It would be wise not to get too excited about the reforms planned for the mainland's airline sector. At least not too soon. The State Council last week gave the green light for the Civil Aviation Administration of China (CAAC) to merge its 10 directly owned carriers into three groups, based on Air China, China Southern and China Eastern. Shares in Hong Kong-listed China Southern and China Eastern surged by nearly 20 per cent to highs for the year to date in response to the consolidation. While there is agreement that joining the fragmented parts of the industry is a positive development, it is unclear what concrete benefits will result, or just how long it will take before the process begins. Beijing ended its monopoly of the air transport sector in 1986, hoping competition would create more efficient operators and improved services. As a result, more than 34 airlines have sprang up, creating a new set of problems. An array of safety, service and management standards emerged across the industry, creating a minefield for regulators. Many regional governments were willing to run their airlines at a loss in order to attract tourists and freight, and the resulting competition was considered anything but healthy. Cut-throat price competition in 1998 caused the industry to lose an estimated six billion yuan (about HK$5.62 billion). In a bid to stem the losses, CAAC last year banned air fare discounting. Having witnessed the effects of fragmentation in the former Soviet Union - which at one point had more than 300 carriers - it was clear further reforms were needed. The idea of consolidation was first floated by the CAAC in 1996. But it took until last week to gain the State Council's seal of approval. There is still no timetable for a set of guidelines for the consolidation to be drafted. After that, the time needed for the consolidation is anyone's guess. The hope is that the consolidation will create bigger, more efficient and more competitive airlines in the face of competition after the mainland's World Trade Organisation accession. Analysts think it could take more than two years for all carriers to merge. 'It is going to be a long and difficult process,' HSBC Securities Asia airlines analyst Mark Webb said. The three merged groups, each with more than 40 billion yuan in assets, would together account for nearly 80 per cent of the mainland air transport market. Some more bullish analysts expect the mergers to result in cost-savings and synergies. But others question the extent of any cost benefits and efficiency gains, given that the merged entities will not be allowed to shed staff. The wide range of aircraft coming together also limits efficiencies and synergies. 'This idea that there will be tremendous synergies does not really stand up,' Mr Webb said. The greater financial strength merged carriers would gain would seem to enable them to clean out old aircraft and replace them with newer, more efficient models. However, this points to another problem - one that is central to the success of the consolidation. The acquisition of new aircraft is in the CAAC's court and its decisions are guided by political and strategic considerations as much as by commercial ones. The merged carriers will still be controlled by the CAAC - a government body motivated less by the profitability of any individual airline than by overall economic and political considerations. It has been reported that the State Council is exploring the possibility of converting the CAAC into a pure regulator - giving the airlines more managerial freedom. But there is still no certainty that this reform will be sanctioned and put into effect any time soon. The possibility of issuing share options to airline managements is another encouraging reform. If carefully implemented, it could motivate managers to focus more on bottom-line realities. Nonetheless, the extent of independence afforded to managements will be limited so long as the final say remains with the CAAC. Peter Lok Kung-nam, former head of the SAR's Civil Aviation Department, said: 'They have been talking about 'separating government from enterprise' for 10 years now, but still nothing has happened.' The story is the the same for many other state-owned enterprises. A key constraint to the mergers' effectiveness is the restriction on shedding excess employees. Having to carry more staff than necessary will kill many of the cost-savings and efficiency gains the merged groups might otherwise enjoy. The mainland's airlines already operate with a high cost structure. China Southern's cost per available tonne kilometre (ATK), for instance, is higher than that of Cathay Pacific Airways, even though Cathay pays some of its pilots up to 100 times more than their mainland counterparts receive. While the government's promise not to cut jobs may not have the desired effect of making the consolidation process develop smoothly, managers at various levels are at the same time going to be battling for their jobs and seniority and so are expected to resist the mergers, prolonging and complicating the process. Another question hangs over whether combined management teams will be able to work together effectively. Some analysts say the consolidation could, in fact, harm the short-term profitability of both China Southern and China Eastern as they merge with their less-profitable counterparts. Donaldson, Lufkin and Jenrette aviation analyst Philip Wickham believes the consolidation of the CAAC-owned carriers alone will provide limited benefits in the near future. 'It might hit [China Southern and China Eastern] operating margins in the short term,' Mr Wickham said. The root of the problem remains that many of the CAAC-controlled airlines are not sufficiently dedicated to profits. Consolidation is no doubt a necessary and healthy development for the sector. Indications that Beijing will raise the limit on foreign investment in its carriers to 49 per cent and institute employee share-option schemes are also encouraging. But it could be some time yet before these reforms are implemented and the benefits materialise. And, without further privatisation and the necessary changes in management cultures and moves to profit incentives, the success of any restructuring will remain limited.