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Latin America’s airlines face strong headwinds

The winds of change have brought some bumpy economic flying weather to the airline industry in Latin America.

National flagship airlines are fast becoming a relic of the past as the aviation sector is swept by the strong headwinds of deregulation, competition, privatization, alliances, and consolidation. Pressures are building to improve safety systems, the quality of service, and price. But airlines are having to meet these challenges with one hand tied behind their back: outdated regulatory systems, monopolistic practices, and burdensome taxes that severely limit their ability to adapt.

Can Latin American civil aviation face up to the challenge? Not if the region’s airlines continue to practice business as usual. That was the stark assessment delivered by a panel of international experts and aviation leaders that gathered for a seminar earlier this year in Santiago, Chile, during the IDB’s annual meeting.

To survive, Latin America’s public and private sectors must modernize the region’s aviation infrastructure, overhaul regulatory systems, and start treating air transportation as an engine for growth rather than a convenient source of tax revenues, the experts said.

Patricio Sepúlveda, regional director for Latin America and the Caribbean for the International Air Transport Association, estimated that 85 percent of the region’s 40 airlines are losing money. Many of these airlines will go out of business in the years ahead as they undergo a "trial for survival," he said.

Sebastián Piñera, chairman of the board of LanChile, said he estimates Latin America’s airlines are losing around $500 million per year. "The period of the flag airline is over," he said. To survive in a market that represents only 5 percent of the world’s aviation sector, airlines must forge international alliances, create economies of scale, and gain access to lucrative routes to the United States and Europe, he said.

In explaining the factors that have led to the current crisis, several speakers at the seminar said that the privatization of state airlines carried out by many countries in the 1990s was in several cases poorly managed. In some countries, the result was the substitution of protected and subsidized state monopolies with protected and subsidized private monopolies, according to these speakers. Moreover, the privatizations typically did not address the problem of overly rigid labor regulations and discriminatory taxes that hurt airlines.

In a similar vein, IDB aviation expert Adolfo Rufatt argued that concessions of airport infrastructure to private operators often have been mishandled by regional policymakers, largely because they have pursued too many conflicting objectives simultaneously. The costs of these policy failures are then passed along to final users.

At the same time, international studies indicate that the safety standards of Latin America’s airlines lag behind those of Europe and the United States, with a significantly higher accident rate on a percentages basis compared with the number of flight departures (See link at right for an article on air safety in the region).

While there was virtually unanimous consent as to the ills afflicting the sector, opinions differed at the Santiago seminar as to how to accomplish a turnaround. Marc Cavaliere, vice president and senior partner of AvGroup, a Miami-based consulting firm, was a strong proponent of "open skies" agreements with the United States that commits participating parties to accept deregulation and competition. He argued that European and Latin American countries that negotiated these agreements have experienced explosive growth in their airline passenger and cargo service, as well as lower fares. He also suggested that phased in open skies agreements will give initial protection to established airlines in emerging markets, but over time will induce competition and an "ability to fail" if a company cannot meet standards and attract customers.

The IDB’s Rufatt noted that deregulation and airline consolidation on the "open skies" model has "both pros and cons." He argued that safety and service could improve and price could go down under this system, but the smaller airlines "will have to face the reality of economies of scale and that for good reasons they will be vulnerable when faced with competition from giant operators."

Rufatt also noted that airline consolidation could leave some Latin American countries at the mercy of one or two dominant operators. In such situations, an airline’s corporate policies and problems—such as labor-related disruptions of service—can directly impact the national economy.

Jorge A. González, vice president of Infrastructure Management Group, Inc., argued that Latin American countries must concentrate on reforming their aviation regulatory agencies. The regulatory laws, some of them dating from the 1950s and 1960s, should be updated and should clearly define the role of the regulatory agencies as independent entities, according to González. Furthermore, the regulators themselves should be highly qualified as well as "creative, dynamic and proactive."

Federico Bloch, president of TACA Group, said aviation progress in Latin America requires a radical change in the way governments view the aviation sector. Now, for example, most airport fees go to general government revenues instead of being used for investments in aviation infrastructure. Moreover, Bloch argued that airlines in the region must pay excessively high taxes at a time when they face downward price pressure from well-financed competitors.

"The state sees aviation as a fiscal instrument, not as an instrument for development," Bloch said. "It is very difficult to compete in the present framework. If we don't change the concept, we won't advance."

Not all is gloom and doom, however.

Ellis Juan, a former vice president of Banco Santander Central Hispano who recently joined the IDB’s Private Sector Department, said that banks have learned that financing the construction of airports is a relatively "low risk" venture in Latin America. As a result, many banks have been willing to offer favorable lending rates for these projects. Given additional tax-based incentives and regulatory reforms, Latin America’s airlines could eventually become vibrant contributors to the region’s development.

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