Peru is trying hard to attract foreign capital by opening its skies, but its policies are not uncontested and Peru's military may have plans of its own. David Knibb reports from Lima.

Deregulation Peruvian-style is not for the faint of heart. Seventeen local airlines have failed in eight years and foreigners can now purchase up to 70 per cent of flag carrier AeroPeru. But neither of these facts seems to have made regulators think they should drop the pace of their continuing drive to liberalise Peru's skies.

The take-no-prisoners style of President Alberto Fujimoro's government applies not only to terrorists, but also to the economy and airline deregulation. Such single-mindedness stems from the crisis Fujimoro inherited seven years ago when terrorists had claimed most of the countryside and The Shining Path were within six months of taking over Peru. Campesinos fleeing the guerrillas flocked to Lima and set up shanty towns that bred cholera. Tourists and their hard currencies stayed away. Inflation reached 7,600 per cent.

Fujimoro's shock treatment brought government by decree, harsh austerity and massive privatisations. Peruvians may grumble that their president is a dictator, but inflation, now the fourth lowest in South America, is in single digits for the first time in recent memory. Foreign visitors are back, spending half a billion dollars a year.

Peru seems intent on out-liberalising its neighbours on the theory that the more open its economy is, the more it can attract foreign investors. Despite vast resources, Peru has been compared to the beggar who owns a street paved with gold but is chronically poor. Investors are certainly flocking to Peru. Chileans have bought so many businesses that Peruvians fear their country is becoming an economic colony. The process started with a sweeping sale of government assets, beginning with the privatisation of AeroPeru in 1993.

An amendment to the aviation law in 1991 permitted foreign ownership of up to 70 per cent of any Peruvian airline. However, when it solicited bids for AeroPeru, Lima decided to limit foreign equity to 49 per cent.

When that bidding process ended in March 1993, Aeromexico had acquired 47 per cent. Peruvians had bought another third with local investors including Sermico, a banking and mining conglomerate with 24 per cent, the airline's employees who exchanged severance rights for 7 per cent, and an individual who bought 2 per cent. The Peruvian government retained the 20 per cent balance.

Nominally, Aeromexico has remained AeroPeru's main shareholder. However, the restructuring of Mexico's airlines means that Cintra, the holding company for Aeromexico and Mexicana, now owns Aeromexico's stake. AeroPeru has moved closer to the Mexican camp. Under its Alas de America or 'Wings of America' alliance with Aeromexico and Mexicana, AeroPeru has become part of a route network built around the Mexican hubs.

More working capital

Events are now thrusting AeroPeru into a second privatisation phase. Since its initial sale, AeroPeru has consistently lost money. Its 1995 operating loss was US$9.7 million on revenues of slightly over $150 million. In 1996, its operating loss grew to $13 million on almost identical revenues.

Aeromexico started paying the bills as soon as it became an owner. But when AeroPeru's accumulated losses reached $189 million, Aeromexico raised the two-fold issue of more working capital and what to do about the $60 million in advances registered as a loan.

'I could see it coming,' recalls John Elliott, AeroPeru's former vice president for operations. 'When I questioned certain expenses, the answer was: "we don't have to pay for this." ' About half the $60 million now owed Aeromexico represents cash advances; the rest was leases, goods, and services Aeromexico provided - some say at inflated prices.

When attempts to find Peruvian shareholders willing to put more cash into the airline failed, Lima was forced to consider a revision of its regulations to allow foreign ownership to rise from a limit of 49 per cent to the statutory 70 per cent. Last October, the government agreed the change. The move entitles Aeromexico to capitalise its loan and take additional AeroPeru shares, raising its stake to 70 per cent.

The shareholders have not yet chosen a course of action. One complication is that Cintra faces growing pressure from Mexican competition authorities to spin off its airlines into separate companies. But the Mexicans also realise that converting debts into shares may not solve anything, and that the guarantee of AeroPeru's long-term survival may require more. 'I don't think the primary objective is to pay off Aeromexico's loan,' says Raul De Solar, AeroPeru's legal adviser. 'This is for the stockholders to decide, but I think the objective now is to inject fresh money and form a strategic alliance.'

Senior AeroPeru officials have spent most of their time recently at the offices of Continental, Delta, United Airlines, and perhaps other US carriers, discussing the sale of a strategic stake in AeroPeru. LanChile and Vasp expressed an early interest, but late last year there were no equity talks underway with any South American airline.

No matter who AeroPeru's ultimate owners are, the prospect of 70 per cent foreign ownership raises nationality questions. Bilaterals typically require an airline to be 'substantially owned and controlled' by nationals of its home country. But Ricardo LaPuenta, head of the Director General Transportes Aereos (DGTA), Peru's civil aviation authority, seems unconcerned. 'Under Peru's law it is still a Peruvian airline. The trend is to globalise. So if it is good for all the countries, why not?'

Raul De Solar is in agreement. 'We have been designated by the Peruvian government as a Peruvian carrier, and under Peruvian law we are.' He cites the example of Aerolineas Argentinas, which is almost entirely foreign owned. 'Even today, Argentineans have less than 5 per cent of Aerolineas,' De Solar claims. Yet Washington negotiated a new bilateral with Buenos Aires. 'What happened on this issue?' he asks rhetorically. 'Nothing.'

To attract investors, Lima awarded AeroPeru a monopoly on most new routes in 1992, but it has now reduced those route rights, in exchange for lifting the foreign equity lid. Again, the aim is to attract foreign investors, but this time not for AeroPeru.'We want to open the market for other Peruvian airlines,' explains DGTA chief Ricardo LaPuenta. 'If AeroPeru has a monopoly on all the routes, who will be interested in investing in this country?'

AeroPeru's monopoly on new US frequencies beyond Miami has been cut to 63.64 per cent and its claim to new routes to Argentina, Brazil, Chile and Mexico will drop over the next several years to 70 per cent. More importantly, AeroPeru can no longer wait two years before exercising a route preference; it now has only six months. LaPuenta sees this as 'a big difference' because 'otherwise another Peruvian airline will take it'.

US route approval

Scaling down route monopolies is more than academic. AeroContinente announced plans to seek US routes right after Peru regained US Federal Aviation Administration Category 1 status in July. At press time, LaPuenta expected AeroContinente to have US route approval very shortly. The airline plans to fly to Miami or Orlando and has also applied for Japan flights via Hawaii. But for the latter, it must await the conclusion of a new Peru-US bilateral after the current accord expires in June.

Granting US routes to AeroContinente does not put other Peruvian airlines out of the running. As a member of the Andean Pact, Peru already has open-skies agreements with its other members - Bolivia, Colombia, Ecuador, and Venezuela. Peru also has open skies with Panama. AeroPeru enjoys no exclusivity on these routes.

In November, Peru also agreed with Chile to triple frequencies, with added fifth, sixth, and seventh freedoms. As a result Cuzco, Arequipa, and Iquitos are growing as gateways. Peru is also a party to talks between the Andean and Mercosur groups. LaPuenta predicts these could produce a merger of the regions within two years, an event that could open skies over most of South America. Some 41 per cent of Peru's air traffic is within South America.

North America is of equal importance, so the US is key to Peru's liberalisation. The current US-Peru accord limits capacity and routes, but not the number of airlines. With the current bilateral expiring in June, Lima and Washington opened talks last November. A second round is slated early in March.

Peru's return to Category 1 sparked speculation that it might embrace US-proposed open skies. Juan Garland, DGTA foreign affairs director, told a Lima aviation audience in November that his office was asking Peru's airlines to estimate how long they needed to prepare for open skies with the US, and that he would hold them to their answer. From Garland's perspective, the question is not whether, but when. In his words: 'Open skies is inevitable.'

Carlos Morales, executive president of AeroContinente, sounds more eager about them than most. 'Contrary to the position of other Peruvian airlines, we agree with the policy of open skies,' he says.'We like competition.' Coming from a carrier that has never flown beyond Peru that sounds like bravado, but AeroContinente has survived Peru's domestic bloodbath.

Even without open skies, a US invasion is already underway. 'The breakdown of the [US-Peru] market is about 75 per cent for the US carriers,' concedes Rosa Maria Plasencia, AeroPeru's senior sales vice-president. In the two years when Peru's US flights were frozen under Category 2, American, Continental and United Airlines boosted weekly frequencies to the 42 allowed under the bilateral, while AeroPeru's remained at 9. Since 1990, US carriers have increased their Peruvian capacity by 27 per cent. During the same time LanChile has added another 24 per cent between Lima and the US, while AeroPeru's US capacity grew by only 11 per cent. In short, foreign carriers dominate north-south routes even without open skies. Delta's current application to expand aggressively in Latin America, and LanChile's plan to add more capacity, will magnify that.

Maria Barrido, aviation specialist with New York-based International Aviation Group, advises several Latin American carriers. A native Peruvian, she thinks Lima is liberalising too fast. She fears its government does not understand what open skies will do to Peru's airlines. 'How can you expect to have open competition between the rich and the poor?'

Peru's domestic skies are even more turbulent. Widespread airline failures and fleet cutbacks by the survivors have produced what LaPuenta calls 'a commercial crisis.' Eight airlines have closed in two years and, at the lowest point, domestic trunk routes were served by as few as eight jets, of which three were AeroContinente's. Peru's typical domestic airline is a closely held company that operates less than five aircraft. These are always Stage I narrowbodies on operating lease ,since Peru has been a dumping ground for older Russian aircraft.

Analysts blame recent failures on three causes: the trauma of Peru's economic recovery, the cost of complying with new regulations, and AeroContinente's low fares. International traffic has averaged 10 per cent annual growth over the past five years, but Ricardo LaPuenta says domestic traffic remains almost flat. 'The cause comes from the past,' he explains, referring to the economic crisis the current government inherited. Some failed due to aviation rules adopted a year ago, 'because they did not have the money to comply,' he adds.

AeroContinente's role in wiping out rivals is still being debated. Some claim its fares were predatory, below cost and financed from drug trafficking. Carlos Morales replies that drug charges against the airline's former chairman have been dropped, and adds that AeroContinente's 10 to 12 cent per kilometre costs were lower than its rivals', allowing it to cut fares, boost loads, and still make a profit. Whatever the cause, AeroContinente has become Peru's first airline to carry a million domestic passengers in one year. In three years its domestic market share has soared from about 20 to 65 per cent.

AeroContinente still faces fleet problems. It charters aircraft elsewhere during the low season, but engines and parts are a chronic headache. At the start of Peru's summer high season AeroContinente had only three jets operating; the rest were still in maintenance.

Peru's domestic seat shortage has had several effects. First, under pressure from Lima, AeroPeru has expanded from a token domestic presence, increasing its domestic flights by 61 per cent over past months. Second, some survivors are growing: T Doble A (Transportes Aereos Andahuaylas), which stuck to turboprops for three years, was expecting its first Boeing 727-100s in December.

Third, two startups have emerged. TransPeru was launching 727 service in December. TransAm, founded by Daniel Ratti, formerly CEO of Carnival Airlines, plans to start operations in March with two B737- 200s. 'Two million passengers served by only eight aircraft offers a tremendous opportunity,' he says. Ratti, a Peruvian, plans an array of US-style fares from low, non-refundable advance purchases to high, on-demand transferable tickets. 'Demand will determine the actual fare,' says Ratti. In a country accustomed to one-fare-fits-all, this is a novel concept.

The most controversial response to Peru's capacity crunch has been an Air Force launch of 'civic' flights. At the start of Peru's winter high season in July, President Fujimoro announced he would make his presidential jets available for domestic passengers. He said such Air Force-operated flights would be temporary and limited to points not served by commercial airlines. He has been wrong on both counts. Flights have continued through both high and low seasons, and the presidential B737 and F28 ply the Lima-Cuzco trunk route, as well as others served by private carriers. Even more perplexing, the Air Force is now carrying civilians on its military transports and has ordered two B737s for more 'civic' flights. Private airlines fear it is using a temporary seat shortage as a pretext to muscle in permanently.

'How can it be temporary if you're buying airplanes?' asks John Elliott, a former AeroPeru officer and now director for regional carrier AeroCondor. 'The Air Force should only go where they are needed, and they're not needed in Cajamarca,' he adds, naming one of several cities where it now competes with AeroCondor.

Cargo lift

Even if the military were filling a temporary seat shortage, that would hardly explain its plan to lease an Ilyushin to lift 350,000kg of cargo for a petroleum company - a job private airlines want. 'They will take everything,' worries Luz Helena Garcia, a Lima-based aviation lawyer and president of Peru's Instituto Aeronautico. 'The Air Force is a big problem,' warns Heimar Campos, a retired Air Force officer who is now managing director of T Doble A. 'Until we have a clear understanding about its long-term plans, we cannot grow.'

Carlos Palacin, AeroCondor's founder and president, echoes this concern. 'Would I invest in a big airplane in light of the uncertainty created by the Air Force? I may be a little loco, but not that much.'

How does competition from the military square with government attempts to encourage private investment? The local airlines have the same answer, best expressed by John Elliott: 'They have to keep the generals happy. You cannot govern in a Latin American country if you don't have the approval of the armed forces.'

Peru faces uncertainties about its flag carrier's ownership, foreign dominance, and now the military's plans. While liberalisation forges ahead, no one seems sure where it is headed. Julian Sevillano, a Peruvian consultant based near Miami, sums up Peru's aviation this way: 'There are no rules, but there is lots of opportunity.' n

Cast of carriers

The past two years have been rough on Peru's domestic airlines. Here is a recap:

The casualties

Expresso Aereo. Operated F27s and B727s before folding in 1996. Imperial Air. Another 1996 casualty. Flew Russian jets and turboprops. Aero Chasqui. One B727 repossessed a year ago. Aero Andrea. Flew F28s; went into receivership. Aerotumi. Operated three Antonov models before folding. Transamazon. Flew Antonov turboprops. Americana. Once Peru's biggest domestic airline. The government grounded its last B727 in mid-1997. Can still fly charters, but not under its own name. Faucett. In November the government found Peru's oldest airline no longer technically competent. Company officials insist Faucett will fly again after it finds funds to clear its debts, but the 69-year old airline has laid off all its employees.

The survivors

AeroPeru. Peru's flag carrier has largely avoided the domestic bloodbath by focusing on international routes. AeroContinente. Now the largest domestic carrier, its low fares helped drive others out. T Doble A (Transportes Aereos Andahuaylas). Has been flying Russian turboprops since December 1994. The first of two B727-100s was due in December 1997. AeroCondor. Operating secondary routes and sightseeing with 21 turboprops since 1975. Expansion shelved over concerns about military 'civic' flights. TANS (Transportes Aereos Nacionales Selva). Military-operated turboprops on remote jungle routes since 1954.

The newcomers

TransPeru. Launch with Boeing 727-100s was slated for December 1997. Principal backers are a US travel operator from Peru and a US medical airlift operator. TransAm. Formed by Daniel Ratti, formerly Carnival Air CEO. Plans a March launch with two B737-200s and $3 million in local capital. Two more B737s due. Air Force of Peru. Launched 'civic' flights last July, using presidential jets and military transports. Has ordered two B737s.

Source: Airline Business