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. Last Updated: 07/27/2016

Salvaging Russia's Wrecked Aircraft Industry

Carrying signs reading "Russian skies for Russian aircraft," about a thousand unhappy aviation employees gathered last Friday outside the White House to protest the decline of the aircraft industry.

Many protesters directed their anger at Russia's No. 1 carrier Aeroflot for buying Airbuses and Boeings with the help of customs and tax breaks instead of domestic products, thus hammering the nail into the industry's coffin.

The protesters are not the only ones lamenting the loss of the Soviet Union's large aviation industry — at one point, Russian planes accounted for 25 percent of the world aircraft and flew 135 million passengers a year.

Both chambers of parliament and industry trade unions have appealed in letters to Prime Minister Mikhail Kasyanov and President Vladimir Putin. In his last response of Jan. 24, Putin ordered the government to look into ways of resolving the issue within a month.

And next month, Kasyanov will host a meeting to agree on leasing mechanisms for domestic aircraft — which many believe to be the solution that will drag the industry out of a decade-long tailspin.

The decision before the government, according to Ilyushin Finance Co., is to spend some $1.3 billion on research, plus an annual sum of $2.8 billion in state guarantees over the next 10 years and get a financial yield of $18.6 billion. The other option is to close down the industry by spending $200 million to $250 million from 2003 to 2005. Following that, the state would carry $6.3 billion in lost budget revenues and $2 billion annually from the acquisition of foreign aircraft.

Time is also ticking away with as many as 500 domestic aircraft decommissioned each year. At this rate, only 40 percent of the current 3,726 civil aircraft will be left. Meanwhile, only three civil planes and one helicopter were delivered to Russian airlines last year. Before 1992, the volume of annual delivery ranged from 300 to 350 craft.

When new international regulations on noise and emission are implemented in 2002, only a few types of Russian aircraft will be eligible to fly the world's skies — among them the Il-96 and the Tu-204. Both are the focus of the leasing projects.

Trial Runs

Two pilot deals expected to get the leasing programs started are the delivery of three Il-96T cargo planes with American Pratt&Whitney engines and Rockwell Collins avionics to Aeroflot and six passenger Il-96-300s and 10 Tu-204/214 to Aeroflot and Transaero, respectively. Priced at around $30 million and $20 million — two to three times cheaper than their foreign counterparts — they are still an expensive purchase for even the strongest of the 293 domestic airlines, which collectively earned only $5.4 billion last year.

To buy a single Tu-204 produced at Aviastar Plant in Ulyanovsk, regional airline Sibir had to pledge a controlling stake in its company as collateral to Sberbank for a loan of $15.8 million.

The first leasing program is expected to require $200 million of financing over two years, while the second will take in $220 million over three years. The federal budget revenue from these leasing programs for 2001-03 is estimated at $410 million.

The leasing deals are operated by IFC, a company set up in 1999 by designer and manufacturer Ilyushin Aviation Complex and Gazprom-affiliated National Reserve Bank. According to the draft deal, planes would be leased for 15 years. Ilyushin Finance, with leasing programs for more than 30 aircraft in its portfolio, is negotiating with Vneshtorgbank and Vneshekonombank to finance the deals.

If the deals do not go through, the most likely alternative would be to spend $800 million on a minimum of five Boeing 767-300s and eight Airbus A-320s or Boeing 757-200s, according the figures from the Industry, Science and Technology Ministry.

One possible hitch is that the banks have asked for $350 million in state guarantees to ensure against losses if aircraft are not delivered on time, according to the IFC. To avoid disrupting the project, the Industry, Science and Technology Ministry, which is in charge of the leasing program, resolved at a recent meeting that the level of government support should be decided by April.

The need for expediency in the decision is widely acknowledged. Industry players say an 85 percent guarantee would enable banks and financial institutions to offer long-term credits at low stakes, as is done abroad, instead of rocket-high 22 percent rates for just two to five years.

Government support for the first few years is vital to the success of the leasing program, said Alexander Rubtsov, head of IFC. "As the market develops, the demand for state guarantees will diminish, and I hope as of 2005 we won't need them any longer," he said.

"The government is facing a choice of whether to preserve the industry or shut it down. I hope that it chooses the former, although there's a slight chance it might not. Then, we'll all switch to railways — with the remaining 1.5 percent flying Boeings and Airbuses," Rubtsov said.

Transaero chairman Alexander Pleshakov agreed. "It's only a matter of political will or else there is only way out — [buying] Boeings and Airbuses," he said.

Leasing Hurdles

By a number of governmental decrees in late 1990s, state-controlled Aeroflot and private carrier Transaero were given tax and customs breaks to lease Boeings and Airbuses. In return, airlines signed deals to buy domestic planes. Under the resolution, the airlines did not have pay 25 percent customs duties nor 20 percent value-added tax.

"Leasing foreign aircraft was a temporary and forced measure," said Alexander Neradko, first deputy transport minister for aviation, adding that the company needed new types of aircraft and a new system for their financing.

"Some airlines, in order to preserve their status on the international market, had to turn to foreign craft," Neradko said.

Seven of Transaero's fleet of nine planes are leased Boeing-737s.

Aeroflot's fleet of 112 planes carries 28 foreign aircraft, which together with four Il-96-300s perform 60 percent of the airline's flight business.

Transaero said it feels it has done its part and is optimistic the government will do the same.

Aeroflot is less cheerful about the prospects of future leasing programs. "Aeroflot has never had a successful experience leasing domestic aircraft," said Aeroflot CEO Valery Okulov in an interview last Thursday.

Under the pilot leasing program, Aeroflot's first passenger Il-96-300 was due in the first quarter of this year, but now delivery looks uncertain. "We included it in our summer program, but we've had to reorganize," Okulov said.

"Looking for guilty parties is a favorite national game," said Okulov. But the Il-96-300 has been held up because [Ilyushin producer] Voronezh Aviation Plant and Ilyushin Finance Co. did not fulfill their obligations, he said.

However, the IFC's Rubtsov said it is the government that is to blame for the delay. "We gave [Deputy Prime Minister Alexei] Kudrin the documents [requesting state guarantees] in 2000. This March, it will be exactly a year, and we are still where we started," he said.

Neither Ilyushin general director Viktor Livanov nor Voronezh plant director Vyacheslav Salikov were available for comment last week.

But the aviation industry employees who came to the White House on Friday said Aeroflot is to blame for their misery, low salaries and stagnant production. They carried signs reading: "Aviation by Okulov means industry collapse," and "Who are you working for, Aeroflot?"

On the heels of Kasyanov and Okulov's visit to France late last year, news broke that Aeroflot had signed a memorandum with Airbus Industrie on the delivery of 30 A-320s, drawing ire throughout the domestic industry. The discord has yet to abate even though Airbus and Aeroflot denied that any aircraft were in fact ordered.

"No concrete orders have been placed," said Okulov. "This memorandum was on cooperation with Airbus in a broader sphere, which includes personnel exchanges and aircraft maintenance."

But Aeroflot does not rule it out that it will lease foreign planes if nothing comes up on the domestic market. In line with its strategic development program adopted last spring, Aeroflot plans to optimize its fleet from 11 aircraft models down to four: a long-haul, a medium-range, a cargo and a regional plane.

"We didn't write in the nationality of the planes," Okulov said. "Uncertainty cannot prevail forever. If we don't get the Il-96T in time, we'll lose the market, and then we won't need it anyway."

Civil aviation authorities agree.

"We pursue a policy of using domestic aircraft but one has to be realistic," said Viktor Gorlov, head of the State Civil Aviation Service's flight safety department. "If Okulov now says that he will return all his 28 foreign craft and asks for guarantees that he will get domestic planes under the same conditions that credits are issued abroad, we will tell him that we cannot do it.

"The industry will ask to wait five years, and in six months, he will lose his market," Gorlov said.

However, if Aeroflot chooses to carry on leasing foreign aircraft, it will no longer enjoy the same tax breaks.

"If Okulov wants to buy [Airbuses and Boeings], he will have to pay VAT and customs duties. In these conditions, the cost of leasing payments will be such that the project will fall apart," said Yury Koptev, head of the Russian Aviation and Space Agency in a recent interview.

Industry, Science and Technology Minister Alexander Dondukov said he's in favor of equal rules for everyone in the market and that there should not be tax breaks for leasing foreign aircraft.

However, Neradko said the government does plan to place different customs tariffs on aircraft that do not have domestic analogues. He added that airlines leasing domestically produced planes would be awarded licenses on the most profitable routes.

Aeroflot said such government initiatives will not allow the airline to compete with foreign airlines on international routes. It needs foreign planes with Western comforts to attract international clients.

"The engineering of the Il-96-300 is excellent, but the engineering of its interior is not acceptable," said Paul Duffy, a Moscow-based independent aviation analyst.

Engine Woes

To further substantiate the need to purchase foreign aircraft, Aeroflot is relying on its safety record. Aeroflot's early-January schedule was upset by two failures in Perm-produced PS-90A engines on its Il-96-300 planes. The airline demanded the engines be replaced at Perm's expense, because the engines did not meet technical requirements and entailed economic loss to the carrier. Aeroflot said it had to dismantle Perm engines 32 times last year, which delayed 200 flights.

Alexander Inozemtsev, chief designer at Aviadvigatel construction bureau in Perm, said in a telephone interview Friday that the December mishap did show that the engine had problems, but that Aeroflot overreacted. The engine had previously performed steadily and a program to upgrade its reliability in the next two to three years is under way, Inozemtsev said.

IFC's Rubtsov agreed the engine has problems but said it would be strange to expect the same performance from an engine that is four times cheaper than its Western counterparts.

"The PS-90 is quite a good engine but it needs a certain amount of correction," Duffy said. "But as not many are in use, the designers don't have enough operational background for quick improvement.

"Aeroflot is the one taking responsibility and all the pain for developing the engine, which makes them nervous to take more such engines until its problems are resolved," Duffy added.

Alternative Leasing

While Ilyushin Finance is waiting for government guarantees to get its deals going, two other leasing companies in the aviation business are elbowing their way into the market.

Financial Leasing Co., set up by Tatarstan's Tatneft oil company and Moscow-based Bank Zenit, last year pooled investments from the Tatar government and a group of investors to subsidize production of two Tu-214 planes at the Kazan production plant.

The planes will be leased to Khabarovsk-based Dalavia for eight years at an 8 percent interest rate. Another regional airline, KrasAir, has also requested two such planes, said Yevgeny Zaritsky, director of Financial Leasing. The company also has signed intentional protocols for 30 more planes for Russian airlines.

Zaritsky said governmental support will be essential for the aviation industry to develop: "Airbus and Boeing receive strong support from their governments, so should our government invest into the future of industry — but not into the pockets of Boeing and Airbus — as our aircraft, by some parameters, outperforms foreign products."

Igor Leiko, president of LEADER, which has been involved in leasing for the past five years, is not waiting for government guarantees as his program is economically self-sufficient. Leiko's LEADER has leased and repaired Tu-154s and Yak-42s on the secondary market, working with Aeroflot, Samara, KrasAir, Krymavia, Dalavia and Belavia.

He said he has presented his program to five governments, but his concept has not yet been implemented because officials prefer moaning about the lack of money to taking action.

"We can organize financing for producing an aircraft and lease it to airlines providing quick return of money if they agree to our conditions," Leiko said, adding that his conditions simply help the airline use the aircraft more effectively.

LEADER is negotiating to lease a number of new Tu-204 fitted with PS-90A engines to Russian airlines without any state guarantees. The only governmental support Leiko sees possible is that which minimizes the risks of changes in currency rates and tax and customs legislation.

Out of the Wreckage

Domestic airlines carried just over 21 million passengers last year, a meager figure compared with Lufthansa's 47 million.

Alexei Komarov, editor in chief of Air Transport Observer magazine, said the government should think about airline passengers when drawing up its industry revival plans and that just pumping money into the industry is unlikely to yield much.

As one airline executive said, no one needs the aviation industry the way it is now. The government realizes this and calls for restructuring, but nothing final has been pronounced.

"If you have a core base of 20 million passengers a year and a reasonable amount of flying hours — say 2,500 hours a year for each aircraft — 400 Tu-204s could easily carry this," Duffy said. He estimated that no more than 30 to 50 Il-96-300 would be sold over 15 years, while in a cargo configuration there could be a market for hundreds.

Rubtsov also estimates the market stands at around 500 aircraft, when the gross domestic product is at least 6 percent. In a case of no economic growth, the estimation comes down to 250 to 300 planes, which is close to Aeroflot's estimation — this rate, spread evenly among the country's 18 aviation plants, would not be enough to save the industry.

Rubtsov said the industry's restructuring should be done on the basis of the Voronezh plant and the Ulyanovsk and Kazan plants, which produce Ilyushin and Tupolev aircraft. "The rest should be kept for parts assembly."

Aeroflot says the way to rescue the industry is to integrate it into the world economy.