eotN.369T aiitnReview of the Air Transport Sector in Tajikistan Report No.35649-TJ Report No. 35649-TJ Tajikistan Review of the Air Transport Sector in Tajikistan A Policy Note Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

June 30, 2006

Poverty Reduction and Economic Management Unit and Central Public Disclosure Authorized Authorized Disclosure Disclosure Public Public Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

Document of the World Bank Public Disclosure Authorized Authorized Disclosure Disclosure Public Public

ACKNOWLEDGEMENTS

This Air Transport Review for Tajikistan is based on the findings of several missions to Tajikistan and Europe between April 2005 and November 2005. Many elements of the study have already entered the policy dialogue between the Bank and the Government of Tajikistan. This report is intended to facilitate further progress in this dialogue and to allow broader dissemination within the country and donor community.

The principal authors of the report are Andrks Ricover and Sudhee Sen Gupta. Additional comment and guidance was provided by Sudharshan Canagarajah, Jakob von Weizsaecker, Jariya Hoffman, Utkir Umarov, Cevdet Denizer, Mehmet Gokay and Firuz Kataev. Administrative support provided by Damika Somasundaram and Zakj a Nekaien- Nowrouz.

The team wishes to thank the Government of Tajikistan for very constructive discussions during and after the various missions, as well as comments provided on the final draft of the report. The team is particularly grateful for the inputs provided by Matlubkhon Davlatov, State Adviser to the President on Economic Policy, Abdukholicov't-h Abdulaziz Sharipov, Adviser to the President of the Republic of Tajikistan on Economic Policy, Ibrohim Jobirov, Head of Department of Civil Aviation, Hokimsho Tilloev, Director General of State Unitary Aviation Enterprise "Tojikiston", Rustam Bozorov, Transport Specialist Natural Monopoly Unit Antimonopoly Agency, and their staff.

The generous financial support for this study by the Swiss State Secretariat for Economic Affairs (seco) is gratefully acknowledged. The team is also grateful for helpful comments and guidance from the peer reviewers, Ellis Juan and Tomis Serebrisky. Finally, the report benefited enormously from the active participation and advice of Charles E. Schlumberger, Principal Air Transport Specialist of the World Bank.

3 4 TABLE OF CONTENTS

EXECUTIVE SUMMARY ...... 7

1. BACKGROUND ...... 11

2. THE PRESENT SITUATION ...... 13 A . THE MARKET ...... 13 B . INSTITUTIONAL FRAMEWORK ...... 24 C. AIRPORT INFRASTRUCTURE...... 28 D. AIR TRAFFIC CONTROL ...... 32 E. FINANCIAL SUMMARY OF TSA ...... 32 F. EFFORTS UNDER WAY BY THE EBRD...... 34

3. GOVERNMENT’S PROPOSED POLICY REFORM ...... 37 A . RATIONALE OF THE REFORM ...... 37 B. GOVERNMENT’S PLAN FOR LIBERAZATION...... 39

4 . GOVERNMENT’S PROPOSED IMPLEMENTATION FRAMEWORK...... 43 A . INSTITUTIONAL REFORM...... 43 B . AIRPORT REFORM ...... 45 C. AIR TRAFFIC CONTROL REFORM...... 46 D. REFORM...... 46

5 . CONCLUSIONS AND NEXT STEPS ...... 50 A . CONCLUSIONS ...... 50 B . ACTION PLAN...... 51 C. SCHEDULE OF IMPLEMENTATION OF RECOMMENDATIONS ...... 53

5

EXECUTIVE SUMMARY

Introduction

1. In a remote and land locked country with limited natural resources and a small population, development and growth are dependent on trade and commercial contact with the outside world. This makes access to Tajikistan a critical need for its development. The communication and its associated trade and commercial contact could be improved significantly, if the air transport sector in Tajikistan were appropriately configured. Tajikistan is also one of the poorest countries in the world and the poorest country in the former . One of its major sources of income is the earnings of migrant workers who go mainly to in search of work (above 20% of the GDP).Migrant labor is dependant on the country's air transport sector.

Background

2. Despite the relatively high volume of passengers, air transport to and from Tajikistan remains expensive by regional comparison. Air ticket prices for the main route between and are around 1/3 more expensive than tickets on comparable routes to other destinations in . Furthermore, ticket distribution systems and ticket availability is poor. The burden of excessive prices and poor ticket availability imposed on a typical migration worker could at times represent an estimated 7 percent of his annual net income. Tajik State Air Company (TSA), the national flag carrier, was the only national airline operating international flights, connected only with a few destinations outside Russia. In fact, Dushanbe used to be the only capital in the region that was not served by a quality international airline acceptable to international business and leisure travelers. The access to Dushanbe is still hampered by the inability of international travelers to purchase or reserve tickets through any of the global distribution (GDS) systems to fly TSA. These factors tend to undermine Tajikistan's ability to attract foreign investment and affluent tourists.

The current aviation policy is still restrictive in terms of market access (number and types of routes that could be operated), in terms of market capture (the maximum capacity allowed, given by number of frequencies and the type of aircraft that could be used) and in terms of market competition (number of carriers per route). For example, the Dushanbe-Moscow route is limited to only one carrier per party (single designation) and to a limited number of frequencies per week. Although some markets seem to be

7 unrestricted, technical regulations can sometimes be manipulated to restrict the access to specific markets. Control on air fares by the Anti-Monopoly Agency can restrict flexibility to seasonal opportunities while at the same time not provide an effective protection to consumers against abusive pricing.

Issues being addressed by Government

3. The root cause for the situation described above was a restrictive aviation policy that limited competition to a minimum, combined with a poor institutional structure of the air transport sector in Tajikistan. The situation was characterized by two different features: i. Inappropriate institutional framework: The Department of Civil Aviation (DCA) centralized the functions of policy making, technical regulation and accident investigation and created conflicts of interest where the function of regulation is affected by policy-making, instead of being performed by a neutral body. ii. Anti-competitive structures: TSA operated the airline, the airport and the provision of air traffic control services. Under this situation, it is unlikely that the airport can deal in an even handed manner with other wishing to land in Tajikistan even if the air service agreements were changed to provide the necessary landing rights. Without an arms length relationship with the national airline, the airport is likely to find every opportunity to dissuade or discourage competition for the national airline, like for instance not providing the ground handling equipment for competing types of aircraft, or manipulating the fuel supply. TSA also benefits from discriminatory practices applied to competing carriers, with respect to fees and charges for the use of infrastructure. TSA are not charged for any of the services, which are in addition the most expensive in the region for other carriers. Ultimately, the cross subsidization provides the airline with significant competitive advantages as it is not only not being charged for the use of the infrastructure, and thus receives a defacto subsidy.

Government3 reform Policy

4. The Government strategy for reform is be based on three lines of action: i. Gradual liberalization of the air traffic rights. Tajikistan will look at eliminating the entry barriers to foreign carriers by defining a policy of liberalization, while assuring that the environment also favors free market access, competition and no control on air fares. Policies will also aim to attract cross border investments by lifting ownership and control restrictions in air carriers. In addition, air fares will be purely market driven, with lesser interference of the anti-monopoly commission only to restrict monopolistic behaviors.

8 The associated result of this liberalization will be a drastic reduction in air- fares, and the increase of supply by the entry of new carriers and/or increased capacity by existing carriers into the most demanded markets. This new policy will increase the welfare of the traveling public, and of the migrant workers, currently levied by an unjust tax that finances the inefficiencies of the airline and the airport infrastructure. ii. Setting the appropriate institutional framework: The institutional arrangement will assure the healthy and complete separation of functions between the policy maker, the technical regulator, the accident investigator and the operator (airports, air traffic control, and the airline, independently).The operation will break the vertical integrated scheme of airline, airport and ATC that limits competition, into three different and independent service providers. Each one will be functioning at arm's length from the government budget and policies, promoting competition and efficiencies, probably under the form of a corporation. iii. Transforming the airline: The national flag carrier will need to be restructured in order to gain competitiveness to meet the challenges of a deregulated and competitive environment. During the gradual process of liberalization, the airline will be prepared to compete in a free market environment. The Government is seeking assistance in this regard to conduct a comprehensive financial audit, implement at reporting and control mechanisms and to develop of a sound business strategy that should dictate the future of the airline.

Action plun

5. The specific actions that the government will take are in three different streams: Policy making - promote a gradual liberalization of traffic rights, by pursuing a liberalized environment, tariff deregulation and facilitation of cross border investments - promote the competitiveness of the regulatory environment - separation strategy of the three different businesses

Institutional actions - institutional strengthening reform towards the separation of the functions of policy making, technical regulation, and accident investigation - legal and organizational implementation

TSAreform

9 immediate financial audit implementation of basic management control & reporting procedures - implementation of IAS accounting systems - legal and organizational implementation of the separation strategy - development of a business strategy for the airline

10 1. BACKGROUND

1.1. Tajikistan's medium-term sustainability of economic growth is threatened by a very restricted accessibility. The aviation policy protected the national flag carrier, Tajikistan Airlines (Tajik Air) on the most important routes, like Dushanbe-Moscow or direct links into Western Europe. As a result, the air transport sector in Tajikistan is still high priced, inefficient and poorly served.

1.2. While there was no explicit definition of the aviation policy, the sector was characterized by a restrictive environment. With respect to international traffic, most bilateral agreements limit capacity in terms of weekly flights. The most attractive route, Dushanbe-Moscow, is still restricted on the number of carriers (one per side) and the total capacity offered. Air fares are controlled in most of the routes, either explicit or implicit'. In some cases, entry barriers can eventually be imposed with unorthodox ways (e.g. lack of ramp handling equipment for specific aircraft types, manipulation on the supply of fuel, etc.)

1.3. On the domestic front, traffic is in theory free, but vertical integration by TSA into the airport and air traffic control operations is still being used to deter the entrance of any competitor to TSA.

1.4. Except now for Turkish Airlines and Southern (from Urumqi), none of the major international airlines operate flights into Tajikistan, depriving the sector from a healthy competition. As a result, air-fares are significantly higher than comparative benchmarks. For example, the route Dushanbe-Moscow, dominated by only two airlines with monopolistic behavior, proved to be the most expensive of 12 destinations out of Moscow. When measured as USD per nautical mile, the route is at least 49% higher than the one to , 38% higher than and 36% higher than .

1.5. Over 80% of the international air traffic of Tajikistan is with Russia the majority of which consists of migrant Tajik workers seeking for seasonal employment. The earnings of migrant workers represent over 20% of the GDP of Tajikistan, which also has one of the lowest GDP in the world. The inefficiencies and extra costs of the present aviation sector result in the fact that migrant workers could spend as much as 7% of their earnings on air fares.

1 Off bilateral accords of pooling or joint tariff setting between the two parties 1.6. During high season periods, the situation becomes further exacerbated. Since demand cannot be met due to the restricted regulated capacity, many workers are obliged to purchase at a parallel market of tickets, increasing the costs of traveling by an additional 15%.

1.7. Service levels are significantly low, with repeated cancellation of flights, long waiting times at airports and baggage frequently left behind. In addition, the lack of integration into the major distribution systems complicates travel arrangements even further.

1.8. Airport infrastructure provides an unacceptable level of service, with lack of proper equipment for aircraft and unpleasant facilities for passengers. In spite of those services, airport fees and charges levied on aircraft and on passengers are amongst the highest in the region.

1.9. On top of the higher air-fares and greater costs for the airport infrastructure, the poor service such as frequent delays, cancellations and detours have associated additional costs, albeit they are harder to measure. In summary, the restrictive policies generate an excess in costs for the traveling public, constrain traffic growth, and thus limit trade and the exchange of ideas.

1.10. A valuable WB study that was carried out by John M. C. King2on July 2005, also identified the restrictions on air liberalization in Central Asia as an important factor limiting economic development in the region.

* Europe and Central Asia Transport. JMC King, World Bank, July 2005.

12 2. THE PRESENT SITUATION

A. THE MARKET

2.1 As the national flag carrier, TSA is the only carrier performing international operations and domestic operations. In the domestic market, there is a second carrier, "Samar Air" that operates flights.

Demand side

International

2.2 The total market of international passengers was of 646 thousand passengers in 2006, a slightly decrease of 7.4% with respect to the 656 thousand passengers carried in 2004. This market is mainly attended by TSA, which accounted for 54% of the market, in terms of passengers carried in 2005.

2.3 The remaining 46% of the international market is served by 23 foreign carriers, of which 16 are Russian. The following table (Table 2.1) shows the evolution of distribution of market share of the international market, by main categories of carriers, for 2003,2004 and 2005:

TSA 346,165 54% 399,633 61 % 31 3,520 73%

Russian carriers (16 carriers) 274,046 42% 237,445 36% 109,141 25% -

CIS carriers (3 carriers) 7,404 1Yo a, 122 1Yo 6,898 2Yo Other foreign (4 carriers) 19,144 3% 10,940 2 Yo 1,665 0% Total 646,759 100% 656,140 100% 431,224 100% Source: Prepared by consultant based on information received by TSA - Economic and Planning Department (updated in 2006)

2.4 From the table stands out that the share of TSA decreased in comparison with 2003 and 2004. While the total number of passengers transported by TSA increased in absolute terms, it did not absorb the increase in traffic in the same proportion.

13 2.5 The most dramatic increase was of the airlines from Russia, whose share jumped dramatically from 2003.

2.6 The importance of the Russian market stands out again, when looking at the TSA international activity in terms of passengers carried, as shown in the following table (Table 2.2):

Table 2.2 - Distribution of TSA international passengers and shares, per city for 2003 and 2004

total TSA international 346,165 399,633 31 3,520 Russia Moscow 190,966 76% 228,212 74% 175,271 69% Novosibirsk 12,339 5% 33,899 11% 38,667 15% Ekaterinenburg 26,626 11% 37,614 12% 40,487 16% other cities in RF 20,687 8% 7,775 3 yo total Russia 250,618 100% 307,500 100% 254,425 100% share of total 72% 77% 81YO Other CIS Almaty 23,432 87% 23,898 74% 14,651 63% Bishkek 3,400 13% 8,504 26% 5,473 24% Other 3,096 13% total CIS 26,832 100% 32,402 100% 23,220 100%

share of total 87'0 8 Yo 7% Non CIS countries Istanbul 6,776 10%

Munich 5,388 8Yo Istanbul-Munich 2,252 3% 13,809 23% 11,112 31yo Delhi- (UAE) 17,199 25% 9,412 16% 6,074 17% Sharjah 7,136 10% 4,707 8% 0 Yo

Tehran 5,247 8% 4,941 8'Yo 0% Urumchi 10,557 15% 13,021 22%

Khujand-Ras AI-Khaima 874 1Yo 3,667 6?Lo 2,589 7 yo other+- 13,286 19% 10,067 17% 16,100 45% total other countries 68,715 100% 59,731 100% 35,875 100% share of total 20% 15% 11% Source: Prepared by consultant based on information received by TSA - Economic and Planning Department +include Mashhad (), Karachi (Pakistan) and Urumchi (China) in 2003

14 2.7 While reduced in 2004 comparing with 2003, the share of Russia of total passengers carried by TSA was 74%. Of these routes, 77% of passengers where carried to/from Moscow, which in turn accounts for 57% of total international passengers flown by TSA in 2004. No single other route challenges this very significant share, the next biggest, Ekaterinenburg with 9% and Novosibirsk with 8%, are far behind.

2.8 The market into Moscow is mainly composed of migrant workers that travel to Russia at the beginning of the spring, and return to Tajikistan by autumn. During that season, some of those workers may return home for short periods of time during short work breaks (Le. the first week of May). Load factors are consistently over 95% during end of March through May on the Russian bound flights, with load factors as low as 30% on the return sectors. The situation is the reverse from end of July through September.

2.9 Services between Tajikistan and Russia are governed by the bilateral air service agreement between the two states of 1997, and the changes introduced in the Protocol, on 21 December 19983. The agreement defines the routes to be operated by designated airlines defined by Tajikistan, to four points in Russia (Moscow, Novosibirsk, and one (1) other point to be agreed in the Russian Federation4), from any point in Tajikistan. In turn, airlines designated by the Russian Federation can fly from any point in Russia to Dushanbe, and one more point to be defined. Overall, there are 25 weekly frequencies of Tajik Airlines versus 38 flights by Russian operators5.

2.10 The Moscow-Dushanbe route is treated separately in a Supplementary Agreement6. This supplementary document establishes the capacity on this route as 14 weekly frequencies of aircraft not bigger than the TU-154M7.

2.11 During 2004, TSA performed 893 flights to Moscow, with an average of 17 weekly flights, just above the established capacity. While currently TSA utilizes all of the given capacity, from the Russian side, Domodedovo Airlines flies only 3 times per week' with a TU-154M. One possible explanation for this unbalanced reciprocity may be Russian national interest to protect Tajik Air'. The Russian carrier has attempted to introduce a larger aircraft (the IL-96lo) into this route. However, the Tajik authorities rejected the request justifying the lack of the necessary ground handling equipment to attend the aircraft. Currently, there is some kind of agreement between TSA and

"Agreement between the Government of the Republic of Tajikistan and the Government of the Russian Federation on Air Transport", signed September 12 1997. 4 Tajik Air also flies to Samara as the "additional point". Summary of meetings with Russian Ministry of Transport, Department of Civil Aviation This document was not made available to the consultant, in spite of numerous requests. 7 % The consultant was not able to confirm this information, which was obtained verbally at the DCA. * Increased to 5 weekly frequencies in late 2005.

10 The IL96 can transport from 257 to 289 passengers

15 Domodedovo Airlines under which Domodedovo can sell up to 7 or 10 seats on TSA flights ll.

2.12 The following table shows the presence of the Russian carriers into the three main entry points of Tajikistan (Table 2.3):

Table 2.3 - Traffic flown bv Russian carriers - 2003. 2004 and 2005

Dushanbe 161,092 59% 128,085 54% 59,268 54% Khoujand 90,971 33% 91,128 38% 49,873 46% Kulob 21,893 8% 18,232 8 Yo 0 0%

Total 274,046 100% 237,445 100% 109,141 100% Source: Prepared by consultant based on information received by TSA - Economic and Planning Department (updated in 2006)

2.13 The presence of the Russian carriers is particularly strong in Dushanbe, where they carried 59% of the total traffic. Also Khoujand is substantial, accounting for 33%.

Domestic Market

2.14 The fleet is based at the airports of Dushanbe and Khoujand, serving the following routes:

Table 2.4 - TSA domestic destinations

Khoujand Dushanbe lsfara Kulob Djirgital Kurgan Tube Rushan -

Pindjikent Khorog

Vanch - Aini Source: TSA

11 Domodedovo Airlines is given 8 seats per flight, based on information provided at a meeting with the Russian Ministry of Transport, Department of Civil Aviation. The agreement was never made available. Domodedovo has proposed to operate joint flights on this route, proposal that is being considered.

16 2.15 All the figures evidence the strong impact on the sector caused by the community of migrant workers traveling to Russia. The business travel and international community portion is minor, mainly on the routes to Moscow and St. Petersburg (Polkovo). Businessmen and traders use also the routes to Europe and Middle East, accounting in total less than 10% of the total international travel.

2.16 The domestic market accounted, in 2005, for 164.5 thousand passengers, or 20.3% of the total passengers carried in all airlines on domestic and international routes. That figure represents 32.2% of total passengers transported by TSA.

Supply side

2.17 TSA operates 61% of the international capacity to and from Tajikistan and Russian carriers operate 33%., as can be seen in the following table (Table 2.5).

national destinations - 2004

TSA 1,730 51 yo Russian 1,400 41 Yo CIS airlines 140 4%

Total 3,409 100% Source: Prepared by consultant based on information received by TSA - Economic and Planning Department (updated 2006) +- Proxy for capacity, since type of aircraft was not made available

2.18 The fleet is composed of 27 aircraft (including 4 helicopters) Russian built airplanes, inherited by during the Soviet era. The entire fleet age averages about 21 years old. Most of TU-154B fleet will be retired during 2006, since otherwise they should have gone through major overhaul maintenance (D check). For each aircraft, the cost of such maintenance is around USD 1.5m to USD 2.0m.

2.19 Key routes are operated with the "Emkas" (TU-l54M), which are the latest model of the type (on average, about 13 years old). While still the most technologically advanced in the fleet, these aircraft burn as much as twice the fuel as a western plane of comparable seating capacity (B737-800, A320).

2.20 The remaining fleet operating in Tajikistan is composed of Russian built airliners. Of the foreign flights serving Dushanbe and Khujand, about 40% are operated by TU- 154s, another 45% by TU-134s and the remaining by Yak42s..

17 The current fleet of TSA is composed as follows:

TU-154 M 160 4.) 4 TU-154 B 167 3.f.) 1+.)+ TU-134 80 3 3

YAK-40 32-36 7 7 Mi-8 MTV 20 3 3

AN-28 17 3 3 AN-24 52 5 3 AN-26 Cargo 2 2 Total 30 27 Source: Prepared by consultant based on information collected by Charles Schlumberger (WB) and information received by DCA aircraft availability depend on major overhaul (D check) pending: .) all four good until 2015 .).) 1 already stopped April 21''. remaining: one due Jan 28 2006, one Feb 27 2006 and one Feb 26 2007. As at July 2006 there is only one (1) aircraft of this type still operational .).).) To be retired February 2007

2.21 It is important to stress that the competition to TSA is offering similar types of aircraft. At present, there is almost no western built aircraft serving the market, currently only with the exemption of operated by the Chinese carrier China Southern and the B737-800 operated by Turkish Airlines

2.22 The situation should change dramatically within the next coming years. As previously noted (table 2.6), two of the remaining TU154-B were retired in early 2006. In addition, it is expected that by 2006, the remaining TU154-Ms will be banned from entering European airspace. All this poses a degree of urgency where new aircraft will be needed to cover the routes operated today by the existing fleet.

Pricing

2.23 Another factor than characterizes supply is pricing. Air fares are set by TSA and approved (coordinated) by the local anti-monopoly agency (Agency for Antimonopoly Policy and Entrepreneurial Support), Tariff regulation allows airlines to move through a band of +/- 25% of fixed prices without prior approval, to allow adjustment to specific seasonal changes. However, airlines are not free to offer discounted promotions during the slow seasons, or to increase prices at periods of high demand.

2.24 The criteria for tariff approval by the anti-monopoly agency are based on the production cost, as reported by the airline. There is no further analysis on the reliability

18 of the information, nor any benchmarking against international industry standards. The lack of a proper benchmarking does not enable the airline to assess the fare structures against those of other carriers .Benchmarking can be a positive aid to efficiency.

2.25 In order to make a comparison on air fares, the following chart (Graph 2.1) compares cheapest round trip air fares between Moscow and selected cities:

Graph 2.1 - Return Fares from Moscow to selected cities in cents of USD per nautical mile

0.40

0.35

0.30

E 0.25 L % 0.20 n u) 3 0.15

0.10

0.05

n nn

Source: prepared by consultant based on data obtained from Olympia Business Travel (Moscow), for lowest published fares, effective May 2005

2.26 From the sample of cities observed, air fares from Dushanbe to Moscow are the highest (USD0.33 per nm, or USD540 for 1,617 nautical miles). This fare is about 49% higher than the one to Almaty, 38% higher than Tashkent and 36% than Bishkek.

These findings are consistent with a very limited competition in the route between Dushanbe and Moscow Domodedovo, served 9 times a week by TSA and 9 times a week by Domodedovo AirlinesI2. In particular Almaty, where the highest difference was found among the CIS countries, offers a more liberalized market with greater competition offered by the presence of some international carriers. l3

2.27 No statistics were available with respect to the amount of demand unsatisfied during the highest seasons. However, it has been reported that a black market for air

'*Based on 2004 traffic figures, TSA share of the market is 95.3%, for this route that accounts for 38.6% of the total traffic of Tajikistan l3Traffic often travels to Moscow via Samara or Kazan as an alternative cheaper option.

19 tickets exists during the highest peaks of demand, where tickets can be found at higher than official fares.

Service Levels

2.28 The pre-flight level of service of TSA is extremely poor. The reservation system of the airline is not linked to any of the major GDS14 used today by airlines and travel agencies. This seriously complicates the reservation and issuing of tickets, in particular for onward travel into Tajikistan. Additionally, the lack of proper reservation systems facilitates the mismanagement of availability of seats.

2.29 Flights are often cancelled or postponed with short or no previous notice at all. Call centers or information desks are often neither responsive nor reliable, forcing passengers to arrive to the airport and cope with long waiting times. The in-flight service is reasonable, although limited by the restricted comfort offered by outdated aircraft. In total, the traveling experience is of very poor service, and often stressful.

2.30 In summary, the supply in terms of infrastructure, is characterized by Russian aircraft with sub-optimal efficiencies of operation and lower levels of comfort than western built aircraft. In terms of pricing, the selected comparison of the return fare for the Moscow-Dushanbe route proved to be the highest among the sample of destinations from Moscow. The supply is poorly served and priced at higher than comparable fares.

New and Prospective Entrants

2.31 At present, there is one private sector initiative to launch a new airline, , with operations in the domestic and the international market. The airline, would be formed by a mixed capital of 51% local (Trust Corporation Orion International Bank) and 49% foreign (Ikar Invest, of the US) has already obtained an AOC15 and is planning to start operations by 2006.

2.32 TSA operates weekly frequencies into two destinations in Europe: Munich and Istanbul. As compared to the traffic into the Russian market, this traffic is mainly composed by a business and VFR16 public, It is also characterized by a significant proportion of beyond traffic, or the passengers coming or going to points further afield from Munich and I~tanbul'~,using both hubs to connect into Dushanbe18.

14 Global Distribution System, such as Amadeus, Sabre, Apollo/Galileo, Worldspan, etc. l5Air Operators Certificate, on February 25, 2005 l6Visiting friends and relatives l7In a lesser extent l8Due to the fact that TSA does not have interline agreement with Western carriers, passengers do self- connecting at these hubs. Therefore, there are no statistics of how much of this traffic is.

20 2.33 In meetings with operators and policy makers in Turkey and Germany, the interest of Turkish and German carriers in operating the Tajik routes was explored. The following is a brief recount of the salient outcomes of these discussions. .

Istanbul

2.34 The Turkish and the Tajik Government have been in long negotiations already around the concrete interest of Turkish Airlines to operate three frequencies to Dushanbe, out of Istanbul. It should be stressed that Turkish Airlines is the single designated carrier by the Directorate General of Civil Aviation of the Turkish Ministry of Transportation. In addition, the Turkish Government still owns 75% of the company's shares. The remaining quarter of the company was floated on the local stock market.

2.35 The Tajik DCA has systematically rejected any Turkish request that would imply more than one weekly frequency from Istanbul, and instead, has expressed flexibility on services to Ankara. Turkish Airlines operates a successful hub operation in Istanbul, with an interesting connecting volume of traffic linking Western Europe and the US with Eastern Europe, Middle East, Central Asia and the Far East. The entrance of Turkish Airlines in Dushanbe would represent a strong competition for TSA on the traffic arriving from points beyond Istanbul, namely the US, Western & Eastern Europe, and even Moscow.

2.36 The Turkish-Tajik relations are currently ruled by a basic bilateral agreement that lacks the specifications of which routes are to be operated. Bilateral air service agreements are often accompanied by documents (minutes of meetings of consultation or memorandums of understanding) in which conditions such as routes and capacities are defined. TSA operates based on a specific permission, setting an ad-hoc relationship of one flight per week. Based on this accord, Turkish Airlines could operate once a week from Istanbul, just by using the privilege of reciprocity.

2.37 A service limited to one single frequency would lack any commercial appeal for market development. In fact, most airlines would not enter into new routes with less than three (or even four) weekly frequencies. It is virtually impossible to build up a business traffic market, which is the most profitable segment, without offering a flexible product of frequent flights per week.

2.38 The Turkish Government is currently requesting at least two weekly frequencies to start with, however it hasn't been granted yet. One of the reasons provided by the Tajik authorities to block the petition is the lack of appropriate facilities at Dushanbe airport. This argument evidences the direct .consequences of the monopolistic power of the airline in running the airport operations. It is obvious that the resistance from the Tajik authorities to grant additional frequencies to new entrants is aimed to undermine the possibility of any competition. It is noted that as of July 2006 the Turkish carrier Turkish Airlines is operating one (1) b.737-800 flight per week between Istanbul and Dushanbe

21 2.39 The two governments have reached a compromising solution under which Turkish Airlines would be granted acceptable conditions to initiate operations, with none flight a week from Istanbul. The consideration of offering a number of seats to TSA on every Turkish Airlines flight, under some kind of block spacekode share agreement, has been considered by the Turkish Airlines management.

Munich

2.40 Lufthansa German Airlines operates out of two hubs in Germany, Frankfurt and Munich. Progressively, Munich is challenging Vienna in becoming one of the major hubs into Eastern Europe, with an increasing presence of Lufthansa after the opening of the new Terminal 2.

2.4 1 Although Lufthansa's expansion plan includes gaining presence in Central Asia, their priority is at the moment . At this stage, Lufthansa is not seeking entry rights to operate to Dushanbe, so the German Government is not investing any efforts in achieving a bilateral agreement that would allow the German carrier to enter Tajikistan.

2.42 However, the increasing interest of Western carriers to gain access into Kazakhstan and to other fast growing economies in the region opens the possibility to connect Tajikistan to Western Europe via additional points within the region. The connectivity within the Central Asia Region requires an effort towards an integrated policy of the countries aimed to mutual benefit from the development of regional hubs for connecting on medium and long haul routes. In other words, the increasing interest of European carriers in other countries of Central Asia will open the possibility of new routes into European via points in the region. The degree of regional integration in terms of air transport will facilitate the connectivity of the individual countries with Europe and the rest of the world. Foreign carriers may find interest in developing regional hubs from where the traffic from the region will be distributed or collected. Fueled by the long haul traffic, more services will appear within the region, motivating a further integration of the region, with its associated economic effects.

The Cargo market

2.43 There is virtually no cargo traffic transported by TSA. This is a consequence of the type of aircraft used by the airline.

2.44 Air cargo can be transported in two different forms, either on full cargo flights or in the belly of passenger airliners. Cargo transported on passenger aircraft is, capacity driven. Since scheduling and frequencies are decided based on the passenger market, belly capacity then becomes a derived consequence of the passenger traffic.

22 2.45 The type of aircraft used by TSA is not suitable for cargo. The TU-l54s, mostly used on the international routes, provide very little belly capacity which is mostly taken by checked-in baggage”. Its cargo compartments are also not designed for pallets or standard cargo containers. As a consequence, passenger traffic does not generate capacity that could induce cargo traffic.

2.46 Additionally, Tajikistan does not generate import or export of high value goods that could justify the operation of full cargo flights. Because of both reasons, the air cargo market in Tajikistan remains undeveloped.

19 Very often, on inbound flights, baggage is left behind at the point of origin due to the amount of excess baggage carried by migrant workers returning home.

23 B. INSTITUTIONAL FRAMEWORK

Aeronautical Authorities

2.47 The institutional scheme in Tajikistan is characterized by a great concentration of functions in two different entities: the Department of Civil Aviation and the Tajikistan State Air Company

The Department of Civil Aviation (DCA) was created in December 2001 in an attempt to respond to the pressure set by various multilateral agencies to separate the regulation from the operations. Presently, it still performs three functions2’:

a. supervision and technical regulation of air transport b. formulation of air transport policy c. accident investigation

2.48 All the functions of operation are concentrated with the Tajikistan State Air Company (TSA). TSA runs the airport operations, provides air traffic control services and operates the national flag carrier.

2.49 The Government has recognized that this lack of proper separation of functions creates conflicts of interest, in which technical regulation can be affected by policy- making and that control and regulation need to be performed independently, by a purely technical body.

2.50 In the last “Summary Report on the Safety Oversight Audit Follow-Up of the Department of Civil Aviation of the International Civil Aviation Organization pointed out that “the financial viability of the DCA still remains a problem as the necessary financial resources for the DCA to perform its safety oversight mandate are still lacking”. Based on preliminary talks, it seems that the situation has not improved since that last oversight mission.

2.51 The Government realizes that ultimately, to guarantee an impartial judgment of events, the body responsible for the investigation of accidents (and incidents) cannot be the same as the regulator, nor the policy-maker. If the regulator is the same as the

*’The functions assigned to the DCA are regulated by Resolution No. 361 dated “3 1” August 2004: Regulation on Department of Civil Aviation of the Republic of Tajikistan *’21 to 23 October, 2002

24 investigator, the investigator can end up being judge and party, when regulatory issues are involved in the accident22.

Operation

2.52 All infrastructure operations in Tajikistan are performed by Tajikistan State Air Company (TSA - or State Unitary Aviation Enterprise "Tojikiston"). The company was founded in 1924 as part of the Aeroflot Regional Directorate. It then became an independent entity in 1992, with the enactment of the current charter by the Council of Ministers, after the dissolution of the USSR and the collapse of the USSR Ministry of Civil Aviation.

2.53 The company operates the airline, the airport and the provision of air traffic control services, the three entities bundled as one single company.

The airline, the airport and the ATC, indistinctly bundled Transparency in accounting

2.54 The Government is concerned about transparency in accounting and intends to address this immediately. Under the current situation, the accounting procedures do not separately reveal the different sources and expenditures for the different nature of businesses. Moreover, there is no management or informal reporting that addresses the different businesses separately.

2.55 This lack of reporting makes virtually impossible the execution and measurement for a normal decision making process23. Managerial decisions need reliable information,

22 The Government intends to take a phased approach to address these issues over time. ( See Chapter 4)

25 in the same way that proper reporting is basic to measure performance and results of decisions made. Basic costing and revenue management procedures are dependent on efficient budgeting and financial planning, which should be based on analysis of actual results. For most airlines, in particular, margins are so narrow that efficient accounting systems are key to keeping costs and revenues under control as a condition for survival.

2.56 This integrated method of accounting seriously compromises transparency in the reporting procedures. It is extremely difficult to analyze the flows of funds within, and between, each one of the different businesses to discriminate costs and to conduct a comprehensive analysis of expenses and revenues.

2.57 It is of further concern that there are no audited financials available for TSA24, raising further concerns about the reliability of the information presented. In addition, this lack of separated accountings for the three businesses contributes even further to the lack of understanding of the real financials of TSA.

Control on cross subsidization

2.58 Today, it is not possible to obtain from the financial reports a clear picture of the sources and uses of the funds, per each one of the different three businesses operated by TSA. It is likely that there is a substantial cross subsidization between the airport and ATC onto the airline, based on the following facts:

The airline does not pay fees and charges for the use of the airport facilities based on an estimate of USD 1,100 of landing fee per operation, and considering 2,120 operations as in 2004, it could be estimated that the airport is subsidizing the airline by not charging approximately USD2.3m25per year. the airline does not pay for the ATC services received estimating the same amount of TSA flights per year as in 2004, and assuming an average revenue of USD300 per flight, the ATC is currently subsidizing the airline by not collecting an approximate amount of USD637k per year the airline uses ATC revenues to cancel their own obligations abroad, for the use of ATC services in other countries the airline does not pay the fuel handling services for the fuel purchased at the airport (fuel handling is operated by the TSA group)

23 During the process of data collection, basic financial information and basic statistics required over a week of preparation from the Financial Planning Department. Other basic data such as statistics on aircraft movements or general breakdown of costs was reported to be unavailable at all. 24 To support this statement, it can be stressed that the information presented in the “Financial Statements prepared in compliance with IAS for the years 2001, 2002 and the first six months of 2003” by IMC Consulting Limited, commissioned by the EBRD, contains a disclaimer (page 2) that “We have neither audited nor reviewed the mentioned financial statements, so we do not make judgements on its reliability”. 25 This figure is conservative, since it does not include revenues for aircraft parking

26 the airport is subsidizing the airline by not charging usual fuelling fees to the airline issues of network pricing and location specific pricing require further exploration

2.59 The cost structure of the three different businesses is integrated, and it is virtually impossible today to allocate the operations and administrative expenses among the different entities, some way of cross subsidies do exist at this level, while it is not possible to determine in which direction.

2.60 Beyond the rationale or justification for any cross-subsidies, it is necessary to identify the flows of fund that finance each business operations. Any business decision and efficient management approach cannot be conceivable without reliable information of revenues and costs. Identifying those mutual financing flows is not possible under the current integrated scheme and given the lack of proper accounting procedures.

Competitive environment

2.61 The Government has recognized that TSA as the airline also provides airport and ATC services and that this represents a situation of vertical integration of activities that does not promote a truly competitive environment. The danger of the vertical integration of services on business of natural monopoly characteristics, such as airports, implies a restrictive framework for other competitors to enter. With the specific example of the airport, the TSA as the airline could take advantage of its monopolistic power as the airport operator and restrict the access of other competitors, or simply by discriminating in the provision of services. In addition, as the provider of other services at the airport, such as fuel, it could restrict the supply of fuel to competing carriers26. Similarly the vertical integration of the airline into ATC services which is monopolistic in nature, could eventually be manipulated to exercise competitive advantage in relation to other carriers.

Management efficiency

2.62 The three businesses are different in their kind and nature. There is no efficient way of managing all three of them with an integrated management approach.

26 In fact, it has been reported that fuel prices are manipulated at the airports in Tajikistan. Current fuel prices are approximately USD950 per ton, as opposed to USD550 per ton in Russia. Allegedly, the delivery of aviation fuel is monopolized and accompanied with huge intermediary charges. Competing carriers have reported the existence of discriminatory pricing, unfairly overcharging fuel supplied to the foreign carriers, posing additional barriers to competition.. In fact, TSA has been suffering from discontinued supply of fuel at Dushanbe, because of irregularities in their payments. As a consequence, TSA occasionally may rationalize the fuel available to other carriers.

27 C. AIRPORT INFRASTRUCTURE

Infrastructure

2.63 TSA operates all the airports facilities in Tajikistan, including Dushanbe Airport.

2.64 The airport of Dushanbe has one runway (09/27) of 3,100 meters long and 45 meters wide, suitable for most operations within the region27. The runway pavement was repaved in 200528. The runway and taxiway system2' does not present any further constraint for the approximately 70 handled operations per day. The airport used to handle up to 300 operations per day during the Soviet times.

2.65 Approaches to runway 09 are supported by an Instrument Landing System (ILS), although there are non-precision approaches3'. No visual aids are installed for visual landing. The apron has plent of capacity for aircraft parking. There are currently about 40 stands for aircraft parking5; .

2.66 The airport services are reported to be basic, offering very poor level of service. There is limited ground handling equipment, outdated and only suitable for a type of aircraft that TSA normally uses. Baggage handling is downloaded from the planes into construction trucks, quite primitive for this type of operations.

2.67 The terminal building shows a serious lack of maintenance, accumulated over the years. Arriving passengers are bused to a very small satellite building outside the main airport building, and required to wait over one hour to claim luggage, on a single small baggage conveyor belt. On departures, serious bottlenecks occur when more than one flight is being operated. The processing flows for check in are awkward, since only one counter is offered per single flight. The waiting lounge has approximately 180 seats, not sufficient when two flights are about to leave at close times32.

2.68 Flights are often cancelled because of airport problems, such as breakdown of equipment, lack of available fuel or other reasons. Communication with passengers is

27 The length of the runway could restrict long haul operations, in particular during the high temperatures of the summer, factored as well by the altitude of Dushanbe. 28 The airport was closed for most operations between 8am and 8.30 pm local time during the process. 29 Five taxiways connect the runway to the main apron 30 It has been reported that the system is not a full ILS categorised equipment, due to the lack of a proper approach lighting system (high intensity) 31 Four for TU154s, 2 for TU134s, 4 technical for TU154s, 3 technical for IL76s, 16 for smaller aircraft (AN24), 4 for helicopters, 3 additional for TU154s and 4 for TU154 currently occupied by the French Coalition Forces in Afghanistan. 32 Delays are common at Dushanbe, accumulating two flights or more at the same time, creating a chaotic scene

28 3,200

f ,000

e00

400

200 n

ed on airport ctinrges drre obtained frcin the selected airports than any 117c

Source prepared by cansui t based (311 airport cha d from $tie selected Graph 2.4 - Impact on passengers of Ian passenger charges USD - fanding and senger charges on a pe

35.00

25 00 x 2000 8

5.00 Table 2.7 - TSA Financial performance Table 2.8 - TSA F~na~~~~~performance

11.8,"; 'Ihe ci ion of [he cox1 (4 2005. is of' USD 14.97 niiflions.

Table 2.9 - TSA ~~t~t~~di~~debt as af June 2006

7 254 820 72,797,395

33 Table 2.1 0 - Major items accauntincr '71 % of TSA ~~t$tand~~~debt

to prtrhabt 4 on short tc'ritr.

ovm 13% of tttc total de

hc VIP hall. at the

that R ifi it I.

34 justification for this particular facility arouses serious concerns, given the present conditions of the Company.

Lack of strategy

2.94 While it can be argued that the current fleet is sub-optimal in terms of operational costs, the fleet cannot be blamed for the mismanagement of the Company. TSA still lacks of a proper transparent accounting system that could enable professional managers to make decisions based on business oriented criteria aimed at best practice parameters. The idea of incorporating new aircraft into the Company is certainly not a strategy by itself, but could eventually be a tactic, if it would be following a particular strategy. In fact, there is no clear definition of a strategy for the Company, although, in a recent agreement reached between EBRD and the World Bank, the EBRD study is proposing to develop the needed strategy.

2.95 Currently, the only strategy the Company has is the operation of the airline with monopolistic advantages given by a state policy of regulating the market access. The airport and the ATC are not conceived as businesses but mainly as cost centers for the airline, and they may eventually generate some revenues.

2.96 The introduction of new aircraft has no bearing to any defined strategy. For example, the traffic flown today to Russia - chiefly migrant workers - is a captive traffic, with no option to choose. In an eventual deregulation and opening of the market, this very price sensitive type of traffic would only follow lower fares, and not western aircraft with better fittings. Also, the connection between more efficient equipment and lower fares is not straightforward in a company with virtually no cost control.

Luck of cost control

2.97 Without a transparent accounting system, it is virtually impossible to implement cost control procedures and budgeting and planning techniques of management control. Although a new accounting system is supposed to be under implementation, it will take some time (from one to two years) until a full budgeting and planning technique is effectively implemented. Until this happens, any increase in the expenses (both capital expenses as well as operating expenses) is extremely dangerous, since a significant proportion of them could end up being wasted in unproductive uses.

2.98 The introduction of a new airplane will definitely involve a significant amount of resources. The facility provided by the EBRD will not be covering any of those, like the lease itself and all the associated capital expenditures associated with the introduction of new equipment (fittings, accessories, support equipment - ground and maintenance - etc.). If the Company would embark in such reform without cost control techniques, valuable resources could end up in the wrong places.

35 The myth of efficiency

2.99 The further indebtedness of TSA to lease two second-hand aircraft is being justified under the name of efficiency. In order to achieve efficiency, efforts should be placed first in controlling the uses of resources and the revenues collected. Following this, a sound strategy should be in place that would involve clear marketing techniques in close collaboration with product design and operational performance. This process would certainly generate far greater efficiencies than those that could derive from the introduction of aircraft with lower fuel consumption flows.

2.100 In fact, within the Russian Federation, new airlines are mushrooming addressing particular market niches. Among them, Mr. Abramovich's Air Bridge Alliance42 is progressively enlarging their operations across the country and internationally. It should be noted that the whole alliance is operating mainly TU-154Ms (or "Emkas"), and yet the company is not only achieving positive results but expanding rapidly.

2.101 Furthermore, the document does not appear to incorporate a Return on Investment analysis to justify the capital expenditure. Being the reform motivated by the achievement of efficiencies, it should be expected that they are measured and assessed. A feasibility analysis for the expenditure is necessary, but not sufficient, to justify the expense.

Lack of definition of the facility

2.102 From the formulated document, it is still not clear the applications where the facility being provided to TSA will be used.

2.103 Interestingly, there are provisions for the "modification of the aircraft or cabin improvements " even before the equipment has been selected and any negotiation with the lessor.

2.104 The document also proposes the "introduction of Central Reservation Systems (CRS43)",although the project component description does not appear to include these costs.

2.105 While it is reasonable that the airline will need external advisory help to undergo a package of necessary reforms, the facility does not seem to address this crucial help.

42 By 2006 , Omsk Airlines, Domodedovo Airlines, Kras Air and Sibavia Trans would be consolidated under the name of Air Bridge Alliance or Union Air, (owned by Boris and Alexander Abramovich). 43 Mistakenly named, since CRS stands for Computer Reservation Systems

36 3. GOVERNMENT'S PROPOSED POLICY REFORM

A. RATIONALE OF THE REFORM

Improving connectivity

3.1 The recent scheme in Tajikistan was of a protected environment for TSA, with price controlling mechanisms and restricted market access. As a result of that, a significant mass of workers that migrate to Russia to work and send their earnings home, are still being taxed with one of the higher air fares in the region. This situation supported a state owned enterprise that is poorly managed, with countless inefficiencies and the reluctance to adopt modem business methods of performing. At the end, the migrant workers are covering all these inefficiencies with a significant part of their earnings.

3.2 Roughly, about 600 thousand passengers travel to Russia every year, either by TSA or by any of the carriers. Based on estimations from industry people in Tajikistan, about 90% of those are migrant workers, accounting for about 540 thousand passengers. Assuming a lower return air-fare of USD 500, the total expenditures of the migrant workers would represent, at least, about 3.4% of the country's GDP.'

3.3 The Government's proposed policy is one of a gradual liberalization of the sector, both in terms of market access as well as on price setting. The outcome would be the progressive entrant of new players into specific routes, driving air-fares to competitive levels.

3.4 More liberalized agreements should be pursued with all of the bi-lateral partners of bilateral agreements, allowing all airlines to serve as many destinations as they wish, with no capacity restrictions. The opportunities will remain open also for new countries willing to establish liberalized relationships of air traffic. The reform will include the promotion of deregulated agreements with flexible terms with respect to ownership and control. The condition for designated carriers to be owned and controlled by own nationals will be replaced by the so called "Hong Kong Clause", allowing for the designation of an airline that has "its principal place of business" in the country of designation. This clause promotes the cross border investments allowing for the establishment of new airlines at any side of the border.

3.5 This liberalization of the aviation sector is likely to raise the number of foreigners visiting the country for business or tourism, thus increasing direct foreign investment and local economic activities, especially in the service sector. Further, migrant workers will be able to travel cheaper and more frequently. This will facilitate transfers of technology

37 and exchange of new ideas and experience brought in by the thousands of Tajiks traveling abroad.

3.6 To measure the economic benefit of a liberalized market and the subsequent reduction of air fares, using the minimum scenario of zero elasticity which means an equal mass of travelers44, a reduction in air fares of 22%45 would have an associated benefit of about USDGOm, or 0.7 points of the 2004 GDP.

3.7 Although, with the present data available, the demand elasticity on price for Tajik migrant workers traveling to/from Russia cannot be measured, any reduction in price is very likely to generate more frequent travel by same workers throughout the year, while may facilitate the access to this labor market to more Tajiks.

3.8 With respect to incoming foreign traffic, the demand to air fare is probably inelastic. Most foreigners traveling to Tajikistan are not tourist related but business related. The tourist market is not dependent on the air fares but on the lack of infrastructure in the country.

Assisting the airline to be competitive

3.9 The liberalization need not pose a threat to Tajik Air. On the contrary, it will reprzsent an opportunity to adapt to a more competitive environiilent, by becoming more efficient and preparing it to provide a better service.

3.10 The implementation of the Government's liberalization policy is proposed to be gradual, to allow the adaptation of the national flag carrier to the more competitive situation. In parallel with the liberalization process, a restructuring plan for the airline will be implemented in phases, with the objective to provide competitiveness to the national flag carrier by the time the market is challenged by international contenders.

3.1 1 The reform for the airline is being viewed as the adaptation for the inevitable, which is the globalization of the air transport market and the liberalization trend that is progressively expanding. Those carriers that do not adapt to the change, while they enjoy a certain level of protection, will hardly survive the deregulated competition. The reform thus should be viewed as inevitable, where "only the fit will survive".

3.12 The Government is aware that such restructuring is not free of costs which the airline does not have the resource to meet. This vicious circle can only be broken by ensuring a transparent accounting and reporting system, a clear strategy for becoming competitive as the sector liberalizes and a financing plan for implementing such a strategy. Without this the airline will not only not be able to attract the required

In fact demand is elastic and will increase with a reduction in air fares. 45 Based on' similar air fares available on competitive markets

38 financing to implement the strategy, it will in all probability also not be able to secure the financing for the two aircraft it seeks to acquire or secure it at a viable cost of financing.

B. GOVERNMENT'S PLAN FOR LIBERAZATION

Towards a liberalized environment

3.13 To achieve these objectives, the Government will adopt a policy towards a more open market by gradually liberalizing the international air traffic market to increase the access of foreign carriers into Tajikistan.

3.14 An ultimate unrestricted market would mean:

(a) from any point in the other country to any point in Tajikistan, and vice versa (b) multiple designation of carriers on all routes (c) no price control of any kind

This means that each country will allow the carriers designated by the other country to operate to any of the cities in its own territory. In the same fashion, following the principle of reciprocity, the carriers designated by the lStparty, will be able to fly revenue traffic to any international destination in the territory of the 2nd. Party. Each side will be able to designate several carriers, as long as they comply with some technical and economic regulatory issues. With respect to control on air fares, airlines will be completely free to set their own prices, since it will be the market that will set the prices. The anti-monopoly agency may have some interference in cases where price dumping is reported, but on a demand driven basis.

3.15 The implementation of such a liberalized policy by the Government of Tajikistan is actually not unilateral, since it depends on the other party and its willingness to liberalize and to renegotiate the respective bilateral air service agreement. Most of the countries dealing with Tajikistan are far more liberal and already expressed their intention to be more open.

Gradual plan

3.16 The liberalization plan will be phased in order to allow a gradual transition from the current situation to the ultimate desired status. The gradual process will allow TSA to restructure and become more competitive so as to adapt better to the changing competitive condition.

39 3.17 It is envisioned that a liberalization plan that will take 5 years to be fully implemented, sufficient time for the airline to adapt. The following milestones are to be achieved at the end of each phase.

Phase I:first year

permit at least 1 new Western European46 carrier linking Dushanbe with any destination within its own country (no restriction on the number of points of origin on the other country) this carrier should be allowed to operate at least 3 weekly frequencies, without specifying the type of aircraft no restrictions on traffic beyond (Fifth Freedom)47 no price control on the new route (free competition) multiple-designation on the Moscow-Dushanbe route, allowing the entry of at least one additional carrier per side full reciprocity on the Moscow-Dushanbe route, allowing Russian carriers to match the capacity offered by TSA (14 weekly frequencies)

3.18 During this first year, a foreign carrier will start operating flights from Western Eurcpe, connecting also to points "beyond", meaning carrying traffic from Tajikistan to other countries, but always through its own base4*. The allowance of three frequencies is the minimum that will be required for any large operator to develop the premium business traffic. In most cases, less than three frequencies would not be enough and would deter new entrants49.

3.19 The introduction of a new carrier will provide competition, so price control should not be required. However, the anti-monopoly agency should remain alert to possible collusion between operators.

3.20 Multiple designations on the most profitable route, Moscow-Dushanbe, will represent the entrance of as many airlines as each side allows, still limited by the total amount of frequencies served per side (14 weekly at the moment).

46 This should not apply for Russian carriers 47 This means that the foreign carrier will be able to carry passengers from Tajikistan into third countries, through its own country, and vice versa (from third countries, through its own country, to Tajikistan). 48 This is called Sixth Freedom Right: The use by an airline of country A to carry traffic between two other countries but using its base A as a transit point 49 In fact, even three frequencies may not be appealing enough for many carriers. Even where the market is uncertain, capacity once in place, allows the carrier to build up volume over time through marketing and other means and the route, if successful, may help the carrier to break even. In this way, allowing capacity to be in place, helps to build traffic, implying tourist trade and investment.

40 Phase 2: second year

The Government will:

allow 1 new foreign carrier to operate between Dushanbe and any destination in Western Europe or the Middle East increase the flight to at least 4 weekly frequencies for all foreign carriers, on any type of equipment 0 allow entry of one additional (third) carrier per party on the Moscow- Dushanbe route, increasing the capacity to up to 21 weekly frequencies per side

3.21 One additional point is now allowed, that could be either to Western Europe or the Middle East. The increase of at least four frequencies will make the route more appealing for carriers catering the business traffic.

3.22 On the route to Moscow,'the addition of one daily flight will increase the capacity by over 33%.

Phase 3: third year

The Government will:

allow5' up to 2 new foreign carriers to operate between Dushanbe and any destination in Western Europe or the Middle East put no restrictions on capacity offered on these routes put no restriction on capacity on the Moscow-Dushanbe route, for the three designated carriers on each side The total number of carriers per side is now four, linking Dushanbe with four possible destinations. Capacity restrictions are now totally lifted. With respect to the Moscow-Dushanbe route, while there are no new entrants, capacity offered will now be totally free from restrictions.

Phase 4: Fourth year

The Fourth year program will include:

allowance of 2 new routes to any country (excluding Russia) under unrestricted terms

50 i.e., not prevent but also not require if the market does not support it. Any restriction or obstacle will be removed to allow the market to play its role and evolve.

41 total deregulation on the Moscow-Dushanbe route, with no restrictions on designation, capacity or pricing At this stage, Dushanbe could be reached from 6 points in any country (excluding Russia). Russia is excluded because points in Russia - other than Moscow - are currently well served. By year four, the Moscow-Dushanbe route will be totally liberalized.

Phase 5: Fifth year

full deregulation an all routes (free designation, no limit on capacity, no price controls) On the fifth year, liberalization would take place in all of the international markets.

Parallel Activity - Airline Reform:

3.23 The Government of Tajikistan is rightly concerned about the ability of the National Flag Carrier to weather the onslaught of competitive forces into the sector, given * its weak management, controls and resource availability. However, the Government recognizes that the answer is not, not to allow liberalization, but rather to strengthen the airline's management, controls and competitive ability so that it can in fact withstand the advent of competition. Accordingly, the actions that will be taken to effect this strengthening are discussed in more detail in the next section under "Airline Reform".

Measurable risk:

3.24 A non desirable consequence of the liberalization reform would be the incapacity of Tajik Air to be able to cope with the new competitive environment. In such a case, the airline while not able to compete under free market conditions may be forced to bankruptcy, and Tajikistan would lose its national flag carrier.

3.25 Such scenario would therefore involve the loss of jobs related to the airline. However, such consequence would force a transformation of the company of separation between the airport and ATC operation from the airline. Both the airport and the ATC would not cease operation, mostly on the contrary, would be managing more volume of traffic derived from the increased presence of competitors that took over the market.

3.26 It should be stressed that the airline reform proposal is aimed to mitigate the risk associated with an airline liquidation, by preparing the company to afford the new challenging situation.

42 4. GOVERNMENT’S PROPOSED IMPLEMENTATION FRAMEWORK

A. INSTITUTIONAL REFORM

Separation of functions

4.1 The proposed institutional framework is based on the strict separation of functions between the policy maker, the operator, the technical regulator, and the investigator. Unless these functions are not separated, conflicts of interest may interfere in the correct performance of their functions.

4.2 The following graph represents the proposed institutional arrangement for the air transport sector that will be ultimately realized under the Government’s phased program.

I Proposed Institutional Arrangement for the Air I ransport Sector

4.3 The role of each one of the different bodies will be as follows:

Policy maker:

This function should be retained by some Ministry office within the Government. This body will be responsible for setting the policies that shape the sector, including bilateral and multilateral agreements, tariff regulation, market access ,foreign investment ,designation issues concerned with capacity allocation between competing carriers when dual or multiple designation exists as well as consumer protection issues and security related matters .

43 Technical Regulator

4.4 The technical regulator is the body responsible for the observance of the safety standards with respect to air transport. These standards emanate from the local applicable laws with respect to air transport safety, as well as from the norms and recommendations from the 18 Annexes to the Chicago Convention (1944) of the International Civil Aviation Organization.Currently, this role is performed by the Department of Civil Aviation of Tajikistan (DCA). With respect to Aviation Security (Annex 17), this is the responsibility of the “aviation security services of aerodromes and airports, the military security units of aerodromes and airports, the aviation security services of the exploiters (aviation entities) as well as the specially authorized bodies vested with this right by laws of the Republic of Tajiki~tan”~’.

Operator:

The operation of each one of the three services will be separate entities, as the Government recognizes that it is crucial that the airline is operated completely independent from the airport and the air traffic control, preventing a vertical integration of the airline into these two monopolistic services.

Accidents investigator: While initially contained within the DCA, eventually, the investigation of accidents and incidents should be the responsibility of a body totally independent from any of the other agencies involved in the sector. In many countries, this function is assigned to a specific body linked directly to the president of the country or the congress, bypassing also the ministry and all other organisms with direct or indirect responsibility on the sector. In Tajikistan, this responsibility could be initially assigned to a separate body that reports to the Office of the President, with capabilities to oversee the functions of any other party potentially involved in an accident, including the policy maker, the regulator and the operator.

4.5 The separation of functions will involve the formulation of a complete new regulation. Currently the functions assigned to the DCA are regulated by the Resolution No. 361 dated “31” August 2004 of the Government of the Republic of Tajikistan, on the “Regulation of Department of Civil Aviation of the Republic of Tajikistan”. The current regulation consists of an amalgamated description of all the functions that are normally accomplished by the three bodies independently (the policy maker, the technical

5’ Air Code of the Republic of Tajikistan, Chapter XII: Aviation Security and Safety, Article 76: Aviation Security - of November 1998

44 regulator and the accident investigator), and some provisions allowing the possibility of functionaries of the Department to be employed by the regulated institutions.

4.6 The proposed reform will include a completely new legal framework, involving specific regulations for each one of the independent bodies.

B. AIRPORT REFORM

4.7 All the airports currently managed by TSA will be placed under the administration of an autonomous body with responsibility for running the airport business. Such a body should be a state owned corporation, conducted under purely commercial principles for the interest of the Tajik people.

4.8 However, this airport corporation will be managed at arm's length of the government, far from political pressure and policy making. In fact, its governance body will be formed by an apolitical board, with active participation of the investment community, the industrial sector and the academy.

4.9 Such an airport corporation, totally independent from the airline business, is likely to treat equally all airlines based on competitive terms, and following the non discriminatory principles of airlines, as underlined by ICAO.

4.10 It is expected that a business oriented corporation will be able to exploit in a better way the non aeronautical businesses associated with the airport. A better layout of the facilities and the incorporation of commercial activities may allow the airport to obtain, conservatively, at least an additional 20%52of revenues. A high proportion of greeters and meters and the existence of a range of services either not exploited or not charged today (e.g. car parking, food and beverage, etc.), supports the notion that additional sources could be obtained from the non aeronautical activities.

4.11 Currently, there is no information about the airport cost structure. However, given the existent charges structure, with values well above competing facilities, the potential exploitation of commercial revenues, employing a reduced and efficient work force, under a cost efficient structure, and without significant capital expenditures to be carrier out, there is no reason why the airport should not be able to generate revenues to cover its own operational costs.

52 The proportion of commercial revenues of the aeronautical revenues varies significantly from country to country. However, at middle size airports like Dushanbe, and given the low purchasing power of the travellers, it is conservative to estimate a 20% of additional revenues from the commercial operations.

45 C. AIR TRAFFIC CONTROL REFORM

4.12 In a similar fashion as the airport business, the ATC will be managed independently as a separate business. The form of a state owned corporation can also be used, following the same scheme applied for the airport company.

4.13 As an alternative option, as a second best option, the provision of ATC services could be provided by the same authority or company that operates the airport infrastructure, following the same guidelines defined for the exploitation of the airport business.

D. AIRLINE REFORM

Audit and control mechanism

Financial audit A financial audit becomes imperative before any reform of the company. Management will have to analyze the level of resources available but will also have access to the correct information for decision making purposes. Any action of reform will need to be measured based on reliable information. The financial information is crucial to design the strategk planning of the company. Implementation of basic control mechanisms In an immediate term, basic management control & reporting procedures will be set in place. In a later stage, accounting procedures will be defined and implemented, in order to assure a constant flow of reliable information for management and decision making. Accounting systems will then be defined and integrated into corporate manuals. In addition, management reports systems and budgeting and planning procedures will provide day to day supportive data to management.

Development of a Strategy for Competitiveness

4.14 The management of the airline will develop a sound strategy that will allow the airline to meet the challenge of affording foreign competition serving the same routes. The strategy will comprise a comprehensive business plan to be implemented along a phased process that will accompany the air transport liberalization reform. The strategy should include the following:

46 Strategic Planning Strategy definition

4.15 The definition of the strategy should involve the introspective look of the company's management to understand "what airline they want to be". Such a forward looking perspective will include the environmental conditions and trends, involving not only the economical and political framework, but also the competition. "The essence of strategy formulation is coping with ~ompetition"~~.A strategy is a deliberate search for a plan of action that will develop a business's competitive advantage, and compound it.

The strategy will involve the definition of what kind of airline the government is looking to have, and drawing a strategic plan accordingly.

Definition of Objectives & Strategic Goals The strategy will involve the definition of objectives and goals, along the line of the defined strategy.

Planning 4.16 Design of the route map will be designed to guide how the strategy with its goals and objectives will be achieved. It will imply the appropriate allocation of resources to achieve the objectives and goals, along a specific time frame. The strategic plan will be consistent with the staged process of liberalization of the aviation policies for Tajikistan, allowing for a gradual strengthening of the airline against the competitors in the different markets. For this reason, the plan will have different scopes, for short, medium and long- terms.

4.17 The strategic planning will consider the industry trends regarding business models, product definition and aviation policies. In addition, target market will have to be defined, on a route per route basis. This will lead to the product definition process.

Product planning Route network The definition of the target market should be directly linked with the definition of the route network. The network may vary along the strategic plan, based on the phased

53 Michael Porter, How Competitive Forces Shape Strategy (Harvard Business Review - Strategy -April 1979)

47 liberalization of the markets and the changes in the competitive environment. This will also consider scheduling, frequencies, and punctuality. The definition of the route network will involve definitions about airline hubs, selection of airports, connecting points with other partners and agreements with service providers (maintenance, ground handling, catering, etc.).

Pricing policy A key feature of the product planning is the pricing policy. It will include the definition of the pricing objectives, pricing strategies, fare structures, criteria used for revenue management mechanisms and the marketing strategies in pricing.

Type of service The strategy will also define the type of service that will be provided. This will involve the range of services and the level of integration of other related services (airport services, VIP lounges, ground transportation, off airport check in, in-flight service classes, policies on baggage, etc.)

Fleet Consistent with the strategy, the route network and the type of service will dictate the type of fleet the airline will require, along with other resources compatible to the fleet structure. The acquisition of the two aircraft (urgent though this is in view of the forthcoming retirement of the TU-154~)~~,should only be undertaken as part of such a strategy. Not to do would result in the high likelihood that the acquired aircraft may not ultimately fit the strate adopted and end up becoming set of "white elephants" which the airline can ill afford$l

Marketing Marketing strategy The marketing strategy will involve the identification of market segments, definition of distribution channels, promotions, and revenue management criteria. The distribution strategy will include the relationship with the General Sales Agents (GSA), distribution commissions, selection of the Computer Reservation System (CRS)56 platform, interfaces with other CRS systems as well as GDSs and e-ticketing.

54 Given the urgency posed by the retirement of the two TU 154s, the airline must immediately seek assistance to commission the advisory services to help it prepare the need strategy). 55 E.g. the decision between a B757 and a B767 would, inter alia, be determined by the role and importance that freight would play in the competitive strategy developed for the airline. 56 The main CRS are Amadeus, Sabre, Apollo/Galileo and Worldspan.

48 Marketing strategy will involve image of the airline, including the logo, corporate message, advertising and media coverage.

Production strategy The production strategy will involve agreements with other carriers, code share accords, alliances, joint production on specific routes, etc. The strategy will reflect the consistency with the overall strategic plan.

Business Implementation Plan

Allocation of resources The Business Implementation Plan will review the resources available to the company and assess the requirements according to the strategic planning. This task will include human resources, fleet assessment and renewal options, information technology, systems, facilities, workshops, offices, etc.

Ownership transformation options It is advisable that the airline will become an independent corporation, even if retained as a state owned company. The status of Independent Corporation will assure the independence from political influence and freedom from the state apparatus possible red tape. Ownership options will be evaluated at some point, allowing for the consideration of private sector participation in the company, as an alternative for cash injection and managerial acquisition.

49 5. CONCLUSIONS AND NEXT STEPS

A. CONCLUSIONS

The aviation sector in Tajikistan is struggling today under a very restrictive air transport policy. Together with it, the whole economy of the country is being deprived from the derived benefits of better connectivity, such as trade, travel and technology transfer. While maintaining safety as the highest single priority, the Government recognizes that the air transport policy should allow for a liberalization of the markets, allowing better connectivity with more efficient services at lower prices. The only possible way to ensure the implementation of a liberalized policy, an appropriate institutional framework needs to be in place, allowing for the complete separation between the policy maker, the technical regulator and the operation. With respect to the operation, the airline, the airport and the air traffic control will be separated, in order to assure truly competition. Currently, all operations activities are concentrated at TSA. TSA is today an inefficient company that provides a poor service to its customers at prices that are high and provide an involuntary price umbrella for the ~ompetition~~.Its present existence was granted by a protective environment, where a concentrated institutional framework allowed regulation to be tinted by policy motivations. Instead of promoting transparency in accounting and efficiency in operations, there have been initiatives to grant further loans that would end up fueling costs and inefficiencies, while not achieving any of the promised results. At the bottom line, all these inefficiencies are paid by the migrant worker community that travels to Russia at unjust air fares, representing a substantial part of their earnings. A new policy that would liberalize the sector will promote efficiency and lower the costs of travel, relieving the tax on a huge mass of people that is crucial to the economy of Tajikistan.

57 . For example: When Turkish Airlines started, they, reportedly, were required to get price approval from the TSA finance department and had to set their prices higher than TSA.

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Y B. ACTION PLAN

In recognition of these issues, the Government of Tajikistan will take action towards the reform of the sector in three different stream lines:

Policy Actions

Policy actions will be in line with the promotion of a deregulated environment, in terms of capacities, prices and liberalized technical restrictions. These actions are not time bounded, but they will be carried out on an ongoing process. Promote a liberalization of traffic rights, by pursuing a gradual liberalization of the agreements, tariff deregulation and facilitation of cross border investments. This involves a process of definition of guidelines to be followed by the policy makers, and the subsequent implementation of individual actions towards those guidelines. Promote the competitiveness of the regulatory environment. As an ongoing process, this action will involve the revision of all the restrictions that result in higher operating costs in Tajikistan, damaging the competitiveness of the country's air transport sector. Separation strategy of the three different businesses. This process will come after the implementation of the management control procedures, since the preliminary results are crucial for the separation strategy design of the three businesses.

Institutional actions

This stage will commence with an institutional reform process with the ultimate goal of separating the functions of policy making, regulation and accidents investigation.

Institutional strengthening reform design: This will involve the definition of each department function and responsibilities, staffing, training and financial sustainability. creation of an independent policy making body (Civil Aviation Board or similar) strengthening program for the technical regulator (CAA) and free from political or Tajik Air interference creation of an airport authority with responsibility to run the airports of the country (this body will eventually concede the operation to the private sector and may retain economic regulation functions of the concession), taking over the airport operation today under TSA the provision of the air traffic control as a separate unit, taking over the air traffic entity today under TSA

51 development of a capacity building program 0 Legal and organizational implementation: The implementation will involve legal and organizational inputs.

TSA reform

The reform on TSA will pursue the accountability of the company as it is today (comprised of the three different entities), and the definition of the business strategy. This process will involve five specific actions:

Financial audit: it will imply a comprehensive audit of all costs and revenues as well as the precise definition of balance sheet. The outcome will be the production of complete financial statements for the group and for each one of the different business entities. Implementation of basic management control & reporting procedures: By the second month of the audit study, the implementation of management control procedures will be implemented, with the intention to monitor the development of the company from the moment the audit becomes available, until a formal accounting system is in place. These procedures will remain as a key tool for managerial decision making, interfacing with the accounting system in place. This process will involve design, training and implementation. Implementation of IAS accounting systems: This will involve the acquisition and implementation of a full accounting system that will consider the three different business entities as business units of the same group, facilitating the later separation. Legal and organizational implementation of the separation strategy of the three different entities bundled today under TSA: At this stage, the implementation will take place, involving legal and organizational support. Airline business strategy: a business strategic analysis should prepare the company to be ready to meet the challenges of competing on a free market environment, along the gradual liberalization process of the aviation policy.

52 C. SCHEDULE OF IMPLEMENTATION OF RECOMMENDATIONS

The following timetable shows the sequence of recommended actions.

Tajikistan Air Transport Reform Time frame for implementation of recommendations (first year)

-

separation strategy of the three different businesses

I- -- ......

on going process

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