germany | 1.6% | 2.9% | 2.8% |
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| Italy | 1.4% | 3.1% | 2.8% |
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| Netherlands | 3.6% | 3.9% | 3.3% |
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| Spain | 3.8% | 4.1% | 3.3% |
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| Belgium | 2.0% | 3.5% | 2.8% |
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| Portugal | 3.0% | 3.3% | 3.0% |
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| Ireland | 9.8% | 10.3% | 8.0% |
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| Euro Area | 2.4% | 3.5% | 3.0% |
| Non-Euro Area | Denmark | 1.7% | 2.1% | 2.3% |
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| Sweden | 3.8% | 4.4% | 3.5% |
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| Switzerland | 1.7% | 3.0% | 2.3% |
|
| UK | 2.1% | 3.1% | 2.5% |
| Middle East |
| -0.8% | 5.3% | 4.1% |
| North America | USA/Canada | 4.2% | 5.2% | 1.8% |
| South America | Brazil | 4.0% | 4.0% | 3.8% |
| NOTE: Estimates (2000e) and forecasts (2001f) from Commerzbank | ||||
The model, of course, cannot simply be based on broad headline GDP. The appropriate weighting has to be given to each of the major players within its relevant market. Not all carriers will have to conform to the headline rate, provided that the market as a whole stays in balance. In Europe, for example, there is considerable focus on the differential rates of capacity planned by the airlines ranging from the 6-7% for both Air France and Lufthansa, to the cut in summer capacity of some 10% by British Airways. The TDI model looks at the outlook for each airline individually and for each aggregate market area as a whole. For BA, the North Atlantic market is more important than Europe as a source of profitable traffic.
We can also look at the influence of currency on the direction of traffic flows. Some markets are more susceptible to changes in the value of the currency on the direction of traffic flows.
But while the balance between economic growth and capacity remains at the core of the model, there is a further dimension that is particularly important too. That is the role of expectations, which can play a significant role in creating so-called self-fulfilling outcomes.
Expectation theory is a particularly interesting branch of economics. Broadly stated, it suggests that if people expect a particular outcome their behaviour will anticipate the event. For example, if there is an expectation of a recession then the response to this could actually result in it being deeper than it might have been. Spending will be cut back and expansion plans abandoned. On the other hand if an environment is created where the population believes and acts as though outright recession is unlikely, then the result is more likely to be gradual slowdown.
In air transport the role of consumer expectations is clearly important and can help to exaggerate or ameliorate an underlying trend. Even short term concerns over the value of the currency, particularly at the time of the major booking season, can play havoc with traffic - and later on with fares if that capacity still has to be sold.
Future forecasts
With those caveats made, what then of the future? Our underlying expectations for economic growth in 2001 are still reasonably upbeat despite the recent US downgrade (see table). Europe's main economies should average growth of around 3% - down half a point from last year, but still healthy. Asia too should see similar levels.
Plugging these GDP forecasts into the TDI model produces a range of underlying traffic forecasts. At the top end of the scale are predictions of 8-9% between Asia and Europe. At the bottom there is 1.8% growth for the US domestic market. But generally the trend for international growth is around the 6% mark - down slightly on 2000 but more or less in line with 1999.
This of course reflects a snapshot of the world at present. Expectations, as suggested, can play a major role in conditioning actual outcomes, particularly where the world is moving out of growth phase and towards decline. Turning points are easier to spot - the issue is the nature of the adjustment process. If expectations for the US become very bearish then this is likely to reinforce the rate of the slowdown. If outright pessimism can be avoided then the economic slowdown is likely to be less painful. With any of the principal economic control measures (primarily interest rates and taxes) the actual effect involves a time lag and, still, a degree of uncertainty. It is the expectations of the effects of such policy actions that are most important.
An accurate gauge of wind speed and direction is inevitably different with transition in the air. Some of the long-term answers will lie with the less than scientific role of expectations. For present, there is a need to keep the downturn in perspective. Yes, there is going to be a slowdown, but the resulting rate of economic growth will be not significantly less than the predicted trend. No, this slowdown should not be catastrophic. Neither are there any signs of a re-run of the collapse of the early 1990s. The process of adjusting to slowdown is clearly going to be less severe, not least because of the more modest ordering of aircraft over the last four years and an increased replacement element. For airlines at present, it may not be so much a case of flying blind as waiting for a little New Year mist to clear.
Source: Airline Business
