Breakthrough Into the Global Arms Market

15 june 2008

Alexander Rybas

Resume: Russia’s present capabilities in promoting its armaments on the global market exceed the defense industry’s ability to fulfill current and potential contracts. The further growth of military exports is mainly limited by production capacity. The technological modernization of the Russian defense sector and a marked improvement in the quality of its management must be a top priority task for the country in the next few years.

The marked consolidation of Russia’s positions on the global weapons market is one of the major achievements of Vladimir Putin’s presidency. Nominal arms sales and hard-currency revenues from these sales have steadily increased. These revenues stood at $3.4 billion in 1999, while Russian state arms trader Rosoboronexport saw its arms exports reach $6.2 billion in 2007.

 At the time of this writing, no official figures on total arms exports for 2007 have been made public yet. However, as follows from past experience, independent exporters account for no less than $1 billion in supplies. This assumption puts overall exports for 2007 at $7.2 billion to $7.5 billion, with arms sales for the last eight years more than doubling.

Even more impressive is the growth of the portfolio for contractual commitments. It stood at $6 billion to $7 billion throughout the 1990s, while it reached a staggering $32 billion at the end of 2007. Rosoboronexport accounted for about $23 billion of this amount, and independent actors accounted for the rest.

It would be fair to say though that the growth of arms exports would not be that impressive if it is counted not in current, but in constant prices. The U.S. dollar was worth much more in Russia and in the rest of the world in 2000 than it was in 2007. However, one can state a marked increase in supplies in physical terms, especially if one takes into account the export of heavy-class fighter aircraft.

The Su-30MK heavy-class fighter has been the indisputable leader in sales in the last eight years. Since 1999, 100 such aircraft have been sold to China and about 50 to India (and as many component kits for the fighter’s licensed production). Another 28 Su-30s have been ordered by Algeria, 24 by Venezuela, and 18 by Malaysia. In addition, several Su-30MK and Su-27 aircraft have been bought by Vietnam, Indonesia and Ethiopia. In individual years, the production of heavy fighters in Russia reached 50 units, which is comparable with the production of similar class fighters in the United States.

The last few years have seen a marked increase in demand for the MiG-29 medium-class fighter. After a difficult period in the second half of the 1990s, when supplies of these aircraft plummeted to almost zero, their export has resumed. At first, they were sold to Asian and African countries of modest means, namely Sudan, Bangladesh, Myanmar and Eritrea. Later, in 2004, Russia signed a major contract with India’s Air Force for the development and production of 16 MiG-29K shipborne fighters for the Vikramaditya aircraft carrier (formerly Russia’s Admiral Gorshkov aircraft carrier). Fighter supplies include demand for expensive airborne weapons and ground aircraft maintenance equipment. Accompanying contracts of this kind may reach the hundreds of millions of dollars. On the whole, aircraft account for about 50 percent of Russia’s arms exports. This export structure is also characteristic of the major classical exporters – the U.S., the UK and France.

China is still Russia’s largest client in the naval arms trade. Over the past several years, Beijing has purchased three destroyers from Russia, about ten submarines, and large batches of sea-launched missiles. India has purchased three advanced Talwar-class frigates and ordered three more ships. It has also launched an extensive program to modernize its submarine fleet and actively purchases shipborne antiship and air defense missile systems. In some cases, India was the first customer of such systems and actually paid for their development and production.

Standing apart from these contracts is the BrahMos project for the development of the PJ-10 sea-, air- and shore-based heavy supersonic missile. The project is being implemented by a Russian-Indian joint venture of the same name on a risk-shared basis. This is the first program of this kind in Russia. The experience gained during its implementation will be used for the development of a Russian-Indian fifth-generation fighter and a medium-class transport aircraft.

Finally, in 2004, Russia and India concluded a major and very difficult transaction for the purchase by India of the Russian Admiral Gorshkov aircraft carrier. The contract provides for the ship’s retrofitting in order to accommodate horizontal take-offs and landings for MiG-29K fighters. New Delhi will receive the ship free of charge, but will pay for its repair and modernization. According to press reports, the contract is worth $750 million; in addition, India will pay as much for 16 deck fighters.

China is the largest buyer of Russian air defense systems – it has ordered more than 10 battalions of the S-300PMU-1/2 long-range surface-to-air missile system. The demand for this and other air defense systems has markedly increased lately, and large contractors have appeared in the Middle East and Northern Africa. One more client is Vietnam, which has bought two S-300PMU-1 battalions.

Many clients purchase Russian armaments and equipment for the Ground Forces. The largest buyers include, above all, India, which has purchased about 700 T-90 battle tanks. Algeria is another major buyer.

DIVERSIFICATION

The very low geographic diversification of Russian arms supplies in the late 1990s was behind the country’s potentially very dangerous structural weakness on the global arms market at the time. Up to 80 percent of Russian arms were sold to only two countries – China and India. At the same time, the structure of the Chinese and Indian demand was markedly different.

China imported large batches of series-produced armaments or those that had not undergone in-depth modernization, and the supplies often were to be made within a relatively short period of time. For example, Moscow and Beijing signed a contract for the development and supply of the Su-30MKK fighter aircraft to China in 1999, and the next year Russia supplied the first few fighters to the customer. The Chinese version of the aircraft was a rather simple modernization; yet, even considering this, its development took an unprecedented short period of time. In all, Russia sold 100 Su-30MKK fighters and 20 Su-27UBK combat trainers to China from 2000 to 2004, i.e. an average of 25 aircraft per year, plus component kits for the licensed production of Su-27SK aircraft.

In contrast, the Indian military ordered armaments with very high operational and technological characteristics, causing Russian science and industry to work at the limit of their capacities in the mid-1990s.

Initially, the Indian Air Force and Navy ordered small batches of armaments, while supplies were made over long periods of time. The 1996 contract for the development and supply of 32 Su-30MKI fighters graphically manifested the characteristic peculiarities of Indian imports. The contract provided for an extensive amount of research and development. New Delhi wanted the fighter’s onboard equipment to include French, Israeli and Indian-made components, which involved high technical risks. The integration of foreign-made equipment with Russian systems proved to be the most difficult task faced by designers from the Sukhoi Design Bureau.

The combination of large short-term orders for series-produced systems placed by China, whose commitments involved no risks, with India’s contracts for sophisticated hi-tech systems helped Russian industries and companies that were awarded the orders in order to survive and develop. In this respect, Chinese and Indian contracts were a good blend for Russia: Chinese orders ensured extensive series production for Russian manufacturers, while Indian orders stimulated intensive R&D for new sophisticated systems.

After 2005, however, the situation changed dramatically. By that time China had achieved the initial saturation of its market, whose demand was increasingly met by the Chinese defense industry. India, which had acquired the initial experience of operating its weapon systems and which had had Russia liquidate technical shortcomings characteristic of the first trial armaments, placed new and very large orders. In addition to 172 Su-30MKI fighters, contracted in 1996 and 2000, New Delhi ordered 58 more. The Indian Navy ordered three more Talwar-class frigates in addition to the three it had purchased in 2003-2004. Rumor has it that the Navy plans to buy a third batch of Russian-built frigates.

Nevertheless, Russia had always realized that exports ensured by the demand of only two clients could not be stable. It was clear that the growth of the Chinese defense industry would inevitably bring about a reduction or even the termination of imports from Russia. The Indian market had always been open, and British, German, French and Swedish manufacturers had always been present there along with Soviet companies. In the early 1990s, the Indian military, shocked by the breakup of the Soviet Union, began a consistent policy to diversify sources of armaments. France and especially Israel have markedly increased their presence on the Indian arms market over the last 15 years. At the turn of the century, the United States also began to display a growing interest in it.

Russia took consistent efforts to diversify its clients. These efforts produced the first serious results in 2003 when Russia signed contracts with three Southeast Asian countries – Vietnam, Malaysia and Indonesia.

Vietnam ordered S-300PMU-1 surface-to-air missile systems, four Su-30MK2 fighters, and Project 12412 missile boats. Malaysia signed a $900 million contract for the purchase of 18 Su-30MKM fighters, while Indonesia purchased four Su-27/30 fighters and ten helicopters, worth a total $200 million. The orders placed by the three countries with Russia in that year reached a total of about $2 billion. The transactions caused some commentators to talk about the formation in Southeast Asia of a third pole of consumption for Russian weapons and military equipment, in addition to China and India.

However, a real breakthrough in diversifying the market for Russian arms exports came in 2006, when Russia concluded large package transactions with Algeria ($7.5 billion) and Venezuela ($3 billion). Coupled with contracts signed with Middle Eastern countries, the Algerian and Venezuelan packages ensured the formation of a balanced portfolio of contractual obligations. This was one of Russia’s most important achievements in the field of military-technical cooperation, which is comparable to, if not more important than, a quantitative growth of exports.


GROWTH FACTORS

What factors are behind the growth in Russian exports and their diversification? Russia’s broader presence on the global arms market was caused by many military-political, economic and image factors. These include, above all, upsurges of military-political tensions in the world in 1999 and 2003, the fast economic, military and technological growth of China and India, favorable trends on the oil market, which ensured a high paying capacity of countries in the Middle East and Northern Africa, and finally, the political and economic strengthening of Russia itself.

In the period from 2000 to 2005, before the contracts with Algeria and Venezuela, Russian exports grew due to Chinese and Indian demand, which increased together with the rapid economic and technological development of these booming great powers. Both China and India are world leaders in economic growth rates, which helps them to allocate more and more resources for the modernization of their Armed Forces, above all the Air Force. Both nations are engaged in large-scale programs for the purchase and licensed production of Su-30MK combat aircraft. Apart from purchasing large batches of the fighters, they have launched expensive projects for creating basically new industries capable of making advanced fourth-generation fighter aircraft.

Both countries do not conceal their regional and potentially global ambitions. India is seeking to become a dominating military power in the Indian Ocean region “from Cape Town to Sidney.” This strategic goal, together with other factors, is behind the purchases of foreign, including Russian, naval armaments.

The contract with Russia for the retrofitting and modernization of the Russian Admiral Gorshkov aircraft carrier has a key role in these plans. After the contract’s implementation, India will become the world’s fourth country (after the U.S., France and Russia) to have aircraft carriers accommodating horizontal take-off and landing deck aircraft. In addition, the need to create an escort group is stimulating the Indian Navy to import new class frigates (Talwar), six of which have been ordered from Russia.

China, which does not have a strong naval tradition like India, has not started yet – at least officially – to create an aircraft carrier fleet of its own. Nevertheless, China’s force projection potential has markedly increased due to purchases from Russia. The Navy of the Chinese People’s Liberation Army has purchased Russian shipborne anti-aircraft systems, which have enabled the Chinese Navy to operate beyond the range of shore-based fighter aviation. Thus, for the first time in its history, the PLA Navy is capable of operating more than 500 to 700 kilometers from shore.

At the same time, there were also short-term factors behind the active purchasing efforts by China and India in the first few years of the new century.

India’s imports were particularly motivated by its armed conflict with Pakistan in the district of Kargil in 1999. New Delhi focused on contracts for Ground Forces armaments. In particular, it bought 40 Mi-17 transport/assault helicopters and hundreds of T-90S main battle tanks. After the Kargil fighting, India also decided to modernize its frontline aviation.

China’s military-technical policy was apparently influenced by the NATO bombings of Yugoslavia in 1999, after which Beijing increased its imports of air defense systems. Unlike other defense fields where Chinese purchases were marked by a conservative approach to technical risks, the PLA was the primary customer of the latest S-300PMU-2 anti-aircraft missile system. In general, Beijing focused its attention on Ground Forces armaments after 1999.

The next stage in the growth of Russian exports, which included the Algerian and Venezuelan package contracts and the purchases of Russian military equipment by Middle East countries, was caused by other factors. These included a sharp deterioration of the military-political situation in the Middle East following the U.S. operation in Iraq in 2003, and U.S. pressure on Iran and Syria. Washington’s policy of force triggered a growth of anti-American sentiment in the world, including a leftward shift in the policies of Latin American countries, above all Venezuela. These changes also contributed to the growth in demand for Russian arms.

This eagerness to buy Russian armaments was also stimulated by soaring oil prices which made it possible for Algeria, Venezuela, Iran and – indirectly – Syria to make large purchases. This factor reflects a general trend in global history, namely a positive correlation between high oil prices and a growth in demand for armaments on the global market. So in this case Russia was simply just as lucky as other exporter countries.

In Algeria and Syria, Russia has used a new and rather efficient instrument to promote its military hardware. The matter at hand is the conversion of those countries’ debts to the former Soviet Union into purchases of Russian machine-building products, including military hardware. This solution has proved particularly effective with Algeria, whose resource base differs greatly from Russia’s. In exchange for its $4.7 billion debt, Algeria has endorsed contracts to the tune of $7.5 billion.

Finally, the improvement of Russia’s financial standing has enabled Rosoboronexport to use the practice – standard for other exporters – of preferential crediting of weapons importers. For example, Moscow and Jakarta concluded an agreement in 2007 to give Indonesia a $1 billion target-specific loan for the purchase of Russian armaments. Indonesia plans to use the loan to modernize its Air Force. Immediately after receiving the loan, Indonesia placed an order with Russia for six Su-30 fighters in addition to the four such aircraft it had purchased in 2003.

The signing of the Algerian and Venezuelan contracts meant more than just a sharp quantitative growth of Russian exports and an expansion to new markets; it signaled a radical change of the quality of Russia’s military-technical cooperation. The package nature of these contracts and their unprecedented (for the Russian defense industry) volume show that Russia has switched over from sales of individual types of armaments to offers of package solutions to the military security issues of importer countries, from supplies of armaments as commercial goods to military security offers as political goods. In this regard, the growth of Russian supplies, their differentiation, and particularly the expansion of export geography mark changes in Russia’s positions in the world.

Some importers have begun to view Russia’s integral might as, at least, equal to that of France or Britain. Unlike China, for which Russia was a non-alternative source of armaments for a long time, Algeria and Venezuela can use the services of European exporters, which can meet a large part of their requirements.

It is only natural that Russia’s success has worried its competitors and made their competition with Moscow still keener. In particular, they have tried to actively counter the implementation of the Algerian package.

Paradoxically, some objective factors must work against Russian exports, yet the latter keep growing from year to year. These factors include the exhaustion of what the Soviet Union had achieved in technology, the saturation of the Chinese market, and stepped up competition on the Indian market. This paradox means that Russia’s achievements in arms sales since 2005 are due to the country’s political and economic consolidation and its return to the ranks of great powers – at least, as regards its image.

GROWTH PROBLEMS

The signing of the Algerian and Venezuelan packages in 2006 and the placement of the Indian orders for fighter aircraft and battle tanks in 2007 have brought about a basically new phenomenon in post-Soviet Russia – some defense industries are operating at full capacity. Whereas in the 1990s the defense sector struggled hard to find orders, it now faces the challenge of their efficient and timely fulfillment. In a way, Russia’s defense industry is now faced with a crisis of transition from occasional contracts and working below capacity to large-scale production. In addition, the industry is experiencing a shortage of manpower and state-of-the-art production assets, which adds to difficulties with fulfilling contracts.

Manufacturers that have encountered this problem include, for example, the Irkut Corporation, which builds Su-30MK fighters, Almaz-Antey (a developer and producer of many air defense systems, in particular the S-300PMU long-range surface-to-air missile system), and the Tula-based KBP Instrument Design Bureau. At present, these companies are fully engaged with orders until 2012. The reason for these changes is not only the high demand for Russian armaments on the global market, but also the compression of the country’s production capabilities. Moreover, the end producers of armaments and military equipment are operating well, as a rule, and are capable of meeting the growing demand.

The problems become aggravated at lower levels of cooperation where the situation is much more difficult. Here are a couple of examples.

The demand for Mi-17 helicopters in the last few years has reached 150 machines a year. Three helicopter plants in Russia can supply 120 to 150 machines, but the production of reduction gear does not exceed 80 to 100 sets, thus impeding the fulfillment of export contracts and putting into doubt the industry’s ability to meet the fast-growing demand from Russian clients. Similarly, the production of Su-30MK fighters is also limited – not so much by the capacity of aircraft plants in Irkutsk and Komsomolsk-on-Amur, as by the capacity of companies producing components (e.g. ejection seats).

Full operating capacity for many years in advance paradoxically has a negative side to it. Previously, one of Russia’s advantages on the arms market was its ability to supply products within a short period of time after a contract was signed, or at least when no large-scale R&D was required. While buyers of Western, especially European, armaments sometimes had to wait for the ordered equipment for years, the Russian defense industry was often able to start delivering products within months after a contract was signed. Now, potential buyers of Russian armaments that are in particular demand – first of all air defense systems – also have to wait several years for their turn. The problem will become even more aggravated when and if the Russian Army, too, decides to place large-scale orders for new weapons systems. Then the issue of large-scale investment in the expansion of production will inevitably rise.

In the last 18 to 24 months, export contractors have been faced with one more problem, namely the fall of the U.S. dollar, since a majority of contracts are denominated in dollars. Coupled with the fast growth of production costs, wages, and energy and utility prices, this factor sharply reduces export profitability. Moreover, contracts, especially those concluded before 2005, increasingly often result in negative profitability. There have already been precedents when Russian companies have had to admit that they are unable to fulfill some contracts or entered into unpleasant negotiations with buyers on a revision of contractual terms.

All these factors show that Russia’s present capabilities in promoting its armaments on the global market exceed the defense industry’s ability to fulfill current and potential contracts. The further growth of military exports is mainly limited by production capacity. The technological modernization of the Russian defense sector and a marked improvement in the quality of its management must be a top priority task for the country in the next few years.

Last updated 15 june 2008, 13:42

} Page 1 of 5