Russian Carriers Struggle as Sanctions Drag Economy Down

by Neelam Mathews and Vladimir Karnozov

Aug 7, 2015

An August 3 ceremony at Vnukovo International Airport in Moscow, Russia, marked the handover of Transaero Airlines’ initial Airbus A321, delivered as part of the Russian carrier’s contract with China’s ICBC Leasing. (Photo: Airbus)

With the Russian economy in retreat and as sanctions prompt airlines to turn from networks populated heavily with international routes to more domestically focused structures, managers have taken steps to decrease fleet capacity by handing back aircraft to lessors and deferring or canceling aircraft deliveries. Even Transaero—Russia’s second largest airline—has taken steps to cut capacity with plans to replace some larger Boeing types with Airbus A321s. The initial A321 delivery on July 28 at Moscow Vnukovo International Airport marked Transaero’s first experience with Airbuses since the turn of the century, when it leased a single A310 for a few months.

Even though worsening economic conditions forced Transaero to indefinitely postpone deliveries of other types and cancel its order for Sukhoi Superjets, the airline will take all six new A321s on order as planned under a long-term operating lease with ICBC Leasing, the Chinese leasing arm of ICBC bank. It marks the first operating lease a Russian airline has ever signed with a Chinese lessor.

The carrier characterizes the A321 acquisition as “a move necessary to cut expenses and adjust [its] fleet to the new economic realities.” Transaero claims it can operate the airplane at least 4 percent more efficiently than other narrowbodies in its fleet, while providing a sufficient range and seating capacity for flying most of its intracontinental services.

Although reflective of a broad need within the airline industry to adjust to Russia’s economic troubles, Transaero’s moves pale in comparison to what network managers believe must involve more draconian efforts throughout the country.

“Russia’s domestic yields are a massive 37 percent lower than a year ago,” said IATA Consulting director Guy Brazeau at last month’s Silk Routes conference in Tbilisi, Georgia. “In part, this reflects the ‘translation effect’ of the sizeable appreciation in the U.S. dollar over the past year.” While foreign investment has clearly fallen and likely will for some time, carriers holding purchase orders with Vnesheconombank have gotten some relief with partial offsets of loan costs for Russian aircraft until 2016. The bank has also begun offering subsidies for finance leasing and is now considering a similar arrangement for operating leases. Further, in April, the government reduced value-added tax (VAT) applied to domestic flights to 10 percent from 18 percent until the end of 2017.

Meanwhile, some Russian carriers have begun to fill capacity gaps left by the suspension or reduction of services by airlines such as KLM and Lufthansa. Emirates, for instance, has announced cuts from 14 weekly flights to 11 to Moscow, including the removal of an Airbus A380.

“Sanctions have devalued the ruble,” said Andras Bognar, senior manager at UK based consultancy ICFInternational. “The CIS [states], with strong ties to the Russian economy, are also feeling the effect as yields fall.” He added the strain on Russia’s main carriers spoke volumes. “UTair [Russia’s third largest carrier] went practically bankrupt, Transaero too nearly went down and Aeroflot recently cut back capacity.” However, with much of the fleets leased in U.S. dollars, most airlines can ill afford to cut capacity and need to keep flying to generate cash.

“It’s a catch-22, and most of the airlines don’t have the financial strength to take the hit and return the aircraft with a penalty,” Bognar told AIN.  He added that Kazakhstan’s Air Astana stood in a better position because its international network hasn’t fallen subject to sanctions. “But the fall in world prices of raw materials affects Kazakhstan as well,” he noted. Air Astana president and CEO Peter Foster recently acknowledged that regional markets remain sluggish due to currency weakness and falling commodity prices. “We do not expect 2015 to be a stellar year,” he said.

Still, if given the choice, most Russian carriers would welcome Air Astana’s circumstances. “For many of Russian carriers it is mere survival,” said Bognar. “Their finances are dire. Currently, almost everyone is sliding downwards and nobody knows how long this will continue.”

On August 6, the International Monetary Fund forecast a nine percent dip in Russia's gross domestic product during the course of the next few years. In addition to sanctions, the agency identified the Russian government's failure to reform economic regulations and reduced oil revenues as other key factors in Russia's economic decline.