Foreign exchange gain became a major profit source for Chinese airlines in the first half of the year as they continue to be saddled with surging fuel costs, waning passenger demand and fierce competition.

But the country's previously buoyant airline industry could face an even worse outlook in the remaining part of the year as analysts expect the pace of the Chinese yuan appreciation to significantly slow down.

China's three largest airline groups reported an aggregate operating loss of 2.58 billion yuan ($377.41 million) in the first half of the year. But the renminbi appreciation against the US dollar yielded a foreign exchange gain of 6.45 billion yuan for the three carriers, up 125 percent over the same period last year. Renminbi appreciated by about 6 percent against the US dollar in the year's first six months.

"The appreciation of renminbi, to a large extent, offset the surging fuel costs because a big chunk of Chinese airlines' borrowing is in foreign currencies," said Li Lei, an aviation analyst with CITIC China Securities.

Air China, the country's national flag carrier, saw its net profit in the first half drop 21 percent year-on-year to 1.18 billion yuan. Fuel costs surged 32 percent year-on-year to 10.61 billion yuan. At the same time the yuan appreciation yielded a 1.92 billion yuan foreign exchange gain, up 122 percent over the same period of last year.

Shanghai-based China Eastern Airlines reported a 188.89 million yuan loss in the January-June period, compared with a loss of 383.95 million yuan in the same period of last year. Its fuel costs rose 22 percent to 8.57 billion yuan while foreign exchange gain surged 160 percent to 1.89 billion yuan.

Guangzhou-based China Southern Airlines reported a profit of 940 million yuan in the first six months, up 316 percent year-on-year. Its fuel costs rose 21 percent to 10.38 billion yuan. A major reason for China Southern's profit growth is its huge foreign exchange gains of 2.64 billion yuan, up 108 percent year-on-year, otherwise the airline would have encountered losses in the period, said Song Weiya, an analyst with Greatwall Securities.

"2008 thus far has been an extraordinary year, with unprecedented challenges for China and for Air China," said Kong Dong, Air China's chairman.

Besides international factors such as soaring oil prices and an economic slowdown, Kong said, Chinese airlines had additional challenges of the earthquake in Sichuan province, a major snowstorm at the beginning of the year and surging inflation, all of which had an impact on traffic demand.

"This is only the beginning. High oil prices and global economic slowdown will continue to deeply affect the airline industry for the remaining part of the year," Li said.

"Chinese airlines will not enjoy the same exchange gain in the second half of this year as the yuan will not appreciate so much in the following months," Li said.

The negative effect of the domestic jet fuel price hike at the end of June will also be more prominent in the year's second half, Li added.

The National Development and Reform Commission (NDRC) at the end of June raised the domestic jet fuel wholesale prices by 25 percent and retail prices by 23 percent. The NDRC allowed Chinese airlines to raise fuel surcharges on domestic flights by as much as 50 percent from July 1. The levy on journeys of over 800 km climbed from 100 yuan to 150 yuan and that on shorter flights rose from 60 yuan to 80 yuan.

But the fuel surcharge rise could not completely offset the soaring fuel prices while it could dampen an already weakening market demand.

Chinese airlines must seize the market opportunities, including a possible slight rebound of traffic after the Olympic Games, the golden week of the National Day holiday, outbound group travels from China to the United States and the weekend cross-Straits chartered flights to Taiwan, Li said.

(China Daily August 29, 2008)