INSIGHT: Challenging market afflicts Russian air transport

After the years of rapid growth Russian air transport industry now suffers virtually no growth in all areas (Photo by Leonid Faerberg / Transport-Photo.com)

Stagnation of Russian air transport last year has turned into a crisis in 2016, as the industry continues to suffer virtually no growth in all areas.

The slump in air transport, caused primarily by shrinking passenger numbers on international routes, has been exacerbated by a sharp domestic slowdown in the summer of this year, with clear indications that the internal air transport market is about to reach its growth limits.

Prior to 2014, the Russian air transport market benefited from the following positive factors:

• a growing GDP, which reflected the general state of the country’s economy and business activity;
• increases in real incomes, which drove demand for tourism and ad-hoc air travel;
• the high exchange rate of the ruble, which enhanced demand for international air travel;
• passengers switching from rail to air, partially stimulated by the lifting of state control over passenger rail ticket prices; and
• government subsidies for regional air transport services.

By 2016, four of these five factors had either exhausted their stimulating potential or developed into negative trends.

The GDP growth has been slowing since 2015, matched by a decline in business activity. The latter process is particularly noticeable in international economic relations which, apart from macroeconomics, have been seriously affected by adverse political factors.

With the GDP slowdown resulting in lower real incomes and curtailed spending power, the falling ruble exchange rate has further increased the cost of vacationing abroad by as much as 100%. These factors combined to dramatically drive down the number of international air passengers.

At the same time, the falling ruble proved detrimental to those air carriers whose primary costs are denominated in foreign currencies. This prompted airlines to raise fares, which only exacerbated the already dire demand.

Source: Russia’s Higher School of Economics

Prior to the first quarter of 2016, continued growth in domestic passenger numbers had played a somewhat stabilising role. But the low-yield domestic routes were merely helping the sector maintain its physical indicators, even though its financial performance was sliding downhill (the sector’s combined losses on domestic routes amounted to 44 billion rubles in 2015, or US$699.5 million at the current exchange rate, against 35 billion in 2014).

In spring of this year, analysts first noted that air passengers were starting to migrate back to rail travel, primarily due to the rising cost of airfares on domestic routes. This development is markedly unusual in that, anywhere else in the world, passenger numbers have been growing faster for air than rail, even during recessions.

These negative factors have been further exacerbated by a number of political developments, which resulted in bans on passenger operations to Turkey, Egypt, and Ukraine.

The only growth factor currently left to the sector are regional subsidies to air carriers, but even these have been shrinking due to budget constraints. In 2012, such subsidies were viewed as a way to develop regional air transport infrastructure. Now they are considered to be regional carriers’ only means of survival.

The crisis has not been affecting all Russian air carriers in the same way. A number of airlines have been reporting significant growth in both physical indicators and financial performance. According to Russia’s Transport Clearing House, Aeroflot Group carried 1.8 million more passengers year-over-year in the first six months of 2016 (up 10.3%), generating 2.5 billion rubles in profit; the figures for S7 Group were 1.1 million more passengers (up 23.2%) and 1 billion rubles. Of the 30 largest Russian carriers, about 50% saw an increase in passenger numbers.

Top Russian airlines reported significant growth in both physical indicators and financial performance in 1H 2016 picking up the passengers of the defunct Transaero

Under the circumstances, these growth figures may appear extraordinary, but are misleading in that they were greatly contributed to by the collapse of Transaero Airlines, the country’s second largest carrier, whose passengers then switched to the largest and most active of the remaining market players. This factor is expected to stop playing a role as the crisis continues.

To be able to predict the direction in which the market is going requires an assessment of the current competitive environment. At present, Aeroflot Group appears to be the single largest market player. The group controlled 19% of the Russian market in 2006; its share exceeded 50% this past winter, and continues to grow. This is due exclusively to Aeroflot Group’s dominant position, as the top player has enough resources to throttle any of its rivals.

Although the Russian government has pledged its commitment to safeguarding market competition, delivering on this promise in the current situation requires active and rather hard measures, each of which would come with significant risks and limitations. Apart from directly regulating the activity of Aeroflot Group, the government may consider a number of other measures to support competition in the sector. It could designate carriers on international routes; improve the existing lease mechanisms (including the introduction of wet-lease schemes); permit airlines to deploy shorter routes if cleared by ATC; force airports to charge airlines lower handling fees; and increase the efficiency of subsidising mechanisms (for example, by extrapolating long-range subsidies to regional routes).

The latter measure could be bolstered by simultaneously developing feeder networks at the existing Russian hub airports of St. Petersburg, Yekaterinburg, and Novosibirsk, thus helping preserve and develop the spread of regional air services.

By Fyodor Borisov