Grounded – Private Airlines Stifled by State-owned Players

Private airlines play a small role in the aviation market in comparison to the three main state-owned airlines – Air China, China Southern Airlines and China Eastern Airlines. Together the three giant airlines account for around 65% of the domestic market, while approximately 30% of the market is owned by second-tier carriers, such as Hainan Airlines, Shenzhen Airlines, Xiamen Airlines, Shanghai Airlines, Sichuan Airlines and Shandong Airlines, according to a report from the Centre for Asia Pacifica Aviation [CAPA] last year. All of them are state-owned except for Shenzhen Airlines. Such an imbalance causes great difficulties for other private airlines, and limits the benefit they get from private capital liberalization.

Private Airlines Have Few Route Choices

Ikwei Chong, partner at Clyde & Co, Shanghai, said that since the state-owned airlines account for the majority of the aviation market, they usually have an advantage in getting better domestic routes. And as the Civil Aviation Administration of China [CAAC] only permits three airlines to service each domestic route, small-scale carriers are often left with the less popular and less profitable routes.

Also, unlike many aviation industries in foreign countries, where low-cost carriers make profits by being able to turn the planes around much faster than the big carriers, the situation in the PRC is different.

“If you are a low-cost airline in China, you can't do that, because the regulations require aircraft to be grounded for a minimum number of hours before taking off. So the competitiveness of a small-scale carrier is in fact uneven to that of a big carrier,” said Ng.

Such barriers also include another obstacle – the CAAC's bureaucratic system. It is not easy to file a route application in the PRC. The CAAC's slow and time-consuming system strands private players, drastically hampering their ability to compete with the big airlines, while slowing down their growth.

“If the Ministry of Railways is the most bureaucratic, the CAAC is the second most bureaucratic,” said Gary Gao, partner at Haworth & Lexon. “Some of the application systems are not at all transparent. If you submit a document, you will be asked to provide further information and documents. They are not as efficient as they should be,” Gao said.

Aircraft and Fuel

Even if an airline succeeds in getting an approval, to have sufficient funding for aircraft and fuel can be a challenge. In the PRC, while all Chinese-registered airlines are required to purchase fuel only from certain fuel suppliers in the country, they have limited freedom to choose what aircraft to purchase. At the same time, both fuel and aircraft are fixed at stunningly high prices.

“Despite the fact that they [the government/Civil Aviation Authority of China] are licensing new private airlines to be set up in China, there is little accompanying regulatory or system changes to help such private airlines flourish in the still highly-regulated and high-cost aviation industry,” said Ng.

In the past, airlines could have been able to easily get funding from local banks. Nowadays, as credit lending is tightened, it could be a drawback for many private airlines.

“The financing channel is tight. Due to the lack of regulatory support, it is difficult for a newly established private company to obtain credit from the bank,” said Zhao Shuzhou, senior partner at Wang Jing & Co. Getting funds for aircraft is much harder than many other funding activities within the aviation sector, he said. Kunlun Airlines, for example, failed to enter into the sector in 2006 as a private airline due to a lack of funds. It was the first airline that could not satisfy the requirements as a private carrier since the liberalization of the aviation industry in 2005.

Yet Zhao added that the financial channels are mostly used by the Chinese private airlines as a way to secure loans rather than to finance aircraft. East Star Airlines, for example, obtained a loan from the Royal Bank of Scotland through a financial lease.

Qualified Pilots Wanted

In addition, a shortage of pilots is another key obstacle that has been hindering private airlines from expanding. With the number of travelers having surged during the Spring Festival to 21.6 million, 70% higher than last year, it is certain that sufficient pilots and aircraft are going to be essential to meet the increase in demand for flights. Although Gao Hongfeng, deputy director of the CAAC, last year acknowledged the existing challenge and said that Chinese airlines needed an additional 9000 pilots by 2010, the regulatory environment in the PRC is not at all favourable to pilot recruitment in the PRC.

According to Zhao, under the CAAC's regulation – The Opinion for Regulating the Management of Mobility of Pilots and Guaranteeing the Stability of Pilots – if an airline recruits a pilot from another airline, the former must pay about Rmb700,000 to Rmb1.2 million as compensation to the latter. The newly recruited pilot is also forbidden to fly any plane before the termination of his contract with the original airline. Private airlines therefore face certain difficulties in recruiting competent pilots, even with the provisions guidelines for the mobility of professionals in the civil aviation industry.

To encourage and expand the flow of domestic pilots, the CAAC granted that those who have a local pilot's license may now become national pilots. However, the state-run airline pilots are often bound by the high penalty labour contract signed between them and the companies. To hire a pilot from a state-owned airline is thus still tremendously difficult for private airlines.

As a consequence, the highly-regulated environment in the PRC airline industry has created a phenomenon: private airlines lack qualified pilots while the state-owned ones have them in excess. Without any other choices, private airlines have to hire pilots from foreign countries, such as Brazil and Russia.

Pilots Are Forced To Work Overtime

The shortage of pilots also hampers the safety image of private airlines, on which the government has been working hard, especially with the Olympic Games fast approaching. People in the PRC now place more weight on airlines' safety than on the cost of an air ticket, Gao said. “Creditability of a private airline is still a problem in China, and this will certainly affect the growth of the private carriers,” he said.

Many private airlines' pilots, according to the China Daily News, are said to be forced to work a lot of overtime, and both passengers and government officials show great concern for the safety of airlines. Early this year, Li Jiaxiang, the newly appointed acting minister of the CAAC, said new measures would be introduced soon targeting private airlines that cannot supply the required number of pilots to fly its planes. These airlines will not be allowed to import any new aircraft or open new routes, he said. Facing more challenges from the government, private airlines are subject to struggles within the industry.

“In a way,” Ng said, “the low-cost airlines in China struggle to be low-cost for reasons [such as] high fuel costs - fuel is purchased at state regulated prices which are usually above international spot rates - high landing charges, controls over fares and routes, relatively high aircraft import levies, and shortages of pilots and second-hand planes.”

CAAC Blocks Airlines' Development

Last year, the then-minister of the CAAC Yang Yuanyuan admitted that their control over the airline industry had artificially held back the development of low-cost airlines, according to China International Business Magazine. Complaints from small airlines still exist due to some policies and regulations, while the development of low-cost carriers in China, he said, is still in the formative stages. “The CAAC is supportive of the development of low-cost carriers, but we admit we still have a lot of difficulties and problems,” he said.

In fact, fearing that the industry's rapid development may jeopardize aviation safety, the CAAC regulator last year announced the suspension of all new airline licenses until 2010. Having been open for two years, the door for private airlines to enter the industry is now closed.

The situation now is similar to that in the 1990s, when the government attempted to have a complete domestic deregulation of the airline industry. Every province was allowed to set up their own airline. The result was disastrous. With more than 20 airlines established, the airline industry experienced a dramatic profitability plunge. The government then took action to consolidate the airlines into three giant carriers – China Southern Airlines, China Eastern Airlines, and Air China Airlines. Then the booming economy in China made the government decide again to liberalize the airline industry in 2005. Since then, the CAAC has received more than 10 applications.

“We are returning to the time of the 1990s, where airlines are set up and have no chance at all to survive in this tough business environment,” said Ng.

Measures and Regulations to Encourage Foreign Investment

Of course, it is unfair to say that the government has not been efficiently regulating this giant industry. In the past few years, in order to gradually open up the aviation industry to foreign operators, the government has stipulated provisions that encourage foreign investment into this highly regulated sector [see table 1.1 below].

“These three main laws and regulations maintain and regulate the administration of civil aviation safety information. And more importantly, I think, [they] are a safeguard guide against civil aviation accidents,” Chong said.

According to Peter Murray chief representative at Ince & Co, Shanghai, the Foreign Investment in Civil Aviation provision that took effect on January 8 2002 clearly stipulates the scope of civil aviation. Under this provision, foreign investors may invest in and shall include: civil airports, public air transport enterprises, general aviation enterprises and projects related to air transport. Foreign investors are therefore welcomed to establish joint-ventures and be partial participants of the aviation industry in the PRC. Though the investment ratio depends on different sectors, such an imbalance of stake ownership has not deferred foreign investors' interest in pushing the industry forward.