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Too Big To Fail?

Russia's bankrupt defense industry.

12:00 AM, Mar 17, 2009 • By REUBEN F. JOHNSON
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Traditionally, one of the more important arms shows for Russian industry has been the International Defence Exposition (IDEX) that took place late last month in Abu Dhabi, the capital of the United Arab Emirates (UAE). Despite the financial woes they are suffering, Russian industry has to participate to try and keep itself alive. However, no one could possibly reconcile the behavior of the Russian delegation at this expo with the dire situation that their industry faces back home.

The fortunes of the Russian defense industrial sector at present make AIG and Bank of America look like the financial picture of health. The Russian industrial conglomerate umbrella company, Rostekhnologia (ROT) that has monopoly control over the entirety of the nation's defense industry is headed by Sergei Chemezov. He is also a life-long--and perhaps the number one--FOV (Friend of Vladimir Putin) in the Russian government, the two having first befriended one another when they served together in the former East German Democratic Republic (GDR) as KGB officers during the waning days of the Cold War.

Chemzov recently announced that 30 percent of Russia's defense industry is on the verge of bankruptcy and that of the 70 per cent remaining only half of those may be categorised as "stable." Those that are in danger of becoming insolvent include more than half of the enterprises in Russia that produce ammunition and explosives.

When ROT was officially formed last year--taking control of a total of 426 firms in one fell swoop--Chemezov looked like the all-time world champion of corporate raiders. Moreover, 118 of these firms had no connection to the defense sector, but were merely large, moneymaking enterprises that were ripe for the picking. "T. Boone Pickens, eat your heart out," seemed to be the theme of the day for Russia's number one FOV.

However, some seven months later, accumulating all of these industries into one basket does not seem like the smartest move any more. The 340 out of the 426 ROT-controlled firms that are defense suppliers currently owe 25 billion roubles (US $17.5 billion) of debt. In the aftermath of the global economic downturn, not only have Russian banks closed their doors to lending to these defense enterprises, but those banks that have remained open to lending have raised interest rates to 12 to 13 percent. These interest levels have caused ROT to open negotiations with western banks, although no one from the Russian arms export monopoly has been willing to reveal which banks they are actually in contact with.

"Credit is the most painful topic," said Chemezov. "With such high [Russian banking] interest rates, we are simply unable to develop industry." The current policies of western banks, however, are not encouraging due to their recently declared unwillingness to make additional loans to the east--even to those former Warsaw Pact nations that are now members of the EU.

Russian defense exports were at a record $8.35 billion in 2008, though industry officials have for more than two years warned that these levels of earnings would be unsustainable without significant state-funded investments in defense industrial technologies. In the last 12 months, senior Russian defense industry enterprise directors have stated that the condition of the industrial base in areas such as advanced miniaturized components, composite materials, and other technologies essential to maintaining competitiveness in the 21st Century now require national campaign-style programs on the order of the 1960s Sputnik race to moon if they are to be saved from collapse.

A long-time Moscow colleague who has analyzed Russia's defense industry for the last three decades commented this month on these consequences of the Russian government's many years of post-Soviet, chronic neglect of the need for technology investment in the defense sector. "Very simply," he said, "we are now moving to the point where there will be no Russian defense industry that is on par with the front-line nations of the west that have a sizeable industry, and in some sectors or technologies Russian industry will even be inferior to Chinese industry."

Which would make one believe that during last month's IDEX show the Russian delegation would have behaved as though they were in a do-or-die situation--desperate to find new markets, new customers, new sources of investment, etc. Eager to please their customers and at the ready to respond to anyone's interest no matter how small. What happened was just the opposite.