Strategic Directions for ASEAN Airlines in a Globalizing · PDF file · 2015-12-20Strategic Directions for ASEAN Airlines in a Globalizing World ... Community or regional ownership

Strategic Directions for ASEAN Airlines in a Globalizing World Ownership Rules and Investment Issues REPSF Project No. 04/008

Authors: Mahani Zainal-Abidin, Wan Khatina Wan Mohd Nawawi, and Sazalina Kamaruddin Final Report Revised (November 2005)

The views expressed in this report are those of the authors, and not necessarily those of the ASEAN Secretariat and/or the Australian Government

Strategic Directions for ASEAN Airlines in a Globalizing World: Ownership

REPSF Project 04/008: Final Report (Revised) i

CONTENTS

CONTENTS...............................................................................................................................I LIST OF TABLES .................................................................................................................... II LIST OF TABLES .................................................................................................................... II LIST OF BOX........................................................................................................................... II 1. INTRODUCTION ................................................................................................................1 2. DEVELOPMENT, GROWTH AND PERFORMANCE OF ASEAN AIRLINES...................3

2.1. Historical Development ...........................................................................................3 2.1.1. Category of Airlines ........................................................................................4 2.1.2. Factors Determining Airlines Success............................................................4 2.1.3. Policies on Routes..........................................................................................5

2.2. Growth Outlook ........................................................................................................5 2.3. Performance SIA ......................................................................................................6

2.3.1. Airline performance ........................................................................................6 2.3.2. Airport performance......................................................................................10

3. OWNERSHIP RULES AND STRUCTURE ......................................................................11 3.1. Private sector financing of transport infrastructure ...........................................11 3.2. The role of government in the aviation sector: Ownership and regulations....11 3.3. Privatisation of airlines in ASEAN ........................................................................12 3.4. Relaxation of foreign ownership rules: international experience .....................13 3.5. Relaxation of foreign ownership rules: the ASEAN experience ........................14 3.6. Impact of 1997/1998 Asian financial crisis on the sector ...................................17

4. FUTURE TRENDS FOR THE AIRLINE INDUSTRY........................................................19 4.1. Liberalization and expansion of air services.......................................................19 4.2. Emergence of second international airlines........................................................19 4.3. Global: Strategic alliance ......................................................................................19 4.4. Community or regional ownership vs. country-specific ownership .................20

5. RELATIONSHIP BETWEEN AIRLINES GROWTH WITH OTHER SECTORS...............23 5.1. Increasing demand for air services due to higher economic activities ............23 5.2. Emergence of China as an important destination for ASEAN carriers .............23 5.3. Increasing consumer influence, affluence and sophistication..........................24 5.4. Airport Infrastructure and Facilities .....................................................................24

6. EXPERIENCE OF LIBERALIZATION OF AIRLINE OWNERSHIP STRUCTURE..........27 6.1. The EU: Setting new standards in M&A activities...............................................27 6.2. Australia and New Zealand: The Single Aviation Market (SAM) ........................27

7. FINDINGS OF THE STUDY .............................................................................................29 7.1. Options....................................................................................................................32

REFERENCES.......................................................................................................................36


ii REPSF Project 04/008: Final Report (Revised)

LIST OF TABLES

Table 1: Size of Fleet, Routes and Workforce......................................................................5 Table 2: SIA’s Financial Performance ..................................................................................6 Table 3: SIA’s Passengers and Cargo Performance...........................................................7 Table 4: Thai Airways Financial Performance .....................................................................7 Table 5: Thai Airways Passengers Performance.................................................................8 Table 6: MAS Financial Performance ...................................................................................9 Table 7: AirAsia Financial Performance...............................................................................9 Table 8: Privatisation initiatives in ASEAN........................................................................12 Table 10: Aviation policy in the ASEAN countries ............................................................15 Table 11: CAAS Group Financial Results ..........................................................................24 Table 12: MAHB Financial Results......................................................................................25

LIST OF BOX

Box: A scenario for liberalization .......................................................................................34


REPSF Project 04/008: Final Report (Revised) 1

1. INTRODUCTION

As a region with huge growth potential, ASEAN should work towards having a competitive, profitable and efficient airline industry that can support or even be the source of its growth. Other regions have begun the move towards a comprehensive Open Sky arrangement so that both the nations and people can benefit from a competitive airline industry through having more flexibility over route development and better pricing mechanism. To prepare for an Open Sky environment, airlines in ASEAN must first be competitive to meet the potentially keen competition that will come from both regional and external airlines.

A critical factor that determines airlines’ viability and competitiveness is the ownership structure. State-owned airlines may face difficulty in accessing the market to finance its operations and expansion. In this regards, it would useful to understand the link between ownership and performance and to analyse the ownership rules and structure to prepare ASEAN airlines for a competitive environment of open sky. Yet, there is also a fear that the open sky could make the environment more uncertain – namely, how the airlines can remain viable under a less stable and highly competitive environment.

The paper will begin with the analysis on the development of ASEAN airlines, including a brief discussion on the growth of selected ASEAN airlines and airports. Airports infrastructure and services are important to support the growth of airlines and airlines and airports ownership structure is often tied to one another. This can be an additional factor that influences the growth and performance of airlines. However, the issue of airport ownership structure is beyond the scope of this paper. Of particular significant is the link between the objectives of the establishment of the countries’ airlines and the structure of ownership (Section 2). Section 3 examines the pattern of ownership rules and structure in ASEAN. Section 4 highlights some key future trends of the global airlines industry. The growth of airlines is mostly determined by the other sectors such as tourism and trade, which is discussed Section 5. Section 6 examines efforts to liberalize the airline industry in other region. The concluding section (7) summaries the discussion on ownership structure and performance of the ASEAN airline industry and offers options for reform of ownership rules including through regional cooperation.


2 REPSF Project 04/008: Final Report (Revised)

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2. DEVELOPMENT, GROWTH AND PERFORMANCE OF ASEAN AIRLINES

2.1. Historical Development The ASEAN region stretches across three time zones and it is a key part of Asia’s

continental landmass and several archipelagos. The member countries are considered as developing world; however, some of them have joined the world’s top 20 most competitive economies. The region’s population is about 500 million, about 10% of the world’s population.

ASEAN comprises of countries with diverse political and economic backgrounds. Even though most of them adopt the market-based system and policies in the management of the economy, the degree of private sector participation and in which the policies are designed based on market factors varies. But, the common feature among the ASEAN countries is that the states continue to play an important part and have a significant influence on the private sector. Likewise, the foreign investment policy also differs from one country to another. At one end, Singapore, adopted a completely open-door policy and welcomes foreign investment as well as foreign expertise. Singapore has a very proactive policy on investing abroad and has invested extensively in developed and developing countries. For the other countries, foreign participation is very much linked to the stage of development and resulting in some countries being very cautious about relaxing the foreign equity rules.

Although ASEAN is open to foreign investment, the governments maintain some degree of protection or control in some industries, which are deemed as national interests, such as public utilities, health services and to a lesser extent the airline industry. Nearly all national carriers in the ASEAN region are majority owned by the government on the grounds of national needs, security and pride. The structure is the same for major international airports in the region. Each government has different objective for its national carrier, which may not necessarily be profit-oriented, thus affecting their ability to compete and develop a more efficient network. In Malaysia for example, the government does not own controlling stake in Malaysia Airlines (MAS) but holds the so-called “golden shares”, which give it veto rights on major decisions. MAS has limited freedom to increase domestic fares so as not to cause inflationary pressure and has been consistently reporting losses for its domestic routes. Domestic routes make up about 15% of MAS revenue.

The ownership structure of ASEAN airlines can be directly linked with the needs of the state, the level of economic development and geography. For geographically large and dispersed countries, national airlines are established as a mode of transportation and a way to connect the different parts of the country. In many cases the air routes to the remote areas are uneconomical and thus operating these routes are subsided by other profitable ones. Indonesia is a good example, where geographically the coverage of the country spreads over thousands of islands. In the case of Malaysia, the national airline, MAS, has to run routes in remote areas in East Malaysia, which is not accessible by other means of transport. Therefore, state ownership is necessary to ensure that airlines serve commercial as well as the national objectives. In most cases the national objectives override commercial considerations. National airlines have also, in some instances, been deployed as a foreign policy instrument; for example, MAS began flying to South America and Mexico when Malaysia wanted to promote closer relationships with these countries.

In contrast, Singapore is a city state, with no hinterland to serve. Thus from the very beginning the objective of the Singapore Airline (SIA) is to service the international routes, which are normally more profitable than domestic ones. The objective of the airline could then be focused on profitability and as such, liberalisation of ownership rules could be undertaken much earlier because it is not burdened with non-economic obligations. Liberalisation of ownership was carried out effectively because of the strong role of the government in the economy as well as the effective system of public sector governance.



For the newer members of ASEAN, namely Cambodia, Laos, Myanmar and Vietnam (CLMV countries), their national airlines are relatively small and have limited capacity. These airlines are at the developmental stage because their economies are in transition from planned to market-based systems. Access and ability to funding and human resources skill are key challenges for these airlines to expand and upgrade their capacity and services. Major cities in the CLMV countries are opened to international air services and as a result these airlines are exposed to competition from the more established international and regional airlines. The CLMV airlines have limited marketing ability and competitiveness compared to other airlines, including the established ASEAN ones such as Singapore Airlines, Malaysia Airlines and Thai Airways. However, air services sector in the CLMV countries has a tremendous growth potential because of the expanding economic, trade and tourism activities.

2.1.1. Category of Airlines ASEAN airlines can be categorized into three groups. The first group is national

carriers, which is usually the main airline company in the country. Airlines in this group are usually majority-owned by the government and serve international and domestic routes. Some of them are successful such as Singapore Airlines (SIA) and Thai Airways (Thai), but there are also those which face financial difficulties such as Garuda Indonesia Airlines . Airlines in this group will operate for a long time because of government support.

The second group can be categorized as small airlines. These airlines are usually private owned or joint venture between the national carrier and private parties. They serve domestic or regional routes. One example is Air Mandalay Limited, which is based in Myanmar. Air Mandalay’s shareholders are Myanmar’s national carrier - Myanmar Airways, Air Mandalay Holdings Pte. Ltd. and Singapore and Premier Airlines of Malaysia.

The third group and the latest that joins the airlines industry is the low cost carriers (LCCs). LCCs serve short to medium distance flights covering domestic and regional routes and has been a success in Europe (RyanAir) and Australia (Virgin Blue). Commonly owned by private parties but lately we have seen the emergence of national carriers as major shareholders such as SIA 49% stake in Tiger Airways, most probably to protect their market share from being diluted by private LCCs. The leader for this group in the region is AirAsia, a publicly listed company based in Malaysia without any government involvement. In a short period, AirAsia has has carried 4 million passengers (2004) and has a fleet of 23 aircrafts. AirAsia is expanding their base in the region by setting up Thai AirAsia and AWAIR, joint venture with private companies in Thailand and Indonesia respectively.

2.1.2. Factors Determining Airlines Success The success of airlines can be attributed to combination of few factors such as

linkage to other industries, the country’s economic policy, good infrastructure such as airports, geographical and of course effective management. Thai Airways success is strongly linked with strong tourism sector in Thailand. Higher number of tourist means higher passengers for Thai. SIA success can be contributed to Singapore’s status as an open economy. As the center of trade in the region, Singapore become the point of transactions for goods and services and it is shown in SIA’s strength in cargo division compared to other airlines in the region. Creation of regional passengers’ hub such as Changi Airport in Singapore and KLIA in Malaysia helped SIA and MAS increase their passengers load. Having a relatively small country can be a blessing for the airlines. International routes normally provide better yield than domestic routes and SIA benefits greatly from that. Other national carriers such as Garuda and Philippine Airlines struggle to record profit as they have



to fly domestic routes to hundreds of islands in their countries, which are economically non viable.

2.1.3. Policies on Routes ASEAN countries adopted different policies between domestic and international

routes. Although the policies are different, they are relatively protective compared to other developed regions. Only local airlines, those majority-owned by locals, are allowed to operate domestic routes. The reason is to protect the national carrier, which has to serve economically non-viable domestic routes. However, foreign airlines may tap into the domestic market by forming a JV with local companies as what has been done by AirAsia, which owned 49% stake in Thai AirAsia in Thailand. As for international route, only Singapore adopts open-sky policy. Others in the region adopt bilateral or multilateral air service arrangements. There is a marked contrast between the way that ASEAN members have treated domestic and intra regional aviation policy (very conservative) and long haul (very liberal and creative trading to maximize sixth freedom opportunities). However, the policy on domestic and intra-regional routes has been liberalized recently where LCCs are allowed to operate and in most cases covering intra-regional routes. This change was due to complaints of high prices for domestic routes and rising demand of regional tourism. However, Indonesia has reversed its earlier policy of liberalization of routes when it disallowed non-Indonesian LCC to land in Indonesian cities. This move is to protect its many small private airlines.

2.2. Growth Outlook

Air travel growth for ASEAN airlines is expected to average 5.6% per year over the 20-year period, with 6.0% growth within the region. The growth is expected to be led by LCCs, who will gain market share over time. Airlines within the region have diverse fleet requirements based on their network strategies. For example, airlines in Indonesia and the Philippines require large numbers of single-aisle airplanes for their domestic markets, while Singapore Airlines needs a high proportion of twin-aisle jets to serve regional and intercontinental routes. Airlines throughout the region will use ultra-long-range airplanes to serve European and North American cities nonstop.

Table 1: Size of Fleet, Routes and Workforce

Note: Data are obtained from the companies’ latest annual report Major airlines in the region have amongst the largest fleet in the world. The average

fleet age is the lowest in the world. SIA’s average fleet age is 5.5 years, the youngest of the major established Asian airlines, a remarkable figure when global average fleet age is about 10 years. SIA plans to increase its fleet size and have ordered 16 more and another 45 on option. SIA will be the first airline to operate the new Airbus A380. Thai Airways has also plans to enlarge its fleet by 16 aircrafts between 2005 and 2006.

Routes served by airlines in the regions are expected to increase in the future especially within the region with the emergence of LCCs. Airlines will offer more routes to consumers through code sharing and cross shareholding. MAS has just announced code

Fleet Size (Aircrafts)

Average Fleet Age

Routes Staff

MAS 111 7.6 years 110 17,313SIA 95 5.5 years 84 (42 countries) 29,734Thai Airways 86 7 years 99 (37 countries) 25,884



sharing with SIA and Silk Air, while Thai has announced code sharing with PB Air and Air Andaman, and possibly Phuket Air in the near future.

Number of staff employed by airlines in the region is relatively high. Thai has one of the highest number of staffs per Available Seat Kilometres (ASKs), which contributed to the high cost incurred by the carrier. There has been a trend towards maximizing usage of Information Technology to minimize staff and cost in the long run. One good example is AirAsia, where ticketing is done on-line and even through short messages system (SMS).

2.3. Performance SIA

2.3.1. Airline performance

Table 2: SIA’s Financial Performance

Financial Year 2002/3 2003/4 % change(S$ million) Total Assets 19,184.0 19,990.0 4.2%Shareholders' Equity 10,708.8 11,455.1 7.0%Share Capital 609.1 609.1 0.0%Revenue from Sales and Service 10,515.0 9,761.9 -7.2%Profit from Sales and Services 717.1 680.4 -5.1%Profit before Income Tax 976.8 820.9 -16.0%Net profit 1,064.8 849.3 -20.2%Amount per Share Net profit (cents) 87.4 69.7 -20.2%Shareholders' Equity (S$) 27.90 33.08 18.6%

SIA is one of the world’s well run and profitable airlines. However, recently the SIA performance has declined but manly due to factors beyond its control, namely the September 11 incident and the SARS outbreak. SIA’s revenue and profit for the financial year 2003/04 declined 7.2% and 20.2% respectively from financial year 2002/03. The decline in performance was largely attributed to the SARS outbreak. Passengers carried in financial year 2003/04 declined 13.4% to 13.3 billion. SIA recorded its first ever quarterly loss in the first quarter of 2003/04 financial year. However, the loss was nearly covered in the second quarter of 2003/04. The arrival of three Airbus A340-500s in January 2004 followed by the launch of non-stop services between Singapore and Los Angeles helped improve financial year 2003/04 performance.



Table 3: SIA’s Passengers and Cargo Performance

Fiscal Year 2002/3 2003/4 % change

Passenger

Available Seat Kilometers /ASK (million) 99,565.9 88,252.7 -11.4% Revenue Passenger Kilometers /RPK (million) 74,183.2 64,685.2 -12.8% Cabin factor (%) 74.5 73.3 -1.2pp Passenger carried ('000) 15,326 13,278 -13.4% Cargo Available Freight Ton Kilometers /AFTK (million) 9,927.1 10,156.5 2.3% Revenue Freight Ton Kilometers /RFTK (million) 6914.6 6,749.4 -2.4% Freight load factor (%) 69.6 66.5 -3.1pp Freight carried (million kg) 1,043.2 1,050.9 0.7% Total Available Ton Kilometers /ATK (million) 19,773.7 18,873.8 -4.6% Revenue Ton Kilometers /RTK (million) 14,059.5 13,033.1 -7.3% Load factor (%) 66.0 66.9 1.4% Yield Passenger (cents per passenger per km) 9.1 9.2 1.1% Cargo ( cents per ton per km) 34.2 36.7 7.3% Total (cents per ton per km) 64.5 65.0 0.8%

For the first half of 2004/05 period, revenue increased 38.5% year-on-year, while

operating profit was S$638.2 million compared to loss of S$62.5 million in the first half of 2003/04 financial year. Introduction of daily non-stop service to New York helped boost performance. Passenger airline continues to be the main source of revenue, contributing 54% of total revenue. Major expense was for fuel, 23.3% of total cost. Higher oil price is a major concern to SIA as fuel cost increased by 53.5% year-on-year. SIA’s passengers performance improved in the first half of 2004/05 financial year. Passenger’s and cargo’s yield improved 13.8% and 9.1% respectively year-on-year.

Thai Airways

Table 4: Thai Airways Financial Performance

Financial Year 2002 2003 %change 2004 %change(Million Baht) Total Assets 178,410 165,095 -7.5% 193,211 17.0%Shareholders' Equity 28,354 36,171 27.6% 54,324 50.2%Share Capital 14,000 14,000 0.0% 16,850 20.4%Revenue from Sales and Service 129,015 134,536 4.3% 152,603 13.4%Profit from Sales and Services 18,688 17,306 -7.4% 20,397 17.9%Profit before Income Tax 14,416 17,431 20.9% 14,284 -18.1%



Financial Year 2002 2003 %change 2004 %changeNet profit 10,182 12,079 18.6% 10,077 -16.6%Amount per Share (Baht) Net profit 7.27 8.63 18.7% 6.14 -28.9%Shareholders' Equity 33.0820.25 27.90 37.8% 33.08 18.6%

Thai’s financial year 2004 net profit fell 16.6% year-on-year because of foreign

currency loss. Thai suffered about Bt2 billion loss in financial year 2004 against a gain of Bt4 billion in the previous year. However, operating profit increased 17.9% year-on-year as operating revenue increased 13% year-on-year on an 11% rise in RTKs and a improvement in yield from having switched from low to higher yield routes.

Table 5: Thai Airways Passengers Performance

Fiscal Year 2002 2003 % change 2004 % change

(03-04)

Passenger ASK (million) 63,198 63,826 1.0% 69,830 9.4%RPK (million) 46,571 44,396 -4.7% 50,633 14.0%Cabin factor (%) 73.7 69.6 -5.6% 72.5 4.2%Passenger carried ('000) 18,315 17,048 -6.9% 19,540 14.6% Cargo AFTK (million) 3,064 3,125 2.0% 3,401 8.8%RFTK (million) 1,771 1,780 0.5% 1,839 3.3%Freight load factor (%) 57.8 57.0 -1.4% 54.1 -5.1%Freight carried (Tones) 521,948 515,122 -1.3% 537,632 4.4% Total ATK (million) 8,752 8,870 1.3% 9,686 9.2%RTK (million) 6,027 5,850 -2.9% 6,478 10.7%Load factor (%) 68.9 66.0 -4.2% 66.9 1.4% Yield

Passenger (baht per passenger per km)

2.18 2.29 5.0% 2.34 2.2%

Cargo ( baht per ton per km) 11.28 12.00 6.4% 10.99 -8.4%Total (baht per ton per km) 20.39 21.30 4.5% 21.62 1.5%

Thai Airways reported lower performance in first quarter of 2004/05 financial year, as

higher fuel costs squeezed margin. Revenues increased by 12.6% year-on-year, a result of better passenger yield. Fuel and oil expenses increased by 74.5% year-on-year, pushing operating expenses to jump by 19%. As a result, operating profit decreased by 14% year-on-year. However, net profit increased 34.5% year-on-year because of foreign currency gain and lower interest expenses. The second quarter of 2004/05 is expected to be weaker because of the impact from the tsunami tragedy.



MAS

Table 6: MAS Financial Performance Financial Year 2003 2004 % change (RM million) Revenue from Sales and Service 8,674.6 8,587.8 -1.0%Profit from Sales and Services 652.8 488.2 -25.2%Net profit 339.1 461.1 36.0%Amount per Share Net profit (sen) 27.1 36.8 36.0%

MAS had recorded a second consecutive year of profit following the implementation

of the Widespread Asset Unbundling exercise in 2002. The net profit of RM 461.1 million is the highest profit attained since was listed in 1985 on KLSE. MAS’ profit the third quarter of 2004 slumped almost by 75% year-on-year, after record jet fuel price increases caused its costs to surge. Although total revenue rose by 24% year-on-year, the jet fuel cost surged by 58% year-on-year, accounted for about 34% of MAS’ operating costs.

AirAsia

Table 7: AirAsia Financial Performance Financial Year 2003 2004 % change (RM million) Revenue from Sales and Service 330.0 8,587.8 19.0%Profit from Sales and Services 14.6 488.2 377.4%Profit before Income Tax 10.4 461.1 446.2%Net profit 18.8 161.2%Amount per Share 36.8 Net profit (sen) 0.8 160.5%

AirAsia had recorded profit for the second time in a row after recording losses for the

first three years of its operation. AirAsia recorded a profit in the second quarter of 2005 as holiday season had boosted sales. Net profit for the quarter was RM44.4 million as compared to RM10.5 million in the first quarter of the same year. Revenue for that period was RM178.6 million.



2.3.2. Airport performance

ASEAN region handles one of the busiest air traffic in the world. ASEAN-5’s

(Indonesia, Malaysia, Philippines, Singapore and Thailand) combined countries rank second place after the US in terms of both passenger and cargo traffics. Performance of airports mirrors the performance of airlines and it is not surprising that ASEAN’s best performance airports are located in Singapore, Malaysia and Thailand, the countries where SIA, MAS and Thai are based respectively.

Singapore’s Changi Airport is the benchmark for the performance of airports in ASEAN region. It is widely acknowledged as one of the best airports in the world by air travelers and is the 6th busiest airport in Asia. Rated by airline pilots as one of the best airports globally in terms of air safety, Changi Airport has been accorded with "deficiency free" rating since its opening in 1981. Changi handles more than 3,700 weekly flights to about 170 cities in 55 countries worldwide operated by more than 75 airlines. The airport has accumulated over 180 accolades from many prestigious trade magazines since 1985. Changi Airport is linked to 152 cities in 51 countries worldwide with 69 international airlines operate over 3,200 flights per week to and from Singapore.

In 2003, Changi Airport recorded over 25 million passenger movements and handled over 1.6 million tonnes of airfreight. Changi handled a record 30.4 million passengers in 2004, an increase of 23% from the previous year, and 4.7% more from the previous record set in 2002. In the same year, it processed 1.78 million tons of cargo, also a record. It was ranked 3rd and 7th for international airfreight and international passenger movements respectively in 2002. In anticipation of continued air traffic growth in the new millennium, a third passenger terminal is being built. When completed in 2008, it will increase the capacity of the airport from 44 million to 64 million passenger movements per annum.

Another successful airport is Bangkok International Airport (BIA). It is recognized as one of world's 50 largest airports. BIA recorded 32.2 million passenger movement in 2002, ranking 18th in the world. In 1998, BIA handled 719,324 tons volume of cargo, ranking 24th in the world. For aircraft movements, in 1994 BIA had 178,458 flights, became the 91st rank of the world.

Malaysia has one of the well-developed airports in Asia. Kuala Lumpur International Airport (KLIA) is ranked number one for overall business passenger satisfaction in an International Air Transport Association (AITA) survey. Malaysia has one of the well-developed airports in Asia KLIA has an initial capacity of 25 million passengers and 650,000 tonnes of cargo per year.



3. OWNERSHIP RULES AND STRUCTURE

3.1. Private sector financing of transport infrastructure The growth in private and commercial transport demand has outstripped

governments’ capability to supply and maintain infrastructure in the conventional tax/charge and expend formula of past years. Estimates of infrastructure investment requirements for East Asia alone were US$1,500bn for the decade 1996 to 2005 and more than US$1,800bn for the next decade. Unfortunately, the combination of government spending, international aid and official lending was insufficient to meet the scale of demand. And so there has been a shift towards private sector participation in the provision of transport infrastructure, further enhanced by the growth in the globalization of private investment funds.

Specifically, privatisation in the airline industry can be traced back to the development of pro-privatisation policy in the U.K. in the early 1980s. While British Airways was targeted as one of the enterprises to be privatised, it was not until 1986 after the airline went for extensive restructuring to improve its efficiency and financial performance that it was finally privatised.

There are several forms that privatization might take: an airline might be listed on the stock market, it might be sold to industrial groups in the home country, or it might be sold to strategic stakeholders.

Privatisation opens up the possibility of foreign investment in airlines, that is, through direct investment by shareholders in the stock market or through formation of strategic alliances, in which one form could be in the holdings of equity. However, foreign investments in an airline could raise the question of nationality of the airline. This in turn leads to issues in international regulation as airlines operate in jointly regulated markets (both home and host countries) and one country cannot change this regulation unilaterally.

3.2. The role of government in the aviation sector: Ownership and regulations ASEAN governments have an entrenched position in the aviation sector in view of

their roles in the ownership of airlines and implementing rules and regulations, especially in terms of trade air traffic rights.

Proponents of state ownership for airlines also argue that it will be difficult for private airlines to fulfill the diverse functions of airlines operating in developing economies, which is to meet the national objectives of integrating the national territory and promoting the tourism and trade sectors. Subsidies and other state aids for most of the state-owned airlines meant that immediate profitability is not priority.

Also, in international markets, air traffic rights are dealt with on a government-to-government basis in a system of bilateral air service agreements (ASAs). Until recently, most ASAs in ASEAN designated only one airline per country meaning that each country was represented by only a single carrier in international markets – placing foreign destinations to be off-limits to potential secondary international airlines. This resulted in most of the ASEAN countries having a single international airline to service the markets. ASAs also contain provisions governing fares, capacity and frequency of service. In essence, these agreements remain the dominant form of airline regulation. Indeed the governments in the region see air traffic rights as a national asset that has to be managed carefully to maintain sensible competition and to protect the incumbent national carriers.



3.3. Privatisation of airlines in ASEAN

Table 8: Privatisation initiatives in ASEAN

Carrier Date privatization programme began

State ownership share in 1996

State ownership share in 2004

Singapore Airlines 1985 54% 56.76%

Malaysia Airlines 1985 10% 69.34%

Thai Airways International 1992 92% 54.2%

Philippines Airline 1992 34% n.a. Source: Asia Pacific Air Transport: Challenges and Policy Reforms (1997)

Major privatisation initiatives in ASEAN could be traced back to the 1980s, starting with the Malaysian Airlines (MAS). Privatisation of MAS began in 1985 and the government’s share remained stable at 42% for nearly a decade. Then in 1992, Bank Negara Malaysia, the central bank, sold a 32% stake in MAS to Tajudin Ramli, effectively giving him control of the airline. Indeed the government’s stake in airline was reduced to 10% by 1996. Unfortunately MAS faced major financial problems – by 2002, MAS recorded five years of consecutive losses and burdened with approximately US$2.4bn worth of debt. In mid-2002, a rescue plan was drawn and the government established a new holding company, Penerbangan Malaysia (PMB), which took control of MAS’ fleet and assuming its liability. Under the re-nationalisation programme, MAS becomes purely an international and cargo services operator, leasing planes from PMB.

The Philippine Airlines (PAL) was founded by a group of businessmen led by Andres Soriano, one of the country's leading industrialists in February 1941 and in September the same year the government invested in PAL, paving the way for the airline's nationalization. In January 1965, the government relinquished control of PAL with Benigno Toda, Jr., the board chairman since 1962, acquiring majority stake in the airline. PAL was privatised in 1992 when the PR Holdings consortium took 67% share with the government holding another 33% in the carrier. Unfortunately political relations between the government and PR Holdings’ single largest investor, Lucio Tan, soured reaching climax in 1996 with the government abandoning its efforts to limit Tan’s control of PAL. Under the agreement with other shareholders, PR Holdings was dissolved and Tan made further investment in PAL increasing his direct stake to 51%. In 2002, President Arroyo Macapagal announced government’s intention to renationalize PAL but the idea has been shelved for the moment in view of the government’s massive fiscal deficit.

In April 1989, Vietnam Airlines was established as a state-owned enterprise (SOE) and in 1996, Vietnam Airlines Corporation was formed, bringing together several service companies with the airline as its core business. However, the members of management remain political appointees - the corporation is run by a seven-seat management board whose members are appointed by the Prime Minister.



Political considerations meant significant government control remains in ASEAN carriers. Governments’ controls in other ASEAN airlines are still significant despite the various

privatisation initiatives. For example, Singapore, despite being seen as having more foreign investor-friendly investment rules in place, sees the Singapore Airlines (SIA) being owned as much as 57% by the state investment holding company, Temasek Holdings. Thailand Ministry of Finance still retains 54.2% ownership in Thai Airways. The Royal Brunei Airlines, which was established in 1974, is a wholly-owned government corporation.

Garuda was declared a state airline in 1949 and nationalized in 1954. Its privatisation programme has been delayed repeatedly with the Asian financial crisis in 1997/1998 delaying decisions further. Finally, on 22 February 2005, Garuda President Director, Indra Setiawan, announced that the airline will launch its Initial Public Offer (IPO) in 2006.

While evidence indicated that governments are retaining control over incumbent or national carriers, they allow participation from the private sector in establishing secondary airlines. Unfortunately restrictions do remain in terms of routes serviced. For example, while the government has liberalized the domestic market in the Philippines leading to the establishment of Cebu Pacific and Air Philippines, the international routes remain the preserve of PAL as long as most bilateral air service agreements permit only one Filipino carrier.

In some cases, survival of secondary carriers is highly dependent on the political backings. Unfortunately this means the future fortune of these carriers fall at the mercy of any political changes occurring within the government. Sempati was partly owned by the Indonesian military and partly by one of former President Suharto’s sons. First Cambodia Airlines is 51% owned by PM Hun Sen’s 23-year old son, Hun Mana, with partners from Hong Kong. The now defunct airline, Royal Air Cambodia, was a joint venture with a Malaysian company that began operation in 1994 – it was reported that the airline shut down was caused by poor management and corruption, in which at least US$20mn was reportedly lost.

3.4. Relaxation of foreign ownership rules: international experience Foreign ownership of airlines is considered a relatively new phenomenon in the Asian

region. However, foreign ownership is common in other regions and has been established since the 1940s and 1950s. For example, Pan American took minority stakes in many Latin American airlines and Air France bought shares in a number of African airlines, especially those in its former colonies. At one time the British European Airways (BEA) owned 40% of the Italian national airline, Alitalia while the British Overseas Airways Corporation (BOAC, now British Airways) owned 50% of Egyptian Airways as well as 47% stake in Middle East Airlines. BOAC was even a majority shareholder in Malayan Airways Limited (MAL, now Malaysian Airlines) and became a technology pioneer for the latter, providing technical services such as repairs, spares and training, even initiating training for local crew members in the United Kingdom. (The presence of BOAC also facilitated MAL's entry as a member of IATA.)

The global trend in the 1960s and 1970s moved towards more nationalistic lines but it has changed again from 1980s onwards. Indeed since then many privatised airlines have been seeking equity stakes in airlines based in other countries that have complementary networks. However foreign ownership in incumbent or national airlines was constrained by governments, largely adhering to the principle that air carriers should be “substantially owned and effectively controlled” by nationals of the state in which the carrier is registered. In the U.K., despite having in place a pro-privatisation policy, the government had made it clear several times that a foreign airline would not be allowed to achieve overall control of a British airline. Even in the U.S. there is a statutory limit on foreign ownership of airline stock – foreign airlines can hold only up to 25% of voting shares, and the president and two thirds of



the board of directors must be U.S. citizens. Before its liberalization policy, the Chinese government had placed a ceiling of 35% on foreign investments in domestic airlines.

Rapid globalization and problems faced by the industry, especially, have resulted in relaxation of restrictions on foreign ownership. Some airlines have been able to build up sizeable stakes in foreign carriers. One possible advantage of foreign ownership, from the perspective of the airlines, is that the act of purchasing shares demonstrates commitment and thus assuring the other airline of a serious interest in long-term collaboration. Alliances struck without either partner purchasing shares might be relatively short-lived or rather ineffectual. The co-operation agreement between Air France and Lufthansa, which involves no exchange of shares, did not materialize into a closer relationship.

Taking an equity stake can often give the investing airline “first mover” advantages over other airlines seeking stakes at a later date as evidenced in the case of SAS’s increasing investment in British Midland. Having built up a substantial holding in take-off and landing slots at Heathrow where slots are in scarce supply, British Midland became something of a target for marketing deals and ownership offers. It has been approached by Lufthansa, Virgin Atlantic and U.S. United Airways.

The Canadian experience: Sector liberalization but not for foreign ownership rules Although Canada has moved with times in deregulating domestic and international

routes and fares (especially after the Open Skies Agreement signed with the U.S. in 1995), its government remains steadfast to the principle of domestic ownership of Canadian carriers. Currently, foreigners may own up to 25% of the voting shares of a Canadian air carrier. Although the panel reviewing the Canadian transportation policy, in the Canada Transportation Review Panel 2001, recommended that the 25% limit be raised to 49%, the government has shown no signs such a step is imminent.

While it is possible that the events surrounding Air Canada’s entry into and anticipated exit from bankruptcy may produce some change, it is clear that the government is still comfortable with the principle that airlines in Canada be domestically owned and operated.

3.5. Relaxation of foreign ownership rules: the ASEAN experience

National or incumbent carriers in mature markets of ASEAN are usually domestic-owned

Almost all of the ASEAN national carriers began life with full ownership by the state. Subsequently, their ownership structure was relaxed and private investors were invited to participate as shown in Table 9. Unlike the national carriers, secondary airlines in ASEAN countries were allowed to have private ownership from the start. But the ASEAN experience also shows the reversal of the trend of equity rules relaxation where the state increased its share of ownership when the airlines faced financial problems that could threaten their survival.

The more established national carriers in ASEAN, notably Thai Airways and Malaysian Airlines, were founded on joint venture basis with foreign partners, but later the respective governments took control of the equity and management of these airlines. This is in line with the principle that air carriers should be “substantially owned and effectively controlled” by nationals of the state in which the carrier is registered. Note that the 51:49 equity rule in favour of the ASEAN countries apply mostly in ownership and control of airlines.



Table 10: Aviation policy in the ASEAN countries

Country Ownership and control policy

Brunei Darussalam

An airline registered in Brunei Darussalam must be substantially and effectively controlled by Brunei Darussalam interests.

Indonesia Scheduled domestic air services are open to new carriers. Foreign operators must form joint ventures. Maximum permitted equity is 49%.

Malaysia Ownership rules of 51:49 in favour of Malaysian nationals apply.

Myanmar Strong belief in state control. (But joint ventures with foreign operators seem to be permitted).

Philippines Foreigners may invest in Philippine-owned airlines to the extent of the Constitutional provision providing for 60:40 ownership by Filipinos and effective Filipino management and control.

Singapore The government would be happy to move to a principal place of business ownership criteria but recognizes that this would pose problems given many of its ASAs specify substantial ownership.

Thailand Incumbent carrier, Thai Airways, is not supportive of a ‘principal place of business’ test and favours further privatization up to a limit of 49% foreign ownership.

Vietnam Operates a 51:49 ownership and control rule in favour of local ownership but government recognized the need to develop ownership rules in compliance with ICAO recommendations.

Source: Preparing ASEAN for Open Sky, February 2004.

Thai Airways International was founded in 1960 as a joint venture between Thailand’s domestic carrier, Thai Airways Company (TAC) and the Scandinavian Airlines System (SAS) with the latter initially providing a 30% share capital of Baht 2mn. On 1 April 1977, after a 17 - year capital participation partnership with SAS, the Thai government bought out SAS remaining 15% holding shares and Thai Airways became fully owned by the Thais. Currently, 17.56% of Thai Airways is owned by foreign investors.

The Malaysian Airlines initial ownership reflected the country’s colonial past. Founded in 1937 as a joint venture between the Ocean Steamship Company of Liverpool, the Straits Steamship Company of Singapore and Imperial Airways, the national carrier, then known as Malayan Airways Limited (MAL), was later government-owned.

While SIA is largely government-owned through Temasek Holdings, there has been a move towards lifting of restrictions on foreign ownership of SIA shares. Indeed Charles Goode, ANZ Banking Corporation Chairman, was named to the SIA board, the first non-Singaporean to serve on the SIA Board.

As mentioned earlier, while PAL is no longer government-owned, its control still rest on local businessmen. Even then, at the height of its management crisis, half of the country’s senators had signed a letter to President Ramos arguing that PAL should be viewed as a “strategic national asset”.

CLMV countries having more relaxed approach but not by choice Governments in the more recent ASEAN members, notably Cambodia, Myanmar and

Laos, seem to be pursuing a more relaxed approach in terms of foreign ownership of their airlines based in their countries. Lack of domestic capital, know-how and technology may be



the main reasons for such approach. First Cambodia Airlines, established in 2004, is a joint venture between the Prime Minister’s family and a Hong Kong-based company while the Myanma Airways International (MAI) was originally a joint venture among Myanmar Airways together with Singapore interests and receiving the support of the Royal Brunei Airlines. Cambodia’s Royal Khmer Airlines Limited, which was only recently established in 2004, is a joint venture between the Cambodian government and an unnamed Singapore company.

Meanwhile, Lao Airlines is one of the state-owned enterprises (SOEs) that have been targeted for restructuring by the Laotian government in December 2003. Following changes in management and some financial restructuring, the government conducted an in-depth analysis of the financial and operational situation, including tariffs to develop restructuring options, indicating clearly sustained losses in the airline operations. In view of government budgetary constraints, it was decided that the best way to maintain a national carrier for Laos is to enter into a joint venture with a foreign airline as a strategic partner. Lao nationals will own 51% of the airline but the government owning less than 51%. This is done by issuing new shares and diluting government’s holdings and in the process obtaining the necessary investment from the foreign partner.

Singapore Airlines (SIA) buying stakes in foreign carriers As an extension of Singapore Airlines (SIA) strategy of pursuing organic growth, the

Singapore carrier has been buying stakes in foreign carriers. In 1986, SIA bought stakes in Delta Air Lines and Swissair and the three airlines created a route network reaching 82 countries. SIA also purchased a 40% stake in Royal Air Cambodge from the Cambodian government in 1993.

The U.S. and Singapore governments signed an open skies agreement in 1997 (the first between the U.S. and an Asian nation), allowing unlimited flights between the two countries. By this time, SIA canceled its alliance with Delta and Swissair in favor of one with Germany's Lufthansa.

In 2000, after failed attempts to buy into South African Airways and Ansett Australia, SIA bought a 49% stake in U.K. carrier Virgin Atlantic and 25% stake in Air New Zealand (ANZ). Observers noted that the move to buy into Virgin would add a further dimension to SIA’s transatlantic business, ease the “problem” of SIA’s mounting cash pile and provide and overall boost to the global ambition of Singapore. Unfortunately, SIA’s shares in ANZ was diluted to only about 7% after the latter faced financial difficulties resulting in renationalisation, with the state having 82% of share in the airline. SIA had earlier invested in ANZ to have bigger Australasian market through ANZ’s share in Ansett, then no. 2 Australian carrier. SIA has since disposed all its shares in ANZ in 2004 at a NZ$523mn loss.

The new private airlines are usually results of joint venture with foreign investors While the above examples revealed that national carriers in the respective ASEAN

countries are mostly government owned or at least privately owned by local investors, the trend with the new private airlines, especially the low cost carriers (LCCs) or the budget airlines, revealed allowance for greater foreign participation in ownership and investment activities.

The Singapore government is leading the way in this respect. Mindful that it lagged Malaysia (and to a certain extent, even Thailand) in the new LCCs sector, the Singapore government has allowed and even encouraged foreign ownership in newly created LCCs in the country. For example, Tiger Airways, is a joint venture between the incumbent, Singapore Airlines (SIA), Temasek Holdings, Indigo Partners LLC and Irelandia Investments. ValuAir is co-owned by Australia’s Qantas, which invested about S$50mn for 49.9% stake in the airline.

Thai AirAsia is controlled by both Malaysia’s AirAsia International and the Shin Corp at 49% and 51% stakes respectively. Note that such arrangements are not always welcomed



by other local investors – for example, the Thai One-Two-Go Airlines founder claimed that Thai AirAsia manages to capture significant domestic market share due to the influence of its local owner, which belongs PM Thaksin’s family, the Shinawatras.

3.6. Impact of 1997/1998 Asian financial crisis on the sector

The ASEAN airlines industry experienced a series of setbacks in the 1990s, starting with the 1997/1998 Asian financial crisis, the 9/11 attacks, the Iraqi war, the SARS outbreak and the latest being the tsunami and earthquake devastation.

During the period 1991 to 1996, air traffic in the Asia Pacific region grew at a much faster rate than the rest of the world, continuing the pattern experienced for most of the 1980s. However the 1997/1998 Asian financial crisis had impacted several traffic-generating and –attracting countries in the region. Most notable was the problem of over-capacity resulting in regional airlines having to redeploy equipment from the most-affected routes into other markets, return some of lease aircraft and defer or cancel aircraft orders from the manufacturers.

The crisis had also placed the affected countries, notably Korea, Thailand, Indonesia and Malaysia, under considerable pressure to undertake reform of their air services industries. In fact, the terms of the IMF adjustment packages introduced for some of these countries require privatisation of a certain number of state owned enterprises (SOEs and which may include airlines) and other reforms to reduce their reliance on government funds. Subsequently, the governments of Thailand and Korea indicated their willingness to relax limits on foreign investment in their airlines.

Asian crisis further precipitated problems faced by Philippines Airlines (PAL)

While the Philippines had relatively escaped unscathed in terms of the crisis impact on the overall economy, the crisis served to highlight the burgeoning problems faced by its airline industry. In 1995, the Ramos administration signed the Executive Order (EO) No. 219 establishing the domestic and international civil aviation liberalization policy. The EO 219 opened domestic routes to competition and designated at least two international carriers as official carriers for the Philippines – the government should pursue national interest objective and not the interest of only one carrier.

The domestic market was opened to competition and new players such as Cebu Pacific Air, Air Philippines, Asian Spirit and Mindanao Express came into the market. Despite this, the incumbent carrier, the Philippines Airlines (PAL) still enjoyed a virtual monopoly of the domestic air services, controlling 75% of the cargo and 80% of the passenger services.

During the four years up to the crisis, the Philippines Airlines (PAL), recorded losses of US$388mn and had to suspend payments on its US$2.1bn in debts. Asia’s oldest airline closed down at midnight on 23 September 1998 after almost six decades of operation. The airline shut down after the collapse of negotiations between the government, trade unions and management.

The closure had a significant impact on the transportation system in a country with 76mn population and 7,000-odd islands. At the time, PAL Indeed there was a real threat that the more remote outlying islands in the Philippines would be without air services altogether unless the government stepped in for a “bail-out” programme for PAL. Compounding the problem was the poor quality of substitute mode of transportation: for many people, the alternative was using the slow, overcrowded and dangerous ferry services.



Garuda defaulted on its external debts during the Asian crisis

Garuda defaulted on more than US$1.1bn in debts to international creditors during the Asian crisis. The debt restructuring process dragged on until 2001, when both the government and creditors came to agreement.

The Indonesian government has considered several options to ease Garuda’s financial burden and boost its competitiveness, including converting the airline’s debts into equity. The option of refinancing Garuda’s dollar-denominated debts was later ruled out because it is feared that no financial institutions would be willing to lend to the state airline or buy its bonds given its low investment ratings.

Post-crisis: PAL is slowly recovering, but Garuda is still facing problems

PAL has since made a comeback as it underwent a rehabilitation programme. PAL posted two straight years of profit – for the financial year (FY) 2000 profits came to Philippines Peso 46mn and in FY2001, profits was more than ten-fold at Peso 419mn.

Unfortunately, Garuda is still facing problems. In 2004, the airline’s debts were US$850mn, of which some US$560mn was owed to an international consortium consisting of creditors in the U.K., Germany and France. In November 2004, Garuda President Director, Indra Setiawan, told the Indonesia’s House Commission V for transportation and communication that the airline is now far behind its regional competitors due to its inability to expand or rejuvenate its fleet. Creditors are only allowing Garuda to borrow a total of US$25mn over 10 years, inadequate to cope with the increasing number of passengers, which in 2004, was 8mn passengers. Indra Setiawan further emphasized that Garuda could eventually collapse unless the government takes action in allowing the airline to refinance its debts to reduce its interest burden and become more flexible in seeking more loans for expansion.

The Asian crisis impact on the airline industry highlighted the need for the government to focus more on the efficiency of the airline management to ensure profitability. Sector liberalization in ownership and investment rules may help to resolve this issue by providing the incentives for greater commitment to improving performance – as mentioned earlier, the Indonesian government is becoming cognizant of this fact by actually considering debt to equity option in restructuring Garuda as the government is unable to fund the full cost for the development required. On the other hand, the PAL case highlighted the fact that even if control is in the hands of private investors, it still does not necessarily guarantee governance and efficient management.

The crisis also highlighted the fact that restrictions on ownership raise the cost of funds to the carriers involved and limit their scope to capture the benefits of their comparative advantage in this industry.



4. FUTURE TRENDS FOR THE AIRLINE INDUSTRY

4.1. Liberalization and expansion of air services

Integrated aviation policies to drive industry growth as in the Singapore’s case

Singapore seems to be pushing to lead ASEAN in terms of sector liberalization. More than a coincident is the fact that its government strongly wants to maintain the country’s position as the regional aviation hub with sector liberalization policies used to complement its other efforts including developing and upgrading the domestic infrastructure facilities.

In 2004, a total of nine new airlines, including three Singapore carriers (Valuair, Tiger Airways and Jetstar Asia) started operations at Changi Airport, while 15 new city links were added. This has enhanced Changi’s connectivity as it is now served by 75 airlines, linking it to 175 cities in 55 countries.

The Singapore government has signed ten air services agreements, which included an open skies agreement with Sri Lanka, and two multilateral agreements for the ASEAN countries – one for passenger services and the other for cargo services.

Changi International Airport introduced two-year, S$40mn Growth Incentive Scheme, which is a performance-based scheme rewarding airlines for increasing their passenger traffic to and through the airport.

The international airport is also undergoing a S$240mn facelift with major improvements being made to its design, making it more user-friendly to airport users and businesses. The construction of Terminal 3 is on schedule and due for completion in 2008, to increase Changi Airport’s handling capacity to 64mn passengers annually from the current 44mn. The authority is also building a low cost terminal to be used by LCCs and the S$45mn project is targeted for completion in 2006.

4.2. Emergence of second international airlines The trend for the emergence of second international airlines is fast catching on in

ASEAN, although this has already been happening in other parts of the Asia Pacific region (for example, ANA in Japan and EVA in Taiwan). Underscoring this development is the growing market for LCCs and the potential revenue earned from related-services industry (tourism) in ASEAN. For example, AirAsia has emerged as second international airline for Malaysia after Malaysian Airlines. AirAsia, in line with its nature as an LCC, focuses on short-haul flights in the region and has so far scheduled flights to South China, Macau (via its subsidiary, Thai AirAsia), Indonesia, Thailand and Hong Kong.

4.3. Global: Strategic alliance Alliances have generally been formed to get around bilateral route and capacity

constraints. These strategic alliances are usually limited to marketing agreements and technical cooperation and include activities such as code sharing, shared use of computer reservation systems, coordinated schedules, frequent flyer programmes, management contracts, joint ventures in catering, ground handling and aircraft maintenance. Indeed many alliances struck between airlines involve no investments in equity at all. This could also be seen as airlines’ efforts to circumvent governments’ restrictions in ownership and control policies.

Most alliances tend to be between just one airline and another, but several major groupings, or global alliances, had emerged – however, situation is very fluid leading in many



changes in recent past. Both SIA and Thai International participate in the Star Alliance where United Airlines (U.S.) is the dominant airline. Malaysian Airlines participates in a loose alliance with Northwest Airlines and KLM/Air France, which in turn are members of the nine-airline SkyTeam alliance.

Expect such non-equity strategic alliances to remain active in the future as governments race to improve competitiveness of their domestic aviation sector. In Singapore, the Civil Aviation Authority of Singapore (CAAS) awarded a third ground handling license to a Zurich-based company, Swissport Pte Lte, to provide greater choice for airlines and to lower ground handling charges.

4.4. Community or regional ownership vs. country-specific ownership

Open Aviation Area agreement as catalyst for change

During the Fifth Worldwide Air Transport Conference, held in 2004, the International Air Transport Association (IATA) argued that there was an increasingly urgent need for governments to grant airlines the same degree of freedom to adjust to global change as enjoyed by other industries. At the time of the conference, the airline industry was facing rising fuel prices, and should businesses in the industry fail to respond swiftly, they would face problems in ensuring long-term financial sustainability. For airlines to adjust quickly, IATA felt that governments should liberalize bilateral ownership and control rules and remove national restrictions.

The Conference adopted a recommendation on liberalizing air carrier ownership that endorsed the notions of “principal place of business” and “effective regulatory control” as alternatives to “substantial ownership and effective control” generally used in air service agreements. The latter could be illustrated by the privatisation of British Airways in 1987 – its prospectus declared that not more than 22% of its share capital would be allocated to investors outside the U.K., although it was accepted that foreign holdings might subsequently rise to almost double that figure.

48 countries responded to the ICAO questionnaire following the Conference and their responses indicated:

• Over one third of respondents do not require a carrier they designate to be majority-owned and effectively controlled by nationals of their country.

• While 83% of respondents apply substantial ownership and effective control to the designation of foreign carriers, between 44% and 69% are also prepared to accept less restrictive criteria, including principal place of business and effective regulatory control.

• Two thirds of respondents are ready to apply relaxed criteria to “community of interest” groupings and over half will in the future be prepared to develop a common policy with partner.

• Over two thirds are willing in the future to accept criteria other than traditional ownership and control, some on a case-by-case basis.

• 25% would be willing in the future to issue an individual statement of policy for accepting designations of foreign carriers.



While some of these may yet be translated in actual policies, the results hinted at some progress in changing the industry landscape. Compared to survey results done in 1994, ICAO members then were not convinced of the benefits of a more competitive framework for international aviation that reduced protection for their own national airlines. One of the major concerns then was that relaxation of ownership rules might lead to unacceptable market access by third country carriers. Also fear of the anticompetitive effects of the growth of mega-carriers, principally U.S. carriers, was also apparent in 1994.

The EU is pacing the change in this respect. On 5 November 2002, the European Court of Justice (ECJ) found that nationality clauses in bilateral Air Service Agreements (ASAs) concluded by EU states infringed the Community Law by limiting the freedom of establishment of Community carriers. Following this ruling, the Commission was given a “Horizontal Mandate” to negotiate with all other third countries on a restricted basis to amend the nationality clauses in ASAs that limit the freedom of establishment of community carriers and to negotiate a single comprehensive agreement for an Open Aviation Area (OAA) with the U.S.

Unfortunately the OAA negotiations have yet to reach the full liberalization objective. The U.S. has reportedly offered to allow EU airlines the right to own up to 49% of the voting stock of a U.S. airline, an increase from the previous 25%, but EU officials have indicated that this may not be enough. In April 2005, the CEO of United Airlines, Glenn Tilton, would like to see the U.S. government ease the rules on foreign ownership in U.S. airlines comparing the industry to the global industrial structure trends as seen in other sectors such as auto and telecommunications.

Indeed the OAA negotiations are seen to provide a blueprint for international air transport by leading to full liberalization between two important trading partners, creating a single market. This may act as catalyst in other regions and attract the participation of other countries. And so if the U.S. or other major countries do not allow ownership of their own airlines by foreign nationals or companies, efforts in the sector liberalization will be one-sided and it will be difficult to persuade developing countries to adopt such rules themselves.



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5. RELATIONSHIP BETWEEN AIRLINES GROWTH WITH OTHER SECTORS

5.1. Increasing demand for air services due to higher economic activities The Asia Pacific region as a whole has been the world’s fastest growing air transport

market in view of the dominance of its cities in economic development, the rapidly developing importance of tourism and the fragmented geography of the region. Between 1991 and 2001, the passenger traffic in the region has more than doubled, from 359bn passenger-km to 744bn passenger-km and the Asia Pacific’s share of world passenger traffic grew from 19.5% to 25.4% in period.

The International Civil Aviation Organisation (ICAO) forecasts of passenger traffic are that until 2007, the region will experience 5.4%YoY in passenger kilometers as compared to the world average of 3.9%YoY. It is anticipated that the region will overtake Europe by 2005 to become the second largest regional market for airline passengers after North America (27% and 37% respectively). Also the aircraft maker, Boeing, is anticipating that Asian airlines will spend US$590bn on aircraft in the next two decades as traffic increases and new budget airlines are established.

Indonesia is an example in which improving economic climate has provided a boost for domestic air travel. In July 2004, the Indonesian Transport and Communication Minister Soenarno said that Indonesian airports will handle 20% more passengers on domestic flights annually starting in 2006 as an expanding economy and cheaper fares spur travel demand. Already the government is expanding secondary airports in Surabaya and Yogyakarta in Java, and Padang in West Sumatra to prepare for the traffic growth. In 2003, more than 26 airports in Indonesia handled about 20mn passengers, up 17%YoY from 2002.

At the time of the announcement, the Indonesian government projected the GDP to grow 4.8%YoY in 2004 and 5.4% in 2005. Tourist arrivals were expected to rise 13% in 2004 to 5.1mn from 4.4mn in 2003. In July 2004, the government had signed an open skies agreement with the U.S. removing restrictions on air services between the two countries. The agreement allows Continental Airlines to add routes to Indonesia while Northwest Airlines is expected to cooperate with Garuda on a new route.

5.2. Emergence of China as an important destination for ASEAN carriers The aviation sector in China is one of the fastest growing in the world – according to

the OECD, China is already the fifth largest aviation passenger market and fourth largest air freight market. Air traffic has grown more rapidly than other domestic transportation modes, and within the next two decades, China is projected to become the largest commercial aviation market outside the U.S. This growth has in large part been driven by economic reforms and liberalization.

Even though China made no WTO commitments to open up its aviation services sector, it took a significant step in July 2004 to increase market access for U.S. service providers. China signed a bilateral agreement with the U.S. that will more than double the number of U.S. airlines operating in China and that will increase by five times the number of flights providing passenger and cargo services between the two countries over the next six years. The agreement also allows each countries’ carriers to serve any city in the other country, provides for unlimited code-sharing between them, expands opportunities for charter operators, grants cargo carriers the right to provide door-to-door delivery services and eliminates government regulation of pricing as of 2008.

Earlier on, in March 2004, China completed its first open skies agreement with Thailand, allowing Thai airlines to offer flights to almost any Chinese destination under code-



sharing arrangements with Chinese airlines, and to keep aircraft overnight in China. It also grants Thai airlines “fifth-freedom” rights to Singapore, Japan and Australia.

The Chinese government also offered foreign airlines access to second-tier Chinese cities if they made Hainan Island their first stop. Carriers from ASEAN countries may no choose to fly via Hainan instead of negotiating direct traffic rights for other cities.

Indeed these exciting developments have resulted in foreign airlines aggressively making moves into China. Already Singapore investors have announced purchase of shares in Chinese regional airlines.

5.3. Increasing consumer influence, affluence and sophistication Rising middle class population and a more aware consumer environment means that governments in the region have to pay more attention to their interests when formulating aviation policy decisions. Already this is happening in the more mature ASEAN markets such as Malaysia, Thailand and Singapore as the respective governments having to engage in debates to decide on locations of new airport facilities to take account of the growing demand for LCCs services. Furthermore, increasing competition in the market means greater choice for consumers, forcing incumbent carriers to compete via upgrading of facilities.

5.4. Airport Infrastructure and Facilities

International airports in ASEAN are predominantly owned and managed directly by the government or through government-linked companies. Singapore’s Changi Airport, one of the major air hubs in the Asia-Pacific, is managed by the Civil Aviation Authority of Singapore (CAAS), a statutory board under the Ministry of Transport. Malaysia Airports Holding Berhad (MAHB) and Airports of Thailand (AOT) Plc which operate five international airports each in Malaysia and Thailand respectively are public listed companies but about 70% of their shares are held by their respective government or government-linked companies. Other international airports in the region follow similar structure.

Although the airports are managed indirectly by the government, they are well-managed and have been able to perform well and comparable to other major airports in developed nations. Passengers and cargo facilities are well-developed in the five international airports managed by MAHB in Malaysia. KLIA has an initial capacity of 25 million passengers and 650,000 tonnes of cargo per year. Cargo import and export procedures are fully automated at the KLIA to cut down delivery time.

However, there are signs that the government has started to give airlines more say in the management of airport. Whether it is a change of trend or a one-off thing is not clear. Responding to growing demand for LCCs services, the Malaysian government plans to build a new LCC terminal at KLIA, costing about USD26m with AirAsia as the main operator. AirAsia plan to make the low cost terminal at KLIA into an efficient design for the carrier's low-cost model and the center for low-cost travel in Asia despite stiff competition from Singapore. While in Thailand, the government may grant Thai 50% control over the new Suwannaphumi Airport, which will start operation in 2006.

Table 11: CAAS Group Financial Results

(S$ million) 2003 2004 % change

Revenue 915.0 906.0 -1.0%

Operating Expenditure 631.0 596.0 -5.5%

Net Profit 182.0 259.0 42.3%



CAAS Group which operates and manages Changi Airport has reported a healthy profit of S$259 million in financial year 2004, an increase of 42.3% year-on-year. Although the revenue has fallen by 1%, CAAS has managed to cut costs by 5.5%, thus sustaining its competitiveness.

Table 12: MAHB Financial Results

(RM million) 2001 2002 % change 2003

% change 02-03

2004 %

change 03-04

Revenue 896.1 935.3 4.4% 894.0 -4.4% 1,015.6 13.6%

Operating Profit 225.0 223.8 -0.5% 140.9 -37.0% N/A

Net Profit 180.0 150.8 -16.2% 84.7 -43.8% 127.2 50.2%

MAHB which operates 5 international operates including the Kuala Lumpur

International Airport (KLIA) recorded improved performance in financial 2004 after profits declined in the previous two years. Revenue has reached an all-time high of RM1 billion. Net profit rose by 50.2% from previous year but it has not returned to its record profit of RM180 million in 2001.

AOT which operates five international airports in Thailand recorded a profit of Bt1.41 billion ($37mil) in first quarter 2004, an increase of 57% year-on-year. The higher profit was boosted by an increase in fees collected from airlines and passengers, and a higher interest income. Revenue was Bt3.8 billion, which rose by 12% from the previous year.



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6. EXPERIENCE OF LIBERALIZATION OF AIRLINE OWNERSHIP STRUCTURE

6.1. The EU: Setting new standards in M&A activities In the past, cross-border merger and acquisition activities in the industry were limited

to airlines from neighbouring countries agreeing to pool their resources and form consortia on a regional basis – SAS in the Scandinavian countries, Gulf Air in the Middle East, LIAT in West Indies and Air Afrique in French West Africa. These cross-border arrangements were made by state-owned airlines and promoted by national governments and their success or failure depending almost entirely upon political considerations. The trend has since changed to privatised airlines seeking to break free from inter-governmental air service agreements and extend their networks by taking equity stakes in carriers operating complementary services, not just in neighbouring countries but, increasingly in other regions.

Air France-KLM merger setting new standards in M&A activities in airline industry

A major consolidation event – the recently approved Air France-KLM merger – is already occurring within the framework of existing Open Skies agreements. The notable feature of this exercise is the inclusion of a series of corporate governance and ownership adjustments not normally found in a traditional merger. This is to protect the air traffic rights granted under bilateral agreement for each airline – the Dutch government has an option allowing it to obtain 50.1% of KLM’s voting rights if its traffic rights are challenged as a consequence of the nationality of KLM’s shareholders. The merger also includes a three-year transitional shareholding structure that will ensure majority ownership of Air France is with French citizens and the majority ownership of KLM is with Dutch citizens.

The basic structure is attempts to preserve the brands and identity of each airline by establishing a French holding company, Air France-KLM, which will own 100% of the economic rights for both Air France and KLM. To protect KLM’s traffic rights, Air France-KLM will only control 49% of the voting rights, with 51% being held by Dutch foundations and the Dutch government. After three years, the Air France-KLM will own 100% of both airlines.

European officials believe that the EU’s February 2004 approval of the Air France-KLM merger signals the start of consolidation of the European aviation industry. It has also inevitably raised questions about how existing global alliances (including code sharing practices) will be affected.

6.2. Australia and New Zealand: The Single Aviation Market (SAM) Government ownership of airlines in both domestic and international sectors and

Qantas as Australia’s national carrier were part of the Australia’s international aviation policy prior to 1989. Since then the government has decided to relax limits on foreign investment in Australian international carriers and to privatize Australian airlines. This allowed up to 49% foreign investment in total, with a single foreign carrier holding limited to 25% and total foreign carriers limited to 35%. Note that foreign investment requirements for Australian domestic airlines are more liberal than those for Australian international airlines. Requirements for control of Qantas and other Australian international airlines include for the location of the head office, location of most operational facilities and composition of board members.

In 1992, Australia and New Zealand established a Single Aviation Market (SAM) as part of the Australia-New Zealand Closer Economic Partnership Relations Trade Agreement. SAM has become Australia’s most liberal bilateral arrangement. Ownership of SAM airlines may be vested in either Australia or New Zealand nationals or both. Ownership and control requirements also include at least 50% ownership and effective board control must belong to



the nationals from either country, at least two thirds of board members must be nationals or either country, the chairperson of the board must be a national of either country and the head office and operational base must be either country.

The agreement has also relaxed foreign ownership of domestic and trans-Tasman carriers indirectly and facilitated the subsequent foreign ownership of Ansett’s domestic operations.



7. FINDINGS OF THE STUDY

The liberalisation of airline ownership rules, which is viewed as an instrument for achieving an integrated ASEAN air services sector, raises many interlocking issues, concerns and possibilities. The role of government in the form of state ownership is central to these sets of issues.

First, the nexus between ownership structure and sustainability is fundamental to the future of the ASEAN airline industry and its dependent sectors, in particular the aviation industry. One of the most persuasive arguments for the liberalisation of ownership is that it will increase access to funds for investment, which is essential if airlines are to expand to meet the raised business demands in a competitive market. An airline with a private sector interest and operating on commercial considerations is not guaranteed financial viability, and in fact a decision to cease operations may be taken more promptly by private owners. But private ownership adds to incentives for efficiency and for services that consumers demand. The availability of private financing provides an attractive alternative for funding airline expansion.

However, there are also arguments made in favour of state ownership in national airlines. State funding may appear to be cheaper than private sector financing at least until an airline can prove its performance and viability. Privately owned airlines are vulnerable to shocks such as steep oil price increases and a severe drop in passenger and cargo load, and as a consequence the state has had to bail them out. In other words, private ownership does not guarantee long-term sustainability and privately owned airlines may not be able to sustain their business in stormy markets. There is also a possibility that liberalisation may not bring in fresh capital, and instead may lead to one owner replacing another. Thus, changing ownership structure does not improve the debt to equity ratio which would otherwise also improve an airline’s financial sustainability.

Second, airlines often have to serve national and strategic interests; chief among them is providing connectivity, namely running commercially unviable routes and ensuring that remote areas are connected with the more developed areas in the country. In some cases, fares for selected routes especially for the rural areas are kept at affordable levels (and may be below costs). In this case, airlines have to meet their social obligations by cross-subsiding these routes with those profitable ones. The presence of the state as an owner will allow it to grant a subsidy in order for the airlines to meet these strategic and national objectives. Airlines that are entirely run on a commercial basis may not be able to suppress their business aims in order to fulfill national objectives. Based on purely commercial considerations, rural areas in which traffic volumes are low may not have an air service or if they do, it would be at very high fares. In addition, a national airline is also a symbol of national identity: majority ownership by the private sector, with commercial considerations as priorities, may not be consistent with national aspirations.

Third, liberalisation of air services sector has significant effects on ASEAN emerging countries and their national airlines. Presently, there is a different level of capacity and competency of air services industry among ASEAN countries. Singapore, Malaysia and Thailand have more developed airlines in terms of capacity, financial resources, capability and competency and have strong international presence. At the other end, the airline industry in CLMV countries is still at the infancy stage, with limited resources, capacity and relatively low skills. In between, Indonesia, the Philippines and Brunei are primarily focused serving their domestic markets and their capacity and competency can be further improved.

The proposed integration of ASEAN air services sector will require, among other changes, the liberalisation of ownership rules and improvement in market access, which may result in increased competition among ASEAN airlines. Ultimately, the objective of the



integration process is to create competitive airlines and for this to happen, consolidation is unavoidable.

The main concern of the relatively less developed ASEAN airlines, including the CLMV countries, is that integration and liberalisation may negatively affect their airlines: many may not be able to survive the competition because they do not have the resources, both capital, skilled workers and management to meet the performance of the three dominant airlines (SIA, MAS and Thai Airways). Thus, although ASEAN is aiming to establish an integrated air services sector, the relatively less developed ASEAN countries are concerned about whether their airlines can benefit. Although these countries may have limited capacity, they have a strong potential for growth in their air services industries – economies at the early stage of development have a high rate of growth and expanding economic activities, tourism and investment. In view of this potential, many established airlines are seeking to obtain air services market access in these emerging countries. This interest gives those countries some bargaining power in the design of reform.

The liberalisation experience of some CLMV countries and of the Philippines has also shown that private ownership of airlines does not guarantee success. In the Indonesian case liberalisation has resulted in the establishment of many private airlines but the remaining protection has contributed to their survival: the recent decision by Indonesia to limit the access of LCCs into its domestic market attests to this. Integration and liberalisation of the ASEAN air services sector which is well sequenced and with a well thought out transition process will help ensure that all members will have the chance to benefit or to minimize the negative impact.

Fourth, changing the structure of ownership has implications for market access. Presently, market access is determined by bilateral air agreements between countries. As such, liberalisation of ownership leading to foreign equity investment is often linked with market access issues. Since market access is important for airlines to expand and improve performance, ASEAN countries should not only view the liberalisation of ownership structure in terms of meeting financing needs, improving efficiency, promoting integration but also for increasing market access. Therefore, the question is whether the liberalisation of ownership should be open to private owners, which include both domestic and foreign investors, and among the latter should it be specifically linked to targeted ASEAN partners or other foreign parties in order to improve market access?

Fifth, liberalisation of ownership raises questions of competition policy and consumer protection. Liberalisation of ownership may result in major airlines consolidating to become a dominant player which will have serious implications on competition and consumer protection. As a dominant market player, the merged airlines can introduce predatory practices that are detrimental to other smaller players or consumers. Hence, the government must put in place an appropriate competition policy when it liberalizes the ownership of airlines.

And sixthly, developments in the global airline industry, in particular growth of tourism and trade and liberalisation of airline ownership structure in other regions affect the competitiveness of ASEAN airlines. They may have to operate in a more competitive environment in “open sky” conditions. The global liberalisation trend includes a change in designation rules from the concept of “substantial ownership and effective control” to “principal place of business” and “effective regulatory control”. These open the prospect of a different ownership structure that can increase airlines’ efficiency and profitability while at the same time ensure conformity with regulatory requirements. The question is whether ASEAN countries can adapt to some of these new global trends while meeting the same strategic targets that they were able to achieve through the ownership of their respective airlines?

The analysis of the relationship between ownership structure and airline performance needs to consider the following issues and the choices are difficult to make because the governments have to balance challenges, benefits and objectives:



a. Can the profitability of the airline industry be ensured if ownership rules and structure are liberalized? In other words: is the ownership structure the single most important criteria for being profitable?

b. Although the primary objective of state ownership is to serve the national and strategic interests, can a state-owned airline be commercially profitable and efficient?

c. Can liberalisation of ownership rules lead to too much competition, duplication of resources and, ultimately, failure of airlines?

d. What is the desirable ownership structure: an airline which is completely state-owned, or entirely private sector-owned or a combination of the two?

e. If national airlines are to be privatized, who should be the appropriate partners – domestic investors, foreign investors or parties with an airline or air services background? The discussion in the earlier sections has clearly shown that airlines, both national

and private, have a strong appetite for new funds to finance expansion and to upgrade services. Without more investment, an airline may struggle to remain competitive. From past experience in ASEAN and elsewhere, liberalisation of equity rules has generally brought benefits and improved the performance of airlines. Through privatization and/or selling part of the equity via a public listing, private sector participation can push airlines to better performance. For listed airlines, this discipline will be enforced through the scrutiny by the shareholders. Hence, liberalisation of ownership rules is a sure way for airlines to improve their cost efficiency, subject to some qualifications discussed further below.

However, liberalisation alone cannot ensure the sustainability and profitability of airlines. Often privatized airlines have had to be “renationalized” and in effect rescued by their respective governments – both in developed and developing countries. Airlines have to operate in a very competitive environment, which means they have a low profit margin. During the 1997 crisis, ASEAN airlines such as Malaysia Airlines, Philippine Airlines and Garuda had to be rescued by their respective governments. Established airlines from developed countries also can be vulnerable. In the aftermath of extraordinary events such as September 11 or the SARS outbreak when passenger air traffic drops dramatically, privately-owned airlines do not have access to the vast resources of a government.

Although private funding, both domestic and foreign, is available, it may not necessarily be cheaper than capital injections from the state. Sovereign debt is usually priced lower than that from the private sector. Moreover, some states can utilize cheap domestic funds, provided by domestic compulsory savings and insurance schemes. However, when viewed in terms of the total cost of funding, the private sector brings with it commercial disciplines that put emphasis on returns and profitability, which will ultimately lower the overall costs. At the same time, public funding, which is apparently lower cost, is only available because of guarantees are ultimately supported by taxpayers of the community.

Singapore Airlines and Malaysia Airlines were able to call on both public and private sources to finance their expansion. Being state-owned airlines, their initial recourse for funding was the state, but after attaining a certain level of development, they then turned to the private sector (via a stock market listing) to seek further financing. Venture capital, as a source of funding, may be only suitable for new airlines that are run primarily for commercial reasons such as the LCCs and not for national airlines. Venture capital would not accept non-commercial and national objectives such as serving commercially unprofitable routes and the contribution of the airline to the long-term development of the country.

With respect to the link between ownership and performance, once again the assumption that private ownership will guarantee better performance needs to be examined closer. If privatization is not done on a commercial basis but instead is based on other, perhaps political, considerations, the outcome can be worse than a state-owned entity. In



such cases, the private owners can use the assets of the airline, which were accumulated using public funds, to pursue their private interests. Finally, should the airline fail the state would have to rescue it anyway.

The rationale for relaxing ownership structure and equity rules is quite clear, namely to expand and upgrade services, improve performance, respond to global developments and more importantly to have access to funds for investments. The composition of public and private ownership of an airline, and where the ultimate control lies, will determine the airline’s role, performance objectives and targets. Thus, it is essential that Government have a clear idea of the type of airline that it desires before relaxing the equity rules.

The objectives set by the state for its airline will determine the degree of intervention that it is likely to make as well as the ownership rules of the airline. If a country’s main focus is on serving national interests such as a means of transportation and connectivity, then the degree of state ownership is expected to be high. Notwithstanding these national priorities, national airlines should also be partly owned by the private sector to ensure that commercial objectives will be part of the airline’s performance targets. Liberalisation of the air services sector has led to mixed ownership with both the state and the private sector as shareholders. Rarely is a national flag carrier completely privatized. Even SIA is still 57% owned by the Singapore Government and its related companies.

An equally important aspect of ownership restructuring is the choice of partners. Each owner pursues different goals and has different constraints. The state may focus on employment, accessibility of transportation and national prestige. By contrast, the private sector is likely to concentrate on efficiency, profitability and productivity. The Government has to evaluate the prospective private sector partners to ensure that the privatized airline will be sustainable and viable in the long term, contribute to national development and produce profits to its shareholders. The government may consider a number of selection criteria: should the partners be private sector investors who are not connected to the airline industry or should they be other interested parties or even operators in the airline industry: should investors be local or foreign, and how will that choice affect market access? The even more fundamental issue is whether the Government is seeking passive investors or those that will wish to have a say on how the industry will be run.

7.1. Options

A number of points for consideration in the design of reform packages are examined in this section.

a. Hybrid state-private ownership offers a solution that draws on the synergy between the best aspects of the public and private sectors.

National airlines should have majority state ownership while low cost carriers can be entirely privately owned. Some countries have put limits on the voting rights of private investors to ensure that the Government still has a significant control on the way the national airline is managed.

The hybrid model is appropriate for national airlines because they have long-term and strategic objectives that cannot be fulfilled by a totally private sector owned airline, such as servicing rural areas that require cross subsidization from profitable routes. In such cases, the state has to support its national airline and provide funds to achieve those objectives. Another compelling reason for national airlines to be majority owned by the state is to sustain the airline.

In addition, from a commercial point of view, the cost of funds raised by the Government is lower than the private sector can generally achieve. Investing in a new airline in an emerging country can be risky. There is little traffic as the country is still



at a low level of economic development, and in such cases private investors will require a high return on their investment.

A significant and active private sector shareholding (local and foreign investors), rather than equity holdings by passive investors, may also be helpful because it can push the airline to meet commercial goals such as performance efficiency, quality service and profit.

The question however is whether the commercial interests of active private investors can be sustained in this model. Private investors may not be willing to invest unless they have effective control of the airline. If so, supplementary measures such as tendering for the provision of services of social but not commercial value may have to be considered, alongside a brief to the airline to pursue its commercial interests.

On the other hand, for low cost carriers, the situation is less complicated. True market competition should be allowed because these airlines are run entirely for commercial reasons and they serve mostly established and popular routes. In the case of low cost carriers, there is no need for the state to participate and it is left to the market to determine their competitiveness and viability.

The challenge in this case however is that when fully private low cost carriers compete with national airlines, the competitive pressure on the latter may be intense, which leads to threats to their sustainability and to further adjustment in their operations in the shorter rather than longer term.

b. The liberalisation of ownership should be done in stages.

In many ASEAN countries, the airline industry is still in its infancy, capacity, financial and human resources are scarce and management skills are still weak. Furthermore, in some countries, the full regulatory framework has yet to be finalized. Thus, there is an understandable fear of a full liberalisation of the airline industry. Domestic companies should be given room to build their capability before unrestrained competition with foreign companies takes place. The experience of the more established ASEAN airlines attests to this approach. A push for full and immediate liberalisation may result in resistance by domestic players and policy makers. Although there is a possibility of backsliding on the liberalisation timetable, the subsequent stages of liberalisation may accelerate. Considerations in the design of the schedule are the following:

I. The timeline of liberalisation of ownership should not cause severe shocks or

steep adjustments such as a large-scale retrenchment of airline workers. Yet, the timeline should not be too long because of the risk of distraction or too much delay

II. The changes in ownership structure should be part of the ASEAN liberalisation effort to develop uniform competition rules within the region. The liberalisation of air services under AFAS should make meaningful and substantial progress at the early stage.

III. The relaxation of equity rules can begin by making a link-up with strategic investors (while noting their likely concerns about control, mentioned above), followed by full privatization and finally listing of the airline in the stock market. Secondary airlines can be immediately opened to private ownership.



c. Cooperative plurilateral arrangements should be expanded.

Existing plurilateral agreements among some ASEAN countries include the liberalisation of all cargo air services between Singapore, Thailand, Brunei and Cambodia based on the “2+X” approach which, while it does not involve ownership reform, is a commendable initial step. Other ASEAN countries may join, if the cooperation benefits all members. Similarly, the CLMV multilateral agreement, which grants the right to conduct international air cargo transportation by other members’ designated airlines, could be another building block for a liberalized air services sector in ASEAN. The Philippines and Indonesia should consider joining this multilateral agreement, as a way of strengthening their international air services. Other areas of collaboration are in marketing and human resources training.

d. Integrate the ASEAN air services sector

i. The quest for higher efficiency, profitability and capacity for ASEAN airlines requires the integration and consolidation of the regional air services sector. This process should be facilitated by a policy framework but driven by the market. The main issue is how the policy framework can steer regional integration and yet meet key national objectives of member countries, achieve commercial targets and bring benefits to all parties.

ii. The existing ASEAN multilateral and plurilateral (and voluntary) agreements on air services are limited in scope and coverage. The cooperation thus far includes sharing international air cargo and does not involve any reform of ownership structure. The agreements have yet to produce any significant impact and therefore their role as a route, model or template for ASEAN integration is questionable. Presently, air services are still being negotiated bilaterally and most ASEAN bilateral free trade agreement negotiations have excluded air services. The approach that ASEAN will take during free trade agreement negotiations with dialogue partners such as China, Japan, Korea and India will have important implications for the integration of air services.

iii. Open competition and immediate full liberalisation of the air services sector runs the risk of the marginalization of smaller ASEAN airlines, although their ability to attract investment because of their emerging competitiveness and their domestic market growth is also noted. This trend has already emerged when Temasek, the Singapore government’s investment arm, acquired 30% of Pacific Airlines, Vietnam’s largest airline. The major ASEAN airlines may however dominate the regional air services sector.

The box below summarises these points by presenting one scenario for reform and consolidation.

Box: A scenario for liberalization

Liberalisation and integration of the ASEAN air services sector might be carried out in three stages:

Full liberalisation of ownership for low cost carriers to service domestic and regional routes is the first step in this scenario.

The ownership of these airlines is made fully open to the private sector both within and from outside the region. The concept of principal place of business applies because airlines are regulated at their principal place of business.



Integration and consolidation of designated/national airlines on regional and international routes is the second step.

The integration process would be expected to end up with perhaps two or three regional airlines that serve the regional and international routes of the members of the consortium while the domestic market is still being served by national airlines and/or domestic private airlines.

An ASEAN country might retain its national airline and/or private airlines to serve the domestic market to meet its strategic objectives such as connectivity. The option of opening its domestic markets either through one of the international airline consortiums or with low cost carriers (supplemented by specific policy measures for particular routes where required) could be considered as the final stage of liberalization. But this can only take place after the national airline has been put on a sound footing, and in any case foreign participation will be limited to areas or sectors where it can complement the national carrier.

The now well-established ASEAN airlines would be the core of the new consortiums and the emerging designated airlines could take up a strategic shareholding. The structures of these consortia would emerge through commercial negotiation and market developments (including the necessary response to the growth of the low cost carriers). Their ownership structures may include the hybrid form noted earlier, although the participation of public interests from a number of countries would complicate their management in that structure.

The effective regulation for the remaining two or three airlines is carried out at the ASEAN community level. The ASEAN Investment Area Agreement can be a facilitating framework for this approach. Attention may also be required to competition policy issues that emerge in the region and which have their origins or effects in various jurisdictions. The consolidation of existing airlines into two or three major regional airlines will allow competition among these major airlines, under similar rules, will improve commercial performance, ensure airline viability and yet need not compromise key national and strategic objectives.

Once ASEAN air services integration has reached a stage in which two or three airlines are operating on a near equal basis, the negotiation for international market access should be done at the regional (ASEAN) level.



REFERENCES

Findlay, Christopher; Chia Lin Sien and Karmjit Singh (eds) (1997) Asia Pacific Air Transport: Challenges and Policy Reforms. Institute of South East Asian Studies, Singapore.

Doganis, Rigas (2002) Flying Off Course. Routledge, London

Forsyth, Peter; John King, Cherry Lyn Rodolfo and Keith Trace (February 2004) Preparing ASEAN for Open Sky. REPSF Project 02/008, Monash International Pty Ltd.

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