Airfare, Inflation and Aviation Recovery
The trend of the FOB spot fuel prices on the Mundi Index continues to move up, relative to the position at the beginning of the year, especially after the Russian-Ukrainian war.
As the commercial aviation sector is trying to recover from a crisis after being battered by the pandemic, another problem arose, namely soaring energy prices, including aviation fuel (AVTUR).
The increase in AVTUR prices of up to 72 percent last July compared to the position in early January has become a nightmare for the aviation industry. The aviation industry has received double blows.
The first blow; the number of aircraft fleets has dwindled considerably due to mobility restrictions, foreign tourists have been halted, the numbers of human resources including pilots is shrinking, debt is piling up and profit is minimal. The second blow; the increase in AVTUR prices, coupled with the depreciation of the rupiah against the US dollar, has worsened the airline's performance.
Garuda Airlines, for example, for the first quarter of 2022 recorded a negative EBITDA (earnings before interest, tax, depreciation and amortization), in other words a net loss of US$161.6 million. Similarly, AirAsia saw a net loss (negative EBITDA) of Rp 555.7 billion ($37 million) for the second quarter this year, after experiencing a negative EBITDA of Rp 543.8 billion ($36.5 million) in the first quarter.
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> Garuda Indonesia’s Commitment
The impact of the Russia-Ukrainian war and the sanctions imposed on Russia by the United States, Canada, the United Kingdom and the European Union, have caused the price of food and energy commodities to skyrocket. If this invasion escalates into a protracted war, the impact will last a relatively long time. Caution is needed.
The trend of the FOB spot fuel prices on the Mundi Index continues to move up, relative to the position at the beginning of the year, especially after the Russian-Ukrainian war. In January, the price of fuel per gallon was $2.45 but jumped to $4.12 in June, up 68.16 percent from the beginning of the year.
The impact of the war has perpetuated the era of high AVTUR prices since early 2019. Previously, AVTUR prices were below Rp 10,000 per liter, as low as Rp 5,490 in January 2015.
The advent era of high AVTUR prices was then affected by the pandemic, ending its heyday in the aviation industry.
According to Pertamina, the price of aviation fuel per liter for domestic flights at Soekarno-Hatta Airport at the beginning of the year was Rp 10,765 then in July skyrocketed to Rp. 18,431, an increase of up 72 percent. AVTUR prices for domestic flights do not include Value Added Tax (VAT).
If there is no adjustment in commercial flight fares, the aviation industry will clearly not be able to operate.
Fuel costs range from 40-50 percent of flight operational costs. This means that if the AVTUR price increases by 70 percent, operational costs (cost of production) will increase by 28-35 percent. Airlines such as AirAsia stated that the increase in AVTUR prices increases operating costs by 90 percent. If there is no adjustment in commercial flight fares, the aviation industry will clearly not be able to operate.
To respond to the increase in AVTUR prices during this year’s Lebaran season, the Transportation Ministry issued Decree No. KM 68/2022 regarding fuel surcharge for economy class passenger services for domestic scheduled commercial air transport in April. This regulation allows airlines to charge an additional 10 percent for jet aircrafts and 20 percent for propeller planes.
This decree was later updated with Decree No. KM 142/2022 which allows airlines to set air ticket prices up to 15 percent of the upper limit fare (TBA) for jet aircrafts and a maximum of 25 percent TBA for propeller aircrafts, effective Aug. 4. The TBA rules refers to Decree No. 106/2019 concerning maximum limit tariffs for domestic economy class passengers in scheduled commercial air transport.
This year's soaring ticket prices occurred during the Lebaran season due to high demand along with rising aviation fuel prices. Ticket prices increased to 20-50 percent. After Idul Fitri, the increase continued, driven by the soaring price of the AVTUR. Although the Transportation Ministry Decree No. KM 142/2022 has taken effect, there was no increase in prices of economy class tickets until the end of August. Why is that?
There are at least two factors. First, August is generally the cheapest time to buy airline tickets. Second, airline companies have a wait-and-see attitude, especially Garuda. This may have something to do with political pressure from the government on airlines to control the increase in ticket prices due to concerns that it will trigger inflation.
While the prices of airline tickets were relatively high in July 2021, in fact, prices of airline tickets decreased in August. For the Jakarta-Bali route, for example, several airlines offered economy class ticket prices of around Rp 1 million, compared with last July when prices were between Rp 1.5 million and Rp 3 million.
Inflation concerns
Another issue related to the increase in airfare prices is inflation. In May 2021, the air transportation sector was one of the triggers for inflation. Based on the Indonesian Statistics Bureau (BPS) data, inflation in May reached 0.4 percent (month-to-month/mtm) and 3.55 percent (year-on-year/yoy), driven by an increase in air transport fares and prices of foods, such
as eggs, fish, shallots, garlic and cooking oil. Inflation for administered price components (prices regulated by the government, including aviation fuel and airline tickets) reached 0.48 percent with a share of 0.09 percent.
On an annual basis, the administered price group experienced 6.51 percent yoy inflation.
In July, inflation rates were even higher, at 0.64 percent mtm and 4.94 percent yoy. Administered price inflation reached 1.17 percent, an increase from 0.27 percent in the previous month. This increase was mainly influenced by air transportation fares, household fuels, AVTUR and others. On an annual basis, the administered price group experienced 6.51 percent yoy inflation.
According to the fiscal policy agency in the Finance Ministry, the contribution of the increase in airline ticket prices was only 0.01 percent of the increase in the consumer price index (CPI). If this is the reality, the increase of airline tickets is not significant to inflation. Moreover, ticket prices and aviation fuel prices can be controlled.
As prices of airline tickets fall in August, it can be estimated that the air transport sector contributes to lower the inflation rate.
Indonesia Incorporated
Williamson argues in his book Market and Hierarchies (1975) that in certain cases, hierarchies are preferred in markets for the following reasons: (i) internal organizations can achieve economic level under bounded rationality, (ii) it is more difficult to obtain the right level of profit through opportunistic behavior in internal organizations, (iii) there is more effective monitoring and conflict resolution mechanisms, (iv) internal organizations reduce opportunistic tendencies, and encourage information sharing and effective communication.
Responding to instructions from President Joko “Jokowi” Widodo to resolve the high prices of airline tickets (referring to the situation in July) both the Transportation minister and the State-Owned Enterprises minister moved quickly to implement the steps according to their authority.
The Transportation minister issued three steps, namely asking airlines to provide discounts at certain times, such as during weekdays, and other innovations. In addition, requesting local administrations to provide subsidies or support a certain level of occupancy (60 percent) of seats and to propose to the Finance Ministry to eliminate or reduce VAT.
Meanwhile, in addition to supporting Garuda and Citilink to control flight ticket prices, the State-Owned Enterprises minister will increase the number of Garuda fleets, from 61 units to 120 by the end of the year. After the issue relating to the settlement of the postponement of the obligation to pay debts (PKPU), the state-owned airline will be injected with state capital participation funds (PMN) of Rp 7.5 trillion ($504 million).
To anticipate the escalation of the Russia-Ukrainian war in the next six months, with an impact on energy prices including aviation fuel, we need to return to the concept of Indonesia Incorporated.
All relevant parties, such as the Transportation Ministry, the Finance Ministry, the State-Owned Enterprises Ministry, the Energy and Mineral Resources Ministry, Pertamina, Angkasa Pura, aviation associations (INA-CA) and Garuda, as well as other aviation industry players, need to sit down with the Coordinating Ministry for Political, Legal and Security Affairs (Kemenko).
With the impact of the escalating Russia-Ukraine war on energy prices, including aviation fuel, the national aviation industry needs to be jointly borne by the framework of Indonesia Incorporated. For example, the Transportation Ministry provides subsidies up to a certain time limit for economy class flights, and Pertamina increases efficiency to reduce AVTUR prices and maximizes AVTUR production capacity (BIOAVTUR). The aviation industry can also control ticket prices and promotion strategies.
The Finance Ministry may retain its position to impose VAT on aviation fuel prices for domestic flights for the sake of state revenue. However, the Finance Ministry needs to support an economy class flight subsidy policy if it is deemed feasible to be implemented within a specified time limit. Likewise, business class consumers and local administrations need to increase their contribution to restore the national aviation industry.
The concept of Indonesia Incorporated as a joint responsibility solution for air ticket prices and aviation fuel prices affected by the Russia-Ukraine war needs to be orchestrated by the Coordinating Ministry for Economic Affairs in order to find a win-win solution. Regulations and agreements are needed to set air ticket prices and aviation fuel prices, as well as the possibility of subsidizing economy class flights at a level that is equally acceptable to all parties.
The case of the aviation cartel found guilty by the KPPU in 2019 need not be repeated. The Omnibus Law (UU No 11/2020 on job creation) is now the new legal umbrella.
After financial restructuring, Garuda is expected to transform into a corporation with good governance but without further stories of corruption in the future. T
Garuda's (re)expansion plan to increase its fleets from 60 to 120 units can be an entry point in building an integrated tourism and aviation industry ecosystem. After financial restructuring, Garuda is expected to transform into a corporation with good governance but without further stories of corruption in the future. This state-owned airline is in a strategic position to build this ecosystem.
The ecosystem involves a number of big business players, ranging from airlines, hotels, the souvenir industry to PT Aviata. The construction of this ecosystem will have a positive impact on restoring the national aviation and tourism industry at large.
Collaboration through institutional developments, such as business ecosystems or vertical integration, can reduce transaction costs due to information asymmetry or bounded rationality. In this case, institutional developments are the rules of the game, set formally or informally by enforcements.
Wihana Kirana Jaya
Wihana Kirana Jaya, Special Staff to the Minister of Transportation
(This article was translated by Kurniawan Siswo).
