ECONOMIC CHALLENGES FACING AIRPORTS IN AN ERA OF GLOBAL FINANCIAL INSTABILITY

A RESEARCH PROJECT IN FULFILLMENT OF THE ACI ASIA PACIFIC 'YOUNG EXECUTIVE OF THE YEAR AWARD'

ARYAN VISWAKARMA Manager TQM

GMR - Delhi International Airport (P) Ltd. Udaan Bhawan, New Delhi - 110037 Landline - +91 011 25661238, website: www.newdelhiairport.in

ACKNOWLEDGEMENTS

I am beholden beyond words to Mr. Dinesh Bhrushundi, Mr. Pradeep Panicker, Mr. Birendra Prasad, Mr.Andrew & Mr. Sunil Bhardwaj of GMR-Delhi International Airport Private Limited, for the encouragement and guidance given to me in completing this project. My thanks are also to my entire Quality & Service colleague for providing me with various inputs for completing of this project and HR department for giving me an opportunity to participate in this programme. I wish to express my heart felt gratitude to my family who have tolerated the injustice of my not able to spend quality time with them because of my involvement in this project. My special thanks to my wife Neha Viswakarma for helping me in successful completion of this project and encouraging me to do it better and better. Last but not the least, I express my deepest regard to all who have directly and indirectly supported in completion of this project.

Aryan Viswakarma

TABLE OF CONTENTS Chapters 1 2 3 3.1 3.2 3.3 4 5 6 7 8 9 Contents Introduction Current Scenario in aviation Industry Economic challenges for aviation industry Recession Air Traffic Volumes Regional Differences Challenges for Indian Aviation Industry Recommendations Conclusion Vision Towards Aviation industry References Abbreviations Page No. 3 4 4 7 11 12 13 14 14 15 15

1. INTRODUCTION Since October 2008 a global financial crisis led to the bankruptcy of many financial institutions in the USA and European countries, threatening the global financial system.

In 20082009 most of the industrialized world entered into a deep recession. The complex of vicious circles which contributed to this crisis included high oil prices, high food prices and the collapse of a substantial housing bubble centered in the United States, which sparked an interrelated and ongoing financial crisis. Around the world, many large and well established investment and commercial banks suffered massive losses and even faced bankruptcy. It has been argued that the huge increases in commodity and asset prices came as a consequence of an extended period of easily available credit and that the primary cause of the downturn was exceptionally financial. This has led to increased unemployment, and other signs of contemporaneous economic downturns in major economies of the world. In December 2008, the National Bureau of Economic Research (NBER) declared that the United States had been in recession since December 2007, and several economists expressed their concern that there is no end in sight for the downturn and that recovery may not appear until as late as 2011. The recession is the worst since the Great Depression of the 1930s. However, so far many economists and politicians have avoided using the term depression, as it is generally recognized to refer to a downturn which lasts considerably longer and has a significantly higher unemployment rate. The unemployment rate has since been increasing since September 2008 with no end in sight. For March 2009 alone, it is estimated that 742,000 jobs have been lost.

World-Crisis.net

2. CURRENT SCENARIO IN AVIATION INDUSTRY Airports are a key link in the world's transportation network. Just like the airlines, they are vital partners in the air transport industry, integral to its success and growth. From mere providers of airline infrastructure, airports have become poles of economic development and genuine gateways to growth for their airline customers and the regions they serve. After seeing current slowdown Airports reacted quickly with cost-cutting measures and cutbacks in capital spending, and some responded with reductions in aeronautical charges for airlines. However, unlike airlines, airports have much less flexibility to change their business model too radically. It is difficult to downsize an airport, or generate new business opportunities, where the infrastructure has been built up over a long period and often carries a significant debt load. Despite this, airports are better positioned than they ever have been to ride out the storm. Over the past decade they have diversified their revenue streams - ACI's latest economic survey shows that over 50% of global airport revenues come from non-aeronautical sources - and are managed in a more commercial manner than ever before. That is welcome news for airlines and travelers as airports seek to navigate their way towards a hoped for economic recovery. 3. ECONOMIC CHALLENGES FOR AVIATION INDUSTRY 3.1 RECESSION 3

Airports are a vital component of a vibrant air transport industry, underpinning tourism, trade and investment in an increasingly interdependent world marketplace. These are critical times for the global economy and for aviation.2009 is shaping up to be one of the toughest years that the airline industry has ever faced. IATA has announced that, they expect losses of US$4.7 billion for 2009. Their previous forecast, issued in December, was for a loss of US$2.5 billion. The most shocking difference between the two forecasts is the revenue line. In December, it was predicting a US$35 billion drop in revenues 6.5%. With lates forecast, the loss in revenue has grown to US$62 billion - 12%. This crisis is re-sizing and reshaping this industry. What has happened in the last few months?

Net loss of $ 4.7 bn forecast for 2009

3.1.1. DEMAND In January, passenger demand fell 5.6% exaggerated by a 16.7% fall in premium traffic, where airlines make their money. An even bigger indicator is cargo, 23.2% down in January. This is a leading indicator not just for airlines but for the whole economy. Air cargo represents 35% of the value of goods traded internationally. A slowdown in

cargo means that consumers are not buying and manufacturers are not producing. And we can fully expect that the economic downturn will get worse before it gets better. IATA now project a 5.7% drop in passenger traffic and a 13% fall in cargo for the year. A 13% forecast for cargo, when we started the year 23.2% down, tells us that we expect some improvement when depleted inventories are restocked. But a demand fall of this magnitude is severe and carriers are not able to take capacity out fast enough to match demand. Overall the mis-match of demand and capacity will lead to yields falling by 4.3%. 3.1.2 FUEL The only good news is fuel. The revised forecast is based on an average of US$50 per barrel for oil (Brent) at that level; the industry fuel bill will be US$116 billion. This represents 25% of costs in 2009 compared to 32% in 2008 and is a US$52 billion drop compared to last year. This is partly related to the price and partly related to the reduction in capacity. The improvement in the fuel bill is not enough.

Lower oil prices should bring about substantial fuel cost savings in 2009. IATA estimate airlines fuel bill to fall $52 billion this year to 25% of operating costs. 3.1.3 REVENUES The loss in revenues is now driving increasing losses. As I mentioned earlier, revenues will fall by 12% or US$62 billion. In 2008, it was a US$530 billion industry and this year this will shrink to US$467 billion. Resizing the industry will be much tougher than the adjustments we saw after 9.11 or SARS. The industry is in intensive care. The biggest barometer to measure this is suspensions from IATAs US$350 billion settlement system. In the last 15 months, IATA suspended nearly 40 airlines because they could not pay their bills. 5

There are two priorities for survival; conserving cash and adjusting capacity to demand. 3.1.4 CHALLENGES IN SECURITY ASPECTS FOR AIRPORTS One of the main challenges the industry faces is implementing and paying for a more stringent security environment that does not sacrifice customer service. ACI has been working with ICAO, IATA and security and immigration services to ensure that the enhancements required are coming on line as quickly as possible. New technologies, including better and faster explosives detection equipment and biometric identification systems, give cause for optimism that airports can achieve the delicate balance between security and facilitation. It is a huge task to undertake, and there is no doubt that for many it is a struggle, but the end result will be a step change in the global security baseline. An unresolved question is who pays for this extra security? It is the view of airports and airlines that governments have a clear obligation to assume the costs associated with the variety of measures being implemented. Although progress is slow, there are some institutions like ACI, are making their voice heard at global and regional levels on an issue that will have a major cost impact for years to come. On issues ranging from the new security measures being introduced today to the airport compatibility of the A380, some of the international bodies are working to see that the views of airports worldwide are heard and taken into account.

3.2 AIR TRAFFIC VOLUMES

Last major downturn in air traffic, driven by recession rather than terrorist attack, was in 1991 when global passenger traffic (RPKs) fell 2.6%. IATA now forecast that global passenger traffic will fall by 3% in 2009.

Weakness in travel markets has lasted three years in previous recessions. IATA does not expect a return to traffic growth above 4% until 2011. Economic forecasts imply that airline traffic will remain below the previous trend over the medium-term, with passenger travel forecast to be 9% lower by 2016 than pre-crisis industry forecasts.

Air freight volumes are also expected to shrink in 2009. However, a more rapid recovery in line with world trade is anticipated with a return to 6%+ growth by 2010.

Comparing IATA's Forecasts With Its Recent Survey of Airline Industry Forecasts 2007 2008 2009 2010 2011 2012 Domestic and international scheduled traffic Passengers departure IATA forecast, millions %change Industry survey, millions % change Passengers departure IATA forecast, millions % change Industry survey, millions % change Freight tones IATA forecast, millions % change Industry survey, millions % change 2,260 6.4% 2,260 2,350 2,236 2,256 2,373 2.0% -3.0% 0.9% 5.2% 2,323 2,386 2,493 2,621 2.8% 2.7% 4.5% 5.1% International scheduled traffic only 854 3.2% 869 4.9% 24.9 -1.5% 26.4 4.3% 829 -3.0% 909 4.7% 23.7 -5.0% 27.6 4.5% 836 0.8% 952 4.7% 24.9 5.1% 28.8 4.5% 885 5.8% 1000 5.0% 26.6 6.9% 30.2 4.7% 2,535 6.8% 2,749 4.9%

828 8.8% 828

953 7.7% 1049 4.9% 28.2 6.2% 31.6 4.7%

25.9 5.9% 25.3

Source :Industry survey IATA Passenger Forecasts 2008-2012, IATA Freight Forecasts 2008-2012 http:www.iata.org/ps/intelligence_statistics/

The table & graphs above compares IATA forecasts with the industry consensus identified by the survey. Airline Industry Forecasts resembles the forecast done by IATA. It is clear that expectations prevailing during the summer for the growth of passenger and freight markets will be disappointing this year. By 2010 IATA forecasts that the level of global passenger departures will be 10% lower than expected by the industry before the recent financial crisis. International freight tonnes are likely to be 13% lower than expected by 2010. 7

Once recovery is solidly established by 2011 IATA forecasts growth rates that are much closer to industry expectations. The two reports of the survey contain much valuable information about medium-term industry expectations for country-pair passenger and freight market developments. These medium-term expectations may not have been significantly changed by the short-term fluctuations due to the recession.

IATA has just published its latest annual survey of airline traffic forecasts (IATA Passenger Forecast 200812) which surveyed airlines in the middle of the year. As the chart above shows the recession shock will disappoint expectations and planning contingent on them, with passenger numbers forecast to be 8% lower than expected by 2012.

It is little surprise that growth in global passenger departures mirrors the pattern for global RPKs, and its relationship with GDP growth. Following the sharp decline in passenger numbers already seen in the second half of 2008, a fall of 3% is forecast for 2009.

System-Wide global commercial aviation REVENUES,$ billion Passengers Cargo Traffic volume Passenger growth % Passenger numbers millions Cargo growth % Freight tones, millions World economic growth % Yield growth % Yield growth Inflation rate adjusted % Expenses,$ billion Fuel % of expenses Crude oil price, Brent,$/b Non-fuel Cents per atk (non-fuel unit cost) % change % change, adjusted for ex rate Break even weight icad factor % Weighted ocod factor achieved % OPERATING PROFIT,$ billion % margin NET PROFIT,$ billion % margin

2000 320 256 40 8.0 1672 9.1 30.1 4.5 -1.1 -2.3 318 46 14 28.8 272 39.2 -2.3 -0.2 60.8 61.5 10.7 3.3 3.7 1.1

2001 307 239 39 -2.7 1640 -6.0 28.8 2.2 -2.8 -2.9 319 43 13 24.7 276 39.7 1.4 4.1 61.5 59.0 -11.8 -3.8 -13.0 -4.2

2002 308 238 38 1.0 1639 8.7 31.4 2.7 -3.7 -5.9 311 40 13 25.1 270 38.8 -2.3 -3.0 63.2 60.9 -4.8 -1.6 -11.3 -3.7 9

2003 322 249 40 2.3 1691 3.9 33.5 2.8 2.3 -5.3 323 44 14 28.8 279 38.9 0.3 -5.0 62.3 60.8 -1.4 -0.4 -7.5 -2.3

2004 379 294 47 14.9 1888 7.9 36.7 4.2 4.5 -2.0 376 65 17 38.3 311 39.5 1.4 -2.4 63.4 62.5 3.3 0.9 -5.6 -1.5

2005 413 323 48 7.0 2022 0.4 37.6 3.4 4 0.1 409 91 22 54.5 318 38.7 -2.1 -2.7 63.3 62.6 4.3 1.0 -4.1 -1.0

2006 465 356 53 5.9 2124 3.9 39.8 4.0 6.9 3.3 450 107 24 65.1 343 40.1 3.6 3.3 63.4 63.3 15.0 3.2 -0.1 0.0

2007 508 401 58 5.9 2280 4.0 41.6 3.8 3 -1.3 488 136 28 73.0 353 39.2 -2.1 -4.1 61.9 63.6 19.7 3.9 12.9 2.5

2008 E 530 417 57 0.1 2247 -4.5 39.7 2.1 5.6 0.2 527 168 32 99.0 360 39.2 0.0 -1.5 62.5 61.5 2.2 0.4 -8.5 -1.6

2009F 467 370 46 -5.7 2118 -13.0 34.6 -1.9 -4.3 -1.5 464 110 25 50.0 348 40.4 3.0 4.7 61.0 60.4 3.0 0.6 -4.7 -1.0

Source: ICAO data to 2007. IATA 2008-9 forecasts. Excludes exceptional accounting items and mark-to-market fuel hedging losses. ; Brian Pearce economics@iata.org ; IATA Economics www.iata.org/economics Correlation study done on various parameters given above w.r.t operating profit and the 3 key contributors identified are 1. Freight tonnes million 2.Passenger ,number millions 3. Fuel profit we are going to have. 3.3 REGIONAL DIFFERENCES Unlike previous crises, which had a geographic focus, this one is global. : with coefficient of correlation(r) 0.688 : with coefficient of correlation(r) 0.634 : with coefficient of correlation(r) 0.510

Above parameters are top 3 contributors to operating profit. Hence, more we concentrate on these elements more

Asia Pacific: Carriers in this region continue to be hardest hit by the current economic turmoil and are expected to post losses of US$1.7 billion (significantly worse than the previous loss forecast of US$1.1 billion). Japan, the regions largest market is expected to see GDP drop by 5.5% in 2009 with exports already in freefall. China has been successful in stimulating demand in domestic markets with pricing adjustments. International demand to and from China is expected to contract by between 5% and 10% over the year. India, whose market for international air services tripled in size between 2000 and 2008, is expected to see capacity increase by 0.7% in 2009, while demand drops between 2% and 3%. Overall, the region is expected to see a 6.8% fall in demand but only a 4.0% drop in capacity.

North America: Carriers in this region are expected to deliver the best performance for 2009 with a combined US$100 million profit. A 7.5% fall in demand is expected to be matched by a 7.5% cut in capacity. Despite the worsening economic conditions, this is relatively unchanged from the earlier forecast of a US$300 million profit. Carriers are benefiting from careful capacity management and lower spot prices for fuel. 10

Europe: Europes carriers are expected to lose US$1 billion in 2009. A forecast 2.9% fall in the continents GDP is expected to result in a drop in demand of 6.5%. Capacity cuts of 5.3% will not keep pace with the fall in demand, driving yields and profitability down.

Latin America: While Latin America is forecast to maintain positive GDP growth in 2009, the collapse in demand for commodity products is expected to see traffic plunge by 7.8%. Carriers are only expected to be able to drop capacity by 3.8% resulting in losses of US$600 million.

Africa: African carriers are expected to produce 2009 losses of US$600 million. This is six times the US$100 million lost in 2008. The continents carriers are losing market share on long-haul routes. Demand is expected to drop by 7.8% with only a 6.0% fall in capacity.

Middle East: Middle East will be the only region with demand growth in 2009 (+1.2%). But this will be overshadowed by the impact of a 3.8% increase in capacity. While this is significantly below the doubledigit growth of previous years, the region continues to add capacity ahead of demand. The result is expected to be a loss of US$900 million (a slight deterioration from the US$800 million loss recorded in 2008).

The state of the airline industry today is grim. Demand has deteriorated much more rapidly with the economic slowdown that could have been anticipated even a few months ago. Nearly 40 Airlines worldwide have suspended their operations in the last 15 month because they could not pay their bills.

4. CHALLENGES FOR INDIAN AVIATION INDUSTRY As per IATA there is severe turbulence over Indian skies. Poor infrastructure, slowing demand and high operating cost have hit the countrys aviation sector hard. Indian market for international air service tripled in size between 2000 and 2008 and is expected to see a capacity increase of just 0.7% in calendar 2009. Demand for air travel will drop by a significant 6.8% this year. IATA has identified five key areas, it says are necessary for the successful future development of air transport in India. They are (1) enhancing safety, (2) urgent infrastructure improvement, (3) reasonable taxation, (4) commercial freedom and (5) SPT-Simplified Passenger Travel. It claims that the most urgent need is for new and improved infrastructure at Mumbai, India's main--and busiest-airport. Specifically regarding infrastructure, IATA reports that airport and airspace capacity must be massively expanded in order to gain the full economic benefits of a vibrant airline sector.

5. RECOMMENDATIONS 11

Macro Level :

Control Operational Costs/ Cut costs, adjust capacity to demand

Reduce charges for airline ,which will benefit both pax ,airlines & airport as well

Provide efficient infrastructure which delivers low cost for all airlines Outsources NVAs (non value added activities) Control expansion plans /optimize resources
Reduce energy consumption with control

Improve non aero revenues-Increase Retail ,F&B range etc Revenue protection/collection control inflow/outflow Chess analogy or Dynamic strategic planning : Its like playing chess as a grand master -- you look
ahead many moves but only decide one move at a time. Private participation in airport ownership (PPP model) Private-sector management practices to replace traditional government-style management in an environment demanding economic self-sufficiency. Micro Level :

Make each employee, Act Like an Owner Run Weekly Revenue Meetings: Holding a weekly revenue meeting to drive revenue from week to
week. Get customers to pay : Charges for free facilities (may be for a short duration) Make system IT enabled

Run Cost optimization projects, simplify processes and encourage innovation everywhere Minimize office related expenses , Improve quality of services Move your office to cheaper office location (if required)
Control wastages on stationeries Transfer from manual system to automatic Promote tourism through Visa on Arrival , tie up with govt. bodies & airlines Invite your customers to office to reduce restaurant bills our major processes/ projects and compare how layoffs going to affect our customers. We should try to layoff temporary projects staff and support staff.

Minimize outside contracts (where you pay more than your employees) Prefer reduce staff salaries then layoff: If we have only layoff option in our hand then we shall list out

6. CONCLUSION

12

Much of the deterioration forecast for 2009 had already happened by January. At manufacturers end their destocking should see a modest bounce in air freight as component shipping rises a little. But weak consumer and business confidence is expected to keep spending and demand for air transport low. The prospects for aviation industry is dependant on economic recovery. There is little to indicate an early end to the downturn. It will be a grim 2009. And while prospects may improve towards the end of the year, expecting a significant recovery in 2010 would require more optimism than realism. This crisis must bring change. Recovery will not come without change. There is no doubt that this is a resilient industry capable of catalyzing economic growth. But we are structurally sick. The historical margin of this hyperfragmented industry is 0.3%. Bail-outs are not the prescription to return to health. Access to global capital, the ability to merge and consolidate and the freedom to access markets are needed to run this industry as normal profitable business. Despite challenges facing the industry, including high oil prices and environmental issues, there are some reasons to be confident 'the industry is starting to experience some favorable tailwinds'. The industry is also learning to work on lean principal, with optimal utilisation of resources. First was the growing trend towards greater liberalisation, especially since the coming into force of the European Union's Open Aviation Area in 1993. In Asia, too, there have been encouraging developments with China and India deciding to progressively liberalise their aviation markets. Within ASEAN, progress is being made to conclude a multilateral agreement to free up access to the 10 capital cities by year-end. In the longer term there would be open skies and a single aviation market in Asean.

7. VISION TOWARDS AVIATION INDUSTRY The aviation sector, like any other industry, can be successful only if its stakeholders share a common vision and commitment to work together.

8. REFERENCES

13

Political and Business Daily ND & Mail Today daily ND 25/03/2009 Financial Express Blore , 25.03.2009 Indian Express ND 25/03/2009 P-16 www.IATA.org Date: 24 March 2009 , Remarks of Giovanni Bisignani on March Forecast, Press Conference, Geneva ,IATA report Date: 24 March 2009 , Grim Prospects - Deep Recession, Bigger Losses , IATA report http://www.airport-int.com/categories/foreword-by-aci-airports-council-international/voice-of-the-worldsairports.asp (AIRPORT INTERNATIONAL) Report by Robert J Aaronson, Director General, Airports Council International (ACI) www.iata.org/economics Common vision needed for aviation success - February 20, 2008 The Business Times http://en.wikipedia.org/wiki/Recession http://en.wikipedia.org/wiki/Late_2000s_recession "Rapidly Weakening Prospects Call for New Policy Stimulus". IMF World Economic Outlook (WEO) Update (IMF). November 6, 2008. Kaiser, Emily (2008-09-16). "Lehman fallout threatens deeper, wider recession". Reuters. http://in.reuters.com/article/businessNews/idINIndia-35488720080915. Retrieved on 2008-09-16. "India sees growth accelerating to 9 pct next year". http://www.google.com/hostednews/afp/article/ALeqM5hOrAONdeEc34190B_3v1rW425XPg. http://en.wikipedia.org/wiki/File:Finance-dowjones-chart1.jpg

9. ABBREVIATIONS

The Association of Southeast Asian Nations (ASEAN) National Bureau of Economic Research (NBER) International Civil Aviation Organisation (ICAO) International Air Transport Association (IATA) Revenue Passenger Kilometer (RPKs)

14