The battle for China’s domestic air passengers is shifting into the country’s vast interior as carriers blaze trails to new destinations and start subsidiaries in second-tier towns, all with the backing of generous state funding for new airports.

Airports in the main coastal hubs of Beijing, Shanghai and Guangzhou are bursting at the seams, while further inland more than 50 cities with populations exceeding three million people are crying out to be connected to the nation’s aviation network.

The opportunities in such towns, which are rapidly catching up with the wealthier coastal cities that dominated the first years of China’s economic boom, are one reason aircraft manufacturers like Airbus and Boeing Co are confident China will remain a lead market for years to come.

The opening up of the interior is also sparking intense competition between carriers like Air China Ltd, China Eastern Airlines Ltd, China Southern Airlines Ltd and Hainan Airlines Ltd, which are fighting to dominate what is destined to become the world’s single biggest aviation market.

“Even though the income level and infrastructure in inland areas are not at the same level as the east coast, the growth potential for both private and business travelers is much bigger,” China Eastern board secretary Wang Jian said.

For the manufacturers, China’s relatively untapped interior means aircraft like the Airbus A320 and Boeing’s 737, which are ideal for routes of up to five hours, will find new markets. Big orders are expected for upgraded variants such as the A320neo and the 737 MAX.

For the airlines, it helps ensure a soft landing as China’s economic growth slows and gives them a domestic fillip at a time when rising competition and insufficient aircraft are making it difficult for them to crack the international market.

It helps that China bars foreign airlines from competing on its domestic routes.

Beijing Lends a Hand

Last week, the Civil Aviation Administration of China (CAAC) announced rebates of around 433 million yuan ($70.7 million) for airlines operating regional services. Air China, China Eastern and China Southern received 252 million yuan in total.

In March, the CAAC said that it had allocated 524 million yuan this year alone to help finance 134 smaller inland airports. China is scheduled to build 70 airports in the 2011 to 2015 time frame, with total airports in the country projected to reach 244 in 2020 – up from 180 at the end of 2011.

But that could just be the start of the airport building boom. The United States had around 5,000 civil airports at the end of 2011 for a population less than a third as big as China’s 1.3 billion, according to a 2012 report by consultancy Frost & Sullivan.

“In the 80s, people would say ‘if you want to get rich build a road’. Nowadays they say ‘if you want to develop, build an airport’,” CAAC chief Li Jiaxiang said at an industry forum in May.

Airlines are taking the government’s bait. China Eastern signed an agreement with the Ningxia regional government to add services and increase existing ones to Yinchuan, its largest city with a population of about 2 million. In July, China Eastern chairman Liu Shaoyong flew to Henan province to seek expansion opportunities in Zhengzhou, a central city of more than 8 million people where Apple Inc iPhones are made.

China Southern already has a joint venture in Zhengzhou. The Guangzhou-based airline also has a stake in Xiamen Airlines, Chongqing Airlines and Sichuan Airlines.

HNA Group, parent of Hainan Airlines, wants to set up five new subsidiaries in the remote provinces of Xinjiang, Heilongjiang and Guangxi, among others. HNA also has a stake in regional carriers such as Tianjin Airlines, and Kunming-based Lucky Air.

City and provincial governments are also piling in to justify their investment in airports. Local authorities, for example, hold a fifth of Air China’s Dalian Air and Inner Mongolia Air. China Southern’s airline in Zhengzhou is 40 percent-owned by Henan provincial government.

“The airlines can get all kinds of perks from provincial or city governments. Capital investment, subsidies, preferential tax treatment, cheap land, you name it,” said a veteran executive with a major airline who did not want to be named.

The Plane Facts

All of this is music to the ears of planemakers as China’s growing middle class in second-tier cities takes to the skies.

Chinese airlines will operate 4,500 aircraft by the end of 2015, up from 2,600 this year, according to the CAAC’s Li.

Boeing said in a September 2012 report that China alone would need more than 5,000 new jets in the next 20 years. The U.S. company’s senior vice-president for sales in Northeast Asia, Ihssane Mounir, said more than 75 percent of that demand would come from new growth rather than replacement. Boeing said last month it was considering lifting the production rate of its top-selling 737 jet to more than 42 a month, from 38 currently.

China itself is developing the Comac C919 aircraft to compete with the A320 and 737, although that jet is not likely to make a significant impact on the market in the near-term.

Other beneficiaries of Chinese demand could include regional aircraft manufacturers like Embraer SA and Bombardier Inc , which make 50- to 110-seat aircraft that cater to smaller cities. ($1 = 6.1247 Chinese yuan)

Additional reporting by Kazunori Takada in Shanghai. Editing by Siva Govindasamy and Stephen Coates.

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