Merger talks between Air China and China Southern Airlines have ended in failure but supporters of consolidation in China's bloated airline sector will be pleased with another positive development: two other Chinese carriers have forged a tentative deal.

Beijing-based industry sources say China National Aviation (CNAC), the commercial arm of the regulatory CAAC, has approval in principle to take over Chengdu-based China Southwest Airlines. The take over was said to have been agreed last year, when it won backing from the former head of the CAAC, Chen Guangyi. When Chen was replaced, however, his successor Liu Jianfeng withdrew approval and forced another round of discussions.

While Liu has now approved the deal in principle, a full take over is not expected until at least early next year as final details need to be worked out. It is nonetheless seen as a positive development, as consolidation efforts in China have moved slowly in recent years.

After years of phenomenal growth, the country's airlines began struggling when the regional economic downturn began in mid-1997. Coupled with domestic ticket discounting and severe over capacity, all but a handful of China's 30 or so carriers suffered losses last year.

While some have since returned to profitability, the CAAC is demanding that larger carriers swallow smaller ones, although the only notable deal so far has been China Eastern Airlines' take over of China General Aviation.

Beijing-based Air China and Guangzhou-based China Southern Airlines are China's two largest carriers and merger talks were ordered in June by the central government. Shares in China Southern, listed on the Hong Kong and New York stock exchanges, soared after the talks were confirmed by the airline in July.

All has gone quiet since, however, and the sources in Beijing say the talks recently ended in failure, in part because of opposition by China Southern.

The failure is not a surprise - not least because 2,000km (1,240 miles) separate their home bases. But the talks have forced others to take the CAAC's calls more seriously and the CNAC/China Southwest deal is likely to force action by others, including listed Shanghai-based China Eastern Airlines. The carrier, China's third largest, is said to be mulling a take over of financially troubled China Northern Airlines and China Northwest Airlines.

The powerful CNAC was China's flag carrier until the communists took control in 1949. It holds a controlling stake in Zhejiang Airlines and its Hong Kong- and New York-listed subsidiary of the same name holds a controlling interest in Hong Kong's Dragonair.

The group also has a majority holding in Air Macau.

Source: Airline Business