Week of April 21, 1997

By Vovick Karnozov Russian Leasing The situation with the airline industry of Russia features a steady decline in air traffic. From the peak of 159 billion km-passengers in 1990, it dropped down to 70 billion in 1996. Although local market analysts predict a rise to come between 1998 and 2001, this looks more like desire than scientific prognosis. The drop in the volume of air traffic came with the break-up of the former Soviet Union's only carrier, Aeroflot, into as many as 503 operators in 1994. However, in the tough business environment only 20 companies have managed to generate profit, with their share accounting for 74% of all-Russian air traffic in 1996. During the same period, the 240 weakest companies carried only 5% of Russian passengers. The rate of decline starts to slow down, showing only 9% in 1996. Last year's drop was partly caused by the Federal Aviation Service (FAS) withdrawing licences from 106 operators, with another 60 waiting to know their destiny. Simultaneously the FAS has tried to create an economical climate, making small companies unite into larger structures thought to be more viable. Ivan Valov, first deputy director of FAS, said that the Service's current policy is not a war against unprofitable operators. "Those companies have rights to live because they employ people and keep pilots flying," he explained. The drastic drop in passenger traffic has paralyzed both operators and aircraft manufacturers - the capacity of available airliners exceeds the market demand by double. Grounded and rarely-flown aircraft increase the burden on operators, who have to pay various dues and taxes for the very existence of their fleets. All this results in the absence of cash in the pockets of aviators - in just 1996, Russian civil aviation losses totaled Rbs 1.3 trillion (US$ 226 million). The Russian Government inflation-suppression policy worsens the situation by making cash the most "in-demand" product on the inner market. The absence of demand for new airframes forces aviation plants to curtail production. In the last five years output of aero-engines dropped by three times, civil aircraft by ten times. Thus a paradoxical situation is created, where modern, highly-economical new-generation airliners like the Tu-204 and Il-96-300, priced at Rbs 170 b (US$ 29 million) and 250 b (US$ 43 million) respectively, stay idle at the factories in Ulyanovsk and Voronezh, while passengers are forced to fly in morally and physically old Yak-40, Tu-134 and Tu-154Bs. FAS proposes aircraft-leasing system The unstable political situation in the Russian Federation on the eve of the Parliamentary and then Presidential elections brought about numerous promises of high-ranking politicians to "rescue" the national aerospace industry with the help of budgetary injections. Hearing those, the FAS and aircraft makers got together and drew up a revitalization plan, which was then discussed at two special hearings in the Russian Government at the end of last year. To show the deep concern of the authorities over those plans, both hearings were chaired by vice-premiers Aleksei Bolshakov and Oleg Lobov. Ivan Valov thus describes the conception of survival prepared by the FAS, "The Government and FAS are deeply concerned with the situation in our aviation industry. Together we came to conclusion that there is only one way to revival - to establish an aircraft leasing system." He adds that manufacturers have agreed to eliminate the current demand for all of the money up front for new aircraft, wanting immediately only an amount sufficient to cover manufacturing expenses. Although this reduces the amount of cash needed to initiate the process, it does not eliminate it. The initial sum, which is thought to be enough to start with, is estimated at Rbs 4.5 trillion (US$ 783 million). This money would be granted to a new specialized aircraft- leasing company or seven existing state leasing companies, which, together with the FAS, would chose suitable operators to provide them with aircraft under financial leasing agreements. The project is expected to break-even in 6-7 years, based on interest rates of 5-6%. Valov states that a 10-11% interest rate was found to be unbearable for Russian air companies. While the discussion of the FAS plan continues in the Ministry of Economics and Ministry of Finance, both the Parliament and President Yeltsin have recently validated the 1997 Federal Budget, which allows the government to grant financial guarantees worth Rbs 4 trillion (US$ 696 million) to local and foreign financiers willing to invest into the Russian civil aviation and aircraft-leasing system in the first place. FAS is now advising the Government which programs and investors should be given priority. Gennady Zaitsev, the FAS head, states he knows a few western financial structures ready to provide hard currency under a 7% interest rate for seven years. He adds, though, that the process of establishing a large state-run aircraft-leasing company would take at least 6 months. RAC begins leasing business Having lost patience to ever see the long-awaited state aircraft-leasing system established, the subject of discussion among state officials for four years, the Russian Aviation Consortium (RAC) has decided to take on the effort all by itself. Established by President Yeltsin's decree No.496 on 18 May 1995, RAC initially consisted of the Tupolev design bureau, Aviastar production plant of Ulyanovsk, Aviadvigatel of Perm, Perm Motors, Universal scientific-industrial center, Aeroflot – Russian International Airlines and Promstroibank. Last year, however, Aeroflot decided to leave the consortium, and its place was taken almost immediately by Vnukovo Airlines. In 1996, the consortium was joined by Donavia, Aviaexport, Bykovo aircraft repair plant and Gorbunov's aircraft production organisation of Kazan (KAPO). In January 1997, RAC obtained a controlling interest in Vnukovo, making the operator a pilot company for introduction in service of the Tu-204. To gain experience of leasing aircraft to commercial operators, last year Tupolev established its own air company - Tupolev Aerotrans - with the design bureau's own aircraft in its inventory. Soon two Tu-154s were leased to Armenian Airlines and two Tu-134s to Transaero Express for two months. Happy with the first results, in early February RAC President Tatevos Surinov announced an agreement with Moscow Aviation International leasing company, where the latter undertakes drawing US$ 301 million from foreign financiers and providing financial guarantees for US$ 129 million to be given by a foreign investor to RAC. Partly the money will be spent on adding 20 more Tu-204s to Vnukovo, which already flies three passenger and two cargo aircraft of this type. The 59-strong fleet of Vnukovo Airlines is already too big for the current traffic via the Vnukovo airport of Moscow. With the same of number of airplanes in inventory, the company carried 6 million passengers in 1989 and only 2 million in 1996. Yuri Kashitsin, General Director of Vnukovo Airlines, comments, "I have three passenger Tu-204s and only one of them is flying. If they make me take an additional Tu-204 in operating lease, I will have to pay US$ 300,000 a month, but what for if the plane will not fly?" Egyptian Tu-204 to Russians Egypt's Kato Aromatic came on the scene on 25 March 1996, with the signing of a comprehensive packet of contracts with RAC on the Tu-204-120, a "westernized" version with Rolls-Royce RB.211-535E4B engines in place of Perm Motors PS-90As on the basic aircraft. The text of the contract contains a "firm" order for 30 aircraft and a "soft" one for a further 170 by 2010. Dr. Ibrahim Kamel, Chairman of Kato Aromatic, believes that if properly marketed, the aircraft, priced at US$ 35 million, can find customers inside and out of Russia. The Egyptian company acts as a buyer, investor and financial backer for the Tu-204-120 program. According to Oleg Alasheev, Tupolev deputy general designer for civil projects, Kamel has already invested at least US$ 100 million. Alasheev says it took Kamel half a year to talk Rolls-Royce into providing a sufficient number of engines for Aviastar in an appropriate time. Finally, the British manufacturer agreed to almost double the RB.211 output by reviving its reserve production line. Kato is known to have paid for first 30 engines priced at US$ 6 million each. Kato offers its aircraft in operating lease to Russian operators at US$ 310,000 a month via the newly-established Sirocco group. To facilitate small air companies putting the aircraft into service, Sirocco offers credits from foreign financiers on favorable terms. On this matter the Egyptian company has reached agreements with Citibank and the Bank of Cairo. Some operators has already expressed an interest to hire Tu-204s, including Transaero, Volga-Dnepr and Orel Avia. Aeroflot works only with western financiers When the turmoil in Russia began, Aeroflot dropped all its regional branches, becoming a specialist in international flights. The developed infrastructure, maintenance facilities and network of overseas representatives has allowed the company to live quite happily on the hard currency from flights across the state border. In 1995 the Aeroflot team was strengthened with seasoned business-minded people from the LogoVAZ commercial group, famous for rather high revenues generated on sales of Lada cars. Nikolai Glushkov, one of LogoVAZ founders, became the first deputy general director for financial and commercial matters at Aeroflot. One of Glushkov's first deeds was getting Airbus Industrie to reduce considerably the leasing rates for the six A-310s taken in financial lease back in 1991. This was the major demand of Aeroflot during negotiations on further four airframes in 1996. Now Aeroflot operates a fleet of 115 airliners, including 14 foreign ones (10 A-310, 2 767, 1 DC-10-30F). The next move was the maximization of profit from the lucrative transatlantic route, from which Aeroflot promptly removed their vintage Il-62Ms, replacing them with modern Il-96-300s, Boeing 767s and A310s. But the most remarkable affair of all is a rather complicated US$ 2 billion political-financial deal with US and European structures on 20 Il-96M/Ts and 10 Boeing 737-400s. The central idea is to finance production of the indigenous wide-body aircraft on foreign money with the 737s used to attract investors. For the latter purpose Glushkov has created a "transparent system of financial streams," in which, he says, participate the US Ex-Im bank, Citibank, Chase Manhattan Bank, World Bank, Ernst and Young and Banc Nationale de Paris. Glushkov thus commented the absence of Russian names in the list, "At the moment there are no Russian banks working with us in the sphere of investment projects. This is so due to a number of reasons. The interest rates of local financiers are 40-50%, leading to fantastic leasing payments. Moreover, Russia does not have banks that would be in a position to grant credits for 10 - 12 years. Our banks offer credits for one or two years at maximum, which is too short a time for aviation business." Whatever next? In late 1996, Aeroflot submitted its own conception of Russian civil aviation development based on the Il-96M/Boeing-737 scheme to the Government and FAS. "I hope there might be some people in the Government who would be able not only to read it, but understand as well," Glushkov says, adding that "many people misbelieve that by finding 3 or 4 or 10 billion dollars for setting up a leasing system we can solve all the problems of our aviation industry." The appearance of the Aeroflot conception was caused by the leading operator not believing in the very usefulness of FAS lease plans. Glushkov comments, "Leasing is just a tool in the system of payments within the industry. To make use of it, we first have to make the whole Russian aviation industry function properly and be profitable. Without it the mechanism of leasing aircraft will not work." Both Kashitsin and Glushkov state that although list-prices for new Russian aircraft remain relatively low, in terms of operational expenses they are very expensive even today. This is caused by low rates of production output at aviation plants and the current taxation system "seeing no difference between garage shops and aviation enterprises." Because of these factors spare parts, repair and maintenance cost more than in the West. Fleet renewal Although the capacity of the Russian existing airliner fleet exceeds market demand by twice, the need for modern aircraft exists. The average age of Russian airliners is 17 years, with 65% of traffic being carried out by models with fuel consumption of over 39 gram/km-passenger. Because the volume of traffic on all inner routes has decreased, local operators need relatively small airliners in the Boeing 737 class. It often happens that modern designs - the Tu-204 and Il-96-300 - prove more expensive in service than the ordinary Tu-154M still in production at Samara. The latter 164-seat type with an hourly fuel consumption of 5.4 t flies more often than the 210-seat Tu-204 with that of 3.2 t. This phenomenon is explained by a high reliability of the old design, low cost and availability of spare parts. "Despite its 25-year history, the Tu-154 is still a very competitive aircraft on the market," Kashitsin states. A Vnukovo Tu-204 usually flies 100 hours a month, whereas a Tu-154M 250-300 hours. "The Tu-204 is a beautiful aircraft, but needs curing of teething problems, which demands time and investments," he explains. His words also explain why Transaero, a start-up operator with a fleet of 13 American-built (5 737-200, 5 757, 3 DC-10-30) and one indigenous Il-86 airliners carries approximately the same number of passengers as Vnukovo, whose 59-strong inventory consists predominantly of old Russian types. Transaero is the only Russian operator having so many Boeing aircraft. According to Aleksandr Pleshakov, Transaero President, last year the average in-flight time was 4,700 hours for the 757, 3,700 for the 737 and 2,700 for the Il-86. The company's fleet expansion plans announced on 21 February call for "tens" of the Il-96M, 767 and new-generation 737, with the first airframes of all three types to be put in service in the next three years. Pleshakov says the whole project, worth US$ 2-3 billion, will last for 10 years and that later this year Transaero will order the first 6 or 7 aircraft. It is interesting to note that both Valov and Kashitsin welcome the advent of Boeing aircraft on the Russian market. "Our company puts a premium on indigenous designs, but we think Western aircraft should exist on the Russian market so that there will be a competition between foreign and local manufacturers," says Kashitsin, adding that "competition is the only way to bring our aircraft to the world's level." Valentin Sushko, Chairman of Russian Air Register, supports him, "My job is to defend the Russian market, to defend it from bad aircraft regardless of their origin. We studied Boeing aircraft and found they meet Russian air worthiness requirements." By the way, neither of the Tu-204-120 and Il-96M has local certificates. Ask Vovick AeroWorldNet Home Page | Contact AeroWorldNet