In the second of 10 installments of the Centre for Asia Pacific Aviation (CAPA) predictions and risk assessment guide, the respected aviation analysts take a look at the potential impact of the US dollar rate

on the industry.

CAPA says that fluctuations in the US dollar – (up to half of non-US airlines' costs can be in US dollars) can make or break airlines – and aircraft manufacturers. ‘As we have seen over the past three years, the industry's life-blood – fuel – can no longer be taken for granted either, as it had been for decades.’

CAPA points out that a significant percentage of non-US airline costs – often as much as 50% – is denominated in US dollars, be it for aircraft leases [or purchases], purchasing fuel, or a host of other international contracts.

Consequently, a strong dollar is generally a negative for airlines. And, even for those airlines which have typically been able partly to set off this currency risk by selling outbound in the US market, the current economic downturn hit the US first, meaning that sales in the US fell simultaneously with the dollar's rise.

CAPA notes that the USD has recently strengthened significantly – and rapidly – against many currencies, as market nervousness sent investors to the safe haven currency.

CAPA said: ‘Foreign airlines have – over a long period – developed US dollar covering strategies, depending on their operating profiles. For example, wholly domestic airlines outside the US (i.e. so that their revenue is predominantly in a foreign currency) have required comprehensive hedging – and had to pay for it – to guard against declines in their currency against the US dollar.

‘International airlines which operate significant services to the US have meanwhile relied to a certain extent on direct revenues from the US to offset their currency exposure, even though the bulk of their traffic originates outside the US.

‘Most foreign, international, airlines have consequently suffered the double whammy of a higher dollar-cost base in the past quarter, together with reduced offsetting US dollar sales from the US, as the American economy slumped. Likewise, US freight imports slumped, hurting cargo operations. The dollar effect has however been partly softened by the speedy reduction in – US dollar-denominated – oil prices, at least where the carriers were not locked into higher priced fuel hedges.

‘For US airlines, the stronger dollar has softened inbound tourist travel and imports at the same time as they suffered reduced outbound sales at home. Meanwhile their yields on product sold internationally also automatically dipped in US terms.’

CAPA concludes that the sheer rapidity of the recent currency – coupled with fuel price – changes will have damaged many otherwise prudent treasury strategies and will show up later in 2009, as reports are released.

Taking its most likely scenario, CAPA says: ‘If economic uncertainty increases or remains around current levels, the dollar should hold existing relativities. At present, the US dollar, as a safe haven, is being priced inversely to negative economics – the worse the news, the higher the dollar (and oil prices fall).

‘At the moment, share market confidence has strengthened a little, as investment dollars with nowhere else to go look hopefully to the upside. But another decline in business conditions – which appears likely given recent consumer confidence reports – will probably keep the US dollar strong.

‘Inversely to oil prices, the US dollar is therefore most likely to float on a sea of uncertainty, strengthening as sentiment declines again. But a prolonged and deep decline in the US economy could subsequently, paradoxically, tip sentiment away from the USD, allowing it to sink.’