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Redefining possibility in the aviation sector: Navigating macroeconomic risks and protecting capital

Despite the tough macroeconomic conditions facing the aviation sector, there are reasons for optimism regarding its resilience and the prospects of increasing demand and revenue.

Organizations around the world are learning to adapt to challenging business conditions, and the aviation sector is no different. Sustained elevated interest rates, rising fuel prices, and the continued supply and demand imbalance of aircraft are impacting profitability and restricting capacity in the sector.

In response to challenges posed by macroeconomic conditions and geopolitical uncertainty, the sector is having to react strategically by diversifying its routes and markets to reduce or avoid volatile situations. It is also stepping up to challenges, such as increasing its air freight capabilities as organizations seek alternative trade lanes to those affected by geopolitical tensions in the Red Sea.

The sector’s proximity to external shocks necessitates proactive risk assessment and mitigation strategies to help organizations guard against serious disruptions and seek opportunities in new markets. At Marsh’s aviation conference, held in London in April 2024, Marsh specialists considered the macroeconomic risks facing the sector, including the implications, considerations, and actions that organizations can take to mitigate these risks and remain resilient.

Macroeconomic challenges introduce new risks in the aviation sector

According to Marsh's Political Risk Report 2024, organizations are facing a world made more volatile and riskier by macroeconomic and geopolitical changes. The global, interconnected nature of the aviation industry means that airlines, lessors, and suppliers are vulnerable to trends outside their control. For example, conflict, tariffs, and trade disputes can lead to airspace closures, route restrictions, and heightened security measures, all of which can significantly disrupt flight operations, logistics, and profits.

Meanwhile, current economic headwinds, including high input prices, a strong US dollar, and limited pricing power, are combining to place additional stress on already challenging conditions and leading to rising costs throughout the supply chain, including spares, maintenance, and salaries. Insurer data suggests that global sectors reliant on voluntary spending, like tourism, and significant labor requirements may see relatively higher insolvency rates. Labor and fuel are by far the two biggest operating costs for airlines.

Supply chain disruption, part shortages, and delays in the delivery of new aircraft can negatively affect tightly controlled operating schedules, resulting in empty seats or reduced air cargo space sales. In this complex context, operators will be under pressure to capture increased passenger demand or risk weak profitability or default.

Airlines, lessors, maintenance, repair, and overhaul (MRO) companies, original equipment manufacturers (OEMs), and part traders are all facing supply chain challenges, with part shortages leading to planned aircraft maintenance schedules being disrupted. Higher interest rates have also increased lease rates as lending becomes more expensive, even for lessors with good credit ratings. With over half of the world’s commercial aircraft leased, this could add to the sector’s headwinds.

The interplay between macroeconomic and geopolitical challenges is another troubling development for the sector. For instance, there are reported instances of non-compliance with the Cape Town Convention, a treaty designed to facilitate asset-based financing and leasing of aviation equipment, potentially signaling an increase in  government intervention in the sector. Moreover, people in countries that account for 40% of the world’s GDP are heading to the polls this year to elect new governments, adding to the atmosphere of uncertainty and potential instability.

However, these trends are not universal, and there remain countries where the aviation sector is looking strong: In the next 20 years, the UAE’s aviation market is forecast to grow by 170%, while domestic passenger air traffic in Africa is expected to quadruple. Similarly, in the aircraft leasing market, investors continue to seek out “high grade investment opportunities.”

Risk management strategies to prepare for challenges

Amid economic uncertainty, organizations may be searching for new opportunities elsewhere or require a better understanding of how to address the risks of operating in potentially volatile regions. Organizations may be asking:

  • In tough economic times, how can we improve our working capital and secure financing?
  • What happens if there is a default by a lessor, borrower, or buyer?
  • How can we protect our aircraft assets or operations from the effects of foreign government interference?
  • How can we mitigate currency risk?

Key credit risk transfer products, such as non-payment insurance, political risk insurance, trade credit insurance, and surety, can help organizations mitigate forms of credit, political, and surety risks.

Trade credit insurance can improve an organization’s access to credit, for instance, by mitigating the effects of clients’ payment delays or defaults, which can in turn improve working capital. Trade credit insurance could help an airline company attract more funding from new and existing lenders to finance aircraft purchases.

In the volatile world of political risk, crises can deter long-term investments and hamper existing strategies. Political risk insurance can support the aviation industry by helping protect organizations against adverse political developments such as political violence, expropriation by governments of assets or operations, restrictions on currency conversion, and credit risks such as non-payment. Political risk insurance can protect assets and investments overseas for the aviation sector and support entry into new markets. In some instances, political risk cover is a prerequisite to facilitating foreign direct investment and global trade.

With interest rates expected to remain high throughout much of the world for some time, lending may remain challenging. Organizations may seek alternative financing through surety bonds, which generally provide financial protection against non-performance, default, or other breaches of contract. Organizations looking to expand internationally may use surety bonds to reduce their exposure to operational and financial risk, which can promote confidence in your organization’s ability to deliver on its contractual obligations. In the US, new investments in airport modernization, as part of the Inflation Reduction Act (IRA), are also expected to drive demand for surety bonds.

Supporting growth

Despite the tough macroeconomic conditions facing the aviation sector, there are reasons for optimism regarding its resilience and the prospects of increasing demand and revenue. Organizations can plan, grow, and adapt to challenges and opportunities with a successful risk management strategy that incorporates analytics, data, forecast planning, and cash flow protection.

Please contact your local advisor to understand more about how Marsh Specialty can provide advice and solutions to organizations and lenders looking to protect their assets, improve the return on their investments, and unlock opportunities for growth.