SARS, war stall airlines’ recovery

One of the major casualties of the US-Iraq War and the recent spread of the Severe Acute Respiratory Syndrome (SARS) in Asia is the airline industry. The general view at present is that recent events will likely prolong the industry’s recovery.

Meanwhile, the Macapagal Arroyo administration in late 2002 identified the airline industry as a major sector that will be reformed to step up the recovery of the Philippine economy. In the absence of a clearer indication of how the government intends to implement this policy, many are guessing that open skies policy is essentially the means to achieve this.

The Philippines, in fact, has just finished the first round of talks with the US government on the implementation of the 1995 RP-US Air Services Agreement (ASA) which if not postponed, will trigger the full implementation of the open skies policy in the Philippines.

Recent Trends in the Airline Industry

The issue of whether the supply-demand situation in the air passenger industry justifies in the adoption of open skies policy can be assessed by examining the capacity utilization, passenger traffic and load factors of the different air carriers in the country.

The load factor of the foreign airlines operating in the country is about 70 percent based on available data on offered seats and passenger traffic in 2002, a drastic decline from 77 percent posted in 2000.

Assuming that a capacity utilization of 80 percent combined with load factor of 70 percent are the bigger conditions to signify a tight supply situation in the industry, then the countries where capacity should be expanded include Hong Kong and France. Hong Kong, however, already has an automatic trigger mechanism incorporated in the RP-Hong Kong ASA which can be invoked to address increased demand. In most of the countries, the problem is not lack of capacity but the willingness to add offered seats probably due to lack of demand or to low passenger-revenue.

The low utilization of entitlements can be traced to the poor financial condition of some of the airlines operating in the country.

While many airlines particularly those in the Asia Pacific region have already been recovering from 9/11, the growing pessimism over the US economy by mid-2002 coupled with the prospect of the US-Iraq War only served to stall the momentum for recovery in the industry.

Unfortunately, while war jitters are beginning to dissipate and war optimism has started to take hold, the spread of the deadly virus in late March placed another setback in the industry’s recovery. To date, two of Asia’s biggest carriers – Cathay Pacific and Singapore Airlines – already announced cutbacks in services of close to 37 percent and 20 percent, respectively. Other airlines have similarly reduced their service due to the various travel advisories that discouraged travel to SARS infected areas like China, Hong Kong, Singapore, Vietnam and Toronto. The Economic and Social Commission for Asia and the Pacific (ESCAP) warned that the SARS outbreak has the potential of derailing the prospects for the region, causing a possible 0.5-1.0 percent reduction in the growth of the Asia-Pacific region (ESCAP 2003). Other than the airline industry, the sectors which will likely be affected by the SARS include the restaurant, entertainment and the retail sectors.

Prospects for the International Air Passenger Industry

During the last two decades, the aviation industry is apparently following a cyclical pattern of growth where 4-6 year of profit were followed by 3-4 years of marginal profits or loss. If this pattern will be followed in the present cycle, it is possible that the full recovery of the industry will happen in 2004-2005.

Recent developments, however, point to a dimmer scenario ahead for the aviation industry. For one, the outlook for the world economy has turned bleaker with fears that the US economy might barely grow this year, dragging world output growth down to around 2 percent. For the Asia Pacific economies, growth could slow down to 5 percent from about 5.3 percent in 2002. Secondly, the US-Iraq war, while nearing resolution, has been estimated to cost the industry around $10 billion. Lastly, the SARS, while initially concentrated at the identified SARS areas, has the potential to spread to other sectors if left unresolved. However, if the spread is contained by June 2003, a significant bounce back is possible by the second half of 2003.

Assuming that the government will still be unable to arrest the outbreak immediately and the Philippines will not be declared SARS free in the next six months, GDP growth could decline from 0.2-1.4 percent points from the present government target of 4.2 percent depending on whether the “SARS-prone” services sectors like transportation, hotels and restaurants and trade will reduce output by 1, 5 or 10 percent in the next six months from March because of the SARS scare.

The slower output growth in turn is expected to affect passenger traffic negatively, with visitor arrivals going to the Philippines for holiday, dropping from 2 percent to 4.5 percent during the year given these scenarios. Passenger traffic in general is expected to be sluggish this year particularly to SARS-affected economies. But the countries highly dependent on tourism like Thailand, Singapore, Malaysia and Indonesia will feel the brunt of SARS more adversely than the Philippines.

In view of this, the present negotiations with the US may consider the following points in assessing the benefits of granting unlimited frequencies to US airlines by 2003:

1. Excess capacity exists in the RP-US routes. As of March 2003, less than half of seat entitlements under the existing RP-US ASA have been utilized by US airlines, which has been reducing seat offers since the winter 2001 up to the summer of 2002 due to financial problems. Due to weak demand for travel given the SARS-related advisories on top of terrorist-related warnings and security checks, US airlines are expected to further cut back in flights in the coming months.

2. Based on the Medium Term Development Plan, government policy does not support the grant of unlimited frequencies to partner countries even in situations where these may be justified.

3. At this time, tourist flow is not expected to increase with expanded seat capacity. External shocks like the US-Iraq war and the SARS virus have a stronger influence on tourist flow than any expansion in capacity at this time.

4 . On the part of the US majors, the sentiment towards “open skies” might be lukewarm and will not likely result in additional seat capacity.

5. The financial difficulties of air carriers will prevent a further reduction in air fares.

6. The grant of unlimited frequencies might further erode PAL’s financial position.

7. The Philippine panel should negotiate for greater access in the US market. National interest dictates that the Philippines get equal treatment in the concessions that will be granted by both contracting parties.

The passenger component of the Philippine aviation industry is going through challenging times. Depressed demand due to the general weakness in the world economy and the adverse consequences of the SARS and the US-Iraq war are taking their toll on the finances of the air carriers in the country.

Because there is no urgency to expand capacities in routes serving the US and the Philippines, which remain largely unutilized, the government should renegotiate for an extension of the transitory period of the 1995RP-US ASA. A breathing space may be necessary in order to allow the national carriers to recover from its present financial difficulties.