London: There are brighter skies ahead for airlines battered by the recent slump in air demand, but carriers must cut costs and capacity if they are to return to profitability, say industry executives.

At a recent forum here on the state of the airline industry, airline bosses said that passenger numbers were showing signs of recovering as the fear of flying sparked by the September 11 deadly hijackings dissipates.

But September 11 only aggravated the downturn in demand for travel, which was already in decline because of the global economic slowdown, they said.

Moreover, many of the airline industry's problems stem from the use of state aid to prop up inefficient carriers and from foreign ownership restrictions, speakers at the Economist Conferences' annual airline forum said.

Andrew Sentance, chief economist at British Airways, said there were some encouraging trends emerging, pointing to signs of stabilisation in passenger numbers and cuts in capacity in line with the fall in traffic.

"But it's too early to talk of a sustained recovery," he warned. BA last week reported that its financial result nosedived into a 160 million Pound loss (260 million Euros, 225 million Dollars) in the troubled December quarter.

"The prospects for global economic recovery are key elements in how quickly the airline industry will recover."

Austin Reid, chief executive of BMI British midland, warned that the traditional link between economic activity and airline traffic had been broken by terrorism.

"Yes, there is light at the end of the tunnel. But it is difficult to tell when the recovery will come, quite what the industry will look like, and who will be around to enjoy it when it arrives," he said.

"I expect to see the industry return to profitability in 2003, as the US market fully recovers and airlines adopt cost bases more appropriate to their revenues."

National flag carriers have been slashing jobs and capacity in the wake of September 11, leaving low-cost budget carriers looking to muscle in on their markets.

According to Kevin Dobby of the International Air Transport Association (IATA), 120,000 airline jobs have already been lost because of the crisis, and another 200,000 could disappear.

Speakers said that cost cutting would be key to the recovery in the industry, because a rebound in passenger numbers would not in itself be enough to ensure a return to profitability.

Chris Tarry, airlines analyst at Commerzbank, said, "Market share is not everything. It's also about yields. If airlines don't make adequate returns, no one's going to invest in them."

He said it was clear a more appropriately sized industry was needed, adding, "It is very much a question of addressing a pre-existing condition."

The bankruptcy of national carriers such as Swissair and Belgium's Sabena has sparked a heated debate over whether governments should sustain flag carriers regardless of their commercial viability, something many executives oppose.

"It's a pretty easy business, the airline business, but it's screwed up by government intervention," said Willy Boulter, executive vice president of South African Airways.

Reid at BMI warned that the use of government aid would stymie efforts to consolidate the industry.

"There may be more airline failures," he said.

"Though not as many as there would be if governments and regulators concentrated more on letting consumers benefit from greater choice and competition, and less on mollycoddling those airlines unable to stand on their own two feet."