The impacts of exchange rate fluctuations on the international air transport

Abstract

The fluctuations of foreign exchange rate can affect the international air transport markets through both demand and supply sides. On one hand, exchange rate variations can affect the passengers’ overseas purchasing power so as to influence international travel decisions (i.e., demand side). On the other hand, as airlines normally pay foreign currency (e.g., the U.S. dollar) for capital/operation costs, the foreign exchanges rate variations also affect airlines’ supply side. This empirical study utilizes monthly data on international routes operated by Chinese airlines (January 2017 – September 2019) to analyze demand and supply dynamics of foreign exchange variations through structural econometric modeling. The impacts on the air passenger traffic from both demand and supply side can be thus disentangled and quantified. To address the potential endogeneity caused by the unobservable confounding factors that jointly affect the exchange rates and international air travel market, this paper innovatively selects the international air routes linking mainland China to five regions that peg their exchange rates to USD, such that the exchange rate fluctuations can be regarded as exogenous on these routes. The empirical findings indicate that on the demand side the moderate bidirectional exchange rate fluctuations significantly influence international passengers’ air travel demand, while on the supply side severe fluctuations significantly impact airfare. Additionally, the demand in China’s aviation market is generally inelastic to airfare and exchange rate fluctuations. By separating the demand-side effects into direct and indirect mechanisms, the findings show that moderate exchange rate fluctuations primarily impact air travel demand through a direct mechanism, (i.e., the demand side) while severe fluctuations mainly influence demand through an indirect mechanism (i.e., the supply side). The findings offer useful references for airline managerial and policy implications.