The Mongolian economy is in crisis. The country’s economy has been reliant far too readily on the fortunes of natural resources being exported into China & Russia for some time. This makes the fortunes of the Mongolian economy a very good barometer of what is really going on with the Chinese economy (safe to say we are well aware that the Russian economy has been hard hit by sanctions and low oil and gas prices).
This month, the Mongolian currency (the tugrik) has totally collapsed as it became clear to observers that the government has used-up close to all of its foreign currency reserves. As a result, from this week many state workers will receive a 60% pay cut. This is significant because the hardest hit are civil service employees, which make up a large percentage of the middle class population. The government is in crisis with a debt burden that it cannot hope to meet with cash reserves down over 20% year on year at an estimated $1.1bn. Yesterday the Mongolian central bank increased its benchmark interest rate by 4.5 percentage points to 15%. All government infrastructure projects have been put on hold and yields on ten year government notes are up above 7%. An IMF bailout must surely be on the way soon.
Mongolia will have nothing to fall back on other than agriculture at this juncture. Given all of this one must be very concerned indeed with the fortunes of MIAT Mongolia. The airline is very well run and it has deferred two 737-800 deliveries this month as its switches focus from a collapsing domestic market to international routes into Singapore, South Korea, India and Frankfurt in Germany. MIAT cannot hope to compete with the likes of Lufthansa and SIA, or indeed Air India, for transfer traffic and thus the airline is over reliant on tourist traffic and although it might be harsh it is only truthful to state that Mongolia does not have a broad appeal to become a big tourist destination.
Venezuela is a single resource-reliant economy which is in a far greater mess than Mongolia with people eating horses from the zoos of Caracas right now – a far cry from what was the richest country in South America. All the resource-rich states across the globe have been hit very hard either by the fall in oil prices and/or by the sharp reduction in demand from China, South Africa, Brazil, Russia, Nigeria, the list goes on.
China’s economic contraction has caused a very large housing surplus and this further highlights the shadow banking threat, so much so that the IMF is dramatically upscaling the release of its concerns on the matter in the public domain. And yet in all this, China has the largest middle class in the world and is rapidly turning into the billionaire capital of the world. We are told that there are 109 million middle class adults in China at this time (the USA has just over 92m) and a total estimated 200 million domestic consumers in 2012, which accounts for over 15% of all urban consumption. Estimates are that this share of urban consumer demand should more than double to 35% within 30 years. China now accounts for a fifth of the world population, while holding nearly 10% of the global wealth. China has 14 cities of over five million people (Shanghai, Beijing, Tianjin, Guangzhou, Shenzhen, Dongguan, Taipei, Chengdu, Hong Kong, Nanjing, Wuhan, Shenyang, Hangzhou, and Chongqing) whereas the USA has only eight.
With these figures in mind, it has been predicted that China will require a fleet of aircraft that is close to or larger than the current US fleet? That is the logical conclusion of the manufacturers for sure, but when considering the growth of Chinese infrastructure and the economy in general maybe we should consider that from a working population (classed as 16 – 60) of some 770m people China has just 2% paying income tax, so just over 15m people. To put that into context, China has around half the number of people paying income tax compared to the UK, which has a total population of 65m. One wonders just how is China going to keep up its massive growth rate and defence spending commitments beyond 2020 if the health of its financial institutions does not improve? The gap for India is far worse with only 1% paying income tax. It should also be noted that in China many workers have to subsidise the income of older and younger family members, eroding discretionary income.
According to a Goldman Sachs report, the average Chinese consumer spends $7 a day primarily on food and clothing with just 9.2% allocated to recreation (travel, dining out, entertainment). The average American spends $97 per day, 17.3% of it on recreation.
Inbound tourist and business traffic into China, although growing exponentially, is still miniscule compared to the USA and Chinese ambitions in the South China Seas will most likely serve to curtail what could have been rapid inbound growth from South East Asia countries. Only 4% of China’s population holds a passport, against 35% in the USA. However, that 4% is spending $200bn per annum overseas annually – more than any other nation according to Goldman Sachs. The reality is that although airlines need to service more cities in China, their customer base remains far smaller than that of the USA, and that will not change before 2020 at least. One also needs to consider that the outflow of middle class educated males from China is truly astounding. A brain drain on a scale far worse than India has suffered of late is happening skewing gender balance in the country where males already outnumber females by 2 to 1 in Chinese cities and 11 to 1 in urban areas. It is also possible that although the population is not forecast to dip below a billion by 2050, it is expected that the working population will see a 20% increase in dependants that will serve to diminish growth in travel/entertainment spending.
The landscape for Chinese aviation is also unbalanced by the very large government subsidies and access rights enjoyed by the big three state owned airlines and by the lack of a modern coherent air traffic policy, which continues to threaten and delay passenger growth. The latter will require a curtailment of the Chinese air force in a way that at this time is clearly not acceptable to Beijing.
In an ideal world China should end up at the end of this decade with a domestic fleet smaller than that of the USA but with more international frequency with more premium seats on those international routes.
If all the aircraft on order into China are delivered, we should expect utilisation to fall or load factors to fall dramatically. In either case, the bottom line is that many aircraft on order have to be deferred or cancelled or will end up being leased out, which will in turn put pressure on lease rates and aircraft values through simple supply and demand measurements.
We also have to consider the viability of mass growth in the low-cost carrier sector while the big state-funded airlines exist. Will Beijing really throw money into those airlines at an ever increasing rate (in Air India fashion) while the independent low-cost airlines take swathes of business from them?
Given the problems of air traffic control, infrastructure and passenger growth, Chinese airlines may be required to cut frequencies and deploy larger aircraft on many domestic routes before too long, given the delays and possible passenger actions resulting from the same. Because of the long distances between Chinese cities, there is a strong argument for more A330s, A350s and 777s and 787s to be placed into China at the expense of some narrowbody orders. The doubt is whether the airlines could fill them? This worry logically suggests that A321s and 737-9s should be at the core of the fleet. We shall have to wait and see.