Russia: The Defense Industry Feels the Credit Crunch's Effects

ALEXEY NIKOLSKY/AFP/Getty Images

Russian Prime Minister Vladimir Putin visits an air defense systems production facility in Moscow

The Russian defense industry could be hit hard by the global financial crisis, according to a Nov. 11 statement by Deputy Prime Minister Sergei Ivanov. Indeed, the Kremlin may have much to fear if the world’s second-largest exporter of military hardware sees orders diminish as military budgets are reduced worldwide.

Russian Deputy Prime Minister Sergei Ivanov voiced concern Nov. 11 over the impact of the global financial crisis on the country’s defense industry. Speaking before a government commission in Moscow that deals with defense industry issues, Ivanov specifically cited the impact of the crisis on Russian military hardware exports. Ultimately, Russia — the world’s second-largest arms exporter after the United States — will find its ability to weather the current global financial crisis contingent on the mix of methods it has used to finance foreign orders for Russian weapons.

To its credit, the Russian government has exercised far more restraint than its Soviet predecessors, thus far avoiding the wholesale transfers of weapons for ideological or competitive reasons. During the bilateral competition of the Cold War, the Kremlin would essentially outfit entire countries’ military forces with little real hope of ever seeing repayment. To this day, many countries like Libya and Syria are simply awash in debt from Soviet-era military assistance “loans.”

Actually, Russia’s biggest customers in recent years — including China, India, Venezuela and Algeria — have either been fiscally reliable (China and India) or have appeared to be better prospects for payment based on energy-related profits (Venezuela and Algeria, although Stratfor is quick to note that the long-term stability of the Chavez regime is not necessarily a safe bet). In the case of Venezuela, Russia offered to extend a US$1 billion line of credit to the Venezuelan government in September to purchase additional Russian arms (on top of the US$4.4 billion in deals already inked).

In some cases (such as South Korea and France), countries have extended lines of credit to or invested money in Russia, often in order to secure technology transfers or in hopes of returns based on the success of projects like the Sukhoi Superjet 100 (a civilian program that has attracted a great deal of foreign interest). In other cases, partnerships have been established in which the financial burden is shared or held abroad (an example of this is the BrahMos anti-ship and cruise missile program).

But in other cases, Russia’s arms export agreements have been financed by Russian state-owned banks that extend lines of credit or loan money to client countries’ import-export banks — essentially providing the money up front for purchases of its own weapons.

While there have been good geopolitical considerations for such deals, there will be even better fiscal reasons in the course of this decade for Russia to provide this financing. Wanting to focus on meaningful military and industrial-base reform at home, the Kremlin is not yet in a position to sustain its own industrial base with domestic defense purchases alone. It has therefore been biding its time until the industry could achieve higher standards of transparency, efficiency and quality control — thus maximizing the quality and quantity of equipment Russia could squeeze out of each ruble. By extending credit to other countries, Moscow could encourage others to sustain and ultimately fund the modernization of the Russian defense industry.

So long as the global economy was booming, energy prices were rising and Russian coffers were growing, this made strategic sense and could support the long-term revitalization of the Russian defense industry. Indeed, it was Chinese money that sustained Russia’s domestic defense industry through most of the post-Soviet period, and even with the recent decline in Chinese purchases, the entire sector remains dependent on exports and money from abroad.

Now the global economy is in recession, energy prices are dropping and global liquidity is in crisis. With Russian money already invested in production for client countries — and, in some cases, deliveries already made — Moscow’s problem becomes twofold.

First, all this money is tied up overseas, waiting to be repaid — in some cases over the course of a decade or more. It is not yet clear if, or to what extent, the Kremlin is overextended and overexposed. But if the liquidity crunch continues at home, the funds Russia has tied up in military hardware either already parked abroad or slated for foreign delivery will be increasingly felt as an opportunity cost. These are fiscal resources Moscow does not have to prop up its own institutions — military and civilian alike.

Meanwhile, the current global economic climate could begin to reduce the international appetite for defense spending in general. The industrial base of the Russian military thus runs the risk of stalling from a simple lack of cash and a reduced export market.

Either way, the continuation of Russian defense reform is predicated on continued spending. It is not yet clear where that money will come from if foreign defense budgets contract over the next few years, or whether the Kremlin will use the crisis as an opportunity to further consolidate its control over the independent-minded remnants of the defense industry.